Quick Depreciation and Amortization Question

[Laxputs]

Looking at HOS.

 

Pg F-7.

 

When they purchase a ship they depreciate the original purchase price over 25 years and, in theory, sell that asset for 25% of the original purchase price and the end of its useful life.

 

So you are spreading the cost of buying the vessel over 25 years, and accounting for it via depreciating the asset. In 25 years when you need a new vessel you repeat the process. Thus there is no one time hit to earnings on the cost of a new vessel.

 

Questions:

1. Depreciation, therefore, accounts for the money to retain the earnings power of the business, i.e. not just the cost to keep that asset working but the full lifecycle of the asset; maintain it in good working order and assume it gets sold or expires at the end of its useful life?

 

2. In regards to HOS, what are they amortizing? What intangible asset has capital expenses? They are not repaying a loan quarterly so I don't believe it is debt servicing?

 

TIA

[Tim Eriksen]

1. Maintaining the vessel falls under maintenance.  Improvements and drydock expense are capitalized and depreciated/amortized. It is a bit of a stretch to say it "accounts for the money to retain the earnings power of the business."  It accounts for the cost of the vessels over their lifetime.  Whether the earnings power of the business is there or not is a separate issue.

 

2. They are amortizing drydock expense 

 

Page 32 says

In addition to the operating costs described above, we incur fixed charges related to the depreciation of our fleet and amortization of costs for routine drydock inspections and maintenance and repairs necessary to ensure compliance with applicable regulations and to maintain certifications for our vessels with the U.S. Coast Guard and various classification societies. The aggregate number of drydockings and other repairs undertaken in a given period determines the level of maintenance and repair expenses and marine inspection amortization charges. We capitalize costs incurred for drydock inspection and regulatory compliance and amortize such costs over the period between such drydockings, typically 30 months. Applicable maritime regulations require us to drydock our vessels twice in a five-year period for inspection and routine maintenance and repair. If we undertake a disproportionately large number of drydockings in a particular fiscal period, comparative results may be affected. While we can defer required drydockings of stacked vessels, we will be required to conduct such deferred drydockings prior to such vessels returning to service.

[rb]

Looking at HOS.

 

Pg F-7.

 

When they purchase a ship they depreciate the original purchase price over 25 years and, in theory, sell that asset for 25% of the original purchase price and the end of its useful life.

 

So you are spreading the cost of buying the vessel over 25 years, and accounting for it via depreciating the asset. In 25 years when you need a new vessel you repeat the process. Thus there is no one time hit to earnings on the cost of a new vessel.

 

Questions:

1. Depreciation, therefore, accounts for the money to retain the earnings power of the business, i.e. not just the cost to keep that asset working but the full lifecycle of the asset; maintain it in good working order and assume it gets sold or expires at the end of its useful life?

 

2. In regards to HOS, what are they amortizing? What intangible asset has capital expenses? They are not repaying a loan quarterly so I don't believe it is debt servicing?

 

TIA

Laxputs,

 

A quick mention first. I don't think you're correct in assuming that there is no hit to earnings when they buy a new vessel. If one were to assume that the company has only one vessel, then in your example because of inflation there is a hit to earning. The new vessel is a lot more expensive than the one you bought 25 years ago. Thus the depreciation for the new vessel is higher than for the old vessel, which hits earnings. In practice this is reflected in the fact that CAPEX is higher than Depreciation and Dep expense creeps up over time.

 

Answers:

1. Depreciation understates the costs to maintain the earnings power of the business. See above.

2. I'm not very familiar with HOS financial statements. You'll have to dig into the notes to exactly figure it out. I took a quick look at the statements and I can see for example that they capitalize drydocking costs and that gets unwound though the amortization line. I'm sure there are other items as well.

[Tim Eriksen]

Good thing it is trading at half of book value, because the ROE and ROA are surprisingly weak for the last three years.

[rb]

Good thing it is trading at half of book value, because the ROE and ROA are surprisingly weak fro the last three years.

It's an asset intensive commodity business. Their trademark is low ROA. Another trademark is lots of leverage. HOS however has less of it than I would have expected - that helps with the lower ROE.

 

rb

[yadayada]

real earnings won't take a hit when they buy a new boat, if earnings take a hit, that is with the assumption that revenue will not adjust for inflation.

Also Old ships get lower rental rates then new ships. and have higher maintenance costs.

 

If you assume revenue tracks inflation, then earnings will be higher in nominal terms. but in real terms they stay flat, except for lower rental rates because of older ships, and higher maintenance costs.