Philippine Markets Daily

As-reported metrics understate this high-tech home appliance manufacturer’s returns at 4%. Its true earning power is HIGHER than that!

April 15, 2020

It has been a month since the Philippines enforced an enhanced community quarantine. This proclamation was supposed to last until today, but was extended to April 30, 2020.

Instead of beating the summer heat at the beach, people are cooling off with their air conditioners at home. They are also stocking up their refrigerators with food rather than eating out in fancy restaurants and visiting tourist spots.

This Chinese company designs, manufactures, and sells a wide variety of household appliances including air conditioners, refrigerators, freezers, small household electrical appliances, and other related products.

Also below, Uniform Accounting Embedded Expectations Analysis and the Uniform Accounting Performance and Valuation Tearsheet for the company.

Philippine Markets Daily:
Wednesday Uniform Earnings Tearsheets – Asia-listed Focus
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Have you ever imagined being able to control the functions of your home through a single device?

In today’s digital age, technology has allowed us to accomplish daily tasks easier than ever before. For example, with just a smartphone, you can video chat with your loved ones, browse the internet, play games, and record moments on video or photo, among other things.

This acceptance of smart technology has led to even more developments in the field. Now, we can enjoy the comforts of controlling certain parts of our homes by using just one device.

This is made possible through the Internet of Things (IoT) technology. IoT allows devices to connect with one another through the internet. This ecosystem allows embedded systems, such as processors and sensors, and artificial intelligence to be able to gather information, analyze it, and interact with the external environment.

This company has stayed at the forefront of innovation by pushing the boundaries of possibility when it comes to smart home appliances.

Haier Smart Home, a subsidiary of Haier Group Corporation, ranks 448 in the Fortune Global 500 by upholding the principle of “prioritizing people’s value.”

Creative Director Huang Cheng explains that their ecosystem brings together cutting-edge smart home appliances from their extensive brand portfolio that enables families to enjoy life powered by IoT technology.

With Haier Smart Home’s seven global brands, namely Haier, GE Appliances, Fisher & Paykel, AQUA, Candy, Casarte and Leader, customization according to different cultures and individual habits of users has been made possible.

The company’s ecosystem allows users to tailor-fit their personal smart home experience.

Aside from developing smart home appliances, Haier shows how each person can fit these appliances into their very own Smart Home Spaces, such as the living room, kitchen, bathroom, bedroom, and laundry room, based on their lifestyles.

The company recently demonstrated this at the CES 2020 Haier booth in Las Vegas, Nevada.

One example that the company showcased was a home designed for the elderly. It was fitted with a Smart Kitchen that monitors and automatically turns off water and gas, and had a Smart Closet that automatically stores wheelchairs.

Today, Haier Smart Home extends the use of its technology and resources in order to help others in crisis. As a response to the global pandemic, they recently launched the Internet of Clothing (IoC) Antibacterial and Epidemic Prevention Guarantee Platform.

This platform connects companies with donors and manufacturers across the globe to aid in material shortages in clothing, cleaning, and other essential prevention products. Specifically, it covers the production of raw materials, enterprise-level health, safety and monitoring in stores and factories, and household health and epidemic prevention.

As a result, companies are able to connect with each other to acquire antibacterial materials and epidemic prevention products such as protective masks, gloves, disinfectants, and more.

Furthermore, consumers are able to select from a range of products to increase safety in their homes. For example, Haier air purifiers and UV disinfection lamps can circulate healthy, clean air for the living room.

Haier Smart Home has developed a user-centred creative system, leading them to gradually become one of the world’s biggest home appliances manufacturers.

Even with the company’s innovative products, as-reported returns have been weak at just 4% levels, which is far behind its true earning power.

Haier Smart Home’s real economic profitability can be better reflected with Uniform Accounting adjustments.

Haier Smart Home has regular material investments in research and development that as-reported metrics record as an outright expense. Because of this, as-reported metrics fail to follow the accounting principle that expenses should be recognized in the period when the related revenue is incurred. This distorts the company’s earning power.

R&D investment is actually an investment in the long-term cash flow generation of the company. If this remains treated as an expense, the company’s profitability may appear substantially weaker than it actually is.

After excess cash and other significant adjustments are made, Haier Smart Home reported a 26% Uniform ROA in 2018, which is almost 7x stronger than as-reported ROA of 4%.

Haier Smart Home’s Uniform valuation is cheaper than market valuation

Haier Smart Home Co., Ltd. (600690:CHN) currently trades below corporate averages with an 8.9x Uniform P/E (blue bars), which is also cheaper than the as-reported P/E of 12.5x (orange bars).

At these levels, the market is pricing in expectations for Uniform ROA to fall to 6% in 2023, accompanied by a 22% Uniform asset growth going forward.

However, analysts have less bearish expectations, projecting Uniform ROA to decline slightly to 24% in 2020, accompanied by 20% Uniform asset growth.

