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Morningstar | Soul Pattinson Sees Solid Earnings Growth in Fiscal 2019 from Coal and Property

Soul Pattinson’s profit is like a duck swimming, smooth on the surface but a lot of activity below the surface. First-half fiscal 2019 net profit after tax, or NPAT, of AUD 179 million included some meaningful losses from associate impairments and gains from asset sales. Adjusted NPAT tax rose 12% to AUD 187 million. At the segment level, the key drivers of the increase were New Hope and Brickworks. Soul Pattinson’s share of New Hope’s adjusted profit was up 27% to AUD 82 million, driven by a 22% jump in the realised coal price to AUD 140 per tonne. In Australian dollar terms, this eclipsed the prior 2011 China boom highs. New Hope increased its own profit by 38%, but Soul Pattinson’s share of that rise was less after reducing its interest in New Hope from 60% to 50% in November 2018.

We maintain our AUD 17 per share sum of the fair value estimate for no-moat Soul Pattinson. The overvaluation reflects Soul Pattinson’s market premium relative to the sum of the parts of the underlying assets. The premium price is supported by the firm’s strong track record, impressive historical returns and consistent dividend growth, but we struggle to support the assumption that above-average returns will continue. Historical returns rest on two big winners: New Hope and TPG Telecom and replication of those will be difficult.

Soul Pattinson’s share of adjusted profit from Brickworks increased 74% to AUD 42 million. Property was the main contributor to the improvement at Brickworks, the segment benefiting materially from revaluations and land sales. Building products has started to decline with pressure on margins, in line with the softening market. Brickworks also benefited from the sale of Soul Pattinson shares, which yielded that company a pretax profit of AUD 110 million. Due to the quirk of the cross-shareholding, Soul Pattinson effectively sold shares in itself at a premium, which we pointed out in our last update in January.

While the outlook for fiscal 2019 earnings is relatively strong, we think future earnings are likely to decline. Our fiscal 2019 forecast of AUD 1.51 per share is underpinned by high coal prices. While growing output from Bengalla will be a positive for New Hope, lower forecast coal prices are the key driver of an expected softer contribution. New Hope contributed 44% of Soul Pattinson’s adjusted net profit in the first half. We forecast Soul Pattinson group earnings to decline to AUD 1.10 per share by fiscal 2023.

The dividend payout ratio should rise over time from a relatively conservative 43% in fiscal 2019. Soul Pattinson has scope to continue to raise dividends despite likely lower earnings in future, given the low starting payout ratio. But we expect the annual growth rate in dividends to remain modest at 3% to 4%. Given the low current payout ratio, there is a chance Soul Pattinson could increase the rate at which it grows the dividend. However, management is rightly proud of its unbroken track record of dividend increases since 2000 and erring on the side of conservatism seems most likely. We continue to expect the dividend to tick up at the rate of AUD 0.02 per share annually.

The implied fiscal 2019 yield of 2% fully franked, based on the current price of around AUD 29 per share, is low given expected modest dividend growth. Our fair value estimate implies a yield of 3.5%.

Adjusted earnings in the first half of fiscal 2019 increased 12% to AUD 0.78 per share. The interim dividend ticked up by AUD 0.01 to AUD 0.24 per share, in line with our expectations for steady growth. The balance sheet remains very strong with modest net debt of AUD 130 million. This reflected the drawdown of debt at 50% owned New Hope, for the acquisition of 30% of Bengalla from Wesfarmers.

Overall, the balance sheet is likely to continue to remain conservative. Soul Pattinson values financial flexibility to be able to invest when others are fearful. Turnover in the portfolio of investments remains low but has risen moderately in the last couple of years. We think it’s likely the portfolio will continue to be slowly shaped into areas outside coal and telecommunications. The investment in financial services is an example.