Icahn Enterprises: Thanks For The Early Retirement, Hindenburg
Neilson Barnard
Shares of Icahn Enterprise L.P. (NASDAQ:IEP), one of the highest yielding stocks in the market right now, were crushed by a short report from the infamous short-seller 'Hindenburg' and then again by investor Bill Ackman. We'll review why they went short later in the article, but for now the most important thing to note is that IEP's share price is down over 50% and is currently trading at around $20.00.
As the company pays $8.00 per unit in dividend annually, the yield has jumped to almost 40%, which if in any way, shape or form is sustainable, should be a no-brainer of an investment. That's because, at 40%, you can turn a $1,000 initial investment, with no additional investment over the course of 20 years, into a pot of over $2 million.
The real question is - can they sustain that payout moving forward?
Icahn Enterprises As A Business
There has been extensive coverage of what the short-sellers are claiming here on Seeking Alpha and in the financial media in general, so I'll spare you a detailed overview, but the gist of it is that Hindenburg and then Ackman believe that the company is overleveraged, saying:
"Overall, we think Icahn, a legend of Wall Street, has made a classic mistake of taking on too much leverage in the face of sustained losses: a combination that rarely ends well"
They are talking about the losses the company has been reporting over the past few years, alongside them issuing a considerable amount of new units. I'll discuss this in greater detail later in the article, as I see it as a net positive for a long term investment (crazy, I know).
The company's revenues peaked in 2013, when they reported almost $21 billion, with a gross profit of over $4.6 billion and have since been stagnant or have declined. In the last full year of reporting, the company reported $12.7 billion in total revenues and just $760 million in gross profit.
However, the company has managed to lower their overall expenses over that time period. Their interest expense (the amount of cash they pay in interest on their long term debt) went from around $1.1 billion in 2015 to just over $575 million in the last full reporting year. Their operating expenses also declined to $1.18 billion from almost $2 billion back in 2015. This has allowed them to foster longer term growth potential once they sort out their revenues.
Revenue Fluctuations Causing A Headache
An issue with the company's revenues, and something which Hindenburg referenced in their report, is that the company's trading and investment revenues have been fluctuating wildly over the past few years. In the most recent quarter alone, the company reported a $443 million loss from these activities, compared to a gain of over $900 million in the same quarter the previous year.
So even though the company is making strides in lowering their expenses, these fluctuations are causing a headache for the company when headline numbers come out as bad even though the relative decline in the company's net sales from operations has been on par with the broader market.
In the most recent quarter, net sales declined just over 7% (not including net gains or losses from investment activities) while the cost of those revenues declined by almost 11%, reflecting the easing inflationary headwinds the company's businesses experienced over the past few quarter - and a good long term investment indicator of growth potential.
What's The Dividend Hoopla All About?
The hoopla is about the fact that it yields 40% annually without doing anything. If you spend $20 buying 1 share of Icahn Enterprises, you will get $8 a year in cash dividend payments. The key here is reinvesting that cash into buying more units of stock.
If you buy $1,000 in Icahn Enterprises and the company maintains the same distribution over the next 20 years (more or less), then you'd be looking at a pot of cash eclipsing $2 million. Ahhhhh, the beauty of compound interest.
Compound Interest Calculator (Investor.gov)
Now, the real question is - can they still be paying out $8 a share for 20 years? Well, there isn't a real way of knowing this. There are companies which have been paying out the same dividend for decades which analysts have thought would be bankrupt years ago and those who have been thought of as recession-proof which have imploded long ago.
The best we can do is assess the next few years and the overall sustainability of their payouts. This is where the unit offerings come in.
The company doesn't actually pay out $8 in cash to every one of the roughly 354M units outstanding. In fact, they pay out less than $0.63 per unit in cash, or just $220 million every year. This is because Carl Icahn himself, and other controlling entities, choose to either forgo their distributions or get them in new units, which is where the big spike in units has come from.
This, then, becomes a very simple equation - the company's $2.6 billion in cash can sustain their cash payouts for 11 years and 9 months.
Ok, fine, this isn't exactly 100% accurate, but it makes my broader point about the company's future - they can focus on forming a more sustainable sales environment and lower their exposure to certain volatile investment activities while maintaining their high distribution and attract investors.
Unit Dilution Is A Problem, But Not A Big One
This is a double edged sword, with new units meaning that the value of your holdings are diluted, but there are 2 reason I don't think this will be long term:
The first is that the amount of new shares issues is declining. After a big bump when Mr. Icahn and others started taking the new units and issuing new units to the public to fund operations, they have since been declining, with the most recent 2 quarters reporting a decline from $178 million and $249 million in new units issued to $173 million and $193 million, respectively. The decline is even sharper in the 2 quarters before that.
The second is that the company currently has a pretty low bar of sales and earnings growth in order to keep up with the rate they are offering new units. If the company reports equal or higher growth, there will be relatively no dilution and that means you can maintain the rough value of your investment for the long run and enjoy the distributions.
So - Sustainable And Worth It
As I mentioned earlier, the company only pays out around $0.63 per share in cash distributions, so net income only has to reach that to make it sustainable.
This should be taken with a fist-full of salt, since it's only projected by a single analyst, but currently the company is projected to report $0.10 in earnings per share in 2023 and then $1.14 in earnings per share in 2024. This means that they will easily be able to cover their growth needs as a company and then pay out cash to all unit holders who want it if these numbers hold.
There are a lot of unknowns with Icahn Enterprises, and even though I have a strong bullish stance on the company's compounding prospects, I acknowledge that we're going to need more information as time goes on and the company announced quarterly earnings and distributions.
Number One Risk Is A Distribution Cut
It's noteworthy that the company can cut their dividend payouts by 50% and still maintain one of the highest yields in the market today at around 20%. Whether they decide to do that or not is an unknown, and while I don't believe they will, it's a risk worth taking into account.
It's pretty clear from the outflows the company has seen, that some risk-adverse big money has left the company. It's highly likely that a bulk of those who remain, including those who are buying in at current prices, are folks who are attracted to the dividends, even if just temporarily.
This means that any material cut in the company's dividend can have a serious adverse reaction in the company's share price, which can bring the value of your holdings down significantly, no matter how many units you've collected.
Overall, even with my bullish stance, this risk has made me not be fully invested in the company, meaning I am not maxed out in my position if the risks were lower. I have some cash ready to buy more shares which is earmarked for IEP, in case it falls further.
Conclusion: Well Worth It
To put it simply, I believe that a position in IEP is well worth the risks associated with the company cutting its dividend or not managing to adequately replace investment activities with other revenues sources.
Not only is the company projected to return to revenue growth in the near future, its cost cutting measures should help it report higher earnings growth, which I believe will help dispel the reports which have contributed to the sharp declines in share price.
Without a single percentage point of share price appreciation, a 40% yield is well worth the investment, and the company returning to a point where they make some profits and growth their revenue streams can return them to where I believe true fair value lies - around $50.00 per share.
These factors have increased my bullishness in Icahn Enterprises and I will continue to add to my position throughout the coming weeks while it's trading at such low prices.
Source: Seeking Alpha
