Why a high payout rate isn’t always a red flag

Your recent article regarding Capital Power Corp. (CPX-T) said the dividend payout ratio is between 45% and 55%, but my discount broker and Globe Investor both say the ratio is between 195% and 205%. Am I missing something?

There are different ways to calculate a company’s payout ratio. Doing it the wrong way can make a dividend look unsustainable when it’s actually quite safe.

Capital Power is a prime example. In my column, I wrote that the power producer “expects its payout ratio to remain below its long-term target range of 45% to 55% AFFO – a conservative measure of cash flow. – giving the dividend sufficient protection”.

The key word to focus on here is AFFO, or Adjusted Operating Funds. AFFO represents net cash available from operating activities after adjusting for sustaining capital expenditures, preferred share dividends and other items. Essentially, AFFO measures the net cash available to fund business growth, repay debt, and pay dividends on common stock.

Based on this metric, Capital Power’s dividend is indeed very safe, which is why the company expects the dividend to continue growing at around 6% per year through 2025.

However, you wouldn’t know that based on the inflated dividend payout ratio published by discount brokers and financial websites. These payout ratios are usually calculated as a percentage of revenue, not AFFO. This can give a misleading picture, as the profits of power producers (and some other companies) are often depressed by accounting items such as depreciation that do not affect the company’s cash flow or capacity. to pay dividends.

The result is that some companies seem to be paying far more than they can afford. I often hear from readers who worry that a dividend cut is imminent based on a seemingly huge payout ratio, when in fact there is no risk.

As I’ve said many times, don’t trust payout ratios published by third-party websites. These are machine-generated numbers that lack important context. They may be correct in some cases, but very misleading in others. You better go straight to the company’s website and read its financial reports and investor presentations to learn more about its payout ratio and dividend sustainability.

I own US depository shares of GSK PLC (GSK-N). According to my June 30 statement, I held 2,700 GSK shares with an adjusted cost base (ABB) of US$40.34 and a market value of US$43.53. However, my July 31 statement shows that I only own 2,160 GSK shares with an ACB of US$50.42 and a market value of US$42.17, in addition to 2,700 new shares of Haleon PLC with a ABR of US$7.45 and a market value of US$7.03. Now I have a loss on paper for my GSK shares. What is happening here?

In July, British pharmaceutical company GSK PLC spun off its consumer healthcare business – maker of Advil, Sensodyne, Centrum, Tums and other brands – into a separate publicly listed company called Haleon PLC (HLN-N ). Investors received one Haleon share for each GSK share held.

All other things being equal, Haleon’s stock rotation would have caused GSK’s share price to drop significantly. To avoid this – and to make its share price and earnings per share roughly comparable to previous periods – GSK decided to consolidate its shares on a four-for-five basis, meaning the number of shares would decrease. but that each action would have more value. That’s why you now own four-fifths the number of GSK shares, but the share price on July 31 was similar to June 30.

As for the ACB of your GSK shares, this is where things get more interesting. In a supplemental filing, GSK said investors should split the full cost of their original GSK depositary shares between their new GSK and Haleon shares pro rata to the relative market value of each. The company provided an example calculation showing that, based on the July 18 closing prices of GSK and Haleon on the London Stock Exchange, 81.84% of the initial ACB should be attributed to GSK shares, the 18.16% remaining being attributed to Haleon. shares.

However, I suspect that your broker did not follow this method. If you multiply your original base price of $40.34 per share by 2,700 GSK shares, your total cost is $108,918. But if you multiply the new ACB (provided by your broker) of US$50.42 by your current 2,160 GSK shares, you get a very similar number of US$108,907. I don’t see how this can be correct, since part of your total ACB should have been allocated to Haleon.

I suggest you read the GSK document and discuss any concerns with your broker or a tax professional. Finally, remember that ACB adjustments do not affect the value of an investment. They only affect the amount of capital gain or loss that will ultimately be reported for tax purposes. A higher ACB – although it may not be correct in this case – is generally a good thing, because it means lower taxes down the line.

Email your questions to [email protected]. I am not able to answer emails personally but I choose certain questions to answer in my column.

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Sallie R. Loera