Philippine Markets Daily

Uniform Accounting reveals that the earning power of the companies this newly-incepted UITF invests in is more than 1.5x its as-reported values!

August 14, 2020

This newly-incepted unit investment trust fund (UITF) has been underperforming compared to its benchmark, the Philippine Stock Exchange Index (PSEi). It was only able to outperform the PSEi year to date, albeit at a cumulative performance decline of 21% versus the PSEi’s 25% decline.

As-reported metrics would leave investors confused by the fund’s stock picks. However, Uniform Accounting financial metrics help make sense of the fund’s investments and how it continues to outperform its benchmark at this time.

In addition to examining the fund’s portfolio, we are including fundamental analysis of one of the fund’s largest holdings, providing you with the current Uniform Accounting Performance and Valuation Tearsheet for that company.

Philippine Markets Daily:
Friday Uniform Portfolio Analytics
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Land Bank of the Philippines (LBP) is a government-owned universal bank that was established in 1963 to finance the needs of the agricultural and aquacultural sectors.

One of LBP’s most recent UITF offerings is the LANDBANK Equity Fund. It was established on August 1, 2016 alongside the LANDBANK Money Market Plus Fund.

LANDBANK Equity Fund’s investment strategy is to generate long-term capital growth by investing in peso-denominated listed equities that comprise the PSEi.

Even though the fund has underperformed over the PSEi over the past 12 months, the fund’s strategy led it to outperforming its benchmark year to date.

The LANDBANK Equity Fund rose from a net asset value per unit (NAVPU) of PHP 1.00 in its inception to a record PHP 1.12 in January 2018, delivering a 12% investment growth.

However, that initial run was cut short due to Brexit fears and weakening manufacturing in China. The fund fell 19% from its January 2018 peak to PHP 0.91 in January 2019, while the PSEi declined by 12% in the same period.

After ending 2019 with a NAVPU of PHP 0.94, the fund plunged to a historical low of PHP 0.60 in March 2020 due to the coronavirus-induced market downturn. It has since settled at PHP 0.74 as of August 7, 2020. Year to date, both the fund and the PSEi are still down—by 21% and 25%, respectively.

Looking at LANDBANK Equity Fund investments using as-reported metrics, investors would not think that the fund invests in high-quality, high-growth companies.

As-reported metrics would have investors believe that this portfolio consists of companies that do not generate economic profit. However, Uniform Accounting reveals the truth behind the companies this fund invests in.

The table below shows the core non-financial holdings of the LANDBANK Equity Fund along with their Uniform return on assets (ROA), as-reported ROA, and ROA distortion—the difference between Uniform and as-reported ROA.

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Most companies in the LANDBANK Equity Fund show as-reported ROAs that range around and below global cost-of-capital levels, suggesting that they are not generating economic profit. In 2019, the fund generated an average as-reported ROA of 6%, which is in line with global corporate average returns.

However, on a Uniform Accounting basis, this UITF has actually delivered stronger earnings with an average Uniform ROA of 10%, above cost-of-capital levels and more than 1.5x its as-reported values. These companies have strong returns, with Uniform ROAs above the 6% global average returns.

The Uniform Accounting framework addresses financial statement inconsistencies attributable to the flaws present in the Philippine Financial Reporting Standards (PFRS). This enables investors to determine the true underlying performance of companies and avoid distorted financial analysis and valuation.

As such, it should not be surprising that when analyzing the non-financial holdings of the fund, the figures that easily stand out are the large discrepancies between Uniform ROA and as-reported ROA for these companies.

While at a glance, the difference between as-reported ROA and Uniform ROA may not seem that great, the distortion in percentage ranges from 40% to 102%, with SM Investments Corporation (SM:PHL), First Gen Corporation (FGEN:PHL), and SM Prime Holdings, Inc. (SMPH:PHL) all having distortions above 60%.

As-reported metrics understate the profitability of SM, suggesting an average company with an ROA of 6%. In reality, this leading conglomerate is a high-quality firm with a 12% Uniform ROA, twice the as-reported number. Over the past 5 years, SM has never seen its Uniform ROA dip below 7%.

