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When Growth is Bad for Shareholders

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When we invest, we want to see our companies grow by selling more products and services and overwork the cash register. But, when can shareholders actually benefit from growth? Retail-mall REIT CapitaMalls Trust (SGX: C38U) grew its revenue by 53% from S$432m in 2007 to S$662m last year, while its distributable income jumped 57% to S$332m. Investors who invested in the company from 2008 must be doing pretty okay, right? Let’s find out.

CMT’s units were worth $3.45 at the beginning of 2008 and would have a distribution yield of 3.9% based on 2007’s payout. But, at the end of 2012, CMT was only worth $2.13 a unit. Distributions and capital gains (or losses in this case) would have resulted in a total loss of 23% for the investor. During the same period, the Straits Times Index (SGX: ^STI) only lost 8.5%, so investors in CMT were walloped by the market.

When is Growth Bad?

How could a respectable growth in income have resulted in such terrible market performance? The key lies in CMT’s distributable income per unit figures.  Despite the growth in the REIT’s distributable income, its corresponding per-unit figures actually decreased by almost half from S$0.337 to S$0.161. CapitaMalls’ unit-count had ballooned from 1.67b at the end of 2008 to 3.46b at the end of last year due to a 9-for-10 rights issue (that’s 9 rights for every 10 shares that are owned) that happened on 2 April 2009.

And the REIT’s not alone. Fishing-vessel operator Pacific Andes Resources (SGX: P11) have seen its share price plunge by more than 70% from the start of 2008 till the end of 2012 even as the company’s annual net income increased by 16% from S$85.3m (on Mar 2008) to S$99.4m (on Sep 2012). The culprit, as you might have guessed, was the deterioration in the company’s earnings per share figure – EPS tumbled by more than 70% from S$0.095 to S$0.025.

The company’s share count increased more than three-fold from 1.39b to 4.79b due to a series of rights issues. That’s what happens when companies constantly ask the market to pony up cash for newly minted shares – shareholders suffer.

You might ask, if a rights issue was offered and a shareholder signed up for it, wouldn’t they have more shares now, negating declines in per-share figures? Besides, it can be argued that most investors will sign up for a rights issue because it is often offered at a discount to a company’s (or trust’s) share price which benefits existing shareholders. But that’s missing the point – companies shouldn’t dip into the cookie jar all the time.

There can be a host of reasons why an investor would not want to partake in the rights issue, including a lack of cash, or having enough shares of the company from an allocation standpoint.

And that’s really one of the key issues here with companies or trusts that can only grow by taking on additional capital through issuing more shares – shareholders who refuse to subscribe for more will see their stake get diluted (often horribly, as is the case with CMT and Pacific Andes) while a subscription might not be feasible due to cash flow or allocation issues. That’s like being caught between a rock and a hard place.

When is Growth Good?

The gulf between beneficial and unbeneficial growth becomes apparent when we look at companies like instant-beverage manufacturer Supergroup (SGX: S10) and commercial testing firm Vicom (SGX: V01).

From 2008 to 2012, both companies have seen EPS figures track net income very closely. Supergroup’s cumulative income growth clocked in at 214% while EPS rose 206%. For Vicom, profits increased by a total of 67% while EPS stepped up by 59%. Along the way, Supergroup’s share price more than tripled from the start of 2008 to the end of 2012 (from $0.78 to $3.24) while Vicom rose by 170% from $1.82 to $4.89.

Foolish Bottom Line

Ultimately, investors have to look hard at how a company’s funding its growth. If substantial dilution of existing shareholders’ stakes can occur, then all that growth might just be for naught. Earnings growth matter, but earnings per share growth is vitally important too.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing doesn’t own shares in any companies mentioned.