Philippine Markets Daily

FIRST in-depth look at the only ETF in the Philippines…Stocks and weightings appear unreasonable, but make sense when viewed under the Uniform Accounting lens

January 31, 2020

There are more investment securities available for us than we can imagine.

Regular investors and professional money managers have an array of options, from common underlying instruments like cash-like securities, commodities, bonds, equities, and mutual funds, to derivatives such as futures contracts, options, and CDs.

While the list of investment securities continues to expand, one particular instrument has yet to gain popularity among Filipinos — exchange-traded funds or ETFs.

We look at the first, and still, the only ETF in the Philippines, which is now up around 30% since its inception.

As-reported metrics would lead one to believe that this ETF comprises weak companies with minimal growth. However, Uniform Accounting shows otherwise, and that their portfolio managers know exactly what they’re doing.

Philippine Markets Daily:
Friday Uniform Portfolio Analytics
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Exchange-traded funds are a relatively young investment vehicle in the Philippines. In fact, if you are not in the field of investment management, research, or consulting, this might be the first time to come across ETFs.

Over the past decade, this security has grown into a whopping trillion-dollar market. Global ETFs ended the decade with a bang after posting a new record in December 2019 with an enormous $6.4 trillion investment influx.

ETFs have become popular following the Great Recession, the massive global economic downturn that was driven by the U.S. subprime mortgage crisis and the worldwide financial catastrophe from 2007 to 2009. Investors placed their money in benchmark ETFs beginning 2009, which turned out to be the onset of the longest bull rally in history.

ETFs are a basket of securities like a mutual fund, but are listed on an exchange so they can be bought and sold similar to stocks. They act as a cheaper alternative to mutual funds and offer diversification unlike individual stocks. ETFs were initially developed to provide individual investors access to passive index funds. Today, they encompass not just broad market indices, but also niche sectors and alternative asset classes like bonds and CDs.

The first form of ETF was launched in 1989 and was called the Index Participation Shares for S&P 500. Unfortunately, this attempt failed, despite drawing huge interest from investors. A federal court in Chicago ruled that Index Participation Shares had to be traded on a futures exchange as it operated like a futures contract.

A year later, Canada successfully listed the first ETF, the Toronto 35 Index Participation Units (TIPs 35). This warehouse, receipt-based ETF tracked the Toronto Stock Exchange 35 (TSE-35) Index.

Despite these initiatives, it was State Street Global Investors’ ETF that grew popular.

On January 22, 1993, around three years after the listing of TIPS 35, State Street released the first U.S.-listed ETF called S&P 500 Trust ETF (SPDR or “spider”).

This ETF seeks to deliver performance similar to the S&P 500 Index, which comprises 500 stocks with a market capitalization greater than $10 billion.

To this date, SPDR remains to be the most actively-traded ETF and the top ETF in terms of assets under management.

The expansion of the ETF industry reached Asia in 1999.

That year, Hong Kong introduced the Tracker Fund of Hong Kong (TraHK) as the first ETF in Asia. Investors embraced this new investment vehicle, which led to the development of the region’s ETF market.

It was just in 2013 when an ETF sprouted in the Philippines.

First Metro Investment Corporation (FMIC) took the courage and ventured in the uncharted ETF territory to be a prime mover of the country’s capital markets and help it grow.

The firm initiated discussions with the Securities and Exchange Commission (SEC) and the Philippine Stock Exchange (PSE) to bring this type of security into the local investment scene.

Through its efforts, in December 2013, months after First Metro’s 50th anniversary, the firm successfully listed the First Metro Philippine Equity Exchange-Traded Fund (FMETF) in the PSE.

Until now, FMETF remains the only available ETF in the country.

FMETF looks to provide returns that reflect the performance of the Philippine Stock Exchange Index (PSEi), which comprises 30 of the largest firms in the Philippines.

The table below shows FMETFs current holdings. Comparing the weightings between PSEi and FMETF, one will notice slight differences that range from -15bps to 24bps.

Using as-reported accounting, investors would be scratching their heads at several of the companies in FMETF.

Based on an as-reported ROA metric, 17 out of 25 non-financial companies in this fund were poor performers in 2018, with returns of around 3%-5% only. This dragged the average return to just 5.6%, which is slightly below corporate average returns of 6%.

It would appear that this fund is composed mainly of low-quality firms, but in reality, it isn’t.

Once we make Uniform Accounting (UAFRS) adjustments to accurately calculate earning power, we can see that the returns of the companies in FMETF are much more robust.

In fact they had an average Uniform ROA of 11.2%, almost doubling global averages.

Once the distortions from the as-reported accounting are removed, we can see that Metro Pacific Investments Corporation (MPI:PHL) does not have a 3.1% ROA, it’s really at 32.4%. In fact, MPI has consistently made a robust 30%+ returns over the past three years.

Similarly, GT Capital Holdings, Inc. (GTCAP:PHL) actually has an ROA of 16.1%, not 5.1%. Meanwhile, International Container Terminal Services (ICT:PHL) produced returns way higher than the global average at 39.3% Uniform ROA, not 6.4% as-reported ROA. The list goes on.

As-reported ROA failed to capture the underlying profitability of each company and has probably led a lot of investors astray.

If First Metro’s investing strategy is powered plainly by as-reported metrics, they won’t be able to see through the true earning power of these companies and won’t be able to adjust their weightings accordingly.

