Philippine Markets Daily

Uniform Accounting makes us notice that this LED display maker’s TRUE earning power is 20%, not just 5%!

June 24, 2020

Technology has paved the way for manufacturers not just in how they innovate their products, but also the manner in which they are advertised. Digital displays have gained popularity in recent years due to their ability to run multiple advertisements and capture their audience.

This Chinese company has revolutionized the LED industry with its high-end visual displays and smart lighting.

Even though the company has been innovating its LED products and making huge partnerships with big organizations, its as-reported profitability does not seem to reflect this. Uniform metrics show that this company’s TRUE earning power is greater than what is reported.

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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Billboards are one of the most popular modes of advertising. They’re hard to miss in high traffic areas, such as highways, business centers, and train stations.

The very first billboards were used in the 1830s, specifically to advertise circus acts like Barnum and Bailey. It became widely popular in the 1860s as businesses started to purchase outdoor spaces for billboard displays.

Toward the end of the 19th century, billboard associations were set up and standards for billboard advertising were put in place.

Today, you can find billboards almost everywhere, promoting various products like food, clothing, and appliances, among others. These billboards have since evolved from the standard still images or big tarpaulins that we commonly see, to massive LED displays that can air commercials.

Digital billboards have become impossible to miss with their bright, colored, and moving displays. One of the companies responsible for these LED billboards is Shenzhen AOTO Electronics Co., Ltd.

AOTO Electronics provides LED displays for several industries such as international sports, transportation, TV studios, and high-end retail, to name a few. The company covers the R&D, production, and marketing of its LED display, financial technology, and smart lighting products. It was the first listed company in China’s LED industry, with over 560 patents and 66 copyrights today.

The company’s LED displays can be found in airports like Singapore Changi Airport, which is considered as one of the world’s best airports. Their displays feature advertisements of different local and international brands within Changi’s busiest terminals, as well as the airport’s digital signages.

In 2019, AOTO Electronics partnered with the world’s largest outdoor advertising company, JCDecaux Group, to enhance the visual displays of Dubai International Airport, one of the busiest airports in the world by passenger traffic, and Shanghai Pudong International Airport.

The company’s products are also used for global sports events like the 2018 FIFA World Cup. In addition, AOTO Electronics provided hardware, control system, and software for Bountie Esports Arena, the first esports arena in Singapore. With the global rise in esports, this will be a great opportunity for the LED industry and the company.

Considering the company’s innovative LED offerings and huge partnerships with well-known organizations, its as-reported returns of 5% in 2019 is weaker than what it should really be.

AOTO Electronics’ real economic profitability is better reflected with Uniform Accounting adjustments, which shows its TRUE earning power.

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.

If 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.

Over the past nine years, AOTO Electronics has had a significant amount of excess cash sitting idly in its balance sheet, ranging from 19% to 68% of its unadjusted total assets.

After excess cash and other significant adjustments are made, the company actually had a 20% Uniform ROA in 2019, which is 4x stronger than their as-reported ROA of 5%.

AOTO Electronics’ valuations are cheaper than corporate averages

Shenzhen AOTO Electronics Co., Ltd. (002587:CHN) currently trades below corporate averages at a 12.1x Uniform P/E (blue bars), below its as-reported P/E of 15.4x (orange bars).

At these levels, the market is pricing in expectations for Uniform ROA to fall to 8% in 2024, accompanied by 1% Uniform asset growth going forward.

Analysts have more bullish expectations, projecting Uniform ROA to remain at 23% levels in 2021, accompanied by a 10% Uniform asset growth.

AOTO Electronics’ 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.

AOTO Electronics’ Uniform ROA has actually been higher than its as-reported ROA in the past nine years. For example, as-reported ROA is 5% in 2019, significantly lower than its Uniform ROA of 20%. When Uniform ROA peaked at 37% in 2011, as-reported ROA was just at 4%. The company’s Uniform ROA for the past nine years has ranged from 2% to 37%, while as-reported ROA ranged only from immaterial levels to 6% in the same timeframe.

From a peak of 37% in 2011, Uniform ROA gradually fell to an all-time low of 2% in 2015, before recovering to 25% in 2018. Afterwards, Uniform ROA compressed to 20% in 2019.

AOTO Electronics’ Uniform earnings margins are weaker than you think but its robust Uniform asset turns make up for it

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

Uniform earnings margins increased from 16% in 2011 to 19% in 2014, before falling to 3% in 2015. It then recovered to 21% in 2016, before fading to 15% in 2019.

Meanwhile, Uniform asset turns fell from 2.3x in 2011 to an all-time low of 0.7x in 2015, before recovering to 1.8x in 2018. It then declined to 1.3x in 2019.

SUMMARY and Shenzhen AOTO Electronics Co., Ltd. Tearsheet

As the Uniform Accounting tearsheet for Shenzhen AOTO Electronics Co., Ltd. (002587:CHN) highlights, the Uniform P/E trades at 12.1x, which is below corporate average valuation levels and its own recent history.

Low P/Es require low EPS growth to sustain them. In the case of AOTO Electronics, the company has recently shown an 8% Uniform EPS shrinkage.

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 (CAS) earnings and convert them to Uniform earnings forecasts. When we do this, AOTO Electronics’ sell-side analyst-driven forecast is a 9% earnings shrinkage in 2020 followed by 25% earnings growth in 2021.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify AOTO Electronics’ CNY 5.71 stock price. These are often referred to as market embedded expectations.

The company can have Uniform earnings shrink by 5% each year over the next three years and still justify current prices. What sell-side analysts expect for AOTO Electronics’ earnings growth is below what the current stock market valuation requires in 2020, but is above what the market is requiring for 2021.

The company’s earning power is 3x the corporate average. Also, cash flows are more than 5x higher than its total obligations—including debt maturities, capex maintenance, and dividends. Together, this signals low credit and dividend risk.

To conclude, AOTO Electronics’ Uniform earnings growth is in line with its peer averages in 2019. The company is also trading below 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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