2023-11-21 13:00:00 ET
Summary
- Icahn Enterprises has a high dividend yield of 23.16%, but there are red flags that discourage investment.
- IEP's financial performance over the past decade has been poor, with negative net income and low/negative return on capital.
- The current NAV per share is too low compared to the price per share.
With a dividend yield ((FWD)) of 23.16%, Icahn Enterprises ( IEP ) looks like a bargain not to be missed. However, as is often the case, when something seems too good to be true, it probably is.
There are several red flags that personally discourage me from investing in this company, both from a short-term and long-term perspective.
Historical results
Over the past decade, IEP's financial performance has been awful in more ways than one and it is difficult to find a silver lining.
Chart based on Seeking Alpha data
- Income has been uneven and decreasing compared to the past.
- Net income has been negative for as many as five years in a row, and in the past 10 years only three times has it been positive.
- Return on capital has often been negative and well below past values.
Certainly, the business model of this company does not allow for perfect stability in revenues and profits, but objectively the results of the past 10 years cannot reassure shareholders. In comparison, those achieved in the previous decade were far better.
Chart based on Seeking Alpha data
At that time, revenues grew year after year and net income was negative in only two out of ten years, 2005 and 2008. In short, today's IEP is not what it used to be.
Chart based on TIKR data
Going into more detail, it is rather puzzling what IEP has achieved since 2013 to date in terms of gain/loss on sale of investment: only three slightly positive years versus six rather negative years, and one slightly negative year. Negative years happened in the past as well, such as in 2008, but that result was justified by the fact that few investments performed well during one of the worst financial crises in modern history. The years from 2014 onward were very bullish for the market thanks to rates close to 0%, yet that was not enough to allocate capital appropriately. In other words, it seems that IEP has not been the same for many years.
Past successes may still influence the current rating, but this hope is likely to turn into a disappointment. There is no guarantee that IEP can return to its former glory; actually, I think it is more likely that the slump will continue.
Dividends and valuation
TradingView
Since the price per share is the same as it was twenty years ago, it is clear that capital gains are not the main reason for an investor to include IEP in his or her portfolio. Fluctuating earnings make the performance of this stock volatile and uncertain, which is not beneficial in the long run. Certainly, this does not detract from the fact that it is possible to get a good return by taking advantage of short-term volatility, but that is not the aspect I want to cover in this article.
The interest in this company comes mainly from the FWD dividend yield, about 23.16%. Any person who notices this figure for the first time will be intrigued; after all, it would mean recovering the entire investment in about four years, excluding taxes. Anyway, as is often the case, such high returns hide pitfalls.
To be precise, in the case of IEP these pitfalls are not even that much hidden, after all, the company is gradually showing major signs of financial deterioration.
In early August 2023 the quarterly distribution was cut in half, from $2 per unit to $1 per unit. This news, widely discussed here on Seeking Alpha, concretized what were earlier concerns. With this halving, the company has pretty much admitted that it is facing a challenging period and I personally do not think it is over. In the coming quarters I would not be surprised to see new distribution cuts, and at that point the panic could spread even more rapidly. If after the first distribution cut the stock reacted with -31%, at the second cut the reaction could be worse.
The reason for my pessimism is that IEP promises a huge yield to its investors but does not actually create value. Typically, the dividend, or distribution, is welcome the moment the company in question creates value through its operating business and decides to distribute some of that value to investors. This simple basic mechanism does not occur with IEP.
Chart based on Seeking Alpha data
In fact, excluding 2020, although the amount of dividend paid year after year is increasing, investors are not getting richer as new shares in circulation dilute their gains. In other words, we can describe it as a zero-sum game: IEP raises capital from investors and that capital is used to remunerate them. Since IEP has not been generating profits for five years, this vicious cycle is not something sustainable in the long run. In fact, the erosion of equity is already evident as evidenced by TBV/share.
As for valuation, for companies with IEP's business model analysts often consider Net Asset Value. As of September 30 , that value was estimated at $5.16 billion, up $147 million from the previous quarter but down $474 million from the end of 2022. Dividing the current NAV by depositary units of $410.80 million, the result is a NAV per share of $12.56, about 27% less at the current price per share.
So, theoretically, at the current price an investor is buying IEP by paying a premium, which seems rather unreasonable to me. The only reason that would justify it would be an expectation of major growth in NAV per unit, however, I do not think this is the case. As we have seen previously, IEP investments have been experiencing major losses for several years and net income has been consistently negative. After years of success in the first decade of the 21st century, today the situation seems to have reversed. Moreover, the last decade has also been marked by a strong bullish market, which makes IEP's overall performance even more disappointing.
Personally, I do not think these are the conditions to buy this company at a price above NAV per unit, which is why I consider it a strong sell. The high distribution may provide relief to investors in the short term, but it will accelerate the gradual deterioration of equity over the long term.
Refinancing
A final aspect I would like to address is debt, since refinancing it would involve adding another driver to the decline in equity. The current net debt is $4.70 billion, quite high for a company that capitalizes $7.09 billion.
Icahn Enterprises Q3 2023
4.750% senior unsecured notes worth $1.10 billion will mature in 2024, a year later a 6.375% senior unsecured notes worth $749 billion. If the Fed maintains its vision of keeping rates high for a long time, this will mean refinancing this debt with double-digit interest.
Chart based on Seeking Alpha data
As of today, interest has a weight of 5.07% on revenues, but I would not be surprised if this weight is greater in the coming years. Beyond the difficult macroeconomic environment, it should be considered that in the interest rate that IEP will have to pay will also be discounted a financial situation that is not as sound as in the past. Overall, interest is yet another problem that this company will have to solve.
Considering all the red flags mentioned in this article, I wonder how it can continue to distribute $1 per unit. Certainly, there has been a progress from $2, but I think a further reduction in distribution is inevitable.
Conclusion
Investing purely on the basis of short-term returns may prove to be a losing strategy, especially if the company promising such dividends is in an obvious state of distress. Increasing investor distributions and at the same time increasing depositary units is nothing more than a way to postpone a further collapse in the price per share. The longer it takes IEP to accept the current distressed state, the more difficult it will be to restart with deteriorated equity.
The current NAV per share is lower than the price per share, and given the return on investment in recent years, I do not find it reasonable to pay a premium for this company. Overall, I find it excessively risky to invest in IEP: it is not the same as it was in its golden years and I prefer to opt for dividend companies that create value over time.
For further details see:
Icahn Enterprises: From The Right Pocket To The Left Pocket