How Is My Bet On Tabcorp Working Out?

| About: TABCORP Holdings (TABCF)

Summary

Tabcorp's operating and free cash flow remains very strong, and the company spent a large part of it on reducing its net debt.

The FCF in H2 will be lower, as the majority of the capex will be spent in the second half of the financial year.

The free cash flow yield of 8% is definitely sufficient to cover the 6% dividend yield, making the dividend very sustainable.

18 months ago, I argued Tabcorp (OTCPK:TABCF) would become a dividend champion as the company's cash flows were quite robust. Since that original article, Tabcorp has indeed already distributed approximately A$0.62 in dividends (including one special dividend I wasn't entirely happy with), bringing the total dividend return relatively to the purchase price at approximately 15%. Not bad for 18 months. But how did the company perform in the first half of its financial year 2016? Will it continue to be a dividend champion? Let's find out.

TABCF Chart

TABCF data by YCharts

Tabcorp is an Australian betting and wagering company, so it would definitely be a better idea to use the ASX to trade in the company's shares. The ticker symbol is TAH, and the average daily volume is in excess of 3.2 million shares. The current market capitalization is approximately $2.45B.

Be aware the majority of the capex will be spent in H2

Tabcorp's revenue in the first half of FY 2016 (which ends in June 2016) was pretty decent with a 2% increase (in AUD terms). However, the revenue wasn't the only thing that actually increased, as Tabcorp's operating expenses also increased tremendously, resulting in a 10% lower EBIT. Whereas Tabcorp generated an EBIT of A$177M ($126M) in H1 2015, this fell to just A$159M ($114M) in the current financial year.

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Source: Press release.

The main culprit is the higher expense on commissions and fees as well as spending more cash on advertising and promoting. That's not necessarily a bad thing, but I do hope this will result in a consistently higher revenue and pre-tax income.

The lower yield environment was working in Tabcorp's favor as the net financing expenses fell from A$40.2M ($29M) to A$34.7M ($25M), and that's a substantial improvement. That being said, a higher tax bill (due to the fact there was a tax benefit in the previous financial year) has reduced Tabcorp's net income by approximately 33% to A$82M ($59M) or just short of 10 cents per share.

Fortunately the company's cash flow statements are looking much better. Tabcorp generated an operating cash flow of A$227M and after coughing up A$73M ($52M) to cover its capital expenditures, it still had approximately A$155M it could spend on whatever it wanted to. Roughly A$74M ($53M) was spent on a dividend whilst Tabcorp also took the opportunity to reduce its net debt by approximately A$115M ($82M) which will ultimately result in Tabcorp spending less cash on its interest payments.

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Source: Financial statements.

However, there's one important caveat I'd like to share with you. Yes, the free cash flow in H1 FY 2016 was approximately A$155M ($111M), but you cannot, and I repeat, cannot just double this amount to guesstimate the full-year adjusted free cash flow. It does look like Tabcorp's second half of the year will be quite capex-heavy, and almost 60% of the full-year capex will be spent in the second semester.

Source: Company presentation.

Assuming the operating cash flows will remain stable, it will be much safer to use an operating cash flow of A$450M ($321M) and deduct the full-year capex guidance of A$160M ($114M) from this amount. When you do so, you'll notice the expected full-year free cash flow will be approximately A$275-290M (midpoint: US$202M) and that's still a very respectable amount. Based on the current share price, the anticipated free cash flow yield is now approximately 8% and that's quite acceptable.

No special dividends anymore, and that's not a bad thing

My main purpose to start covering Tabcorp was to find out whether or not this company would be a useful and nice addition to my dividend portfolio. Unfortunately Tabcorp did something I couldn't agree with at all. Tabcorp actually sold new shares to its existing investors to cover a special dividend. So basically, shareholders were bankrolling their own special dividend and that's not really something I was happy about. Why would I want to finance my own dividend for 100% whilst incurring dividend taxes when it would be wired back to me? I didn't agree at all with this approach and sold my shares after that announcement.

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Source: Company presentation.

Fortunately the special dividend indeed was a 'special' dividend and the possibility this will reoccur in the near future is close to non-existent. Instead, Tabcorp has declared a normal dividend over the first half of FY 2016. Tabcorp will be paying a A$0.12 dividend ($0.085) which is a very nice 20% hike compared to the previous dividend payment.

Shareholders will also be happy to see the dividend is 100% franked (which basically means the dividend withholding tax in Australia will very likely be quite low), and there's no reason to assume the final dividend over FY 2016 will be lower than the interim dividend. This would result in a total dividend of A$0.24 ($0.17) and a yield of almost 6%, and that's not unattractive when the Federal Reserve is keeping the option of a negative interest rate open for discussion.

Investment thesis

Tabcorp remains a preferred dividend pick as it enjoys an excellent position on the Australian gambling market. The free cash flow remains very strong (and I'm anticipating a FCF yield of approximately 8%), so paying a 6% dividend yield shouldn't be a problem at all!

I sold my shares after disagreeing with Tabcorp's plans to raise cash to fund the dividend, but I would be interested to dip my toes back into the water as the dividend will very likely continued to be increased.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in TABCF over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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