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Forecasting dividend payouts is challenging because for many firms equity and quasi-equity payouts are not statistically tractable directly. As is well documented in the corporate-finance literature, private firms tend to have a more erratic dividend-payout behaviour than listed firms (dividends are less “sticky”), and their equity payouts can vary considerably in size and frequency. In fact, the best model of broad equity payouts across the infrastructure universe is a random march.
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While some infrastructure companies pay dividends regularly, others pay dividends in irregular and more unpredictable patterns. A non-negligible subset of companies in the EDHECinfra database (about 10%) has never paid out a single dividend, some in more than ten years of operation. Still, these “zero payout” firms can be assumed to have a positive present value (otherwise investors would not hold them). Hence, they should not be excluded from a broad market infrastructure equity index, since they represent a certain pattern of equity payout found in the market. |
Quantities of interest
Our approach to forecasting cash flows in unlisted infrastructure projects aims to minimise the multiplication of estimation errors by using the smallest number of variables possible. We focus on modelling the free cash flow to equity of infrastructure companies as a stochastic process described as a two-dimensional state vector (mean and variance). This is parsimonious.
The future free cash flow to equity of each firm is defined as:
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FCFE_t=CFADS_t-DS_t |
where
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This free-cash-flow process is the result of the firm’s business model and risk, the choice and evolution of its financial structure, and it ultimately determines the ability of the firm to repay its senior creditors and equity investors. Crucially, infrastructure companies are characterised by limited growth opportunities and numerous long-term commitments (to invest only in their core business, to deliver service, etc.) thus making future debt service and equity payouts a direct function of the firm’s free cash flow, which cannot be used for other purposes.
While we cannot model the payouts to equity investors directly, we can use the following indirect, two-step approach:
- We first estimate the parameters of the firm’s free-cash-flow process (free cash flow to equity or FCFE) as defined above. Unlike equity payouts, this first quantity can always be observed: as long as a firm is operational, it must have a free cash flow (even if it is negative).
- We then estimate the firm’s FCFE retention rate (FCFE-RR), that is, its tendency to distribute FCFE in any given period. Likewise, this quantity is always observable and partly embodies the economic dynamic of the firm, including its ability and tendency to reinvest free cash, to keep it in various reserve accounts, or to distribute it as dividends or shareholder loan repayments.
The FCFE-RR is computed as
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RR_t=\frac{\text{Cash at Bank}_t}{FCFE_t} |
where
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Hence,
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Thus, future equity payouts of each firm are simply written:
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Payout_{t+\tau}=FCFE_{t+\tau} \times (1-RR_{t+\tau}) |
Likewise, the volatility of future equity payouts is the combination of the conditional variance of
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Modelling approach
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Watch a 2-minute video highlighting our approach to dividend forecasting: here. |