Philippine Markets Newsletter

A charge towards renewable energy should power this utility player’s future generating Uniform returns of 8%, not 6%

August 30, 2023

As electricity prices rise due to global supply chain disruptions, investments on renewable energy (“RE”) could unlock the potential of this power generation company.

However, as-reported metrics seem to dim its bright initiatives showing returns of 6% while TRUE Uniform returns are at 8%.

Also below, Uniform Accounting Embedded Expectations Analysis and the Uniform Accounting Performance and Valuation Tearsheet for the company.

Philippine Markets Newsletter:
Wednesday Uniform Earnings Tearsheets – Philippine-listed Focus
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The year 2022 saw global macroeconomic headwinds due to Eastern Europe’s geopolitical conflict. This caused a surge in fuel and crude oil prices as Russia faced sanctions, being the third-largest crude oil exporter worldwide.

The declining crude oil supply resulted in higher electricity costs from the increased generation charges in the Wholesale Electricity Spot Market. In response, the Department of Energy advocated for greater adoption of RE in the country to counter rising electricity prices.

In 2022, the Philippines utilized about 24,000 gigawatt hours of RE, comprising roughly 26% of the nation’s energy mix. The Energy department aims for RE to constitute around 35% by 2030 and half of the energy mix by 2040.

One of the companies that would benefit from this push is First Gen Corporation (FGEN:PHL) along with its RE subsidiary, Energy Development Corporation (“EDC”). EDC is FGEN’s largest sustainable power arm and the subsidiary specializes in geothermal power plants.

At present, EDC has an aggregate installed capacity of approximately 1,185 megawatts, constituting about 61% of the country’s geothermal capacity. In 2022, it contributed $96.4 million to FGEN’s consolidated net income, marking a 10% increase from the $87.5 million recorded in 2021.

However, this growth was offset by foreign exchange losses due to a lower net Peso asset position. Consequently, FGEN’s consolidated net income rose only by 4%, reaching $369.5 million in 2022 from $354.2 million in 2021.

This signals that FGEN’s growth hinges on its investments in RE. Recently, EDC revealed plans to drill two new exploration areas, adding 90 megawatts to its capacity at a cost of around PHP 27 billion.

EDC aims to expand its RE capacity to 9,000 megawatts by 2030. A third of this expansion will come from wind concession projects in Guimaras, Iloilo, and Negros Occidental, marking a significant jump from its current 150-megawatt capacity.

Clearly, FGEN’s strategic direction positions it as one of the frontrunners in the RE sector. Its plans should unlock a considerable potential for long-term value growth for its shareholders.

First Gen’s earning power is stronger than you think

Despite its RE initiatives, as-reported metrics still seem to understate FGEN’s development and distort the company’s profitability with returns only showing 6%.

In reality, the company achieved higher Uniform returns of 8%.

Historically, one of the largest distortions for FGEN comes from the treatment of minority interest expenses or the income attributable to the non-controlling interests of a company’s subsidiaries.

The Philippine Financial Reporting Standards (PFRS) allows minority interest expense to be recognized under operating cash flow, leading people to incorrectly think that it is essential to the firm’s core operations.

In reality, it should always be classified as a financing cash flow. Minority shareholders provide capital to the subsidiary in exchange for a piece of the company’s profits. As a result, minority interest expense should not be subtracted from revenue when calculating a company’s real core earnings.

In 2022, First Gen recognized PHP 108 million in minority interest expense, resulting in a PHP 261 million net profit and a 6% as-reported ROA. Adding this back alongside the many other adjustments Valens makes, the company should actually be recognizing PHP 354 million in Uniform earnings and an 8% Uniform ROA.

First Gen has a more efficient business than you think

Trends in Uniform ROA have been driven by trends in Uniform asset turns. For more than two decades, as-reported metrics have understated FGEN’s asset efficiency, a key driver of profitability.

Moreover, as-reported asset turnover has reached a peak of 0.6x. In comparison, Uniform turns have reached a high of 1.2x over the same time period, making FGEN appear to be a less efficient business than real economic metrics highlight.

SUMMARY and First Gen Corporation Tearsheet

As our Uniform Accounting tearsheet First Gen Corporation (FGEN:PHL) highlights, the company trades at a Uniform P/E of 6.1x, below the global corporate average of 18.4x, and its historical P/E of 7.7x.

Low P/Es require low EPS growth to sustain them. In the case of FGEN, the company has recently shown a 1% 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 Philippine Financial Reporting Standards (PFRS) earnings and convert them to Uniform earnings forecasts. When we do this, FGEN’s sell-side analyst-driven forecast is to see a Uniform earnings growth of 9% and 13% in 2023 and 2024, respectively.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify FGEN’s PHP 19.24 stock price. These are often referred to as market-embedded expectations.

The company is currently being valued as if Uniform earnings were to shrink by 23% annually over the next three years. What sell-side analysts expect for FGEN’s earnings growth is above what the current stock market valuation requires through 2024.

Moreover, the company’s earning power is in line with the long-run corporate averages. Also, cash flows and cash on hand are at 219% of its total obligations—including debt maturities, capex maintenance, and dividends. Together, this signals low dividend risk.

Lastly, FGEN’s Uniform earnings growth is around its peer averages, and its peer average valuations.

About the Philippine Markets Newsletter
“Wednesday Uniform Earnings Tearsheets – Philippine-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 IFRS, 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 Philippine-listed company 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 Earnings Tearsheet on a Philippine company interesting and insightful.

Stay tuned for next week’s Philippine company highlight!


Angelica Lim
Research Director
Philippine Markets Newsletter
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