I have to be honest, I hadn't really thought about the importance of EBIT (Earnings Before Interest & Tax) as a measure of the financial success of a growing business. It is only when I looked carefully at the Cellestis 2011 H1 results that I realized why this gives us a picture of what is happening (financially) with our company.
Tax is, to all intents and purposes, something that is totally outside the control of the Company. The tax rate and requirements can change from year to year. For that reason, if you want to measure how well the Company is being run in making profits it is sensible to exclude tax from the figures that you judge the Company by. After all, we shouldn't judge the Company by something that they can't control. As it happens, in Cellestis' particular case, at this particular time, there is a huge reason to exclude tax (ie use EBIT as a measure). In the past, Cellestis has not paid income tax at the full rate - most of the reason for this has been the consumption of tax credits that were accumulated during the early, development, years of the Company. It seems that we have now used all of those tax credits and are paying tax at close to the full rate.
If we look at the last four half years (2009 H2 -> 2011 H1) then our effective income tax rate has been 17%, 17.6%, 20% and 27%. So, in the last half year we have paid 27% income tax which is pretty much full Company tax rate. What this means is that if we used PAT (Profit After Tax) to compare successive period profit growth we would see a distorted figure that has been dampened by the increasing tax rate. (The impact of this will probably end now as we would expect the tax rate to flatten out. In other words, in the future, the growth rate of EBIT and PAT will probably converge.)
So, excuse me for getting excited, but I think that a 46% growth in earnings (cf pcp) is a spectacular result. Particularly on a 24% increase in Revenue. A 30% increase in Profit After Tax, even forgetting that tax dampening effect above, is something to shout about.
If they can do this when the Forex winds are working against them, just imagine how things might look when those winds die down (as they now have) or swing through 180 degrees (as they most certainly will at some point.)
Or have the results been distorted until now since they have not been paying a true tax rate? EBIT is not the true measure of a company's performance simply because shareholders do not partake in EBIT. You cannot pay dividends out of EBIT, unless you borrow to pay dividends and of course that is not sustainable.
ReplyDeleteG'day Fundamental Analyst,
ReplyDeleteThanks for your comment.
You are correct about the "distortion", when looking at ABSOLUTE results. However, my comments re EBIT above are aimed at pointing out the success of the Company in INCREASING profits.
If we want to compare a previous period result with a current period result then we need to compare apples with apples. That is, we need to remove the effect of the tax because, as you say, in the past the Company has not paid tax at the full Company rate.
Or, looking at it in your terms, we are removing the "distortion" so that we have a clear view.
I don't understand the point that you are trying to make when you say "You cannot pay dividends out of EBIT, unless you borrow to pay dividends".
Forrest,
ReplyDeleteI accept that your comparison of EBIT is a better like for like comparison at the operational level. However, even looking at EBIT or PBT, 1H11 PBT is more than 10% down on 2H10. Some of that can be explained by exchange rate movements but at best you have flat EBIT over the last 12 months. Is the there some seasonality in the business?
The point about dividends is an important one. As a shareholder you have a share in the equity of the business. The Equity of the business is increased by NPAT minus distributions in the form of dividends plus any capital raisings minus buybacks.
In short, NPAT is what counts in the pocket of shareholders not EBIT. Imagine a company that paid 100% of EBIT out as dividends. They'd soon have to raise capital or borrow money to cover the dividend payment. In fact you don't have to imagine, this is exactly what Telstra was doing a few years ago and it is what some of the large North American oil companies are doing today.
Of course CST is not in that position, they are still reinvesting most of their profits back in their business and generating high rates of return which is positive and indicates above average rates of growth. My point here is just to illustrate that NPAT is what matters for shareholders.
G'day FA (hope you don't mind the abbreviation),
ReplyDelete"Is the there some seasonality in the business?"
Sure is. Just check out the data sheets.
"As a shareholder you have a share in the equity of the business. The Equity of the business is increased by NPAT minus distributions in the form of dividends plus any capital raisings minus buybacks."
Of course that is true.
"In short, NPAT is what counts in the pocket of shareholders not EBIT."
True. In an absolute sense. However, as you agreed above, I am using EBIT validly to examine the company growth. Once the tax rate stabilises then we can happily use either EBIT or NPAT to perform a similar exercise.
Nobody is trying to hide anything, deceive anybody or gild the lily. NPAT is clearly shown in the accounts and is used to derive the EPS.
Given the seasonality of the business what are you forecasting for FY11 NPAT? I'm working off $11m for the full year. Since you were forecasting a tax rate of 20% for the full year and NPAT of $15.7m, I assume you will be downgrading your numbers?
ReplyDeleteG'day FA,
ReplyDeleteI don't forecast. (at least not publicly).
I presume that the figures you are quoting have been taken from my projection spreadsheet. You should be aware of the disclaimer that comes with that spreadsheet.
"This is a tool, not my own prediction of the future. The current figures that are in the spreadsheet are purely for example purposes. You should definitely play with your own figures."
I would think that you should feel quite comfortable with your $11m NPAT figure. That figure also happens to be pretty much in line with the recently released Shaw StockBroking estimate.