Philippine Markets Daily

This IoT company’s 32% Uniform ROA shows a connection between innovation and profitability that its 7% as-reported returns hide.

May 27, 2020

This China-based company provides IoT solutions and communication modules, standing to benefit from the digitalization trend and the expansion of the IoT market.

However, as-reported metrics are hiding this company’s TRUE profitability, making it seem like this company hasn’t benefited from its efforts.

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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“Anything that can be connected, will be connected.”

This is the goal of the Internet of Things (IoT), one that Haier Smart Home has kept in mind for their smart home appliances.

With the advancement of technology and the push for IoT, companies have adapted to better create and capture value for their customers. Value creation and value capture have evolved from merely selling a stand-alone product to a personalized set of products continuously enhanced through cloud-based solutions.

IoT has been transforming various industries, including healthcare, retail, manufacturing, and robotics—and it’s unlikely that this will slow down in the near future. Transforma Insights forecasts that the number of IoT connected devices will grow from 7.6 billion to 24.1 billion between 2019 to 2030, with revenue reaching over $1.5 trillion.

This company has helped its customers from over 100 countries in solving challenges within their industries by ensuring that their products are readily available to the market.

Fibocom Wireless Inc. provides wireless communication modules and IoT solutions to customers from various industries including consumer electronics, wireless payment, metering, security surveillance, and connected cars. The company offers its clients easy-to-use development kits and technical support to aid in their development cycles and product enhancements.

In 2005, Fibocom established a machine-to-machine (M2M) service center with Motorola in Asia-Pacific. Through the continuous innovation of M2M technology, Fibocom has extended applications based on wireless payment through all kinds of mobile handheld devices.

Fibocom modules have passed the strictest tests in the financial payment industry, with an online rate reaching 99.9%. Fibocom global modules have also received more than 20 carrier certifications and industry certifications in more than 100 countries.

Moreover, the company’s modules have proven to be cost-efficient and are easily integrated into existing systems. This allows Fibocom to quickly respond to customers’ demands and provide them with a secure and stable data transfer.

In 2017, Fibocom acquired 100% of shares in Zhejiang Nodecom Communication Technology Co., Ltd, a leader in security monitoring technology. This enabled Fibocom to further develop in the field of IoT and expand its product line-up to better serve its customers.

Today, in the era of 5G, Fibocom continues to achieve its R&D milestones.

The Fibocom 5G IoT Wireless Modules have recently completed their first data call and end-to-end data transmission services under China Mobile’s Standalone (SA)-Structured 5G network. Its SA uplink and downlink peak rates reached the highest recorded in the industry.

Looking at Fibocom’s profitability, the company seems to not have benefited at all from its innovative offerings and efforts in the IoT space. As-reported return on assets (ROA) in 2019 was only at 7%, weaker than what it actually is.

Fibocom’s real economic profitability can be better reflected with Uniform Accounting adjustments to show its TRUE earning power. Looking at the company’s performance in 2014, Fibocom’s Uniform ROA peaked at 45%, which is 3x its as-reported ROA of 15%.

One key metric that is causing distortions in as-reported ROAs is R&D expenses.

Fibocom has regular material investments in research and development that they record as an outright expense, in accordance with the accounting standards. However, expensing R&D fails to recognize the matching principle of recognizing expenses in the period when the related revenue is incurred.

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 R&D and other significant adjustments are made, the company’s Uniform ROA is at 32% in 2019, which is almost 5x stronger than their as-reported ROA of 7%.

Fibocom’s valuations are in line with corporate averages, but cheaper than as-reported P/E

Fibocom Wireless Inc. (300638:CHN) currently trades in line with corporate averages at a 22.4x Uniform P/E (blue bars), but is much cheaper than its as-reported P/E of 40.6x (orange bars).

At these levels, the market is pricing in expectations for Uniform ROA to fall to 8% in 2024, accompanied by 46% Uniform asset growth going forward.

However, analysts have less bearish expectations, projecting Uniform ROA to slightly decrease to 27% in 2021, accompanied by a 53% Uniform asset growth.

Fibocom’s profitability is much better than you think it is

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 highlight.

Fibocom’s Uniform ROA has actually been higher than its as-reported ROA in the past eight years. For example, as-reported ROA is 7% in 2019, significantly lower than its Uniform ROA of 32%. When Uniform ROA peaked at 44% in 2014, as-reported ROA was just at 15%.

Through Uniform Accounting, we can see that the company’s true ROAs have actually been higher. Fibocom’s Uniform ROA for the past eight years has ranged from 17% to 45%, while as-reported ROA ranged only from 4% to 15% in the same timeframe.

After climbing from 27% in 2012 to a peak of 45% in 2014, Uniform ROA gradually fell to 17% in 2017. Afterwards, Uniform ROA recovered to 32% in 2019.

Both Fibocom’s margins and turns are stronger than you think

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

Uniform earnings margins fell from 16% in 2012 to 12% in 2013, before recovering to 15% in 2016. It then declined again to 11% in 2017 and surged back to 15% in 2019.

Meanwhile, Uniform asset turns increased from 1.7x in 2012 to a peak of 3.1x in 2014 before falling back to 1.6x in 2017. It then rebounded to 2.2x in 2019.

Summary and Fibocom Tearsheet

As the Uniform Accounting tearsheet for Fibocom highlights, they are trading at a 22.4x Uniform P/E, which is around average market valuations but above its historical P/E of 19.1x.

High P/Es require high EPS growth to sustain them. In the case of Fibocom, the company has recently shown a 88% 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 Chinese Accounting Standards earnings and convert them to Uniform earnings forecasts. When we do this, Fibocom’s sell-side analyst-driven forecast is for Uniform earnings to decline by 25% in 2020 and grow by 26% in 2021.

Based on current stock market valuations, we can back into the required earnings growth rate that would justify CNY 43 per share. These are often referred to as market embedded expectations.

In order to meet the current market valuation levels of Fibocom, the company would have to have Uniform earnings grow by 10% each year over the next three years. What sell-side analysts expect for Fibocom’s earnings growth is below what the current stock market valuation requires in 2020 but above in 2021.

The company’s earning power, based on its Uniform return on assets calculation, is 5x corporate average returns. Furthermore, with cash flows and cash on hand consistently exceeding obligations, Fibocom has low credit and dividend risk.

To conclude, Fibocom’s Uniform earnings growth is below its peer averages in 2019 and it is also trading below peer average valuations.

About the Philippine Markets 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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