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Building material manufacturer Brickworks holds ~40% equity in the investment company Washington H Soul Pattinson with the latter owning ~44% in equity in Brickworks, per the duo’s latest annual reports. This unusual set up between the pair is not only expected to take a toll on equity-accounted investments, but cash flows as well – as a result of potentially lower dividend payments to each other.
Recently, Washington H. Soul Pattinson and Company Limited (ASX:SOL) highlighted that its net profit to WHSP shareholders would be in the range $45 million-$55 million for the period ended 31 January 2020, as a result of the impact of non-regular items.
Source: SOL AGM Presentation
Excluding non-regular items, the net profit to WHSP shareholders is likely to be between $120-130 million. The regular profit is believed to reflect the subdued and potentially subdued income by the underlying investments.
Drag on WHSP’s cash earning prowess is being exhibited by softer earnings from its significant investments, including TPG, New Hope, Brickworks and Round Oak Minerals.
TPG Telecom (ASX:TPM) has posted a lower underlying profit for the half-year period and was down 29.8%. New Hope Corporation (ASX:NHC) has been under pressure due to falling coal prices, and its 1Q results were down 51%.
Brickworks’ earnings would reflect lower earnings from its substantial holding in WHSP. And, Round Oak Minerals has suffered headwinds due to falling copper and zinc prices.
Washington H Soul Pattinson & Co indicates that it is focused on:
Increasing capital value
WHSP reports that as on 31 January 2020, the gross value of portfolio was consistent with FY19 year-end. It was noted that the SOL was trading at a discount of 5.8% when compared to the gross value of the assets in the portfolio.
Although the gross value of the portfolio ‘was’ consistent, the downside in its listed portfolio has intensified in the recent past, especially since February. At the same time, it has created space for the investment firm to increase stakes in its favourable areas, given that there has been substantial correction from the recent highs.
Consistent and growing dividends
WHSP says it declares dividends from the cash flows received through its portfolio, and not through accounting earnings. In FY20, it expects that regular cash acquired by its portfolio would be consistent with the previous year, thereby enabling the investment to augment its propensity to pay growing interim and final dividend.
Capital management skills of the investment firm have been on point. In light of the capital management skills, one should note that WHSP’s tax paid for the year ended 31 July 2018 was reduced to zero for the tax year 2018 as a result of income tax paid by its portfolio holdings. Thus, WHSP received franking credits on these dividends.
At the same time, WHSP has grown its retained profits efficiently. Over the financial years FY17, FY18, and FY19, the investment holding company was carrying retained profits worth $2.6 billion, 2.71 billion and $3.3 billion, respectively at the end of financial years (i.e. 31 July).
Substantial portfolio moves
Since the start of the year, the investment firm has taken a 6.26% stake in 360 Capital REIT 360 (formerly known as Capital Total Return Fund), as a result of its holding in URB Investments, which was acquired by TOT. SOL has trimmed its stake in Bailador Technology Investments Limited (ASX:BTI) to 18.49% through sale of equity.
Brickworks Limited (ASX:BKW) has reported that its earnings would see an impact due to its holding in SOL. In its AGM, the company announced that the Brickworks Property would deliver strong results. However, the conditions supporting that assumption are deteriorating.
These conditions include no land sales in the first half of the ongoing financial year, and the sale of ten hectares at Oakdale East is expected to complete in 2H FY2020. Also, the company has recorded a lower rate of capital rate compression within Property Trust when compared to 1H2019.
In 1H FY2020, the expected earnings from its Building Products Australia are likely to be at a low point – well below the previous corresponding period. Some factors that had resulted in lower earnings includes high energy costs, low building activity, and in WA, the business had seen extensive plant shutdowns for maintenance and upgrade works as well as challenging conditions.
Nonetheless, the company noted its North American building products business would deliver higher contribution as previous corresponding period only included contributions from two months of ownership.
As a result of all above-mentioned developments, the company expects:
- A decrease of around 49% in statutory NPAT for the period 1H FY2020 as against in 1H2019.
- Underlying NPAT from continuing operations to be 37% lower when compared to 1H2019.
At the outset, the cross-holding of both companies in each other’s equity is not likely to impact EPS and cashflows of each other substantially, but it appears that:
BKW is expected to have impact on earnings due to lower reported profits by SOL, which would impact the company’s equity accounted profits by SOL in the books. At the same time, SOL appears to have headroom for dividends. Thus, it is possible that SOL dividends would not be lower, meaning there would be no impact on expected cash flows by SOL dividends.
SOL has a large portfolio of companies, and the diversification benefit is likely to reflect some offsetting gains. The investment company’s reported profits could be lower, as the companies in its portfolio are pegged to report lower statutory earnings. Nonetheless, SOL had retained earnings of $3.3 billion at the end of previous financial years.
On 13 March 2020 (at 03:16 PM AEDT), SOL stock was trading at $17.760, down by 1.003% from the previous close.
On 13 March 2020 (at 03:16 PM AEDT), BKW stock was trading at $14.640, down by 3.366% from the previous close.
