Philippine Markets Newsletter

At first blush, this Philippine insurance and asset management giant looks like it buys the wrong stocks… think again, as Uniform Accounting proves right.

January 24, 2020

Estate planning in the Philippines includes details of wills that specifically state how assets should be divided among heirs, portfolios of investments managed by a professional, and all kinds of insurance policies.

It’s no longer just the 1% who can afford life insurance policies. Payment schemes have become more attractive and plans have become more flexible for a lot of people.

A particularly popular insurance plan is the variable universal life (VUL) policy that includes the investment of a policyholder’s cash in some financial instrument. This is how the policy’s value is expected to grow.

Policyholders must be mindful over which fund their money goes into and which fund manager is responsible for their returns.

We look at one insurance firm that has made the transformation to an asset management company.

As-reported metrics would lead one to believe that the firm is managing a low return portfolio. However, Uniform Accounting shows that their portfolio managers know exactly what they’re doing.

Philippine Markets Daily:
Friday Uniform Portfolio Analytics
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Many of us would be surprised to learn that the concept of life insurance has been around since the beginning of the 18th century.

The Amicable Society for Perpetual Assurance Office in London was the first to offer this to its members. Members paid a fixed annual amount per share depending on their age. The actual distribution to beneficiaries was dependent on the number of shares that the heirs owned.

In the second half of that century, the computation of premiums would be standardized using actuarial valuations and by adjusting according to interest rates. Premiums would also be regulated by age without restrictions on memberships.

It was also at this time that selling life insurance would begin in the US.

In the Philippines, the earliest record of life insurance was in 1895 when Sun Life Assurance of Canada entered the local insurance market.

Their entry into the Philippines during this time is noteworthy as three years later, the Spanish-American War would break out in the country. In just its first years in the country, insurance would already prove highly useful to the beneficiaries claiming their payments.

Then came World War II, where they had to pay out $1.3 million post-war death claims.

By the end of the 20th century, Sun Life decided that they did not want to just be in the insurance business offering one kind of product.

They became a wholly-owned subsidiary of a publicly-traded company.

By March 2000, Sun Life Financial shares were listed on the Philippine Stock Exchange. A month later, Sun Life started offering mutual funds through Sun Life Asset Management Company, Inc.

One of Sun Life’s mutual funds is the Sun Life Prosperity Philippine Equity Fund (Sun Life Fund). It contains mostly blue-chip stocks, with an investment horizon meant for the long term.

Blue-chip stocks are traditionally thought of as high-value stocks.

Eventually, investors considered blue chips as high-quality companies that have withstood and can withstand the test of time.

Meaning, the stock prices of these companies are not affected by market volatility the same way that the stock prices of seemingly lower-quality companies would be.

When the stock market is down, these blue chips don’t fall as much or stay down as long.

Thus, blue chips are popular among conservative investors whose investment philosophy centers around capital preservation and general risk aversion.

For funds with the goal of generating long-term capital appreciation, such as the Sun Life Fund, blue chips’ stable growth and high quality are the perfect fit.

Two metrics commonly used to determine which blue-chip stocks to add to portfolios are return on assets (ROA) and earnings per share (EPS) growth.

However, simply using as-reported numbers would mislead investors in determining a company’s true profitability.

In order to find out this true profitability, the financial statements of companies must be restated to create a single, consistent set of global accounting standards called Uniform Adjusted Financial Reporting Standards (UAFRS) or Uniform Accounting.

The table shows the top non-financial holdings of Sun Life Fund, as well as their Uniform ROA (ROA’), as-reported ROA, and ROA distortion.

Looking solely at the as-reported ROA, you may wonder why these companies were chosen in the first place since their ROAs are just around the cost-of-capital levels. However, the Uniform ROA paints a different picture.

Based on Uniform Accounting, the ROA’ of the selected companies range from 7% to 39%. Contrary to what as-reported numbers suggest, these companies are actually profitable with real earnings above cost-of-capital levels.

As such, it should not be surprising that when analyzing the non-financial holdings of the Sun Life Fund, the figure that stands out is the huge discrepancy between ROA’ and as-reported ROA.

