Philippine Markets Daily

Taking advantage of the IoT trend and AI, this company has shown Uniform ROAs of 20%+ levels

February 17, 2021

With the Internet of Things (IoT) trend on a continuous rise, this Japanese company has placed its bets on 5G and artificial intelligence to keep its relevance in this digital revolution. Its focus on its long-term vision pushes this company to consistently pursue innovation after innovation.

However, as-reported metrics do not seem to reflect how this company’s efforts to advance its products through innovation are boosting its returns. Uniform Accounting shows that the business has a better Uniform return on assets (ROA) than what you might think.

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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With the growing number of devices being connected to the internet, the Internet of Things (IoT) is the biggest battlefield for technology companies.

As this digital transformation trend continues, the possibilities for innovation and automation become wider.

In our previous articles, we discussed how several Asian companies like MideaThunderSoftAisino, and Haier, are taking advantage of the IoT trend. These companies are developing technologies so that their offerings like home appliances, operating systems, and even tax systems can take part in IoT.

IoT’s capability is not limited to the aforementioned offerings. Since we can connect almost everything to the internet, there are still many applications yet to be discovered. The endless possibilities in innovation make IoT an attractive space for businesses to evolve in.

However, to fully utilize IoT, the first and the most important thing to have is connectivity, which is how this company is taking advantage of the IoT trend.

SoftBank Group Corp. is one of the top providers of connectivity and other technological innovations in Japan.

The firm began as a telecom company offering telephone services in the 1980s. By the 1990s, it completed its nationwide digital network, and by the early 2000s, it expanded its fixed-line telephone services.

As technology continued to advance, so did SoftBank. It entered into various joint ventures and invested in ICT platforms, cloud services, and other software businesses for enterprises.

Understanding the increasing importance of connectivity as technology evolves, SoftBank launched its Beyond Carrier strategy, a move to enhance user experience through IoT and AI.

SoftBank focused on strengthening its network for the IoT era, which is centered on 5G. In 2018, SoftBank pioneered the first connection test for Non-IP Data Delivery (NIDD), which is the technology for transmitting data to IoT devices without the allocation of IP addresses.

With the continuous expansion of digital transformation, SoftBank is also accelerating its efforts to roll out its initial building of its 5G network, ahead of its competition in Japan. It aims to complete its first 5G buildout by 2023.

SoftBank is not only taking advantage of IoT and 5G, it is also recognizing the growth opportunities in Artificial Intelligence (AI) initiatives.

As part of the Beyond Carrier plan, the company established Vision Fund, the world’s largest tech fund with a committed capital of USD 98.6 billion, which focuses investments in unicorn companies specializing in AI. This allows the company to further expand its market reach and build their foundation in a rapidly growing sector that goes hand in hand with the IoT trend.

A notable example of this fund’s investment is in a Chinese online property platform run by KE Holdings Inc, which led to a USD 5.1 billion unrealized gain or a 375% return for SoftBank.

However, even with the company’s successes in innovation, as-reported metrics have been displaying a lackluster performance. Currently, as-reported ROA is only 1%.

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Uniform Accounting, on the other hand, reveals that the company is in fact a high-return business as expected, with Uniform ROAs actually at 27% in 2020.

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One of the most significant distortions is due to the treatment of special items.

Special items are accounting events or transactions that are unusual in nature and infrequent in occurrence, which can cause volatility in a company’s earnings. Examples of these types of items include one-time legal or restructuring charges, gains/losses from sale of assets, and asset write-downs.

Non-recurring income and expenses do not come about as a result of the company’s actual operations. Therefore, the after-tax effect of these are added back or subtracted to the firm’s earnings.

As a result, as-reported ROAs are not capturing the strength of SoftBank’s earning power. Adjusting for these special items, we can see that the company isn’t actually displaying lackluster performance. In fact, it is the opposite, with returns that are more than 27x greater.

SoftBank Group’s profitability is more robust than you think

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

SoftBank’s Uniform ROA has been higher than its as-reported ROA in thirteen of the past sixteen years. For example, Uniform ROA was 27% in 2020, while as-reported ROA was only 1%.

The company’s Uniform ROA for the past ten years has ranged from 2% to 27%, while as-reported ROA has ranged only from 1% to 9% in the same timeframe.

Specifically, Uniform ROA rose from -15% in 2005 to 24% in 2012, before gradually fading to 2% in 2018. Uniform ROA then rebounded to a historical high of 27% in 2020.

SoftBank Group’s Uniform earnings margins are weaker than you think, but its Uniform asset turns make up for it

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Volatility in Uniform ROA has been driven by trends in Uniform earnings margins and to a lesser extent, trends in Uniform asset turns, with peaks and troughs lining up historically with that of Uniform ROA.

From -13% in 2005, Uniform margins gradually expanded to 13% in 2012, before declining to 2% in 2018. It then rebounded to a historical high of 33% in 2020.

Meanwhile, Uniform turns improved from 1.1x in 2005 to 1.8x in 2012, before dropping to 0.6x in 2013. It then rebounded to 1.7x in 2019, before falling to 0.8x in 2020.

SUMMARY and SoftBank Group Corp. Tearsheet

As the Uniform Accounting tearsheet for SoftBank Group Corp. (9984:JPN) highlights, the Uniform P/E trades at 33.3x, which is above the global corporate average of 25.2x and its own historical average of 26.0x.

Moderate P/Es require moderate EPS growth to sustain them. That said, in the case of SoftBank, the company has recently shown Uniform EPS turned positive at JPY 753.55 from JPY -126.23 in 2019.

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

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, SoftBank’s Wall Street analyst-driven forecast is a 42% and 71% EPS decline in 2021 and 2022, respectively.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify SoftBank’s JPY 9,797 stock price. These are often referred to as market embedded expectations.

The company can have Uniform earnings shrink by 3% per year over the next three years and still justify current stock prices. What Wall Street analysts expect for SoftBank’s earnings growth is below what the current stock market valuation requires in 2021 and 2022.

Furthermore, the company’s earning power is 4x the long-run corporate average. Also, cash flows and cash on hand are below its total obligations within the next five years—including debt maturities, capex maintenance, and dividends. All in all, this signals a high dividend risk. However, credit risk is low because of its refinancing capabilities.

To conclude, SoftBank’s Uniform earnings growth is below its peer averages but the company is trading above its average peer 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!

Angelica Lim
Research Director
Philippine Markets Daily
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