Inventors have the tendency to overreact to short-term execution issues and market volatility while ignoring underlying fundamentals. Amid all the accounting noise and uncertain fundamentals, investors can also identify the companies with significantly undervalued growth potential using Uniform Accounting.

This chart shows three interesting data points:

– The first datapoint, 2-year EPS’ growth, is what Uniform earnings growth is forecast to be over the next two years when we take consensus analyst estimates and convert them to the Uniform Accounting framework. This represents the Uniform earnings growth the company is likely to have in the next two years

– The second datapoint, market expected EPS’ growth, is what the market thinks uniform earnings growth is going to be for the next two years. Here, we are showing how much the company needs to grow Uniform earnings by in the next two years to justify the current stock price of the company. This is the market’s embedded expectations for Uniform earnings growth

– The final datapoint, EPS’ growth spread, is the spread between how much the company’s Uniform earnings could grow if the Uniform earnings estimates are right and what the market expects Uniform earnings growth to be

The average company in the Philippines is forecast to have 6% annual Uniform Accounting earnings growth in the next two years.

Sell-side analysts forecast FMETF components to outpace that with 11% average uniform earnings growth over the same time frame. This provides better insights in adjusting weightings to add premium to companies with higher growth potential than what as-reported numbers are saying.

On average, the market is pricing these companies to grow earnings by a paltry 1%. While these companies are strongly expanding, they are being intrinsically undervalued as the market is grossly mispricing their growth by 10%.

Without the Uniform numbers, the PFRS numbers would leave everyone in the dark.

Notably, FGEN has the highest Uniform earnings growth mispricing. Sell-side analysts forecast FGEN to have a 22% Uniform EPS Growth, but the market thinks that the earnings could shrink by 9% each year over the next two years.

SM Investments Corporation (SM:PHL) is another leading conglomerate with material earnings growth dislocation. Market expects SM to grow in earnings by 4%, but sell-side analysts are seeing a more robust 20% Uniform earnings growth.

Yet another big name, Ayala Corporation (AC:PHL), is priced for a huge 13% decline in earnings, but they are forecast to grow by 3% a year.

However, First Metro may need to take a deeper look at Jollibee Foods Corporation (JFC:PHL), which is priced in for a strong 16% earnings growth, but is forecast for 2% decline over the next two years.

San Miguel Corporation (SMC:PHL) may be worth another round of review, too, as the market thinks they are bound to grow by 7% a year, but sell-side analysts are seeing flat growth moving forward.

Looking at the difference in weightings, one might realize noticeable increases in FMETF’s AC, SM, and GTCAP holdings, which are reasonable considering the strong uniform earnings and growth potential these companies show. However, FMETF cut its shares for PLDT due to weak profitability.

Although there are a bunch of names that need another bout of analysis, these dislocations cannot be understood using as-reported metrics.

Uniform Accounting enables investors and money managers to pinpoint these distortions and generate better insights in making sound investment strategies and decisions.

Ayala Land Tearsheet

Today, we are highlighting one of the largest individual stock holdings in FMETF—Ayala Land (ALI:PHL).

As the Uniform Accounting tearsheet for Ayala Land highlights, Uniform P/E trades at 20.5x, slightly below market average valuations and at par with its historical averages.

Low P/Es require low, and even negative, EPS growth to sustain them. In the case of Ayala Land, the company has recently shown a robust 19% Uniform EPS growth.

Sell-side analysts provide stock and valuation recommendations that 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 PFRS earnings and convert them to Uniform earnings forecasts. When we do this, Ayala Land’s sell-side analyst-driven forecast is at 4% earnings growth into 2019 and increases to 18% in 2020.

Based on the current stock market valuations, we can back into the required earnings growth rate that would justify PHP 45.75 per share. These are often referred to as market embedded expectations. In order to meet the current market valuation levels of Ayala Land, 3% Uniform earnings growth is required of the company over the next three years.

What sell-side analysts expect for Ayala Land’s earnings growth is above what the current stock market valuation requires.

To conclude, Ayala Land’s Uniform earnings growth is above peer averages in 2020. Furthermore, the company is trading around peer average valuations.

The company has above average earning power, based on its Uniform ROA calculation. Together, this signals a low cash flow risk to the current dividend level in the future.

About the Philippine Market Daily
“Friday Uniform Portfolio Analytics”

Investors who don’t engage in the buying or selling of securities for a living oftentimes rely on professionals to manage their own investments within the scope of their investment policies.

With so many funds and managers out there, it can get confusing and difficult to decide which one best suits your needs as an investor.

Every Friday, we focus on one fund in the Philippines and take a deeper look into their current holdings. Using Uniform Accounting, we identify the high-quality stocks in their portfolio which may not be obvious using the as-reported numbers.

We also identify which holdings may be problematic for the fund’s returns that they would need to reconsider from a UAFRS perspective.

To wrap up the fund analysis, we highlight one of their largest holdings and focus on key metrics to watch out for, accessible in our tearsheets.

Hope you’ve found this week’s focus on the First Metro Philippine Equity Exchange-Traded Fund interesting and insightful.

Stay tuned for next week’s Friday Uniform Portfolio Analytics!

Regards,

Angelica Lim & Joel Litman
Research Director & Chief Investment Strategist
Philippine Markets Daily
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