While the difference in raw figures may not seem too distant, the distortion in percentage ranges from 39% to 514%, with Ayala Corporation and International Container Terminal Services both having distortions greater than a hundred percent.

This chart shows three interesting data points:

– The first datapoint is what Uniform earnings growth is forecast to be over the next two years when we take consensus analyst estimates and convert them to the Uniform Accounting framework. This represents the Uniform earnings growth the company is likely to have for the next two years

– The second datapoint is what the market thinks Uniform earnings growth is going to be for the next two years. Here, we are showing how much the company’s Uniform earnings need to grow 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

– The final datapoint is the spread between how much the company’s Uniform earnings could grow if the Uniform earnings estimates are right, and what the market expects Uniform earnings growth to be

On average, Philippine companies are expected to have 6% annual Uniform earnings growth over the next few years. Meanwhile, Sun Life’s major holdings are forecast to surpass that with 8% projected Uniform earnings growth in the next two years. The market, meanwhile, is seeing these companies decline by 1% a year, mispricing their growth by an average of 9%.

These are the kinds of companies that have growth potential.

Without Uniform numbers, the as-reported numbers would leave everyone confused.

Among Sun Life’s top holdings, SM Investments Corporation (SM:PHL) has one of the most notable earnings growth dislocations. The market is pricing the country’s largest conglomerate to grow by 4% in the next two years, but analysts are seeing a robust 20% Uniform Earnings Growth fueled by the firm’s extensive expansion projects through 2022.

Another company with understated earnings growth is Ayala Land, Inc. (ALI:PHL). The real estate giant launched several projects worth more than PHP 100bn in 2019. The market is seeing earnings growth to be at 11% in the next two years. However, ALI’s analysts are pricing in a stronger 19% Uniform earnings growth over the same period.

Meanwhile, there is one company in the portfolio that Sun Life may need to take another deeper review—San Miguel Corporation (SMC:PHL).

The market is pricing San Miguel to have 7% earnings growth moving forward when analysts are forecasting flat earnings growth annually. This doesn’t look like an intrinsically undervalued company—if anything, the market is too bullish.

With an average as-reported ROA of 5% and market-expected earnings shrinkage of 1% annually, one might think that Sun Life’s portfolio is weak. However, looking through the lens of Uniform Accounting, for the most part, Sun Life’s portfolio looks like a high quality, undervalued set of stocks with businesses displaying strong earning power.

SM Investments Tearsheet

As the largest individual stock holding in the Sun Life Prosperity Equity Fund, we’re highlighting SM Investments’ tearsheet today.

As the Uniform Accounting tearsheet for SM Investments (SM:PHL) highlights, SM Investments’ Uniform P/E trades at 18.8x, below market average valuations and at par with its recent averages.

Low P/Es require low, and even negative, EPS growth to sustain them. In the case of SM, the company has recently shown a robust 43% 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 PFRS earnings and convert them to Uniform earnings forecasts. When we do this, SM’s sell-side analyst-driven forecast is at a lower 26% growth into 2019, which drops to a 14% growth in earnings in 2020.

Based on the current stock market valuations, we can back into the required earnings growth rate that would justify PHP 1,069 per share. These are often referred to as market embedded expectations. In order to meet the current market valuation levels of SM, immaterial Uniform earnings growth is required of the company over the next three years.

What sell-side analysts expect for SM’s earnings growth falls far above what the current stock market valuation requires.

To conclude, SM’s Uniform Earnings Growth is slightly above peer averages in 2020. Also, the company is trading at peer average valuations.

The company has an average earning power, based on its Uniform ROA calculation. Together, this signals a low cash flow risk to the current dividend level in the future.

About the Philippine Markets 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.

These portfolio managers either take on an active role in trading securities or take on a more passive role by putting additional investments in funds.

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.

Sometimes, it might look like the manager is buying stocks that don’t seem like high-quality firms. Other times, it might look like the manager is taking a very long-term position on a stock that has not moved for a long time.

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 the Sun Life Prosperity Equity Fund interesting and insightful.

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


Angelica Lim & Joel Litman
Research Director & Chief Investment Strategist
Philippine Markets Daily
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