Haier Smart Home’s profitability is actually much better than you think it is

As-reported metrics distort the market’s perception of the firm’s recent profitability. If you were to just look at as-reported ROA, you would think that the company is a much weaker business than real economic metrics highlight.

Uniform ROA has been higher than as-reported ROA in the past sixteen years. For example, as-reported ROA was 4% in 2018, lower than Uniform ROA of 26%.

Haier Smart Home’s Uniform ROA ranged from 5% to 68% over the past sixteen years. After dropping from 16% in 2003 to an all-time low of 5% in 2005, Uniform ROA gradually rose to a peak of 68% in 2012. Afterwards, Uniform ROA slowly dropped to 35% in 2016 and rebounded back to 44% in 2017, before falling again to 26% in 2018.

Haier Smart Home’s margins are weaker than you think, but asset turnover makes up for it

Cyclicality in Uniform ROA has been primarily driven by trends in both Uniform earnings margins and Uniform asset turns, with peaks and troughs lining up historically with that of Uniform ROA.

Uniform earnings margins decreased from 4% in 2003 to a historical low of 2% in 2005, before recovering to 6% in 2012. Thereafter, Uniform earnings margins fell to 4% in 2013, before recovering to 8% in 2017 and falling back again to 5% in 2018.

Meanwhile, after trending at 3.3x to 4.9x levels from 2003 to 2008, Uniform asset turns dramatically increased to 9.0x in 2009, before peaking at 14.5x in 2011. It then declined to 11.6x in 2012 and recovered to 12.7x in 2013, before gradually contracting to 5.1x in 2018.

Summary and Haier Smart Home Tearsheet

As the Uniform Accounting tearsheet for Haier Smart Home highlights, they are trading at 8.9x Uniform P/E, which is below market average valuations but around its historical P/E.

Low P/Es require low EPS growth to sustain them. In the case of Haier Smart Home, the company has recently shown a 37% Uniform EPS shrinkage. This is due to a weaker earnings after interest and investment income, and PP&E maintenance capex adjustments.

Sell-side analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, sell-side analysts’ near-term earnings forecasts tend to have relevant information.

We take sell-side forecasts for Chinese Accounting Standards earnings and convert them to Uniform earnings forecasts. When we do this, Haier Smart Home’s sell-side analyst-driven forecast is for Uniform earnings to increase by 29% in 2019 and then decline by 5% in 2020.

Based on current stock market valuations, we can back into the required earnings growth rate that would justify CNY 15.29 per share. These are often referred to as market embedded expectations.

In order to meet the current market valuation levels of Haier Smart Home, the company would have to have Uniform earnings shrink by 10% each year over the next three years. What sell-side analysts expect for Haier Smart Home’s earnings growth is well above what the current stock market valuation requires.

The company’s earning power, based on its Uniform return on assets calculation, is 4x greater than corporate average returns. Furthermore, with cash flows and cash on hand consistently exceeding obligations, Haier Smart Home has low credit and dividend risk.

To conclude, Haier Smart Home’s Uniform earnings growth is above peer averages in 2019 and it is trading below peer average valuations.

About the Philippine Market Daily
“Wednesday Uniform Earnings Tearsheets – Asia-listed Focus”

Some of the world’s greatest investors learned from the Father of Value Investing or have learned to follow his investment philosophy very closely. That pioneer of value investing is Professor Benjamin Graham. His followers:

Warren Buffett and Charles Munger of Berkshire Hathaway; Shelby C. Davis of Davis Funds; Marty Whitman of Third Avenue Value Fund; Jean-Marie Eveillard of First Eagle; Mitch Julis of Canyon Capital; just to name a few.

Each of these great investors studied security analysis and valuation, applying this methodology to manage their multi-billion dollar portfolios. They did this without relying on as-reported numbers.

Uniform Adjusted Financial Reporting Standards (UAFRS or Uniform Accounting) is an answer to the many inconsistencies present in GAAP and IFRS, as well as in PFRS.

Under UAFRS, each company’s financial statements are rebuilt under a consistent set of rules, resulting in an apples-to-apples comparison. Resulting UAFRS-based earnings, assets, debts, cash flows from operations, investing, and financing, and other key elements become the basis for more reliable financial statement analysis.

Every Wednesday, we focus on one company listed in Asia that’s relevant to the Philippines and that’s particularly interesting from a UAFRS vs as-reported standpoint. We highlight one adjustment that illustrates why the as-reported numbers are unreliable.

This way, we gain a better understanding of the factors driving a particular stock’s returns, and whether or not the firm’s true profitability is reflected in its current valuations.

Hope you’ve found this week’s Uniform Earning Tearsheet on an Asian company interesting and insightful.

Stay tuned for next week’s Asia company highlight!

Regards,

Angelica Lim
Research Director
Philippine Markets Daily
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