I was introduced to Centurion Corporation Limited by a friend some time ago. He went in early, made his money, a lot of money, and scooted. Clever fellow.
AK is more of a plodder when it comes to investments. Investments which pay dividends consistently and meaningfully get his attention. A judicious amount of leverage is acceptable but too much leverage is scary especially now that interest rates are more likely to go up than not.
Anyway, sorting through piles of notes and cuttings in the last few days, I came across some scribbles I made about Centurion many moons ago.
I took a quick look at the chart and it got me interested enough to do something more.
Centurion's share price was declining. It was clearly in a downtrend.
Now, it looks like it has bottomed.
I always say that when there is blood on the street, I want to take a look.
This time, I think that I am a little late since the share price broke resistance provided by the 200d moving average (MA) at 35c, came down a bit, not quite testing the 200d MA and moved back up.
The blood might have begun coagulating by now but, still, blood is blood.
For those who don't know, Centurion is in the business of running dormitories for workers and students. They are landlords.
It is a business that is easy enough to understand, especially for those of us who like investing in REITs.
A taste of life in a dorm for workers.
So, what prevented me from investing in Centurion until now? A very high debt level and a weakening business environment.
There are many ways of looking at debt. I just look at their properties' valuations and what they owe to get a quick idea of the gearing level.
They had about $700 million worth of debt against investment properties valued at about $940 million.
Without taking anything else into consideration, that was a gearing level of about 74.5%.
I read that they have repaid $100 million since my scribbles and, so, their gearing level should be reduced to 64% or so. Still pretty high.
Having said this, some might remember that I said before (and most recently in a blog post on Croesus Retail Trust) that if a high debt level is matched by an ability to service the debt, it becomes less of a concern. So, interest expense must remain manageable.
In Centurion's case, there is a legitimate worry that a slow down in the economies in Singapore and Malaysia where its dormitories for workers are located would affect its business negatively.
Of course, Centurion has dormitories for students in Singapore, Australia and the UK too but the bulk of its business is still in dormitories for workers.
During bad times, highly leveraged businesses with reduced cash flow would find themselves in a pinch, to put it mildly. If interest expense goes up and cash flow goes down, the ship could be in danger of sinking.
Centurion has pretty strong cash flow and they have been able to cope with a high level of debt. Its operating cash flow is about 3.4x its interest expense. It isn't a fantastic interest cover ratio but it shows that interest expense is manageable.
However, if interest rate goes up, interest cover ratio will reduce if we do not see an improvement in cash flow, just like for REITs.
Assuming that cash flow and debt level stayed the same, in Centurion's case, based on $600 million worth of debt, a 1% increase in interest rate would mean $6 million more in interest expense. This would increase interest expense by 33% and reduce interest cover ratio to about 2.55x.
Of course, it would also put a dent in earnings. As investors for income, this is of interest to us because Centurion is not a REIT and it doesn't have to pay out 90% of its cash flow since it has no incentive to do so. However, Centurion does pay a percentage of its earnings as dividends to shareholders. Reduced earnings could mean reduced dividends.
Assuming an earnings per share (EPS) of 4.5c and number of issued shares at 740 million, a $6 million increase in interest expense would knock about 0.8c off EPS. This brings EPS to 3.7c.
Based on a possibly reduced EPS of 3.7c a year in future, paying a dividend per share (DPS) of 1.5c per year is still undemanding. This is assuming that business does not take a turn for the worse.
Paying 38c a share, I decided that a dividend yield of 3.95% is acceptable to me based on the above assumptions and a 40% payout ratio.
Centurion's share price seems to have bottomed although a retracement to the 200d MA which has started rising wouldn't surprise me. Prices climb a wall of worries.
Presentation (January 2017): HERE.