Since IPO in 2014, GYM
is a public company traded in LSE with a current market capitalization about
₤269 million. Founded in 2007 by the current CEO John Treharne, the company provides
147 low cost gyms across the UK and is considered as a high growth firm by many
investors (as well as by me).
If GYM is in a growth stage
of its life cycle, as we see in the figure above, I would not expect neither dividends nor buyback stocks because it is highly probably that the company need the cash
to great investment opportunities, but GYM don’t follow this expectation: the
firm initiated a token dividend in 2016 of ₤0.32 million, increasing it to
₤1.35 million in 2017 and all seems that it´s going to increase again in 2018
as we see in the last TTM ₤1.54 million (we don´t have yet the results of
2018).
Is GYM right about
this dividend policy? The acid test to answer this question is estimation of how
much cash a firm can afford to return to its stockholders (or the Free Cash
Flow to Equity).
In order to come to a
conclusion, I will begin with the P&L statements reported by the company in
the last four-five years, including the last TTM:
The next step is the adjustment
and normalization of this statement, and several adjustments are needed:
- One-time charge from other income in year 2015, is eliminated.
- Amortizable Intangibles is non tax deductible item and should be added back to the revenues. Only tax deductible depreciation and amortization counts.
- Our tax should be in accordance with a normalized effective tax rate
With all these pieces,
we come to our Net Income adjusted and normalized:
My next step is estimations
of incremental in non-cash working capital, difference between debt issued and
debt repaid, and computation of capital expenditures:
- The Change in non-cash working capital year by year is
described as follow:
- For the difference between debt issued and debt
repaid, I will take a proxy through the incremental book value of debt reported
in the balance sheet
- In estimating capital expenditure I will not distinguish between internal investment (maintenance capex) and external investment (growth capex). The capital expenditure of a GYM, therefore, need to include all purchases, business combination, etc, reported as cash flow from investing activities.
Finally, with all
these pieces attached, the result is as follow:
As we see in the table
above, the Free Cash Flow to Equity is negative and some years (e.g. 2015) very
negative. Thus, GYM don´t have capacity to return cash to stockholders and
should stop what it is doing.
But, why GYM pay
dividens, as it should not do it? a possible answer could be that high growth
firms are sometimes advised by the banker to initiate dividends because it
increases the potential stockholder base for the company and, by extension, the
stock price .. and that´s true, for example look at pension funds, pension
funds cannot buy stocks that do not pay dividends. Thus, the banker makes the
suggestion to pay a token dividend, a small dividend that increase the demand
of the stock and push up stock prices. It sounds awful good, but that is the
way the problems get started. When the stockholders receive for the first time
dividends, what investors expect the next year?, of course more dividends!, the
firm can´t blame investors.
In
summary if the firm cannot pay dividends, the firm should not get start this
process, it seems easy to say, but hard to stick with this rule.
