Philippine Markets Daily

Uniform Accounting reveals that the ROA of this mutual fund’s portfolio is understated, since its true earning power is 1.5x as-reported numbers

July 23, 2020

Since its inception, this mutual fund has outperformed its benchmark, the Philippine Stock Exchange Index (PSEi). The fund’s cumulative returns since its launch is 3% as compared to the PSEi’s -3%.

As-reported metrics would leave investors confused with the fund’s stock picks. However, Uniform Accounting financial metrics help make sense of the fund’s investments and how they continue to outperform their 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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Philequity Management, Inc. (PEMI) is an investment company established in 1994. They offer a wide array of mutual funds for risk-aggressive investors with long-term investment objectives.

We’ve written about two of PEMI’s mutual funds before: Philequity Fund and Philequity Alpha One Fund. This week, we’re focusing on Philequity Dividend Yield Fund, which was established in August 2012.

Philequity Dividend Yield Fund’s goals are capital appreciation and high dividend yield payouts. To meet its objectives, the fund invests in listed equity securities that regularly pay out dividends to generate long-term capital market appreciations.

While the fund recently lagged behind PSEI’s cumulative returns in 2019, it has recently been generating better returns by incurring smaller losses than the PSEi.

Philequity Dividend Yield Fund rose from a PHP 0.96 NAVPS in February 2014, to a record PHP 1.45 in January 2018, delivering a 51% investment growth.

However, that initial run was cut short due to various concerns such as Brexit and the U.S.-China trade war. The fund fell 18% from its January 2018 peak to PHP 1.19 in November 2018. The PSEi had a loss of 23% in the same period.

After ending 2019 with a NAVPS of PHP 1.28, the fund plunged to a low of PHP 0.81 due to the coronavirus-induced market downturn. It has since settled at PHP 1.02 as of July 20, 2020. Year to date, both the fund and the PSEi are down by 19% and 21%, respectively.

Looking at Philequity Dividend Yield Fund’s investments using as-reported metrics, it is not apparent that the fund invests in stable and established 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 Philequity Dividend Yield Fund along with their Uniform return on assets (ROA), as-reported ROA, and ROA distortion—the difference between Uniform and as-reported ROA.

PMD%2396-1.png

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

However, on a Uniform Accounting basis, this fund has actually delivered stronger earnings with an average Uniform ROA of 9%, 1.5x as-reported levels. These companies have strong returns, with Uniform ROA above the 6% global average returns except for PLDT Inc. (TEL:PHL).

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 -43% to 197%, with Ayala Corporation (AC:PHL), JG Summit Holdings, Inc. (JGS:PHL), and SM Investments Corporation (SM:PHL) all having distortions above a hundred percent.

As-reported ROA understates the profitability of AC, suggesting a below-average company with an as-reported ROA of 4%. In reality, this leading conglomerate is a high-quality firm with an 11% Uniform ROA, almost thrice the as-reported number. Over the past 15 years, AC has never seen its Uniform ROA dip below 10%.

Similarly, JG Summit Holdings, Inc. (JGS:PHL) is not just a 4% ROA firm like what as-reported numbers suggest. It is, in fact, an above-average company with an 8% Uniform ROA, consistently generating above-average returns over the past five years.

By focusing on as-reported metrics alone, PEMI 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 understating the company’s earnings growth potential.

PMD%2396-1.png

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

  1. The 2-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 2-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, Philequity Dividend Yield Fund’s major holdings are forecast to lag that with immaterial Uniform earnings growth in the next two years.

Meanwhile, the market is seeing a 1% Uniform EPS shrinkage for these firms in the next two years.

Among these companies, TEL and SM have the highest positive Uniform earnings growth dislocations.

The market is expecting TEL’s Uniform earnings to rise by 5%, but analysts are projecting a robust 41% earnings growth for the telecommunication company in the next two years.

Meanwhile, the market is pricing SM’s Uniform earnings to plummet by 11% in the next two years. However, sell-side analysts are projecting the company’s earnings to accelerate by 9% moving forward.

Overall, as-reported numbers would have investors incorrectly conclude that this portfolio consists of low-quality companies. While these firms suffer 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 Ayala Land, Inc. Tearsheet

Today, we’re highlighting one of the largest individual stock holdings in Philequity Dividend Yield Fund—Ayala Land, Inc. (ALI:PHL).

As the Uniform Accounting tearsheet for ALI highlights, it trades at a Uniform P/E of 20.3x, around the global corporate average P/E of 21.7x, but below its historical average of 22.4x.

Moderate P/Es require moderate EPS growth to sustain them. In the case of ALI, the company has recently shown a 1% 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, ALI’s sell-side analyst-driven forecast shows that Uniform earnings is expected to decline by 34% in 2020, before accelerating by 59% in 2021.

Based on the current stock market valuations, we can back into the required earnings growth rate that would justify PHP 31.70 per share. These are often referred to as market embedded expectations.

The company can have Uniform earnings shrink by 2% in each of the next three years and still justify current price levels. Sell-side analysts’ expected 59% Uniform EPS growth for ALI is well above what the current stock market valuation requires.

The company has an earning power of 2x global corporate averages—based on its Uniform ROA calculation. Since the combination of the company’s cash flows and cash on hand are at 135% of total obligations, AC has a low dividend risk.

To conclude, AC’s Uniform earnings growth is well below peer averages. Moreover, the company is trading above 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 Philequity Dividend Yield 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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