Philippine Markets Daily

This cement company is benefiting from the construction boom in the world’s most populated country, building an ROA of 8%, not 5%

March 10, 2021

The growing demand in the global construction industry has opened up a lot of opportunities all around the world. This Taiwanese cement company is taking advantage of that through its strategic global expansion and partnerships.

However, as-reported metrics show that the company’s profitability is just below cost-of-capital levels. Uniform Accounting reveals that this is not the case.

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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The global construction market has experienced robust growth over the past few decades, thanks to technology, construction technique improvements, and superior-grade raw materials.

While these factors remain significant drivers of growth, another factor is expected to generate massive demand for the global construction market—population growth.

According to the World Economic Forum, the global urban population is expected to exceed the 6 billion mark by 2045, with roughly 200,000 people being born each day. As a result of this growth, the construction market is expected to see demand for residential, commercial, and industrial construction projects across the world.

The favorable impact of population growth to the construction industry is exemplified by the most populous country in the world—China.

With almost 20% of the world’s population at 1.4 billion, China has become the world’s second largest economy partly because of its massive consumer market and its manufacturing capabilities.

The country’s growing working age population and increasing focus on urbanization have also paved the way for its construction industry to flourish. With household incomes rising, demand for residential and non-residential infrastructure has also risen. As a result, growth prospects have also appeared for essential building materials such as stone, timber, and cement.

This Taiwanese cement company has been taking advantage of this massive opportunity in China’s construction market.

Taiwan Cement is the largest cement manufacturer in Taiwan and the sixth largest producer in mainland China. The company achieved this by aggressively expanding in China through acquisitions and partnerships, along with diversifying across different business segments and different geographies.

As early as 2002, Taiwan Cement started taking advantage of the numerous opportunities in China by setting up a large scale plant in Yingde, and further expanded by adding two production lines in Guangdong province in 2008. Moreover, with the demand from building the Beihai Economic Zone in 2006, the company set up another plant in Guangxi province, which also expanded in 2009.

In 2010, it also acquired Prosperity Minerals Holding’s cement business, increasing its production capacity in China. Furthermore, it partnered with China National Building Material Company to increase its capacity in regional markets, and research and development of technologies that can produce high quality cement with a smaller environmental impact.

Taiwan Cement’s expansion plans did not stop with China.

In 2018, the company partnered with OYAK Cement for a joint venture in Turkey, in line with its plans to expand in the Mediterranean region. The company also has plans to further expand in the European and African markets.

Given the company’s massive efforts to take advantage of China’s flourishing construction industry and expanding in other parts of the world, one might expect the company to record large profits in this lucrative business.

However, despite the company’s strategic expansion, as-reported metrics make it seem that Taiwan Cement is barely earning above cost of capital, with as-reported ROAs ranging only from 2% to 6% levels.

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On the contrary, Uniform Accounting reveals a different story, with Uniform returns that have been consistently more robust than what the market thinks. As an indication of its successful strategic expansion, Uniform ROA was actually at 8% in 2019, which is almost double the as-reported numbers.

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What as-reported metrics fail to do is to consider the company’s excess cash on the balance sheet. While most companies inherently need some level of cash to operate, the portion of that balance that is earning limited or no return—or excess cash—ends up diluting as-reported ROAs.

When excess cash remains included in the company’s asset base in computing its performance metrics, the company’s profitability and capital efficiency may appear weaker than it actually is. Removing excess cash allows investors to see through the distortions that come from management carrying much more cash on the balance sheet than what is operationally required.

From 2005 to 2019, Taiwan Cement has had a significant amount of excess cash sitting idly in its balance sheet, ranging from 10% to 18% of its as-reported total assets.

After excess cash and other significant adjustments are made, we can see that Taiwan Cement’s returns are actually a lot stronger than what as-reported metrics show. Without these adjustments, it appears that the company hasn’t been benefiting from acquisitions, leading to poorer valuations.

Taiwan Cement’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.

Taiwan Cement’s Uniform ROA has been higher than its as-reported ROA in fifteen of the past sixteen years. For example, when Uniform ROA peaked at 8% in 2019, as-reported ROA was only 5%.

The company’s Uniform ROA for the past sixteen years has ranged from 2% to 8%, while as-reported ROA has ranged only from 2% to 6% in the same timeframe.

Specifically, Uniform ROA fell from 6% in 2004 to 2% in 2008, before rising to 4% to 6% levels from 2009 to 2014. It then declined again to 2% in 2015, before rebounding to 8% in 2019.

Taiwan Cement’s Uniform earnings margins are overstated while Uniform asset turns are understated

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Volatility in Uniform ROA has been driven by trends in Uniform earnings margins, with peaks and troughs lining up historically with that of Uniform ROA.

From 13% in 2004, Uniform margins fell to 5% in 2008, before rising to 10% to 12% levels from 2009 to 2014. It then contracted back to 5% in 2015 before peaking at 17% in 2019.

Meanwhile, Uniform turns have been consistent, ranging at 0.4x to 0.6x levels in the past sixteen years.

SUMMARY and Taiwan Cement Corp. Tearsheet

As the Uniform Accounting tearsheet for Taiwan Cement Corp. (1101:TAI) highlights, the Uniform P/E trades at 12.0x, which is below the global corporate average of 25.2x but above its own historical average of 10.3x.

Low P/Es require low EPS growth to sustain them. That said, in the case of Taiwan Cement, the company has recently shown a 10% Uniform EPS growth.

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 Taiwan Financial Supervisory Commission: International Financial Reporting Standards (TIFRS) earnings and convert them to Uniform earnings forecasts. When we do this, Taiwan Cement’s sell-side analyst-driven forecast is a 1% decline in both 2020 and 2021.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Taiwan Cement’s TWD 42.50 stock price. These are often referred to as market embedded expectations.

Taiwan Cement is currently being valued as if Uniform earnings were to shrink 8% annually over the next three years. What sell-side analysts expect for Taiwan Cement’s earnings growth is above what the current stock market valuation requires in 2020 and 2021.

Furthermore, the company’s earning power is slightly above the long-run corporate average. Also, cash flows and cash on hand are 3x its total obligations—including debt maturities, capex maintenance, and dividends. All in all, this signals a low dividend risk. However, its 120bps intrinsic CDS signals a moderate credit risk.

To conclude, Taiwan Cement’s Uniform earnings growth is on par with its peer averages but the company is trading below 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!

Regards,

Angelica Lim
Research Director
Philippine Markets Daily
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