Partner Q&A (#2)
The nuances of modeling and steady-state NOPAT
The second blog on our premium members’ questions relates to ROIIC, organic reinvestments, past years’ ROIIC, modeling assumptions, our definition of steady-state NOPAT, and calculating the projected CAGR.
Let’s get started with steady-state NOPAT, as it’s a term we use frequently.
Calculating Steady-State NOPAT for Linde
Q: What’s the difference between NOPAT and steady-state NOPAT for Linde, and how do you calculate it?
“Steady-state" NOPAT refers to the net operating profit after tax a company would earn if it made no further growth-related capital expenditures. In this context, depreciation should reflect only maintenance capex, excluding depreciation from recent growth investments.
This approach avoids penalizing companies that have completed growth projects - like expanding factory capacity or making front-loaded marketing investments (difference between maintenance/recurring vs. growth expense is a lot more difficult to parse, especially in industries that are intangible or can be disrupted fairly quickly) - that have yet to generate revenue.
Steady-state NOPAT is a proxy for FCF before interest costs (and their tax shield), and higher depreciation related to growth CAPEX that would result in lower reported taxes and thus higher FCF (as depreciation is non-cash).
Calculating the steady-state NOPAT sheds more light on the truly created incremental profit growth from growth investments by looking at their total cash outlay excluding the impact from external funding (or share issuances). Understanding NOPAT leads to terrific insights into why seemingly higher valued stocks are intrinsically undervalued.
Important to note: NOPAT excludes non-cash amortization of acquisition-related intangibles (i.e. the non-cash charges serial acquirers have to record in their P&L). It does NOT exclude amortization of internally developed intangibles (such as software, capitalized R&D).
Because of steady-state NOPAT requiring a company-specific view on capital intensity, incremental returns, we never duplicate the exact same valuation sheet for our portfolio holdings. Each valuation exercise requires a careful and non-generic input. Hence, we don’t use screeners’ information.