Dewhurst – earnings and owner earnings

PUBLISHED: 26 Jul 2017 @ 11:37 | Comments (0) |

The collection of Dewhurst (LSE:DWHA) businesses grew slowly over decades. Sometimes the pace of progress seems disturbingly slow, but you have to be impressed with this statistic: in 33 out of the last 34 years the dividend has grown by 5% or more.

And the latest interim dividend has been raised 17% from 3p to 3.5p, indicating another year of dividend growth above 5%.

Also, dividends are well covered by earnings, which are generally 4 to 5 times the dividend. Given this and a balance sheet with £16m of cash and no debt we might expect the pattern to continue.

Dividends and reported earnings per share have doubled over thirteen years. But the reported earnings numbers are not as impressive as the dividend numbers, with most of the earnings growth occurring some time ago. Significantly, 2016 profits are much the same as 2010’s. Admittedly, there has been a rise in the latest six months – see table.

To end of September	2010	2011	2012	2013	2014	2015	2016	1^st half 2017 times 2
Turnover, £m	37.0	41.5	51.6	43.7	46.6	45.9	47.2	52.1
Reported earnings, p	40.97	30.67	40.24	8.85	43.87	50.21	40.75	51.6
Dividend, p	6.36	6.69	7.02 (plus 5p special)	8.00	9.00	10p (plus special 3p)	11.00	Interim up 0.5p (17%) to 3.5p

Half year numbers:

To March	2012 first half	2013 first half	2014 first half	2015 first half	2016 first half	2017 first half
Turnover, £m	26.0	21.6	23.0	22.8	21.3	26.1
Reported earnings, p	24.16	14.36	17.82	18.63	13.1	25.8
Dividend, p	2.34	2.34	2.8	3	3	3.5

Dividend yield 11.5p/480p = 2.4%

It is difficult to make a case for optimism that earnings per share will rise above the range of 40p to 50p given the pattern of water treading over the last few years.

On a 40p EPS assumption the “A” shares are on a price earnings ratio of 480p/40p = 12, giving an earnings yield of 8.33%.

On a 50p EPS assumption the “A” shares are on a price earnings ratio of 480p/50p = 9.6, giving an earnings yield of 10.4%.

Thus, on the measures of conventional earnings and dividend yield with a 5% growth pattern, the shares are not highly priced, but they are not the bargain they were in 2014.

A more appropriate method of valuation is owner earnings, which leads to an intrinsic value estimation.

Owner earnings analysis

With owner earnings we are trying to obtain the earnings that would be left for shareholders to take out of the business after the managers’ use of cash generated to pay for items of expenditure to maintain the strength of the economic franchise (e.g. additional capital items, additional working capital, marketing spend, R&D and staff training) and to maintain unit volume and to invest in all value-generating projects available.

Depending on the circumstances the owner earnings figure may be the same for every future year or on a steadily rising (or falling) trend.

Naturally, owner earnings are impossible to obtain with any degree of precision because many of the input numbers are merely educated guesses about the future. Despite this imprecision it remains the most important method for thinking through valuations. It is Warren Buffett’s main method.

Owner earnings analysis is about future cash available for shareholders. But the only evidence we have available is past data. We start with that, and then use judgement on whether to simply project forward the past pattern or modify the previous trend for future orientated thinking.

In the following we use what the company actually invested in new working capital items and in new fixed capital items, and what they spent on marketing, R&D and staff training etc. already deducted when drawing up profit numbers.

What the analysis really requires is the amount necessary to maintain the quality of the economic franchise, unit volume and invest in value generating projects. To start with we make the bold assumption that what was spent by the managers was also the necessary amount.

When we move to forward-looking analysis to value the firm we need to make another bold assumption on the real amount needed to invest in new WC, fixed capital items, etc., in the future. The historical analysis helps us make that judgment.

£m YEAR	2009	2010	2011	2012	2013
Profit after interest and tax deduction	3.27	3.50	2.90	3.75	1.30
Add back non-cash items such as depreciation, goodwill and other amortisation	0.58	0.70	1.31	0.88	2.50
Totals to: Amount available for distribution to shareholders before considering the need to spend on fixed capital items and working capital items to maintain the company’s economic franchise, unit volume and invest in value generating projects.	3.85	4.20	4.21	4.63	3.80
Deduct fixed capital and working capital investment. (The figures shown are actual expenditures and are therefore a rough proxy for the ‘needed’ expenditures to maintain franchise, etc.)	-0.4	-0.64	-0.48	-1.50	-0.60
Owner earnings	3.45	3.56	3.73	3.13	3.20

£m YEAR	2014	2015	2016	1^st half 2017 times 2
Profit after interest and tax deduction (excluding gains on property)	3.95	4.11	3.51	4.37
Add back non-cash items such as depreciation, goodwill and other amortisation	1.19	0.99	0.91	0.81
Totals to: Amount available for distribution to shareholders before considering the need to spend on fixed capital items and working capital items to maintain the company’s economic franchise, unit volume and invest in value generating projects.	5.14	5.10	4.42	5.18

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