Stefan Bjarne

Jason, Thank you for a very interesting article. I have a couple of questions on SYD: 1. Why is the dividend consistently about 2 times the earnings? 2. Can that be sustainable? Regards: Stefan

James Rees

Thanks for the article Jason. I think you make some good points about the operational performance of SYD, but I don't understand why you're so dismissive of the link between Australian Bond-proxy equities and US interest rates. You seem to make a fundamental assumption that Aussie bond-proxies are not linked to US bond yields ( which seems incorrect to me) and then every subsequent assumption flows from this. US interest rates have a massive effect on other global interest rates through a whole range of mechanisms. Australian bond yields are more highly correlated with US bond yields than with Australian cash rates. It doesn't make sense to ignore that link with a sweeping statement that it's "fundamentally incorrect". Both SKI and SYD continue to be priced based on US 10 year bond yields. If you replaced the Australian 10 year bond yield with the US 10 year bond yield when comparing to SKI and SYD dividend yields, you'd still see a very high correlation over the last 5 years, but would not see the divergence of recent months. You note that the market is very good at marking to market in real time and this is a hallmark of an efficient market - but assume that the market has suddenly become inefficient when an entirely obvious alternative (that they are priced against US bonds) is available. You even reference SYDs balance sheet and the level of hedging debt is hedged, but don't make the link that it's hedged because a significant portion is raised in international bond markets. It seems clear to me that Aussie bond-proxies ARE price off US Bond Yields. So I'd be interested if you have any further detail to support the notion that they not.

Jason Teh

James, thanks for your comments. Correlation does not mean causation so please read my previous “Run for the hills” livewire post to understand how the US and Australian economies have diverged in recent years. And yes you are right, SYD and many other Australian companies access international bond markets. However, these interest rates are priced based on Aussie rates (plus a margin if they want to hedge). I’m sure it’s possible for Australian companies to finance their operations with Japanese debt or any other denomination but no company does this as this is a clear sign of mismanagement.

Jason Teh

Stefan, good question. SYD’s dividend is about 2x their accounting profits. But SYD does not set their dividend policy on accounting profits as there are large non-cash items (eg. depreciation). Since their restructure from Macquarie Airport in late 2013, SYD has paid 100% of their dividend from cash profits. Hence, SYD’s dividend is sustainable. Page 14 in SYD’s FY17 results presentation highlights the difference between accounting profits and cash profits. There are two follow-up questions you may ask: Why does capex not equal depreciation like normal companies? This question relates to the useful life of the asset. Infrastructure asset useful lives are very long versus industrial companies. If you divide SYD’s depreciation by the PPE, it implies that the useful life is around 20 years based on Australian accounting standards. However, SYD’s concession to operate the airport last to 2097. There is a mismatch between actual useful life (79-year concession life) and accounting useful life (about 20 years). For example, SYD depreciates their runways over 30 years even though the assets probably last 100 years. Sure, there will be maintenance capex but the bulk of the capex was made upfront and won’t be repeated. Given that SYD’s capex program over the last couple of years has been elevated and will continue to be in the next few years you should expect higher depreciation affecting their accounting profit. Why does SYD not retain some earnings like normal companies? This question relates to the capital structure of SYD. If SYD retains earnings their balance sheet will degear more aggressively. At a 100% payout ratio on cash profits, the balance sheet is already degearing but at a slower rate. SYD is a very unique business where they can have an elevated capex program funded from debt while their balance sheet is degearing at the same time.