As I rapidly approach retirement, my financial plans are crystalizing and I couldn’t help be drawn into investigating Spark’s attractive dividend yield of 7.891% as published on the NZX website. Such a yield opens up several options around my strategy such as using it to reduce the reliance of dividend income from other stocks so I can have a greater investment in reliable low yield stocks or high growth low yield stocks.
I’ve never been attracted to the idea of investing in Spark as they act like a monopoly (high prices, not agile for a number of their divisions, and low levels of growth), but with a yield of nearly 8%, I would get my money back on the investment even if Spark became permanently unprofitable after 13 years (100[% of investment] / 8[% annual ROI] = 12.5 years, not accounting for inflation). While Spark certainly has more competition coming in its future, I don’t foresee this whale being beached-as within the next few decades.
The first thing I noticed about Spark (when I went to confirm the dividend yield calculation on the NZX website and check the share price) is that their share price is in a downwards pattern. This (combined with a high dividend) gave me concern that this could be a dividend trap or signs of serious headwinds, which gave me a place to start my research.
Upon looking at the H1 FY21 financials, it looks like there was an 11.4% drop in income compared to the H1 FY20. According to the financials released, most of this drop was in their Voice (mobile is listed separately) and Broadband products. In Spark’s Investor Presentation however, they state that the drop is due to decline in mobile market due to border closures and loss of roaming revenues, and fewer people migrating to NZ which affected the broadband and prepay markets.
Personally I can’t see how border closures would cause people to use less broadband when everyone had more reliance (and spending) on work from home services over the period. Perhaps fewer people working from home since lockdowns finished could be an explanation for this?
I also can’t see how lack of population growth would cause a reduction of broadband; it should be static, if anything. This makes me wonder if Spark are making excuses rather than offering reasons for the change.
I do have a slight concern that people could be wising up to cheaper alternatives offered by competitors, such as cheaper broadband & mobile rates, which might cause people to cancel their packaged services with Spark.
Nevertheless, for the purpose of this initial research I will assume that the numbers are solid and what we’re seeing is just a drop back to normal levels post COVID lockdown.
Let’s assume that the last H1 is indicative and proportional to H2, and relatively little growth will follow (nil). In fact, we can assume that following years are likely to be equal to FY19. From this, I estimate a long term average NPAT of $400m per year, growing in line with inflation.
As I’m happy with an ROI of 5% at the moment (though realistically I would probably want more to mitigate the risk that unpaid earnings might find their way into the retained earnings part of the balance sheet), a PE of about 20 is a sufficient upper limit on which to base a value investment in Spark. This would give Spark an upper market cap of $8bn which is a share price of $4.28.
However, as mentioned earlier, I would really need more than 5% ROI, so I would probably make a deduction from that price relative to the dividend payout ratio to find the maximum price I’d be willing to pay. Assuming Spark have an 80% payout ratio on their dividends vs earnings, this would put the suggested trading range of Spark shares between $3.42 and $4.28. Given that the market seems to historically agree with this back-of-the-beer-mat quick analysis, I’m not going to look too much further into the stock until it drops down to more sensible levels and enters the range in which I’d consider buying.
Before I wrap up so I can go biking, I just wanted to leave a note that it’s possibly worth investigating if Spark are a dividend trap stock, as they are offering a dividend above 5% of the share price, and the share price is trading at only a little over a PE of 20. In other words, without dipping into treasury reserves or debt, I can’t see how they can afford to maintain the dividend that they are paying – though this needs a proper analysis to confirm this, I see Simply Wall St have similar concerns in their analysis that the “…dividend is not well covered by earnings…” and Spark has “…a high level of debt…”. It’s always good to double check your own analysis against someone else’s research after you’re done.
Summary: Revisit Spark shares as a potential investment once they fall below $4.28, check debt levels and whether the dividend is sustainable.