Similarly, FGEN is not just a 7% ROA firm like what as-reported numbers suggest, but an above-average company with an 11% Uniform ROA. In fact, its Uniform ROA ranged from 8% to 12% over the past decade, while its as-reported ROA never exceeded 7% over the same time span.

By focusing on as-reported metrics alone, LBP would never pick most of these companies because they look like anything but profitable businesses.

That said, looking at profitability alone is insufficient to deliver superior investment returns. Investors should also identify if the market is significantly undervaluing the company’s earnings growth potential.

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This table shows the earnings growth expectations for the major non-financial holdings of the fund. It features three key data points:

  1. The two-year Uniform earnings per share (EPS) growth represents the Uniform earnings growth the company is likely to have for the next two years. The earnings number used is the value of when we convert consensus sell-side analyst estimates to the Uniform Accounting framework.
  2. The market expected Uniform EPS growth represents what the market thinks Uniform earnings growth is going to be for the next two years. Here, we show by how much the company needs to grow Uniform earnings 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.
  3. The Uniform EPS growth spread is the difference between the two-year Uniform EPS growth and market expected Uniform EPS growth.

On average, Philippine companies are expected to have 6% annual Uniform earnings growth over the next two years. Meanwhile, LANDBANK Equity Fund’s major holdings Uniform earnings are forecast to grow by 1% in the next two years.

However, the market is seeing an 8% Uniform EPS shrinkage for these firms in the next two years.

Among these companies, SM and FGEN have the highest Uniform earnings growth dislocation.

The market is pricing SM’s Uniform Earnings to fall by 12% in the next two years. However, sell-side analysts are projecting the company’s earnings to accelerate by 8% moving forward.

Meanwhile, the market is expecting FGEN’s Uniform earnings to shrink by 15%, but analysts are projecting a 2% earnings growth in the next two years.

Overall, as-reported numbers would have investors incorrectly conclude that this portfolio consists of low-quality companies. While these firms are currently suffering from the adverse effects of the coronavirus pandemic, dragging down their short-term earnings growth expectations, Uniform Accounting metrics show that these companies are high quality with intact business models that would drive economic profitability moving forward.

SUMMARY and First Gen Corporation Tearsheet

Today, we’re highlighting one of the largest individual stock holdings in the LANDBANK Equity Fund—First Gen Corporation (FGEN:PHL).

As the Uniform Accounting tearsheet for FGEN highlights, it trades at a Uniform P/E of 9.6x, well below the global corporate average P/E of 21.7x, but around its historical average of 9.3x.

Low P/Es require low, and even negative, EPS growth to sustain them. In the case of FGEN, the company has recently shown a 48% Uniform EPS growth.

Sell-side analysts provide stock and valuation recommendations that poorly track reality. However, sell-side analysts have a strong grasp on near-term financial forecasts like revenue and earnings.

We take sell-side forecasts for PFRS earnings as a starting point for our Uniform earnings forecasts. When we do this, FGEN’s sell-side analyst-driven forecast shows that Uniform earnings is expected to decline by 4% in 2020, before accelerating by 8% in 2021.

Based on the current stock market valuations, we can back into the required earnings growth rate that would justify PHP 27.00 per share. These are often referred to as market embedded expectations.

The company can have Uniform earnings shrink by 15% over the next three years and still justify current price levels. Sell-side analysts’ expected 8% Uniform EPS growth for FGEN is well above what the current stock market valuation requires.

The company has an earning power almost 2x long-run corporate averages and consistently well above global long-run corporate averages—based on its Uniform ROA calculation. Since the combination of the company’s cash flows and cash on hand are at 123% of total obligations, FGEN has a low dividend risk.

To conclude, FGEN’s Uniform earnings growth is well above peer averages. Moreover, the company is trading well below peer average valuations.

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 LANDBANK Equity Fund interesting and insightful.

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

Regards,

Angelica Lim
Research Director
Philippine Markets Daily
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