Dividends, a new idea (857.HK), and updates (EQH, SRG)
Dividends, a new idea (857.HK), and updates (EQH, SRG)
Programming note below. Might move to paid at some point
Old Rope will continue to publish markets-related securities commentary at least once a month. Unfortunately, my day job has cut down the publishing frequency I was at earlier in the summer. Additionally, rather than spamming your inboxes, I’ve taken to posting smaller, quicker updates to my twitter account. The account is locked but feel free to request and continue conversations there. I have positions in all the stocks mentioned today as of this writing. That could change at any minute! This is not investment advice as always etc. etc.
857 HK
Oil + China- what’s not to love? Buffett once made money in this stock. I have kept it on the watchlist for a while. He walked through his folksy thesis pretty openly and candidly back in 2003. He’d never seen a company dictate in their annual report that they’ll pay out 45% of their profits as dividends (now tuned back to 30% of profits). So he got a 15% cash yield for an oil major at 3x earnings. PetroChina eventually traded to parity (on EV/EBITDA) as both Exxon and Chevron! All while collecting some large dividend checks along the way.
A brief tangent on dividends:
Modigliani-Miller truthers would tell you that neither capital structure nor dividends matter in moving the multiple of a business. John Malone would tell you that dividends are just another excuse for the government to tax you. Buffett once said dividend policies need to be laid out pretty well and suited to the business: if I’m a Chinese food restaurant that starts serving pizza, my customers are going to get mad. John D. Rockefeller once said "The only thing that gives me pleasure is to see my dividend coming in."
Ultimately the specious “value of dividends” comes from the optionality they grant individual investors. You could posit that regular dividends add value to a business because it attracts a given shareholder base, but doing dividends for the sake of multiple expansion is bad management. Buffett himself sweeps all the retained earnings from his subsidiary companies up to the holdco level to provide himself with the optionality to do deals, buyback stock, paydown debt, or move money from one subsidiary to the other. Having the cash on hand as an individual investor means you can do roughly the same without the friction of selling shares; it would stink if Buffett had to go out and sell 3% of BNSF in the private market every time he wanted to take cash out and invest elsewhere.
Depending on the cyclicality of the business, my view is that there two correct ways to go about dividends:
1.) Variable dividends that reflect the current strength of the business. Setting a fixed payout ratio is the perfect avenue to do this and sets investor expectations. Good years=good money, bad years=bad money. This adds some “automatic stabilizers” to the business as well- no need to borrow money and hollow out the franchise in the name of “maintaining the dividend”.
2.) Sporadic variable special dividends that signal boom times. Transdigm and Costco do great jobs of this. Show investors that yes, things are good, but take your money back because there’s only so much we can do with it. Also tax-advantaged in some cases! Buybacks or accelerated share repurchases have a timing and pricing component that can’t be overlooked. Why not just let investors decide if they want more stock at the company at the prevailing market price? Most of them are non-taxable anyway!
Some less good ways of doing dividends:
3.) Annual dividends for staples or staples-like businesses that attempt to show a smoothed earnings path for investors. This is fine, especially for a company like Nestle, where there’s virtually no earnings volatility and the business sort of just marches on year-to-year at GDP+ growth. I don’t necessarily see the need to increase it *every* year, especially if the business is truly long-term oriented, but it creates an impressive track record to look back on. I suppose if you don’t have to break the bank borrowing to do it every year it creates good optics, but if I were running it I’d simply use the fixed payout percentage model, regardless if it creates dividend volatility.
4.) Regular quarterly dividends with annual jumps. These tend to have a bad track record of hollowing out businesses that otherwise need capital investment (see: GE, IBM, AT&T). Not a huge fan. But I understand the appeal of hearing management teams tell you that every quarter is better than last years and its all rosy and good.
Back to PetroChina: I’ve been obsessed with energy businesses since July of this year (I talked about Noble (symbol: NE) in last month’s letter which I still like). Margin compression across the equity markets seems like a foregone conclusion: higher interest expense, labor expense, input cost, and the need for potential need for margin-dilutive acquisitions to near-shore or re-shore supply chains. What’s funny is that I believe that energy might have the best margin visibility 5 years out than most other businesses I look at. Integrated majors like PetroChina that control their supply chain really aren’t going to see much margin volatility- in fact, for being in a cyclical business, all three of the majors mentioned previously had a range of 15% to -15% operating margin over a 23 year period:
Almost all aspects of PetroChina’s business are centrally controlled by the CCP- diesel prices are set nationally Taxes paid by the company are whatever the party wants them to be. But you’re aligned to a degree- the CNPC relies on the dividend from PetroChina, and thus the party *sort of*, optically, relies on a functioning market for the shares (well, the <10% of shares that float). The government takes their policies very seriously! Excerpt from 2021’s annual report:
To safeguard the interests of vast shareholders, it is provided by the Company in the Articles of Association of PetroChina Company Limited (“Articles of Association”) that in the premise that the net profit attributable to owners of the Company and the accumulated undistributed profit for the year are positive, and the Company’s cash flow can satisfy the normal operation and sustainable development of the Company, the amount of cash dividend to be distributed shall not be less than 30% of the net profit attributable to owners of the Company realised in the relevant year. The Company distributes dividends twice a year, with the final dividend to be determined by the general meeting by ordinary resolution and the interim dividend determined by the Board of Directors as authorised by the general meeting by way of ordinary resolution. Since its listing, the Company has strictly complied with the Articles of Association and relevant regulatory requirements, and made decision on dividend distribution adopting the principle of returns to shareholders. The steady and active dividend distribution policy of the Company is welcomed by the shareholders. The independent directors of the Company have performed their duties faithfully and diligently, formed opinions on dividend distribution independently and objectively, and played a desirable role. The Company distributed 45%of its net profit attributable to owners of the Company as dividend.
As a minority holder you’re of course subject to nationalization or seizure or what have you. Most likely PetroChina will make some bizarre “investments” (read: bailouts) in certain assets in the property or banking sector in the next 18 months at the behest of the CCP. But I feel okay about being alongside the CCP on this one (DYODD/caveat emptor/I’m a generalist by trade/don’t invest anything you would be comfortable losing 100% of).
I would be a seller at the stock if it came to parity with the U.S. majors, but the company is not at peak earnings yet and we could see multiple expansion with margin expansion. The European oil majors are another interesting question but I would prefer the Chinese end market to the European one. I won’t lay out any specific scenarios or outcomes here; suffice to say there’s a nonzero chance the business is nationalized and public shares go to zero. But I believe more good things than bad things can happen to PetroChina shares in the next 18 months, especially at the current valuation.
EQH:
I wrote about EQH- Equitable Holdings, Inc.- almost exactly 1 quarter ago. At the highest level, the structured capital solutions business (“SCS”) is a higher margin, less capital intensive business than industry standard. If SaaS businesses “invest through the income statement” than EQH is currently investing through the AOCI account. General account investments are 96% investment grade bonds. It’s been one quarter, so much of the old investment thesis is still intact. I can’t take credit for the move one quarter in but the results have been nice- simply being in financials for the past 100 days has been a nice trade:
SRG:
On August 29th I published on Seritage, another name that has performed roughly in line with its index as of this writing (albeit with intermediate volatility caused by insider sales- I wouldn’t read much into this, it was a small portion of a massive stake). I see this as a classic workout situation where a liquidation is going to happen, and there’s a high enough probability of a good outcome that its worth seeing it play out for the next 18 months:
