Question
COS 2007 earning is 1.55 per unit but the annual dividend is 3. Explain why the dividend is higher than the earnings? Will the high dividend sustainable given the low earning figure? Thanks
Answer
Hello, In the Income statement we have revenues and expenses and we are left with Net Income(or Loss). Net Income(or Loss) is then transferred to the Balance Sheet account as retained earnings(or deficit) under Shareholder’s Equity. Dividends are a temporary balance sheet account under shareholder’s equity. When dividends are paid out, it is paid out from retained earning. Hence, EPS is INDEPENDENT from dividends. EPS does not show earnings before dividends.
The real reason COS.UN pays more in dividends than it makes in EPS can be explained by its legal structure. Income Trusts have to pay all out all CASH FLOWS FROM OPERATIONS, in order to retain their Income Trust status.
In order to calculate Cash Flow from Operations we take the following formula (Cash Flow from Operations = Net Income + Depreciation and other Non-Cash Expenses). We add back Depreciation because it is a non-cash expense, which does not effect cash flows. Because Cash Flows from Operations are always higher than Net Income COS (as do all Income Trusts) will pay out more than EPS. That’s why most income trusts have accumulated deficits instead of accumulated retained earnings when we observe the balance sheet.
To analyze the sustainability of dividend payments we need to look at the Cash Flow Statement. COS.UN dividends are sustainable as dividends last year were smaller than cash flow. They paid $791 million in dividends last year while Cash Flows from Operations were $1377 millions, giving us a dividend payout ratio of 57%, which is one of the lowest and safest in the energy trust sector.
Note: Their EPS currently looks low at a $1.55 for the Trailing Twelve Months, however if you exclude the one time tax loss (declared in Q2 2007) for income trusts their adjusted EPS is closer to $2.80. And assuming oil prices stay north of $90 their forward EPS as of Q2 2008 should be around $3.40.
Hope that helps.
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