Philippine Markets Newsletter

Beating the heat through innovative solutions powered up this company’s profitability, reaching Uniform ROAs of 10%+

February 9, 2022

This air conditioner and refrigerator company was able to capitalize on the hot temperatures in the Philippines and position itself to be the country’s market leader.

Although its as-reported metrics do not show it, the company’s continued efforts in product improvement and innovative cooling solutions enabled it to reach Uniform ROAs of more than 10%.

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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As a tropical country, the Philippines’ climate is only divided into two that come in extremes—rainy and dry seasons.

Situated near the equator, this means the Philippines is more prone to extremely high temperatures. This is why Filipinos are constantly looking for ways to beat the heat, especially when they are at home.

Some would buy thirst-quenching drinks and store them in their refrigerators, and others would coop themselves up in their air-conditioned rooms.

As the world continues to heat up, demand for these appliances will continue to increase.

Luckily, both of these appliances can be purchased under one company—Concepcion Industrial Corporation (CIC:PHL).

When it started out, the company’s focus was only in the air conditioner market. Today, not only is Concepcion Industrial the largest provider of the appliance in the country, but it has also expanded its product lineup to include a wider range of offerings, dominating the refrigerator business as well.

Since then, the company’s portfolio just grew bigger, sporting successful brands such as Carrier, Condura, Toshiba, and Midea.

By the end of 2018, Concepcion Industrial has already begun investing in innovation and technology ventures, scoring several strategic partnerships under its subsidiary Cortex Technologies. 

Specifically, the company was able to launch CNX for Home, enabling its customers to have a smarter and more efficient home. On top of that, Concepcion Industrial also acquired start-up firm Teko Solutions, which further paved the company’s path to innovative and technological success.

Additionally, the company continued to look for more ways to catch up with the emerging trends. It even partnered with Oracle Fusion Cloud Applications to consolidate its business operations.

In 2020, due to the pandemic, Concepcion Industrial added another offering to its roster of already-successful products under Condura—Condura Vax Safe—to keep vaccines from spoiling.

Concepcion Industrial’s continued focus on product improvement and innovative solutions implies that the company has indeed strongly positioned itself in the appliances market. 

However, looking at as-reported metrics, it appears its strategy resulted in unremarkable profitability, with return on assets (ROAs) only reaching a peak of 17%.

In reality, thanks to the company’s drive to pursue innovative investments, it has been able to achieve higher ROAs than as-reported, with Uniform ROAs reaching as high as 26% in recent years.

What as-reported metrics fail to consider is how current liabilities are factored into the ROA calculation. Traditional ROA calculations for measuring a firm’s earning power only include current and long-term assets as part of the cost of investment. 

However, a company’s ability to receive goods and services in advance of payments—the current operating liabilities—ought to be factored in as well.

Current liabilities (excluding short-term debt) are necessary for operations. Items such as accounts payable, accrued expenses, and others are used to maintain the firm’s current capital position. On the other hand, long-term liabilities are mostly just used to finance the business.

If a company has a ton of cash to service its current liabilities and we only factor in its cash, it would make the company look inefficient. In reality, the company is just being responsible by building liquid assets to meet short-term obligations. 

As such, net working capital (current assets – current liabilities) is used for the firm’s ROA calculation. This shows a company’s real cash management ability and thereby, its true earning power.

In the case of Concepcion Industrials, the as-reported metrics’ asset base for ROA calculation is at PHP 12.7 billion in 2020, leading to a 5% as-reported ROA.

However, when subtracting current operating liabilities and applying other needed adjustments, we arrive at Concepcion Industrials PHP 7.6 billion Uniform assets, resulting in a 10% Uniform ROA.

Concepcion Industrial’s profitability is stronger than you think in recent years

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 reveal.

For example, Uniform ROA for Concepcion Industrial was 10% in 2020, substantially higher than the as-reported ROA of 5%, making the company appear to be a much weaker business than real economic metrics highlight for the past six years. 

Moreover, since 2011, Uniform ROA reached a peak of 26% in 2016, while as-reported ROA has not run past 17% in the same time frame, substantially distorting the market’s perception of the firm’s ceiling.

Concepcion Industrial’s Uniform asset turns are stronger than you think in recent years

As-reported metrics are distorting the market’s perception of the firm’s asset efficiency. If you were to just look at as-reported asset turns, you would think that the company is a less efficient business than real economic metrics reveal.

Specifically, as-reported asset turnover ranged from 1.2x to 1.6x through 2019, before contracting to a low of 0.8x in 2020.

Meanwhile, Uniform asset turns have expanded from 1.2x to a peak of 2.2x in 2016, before compressing to 1.4x in 2020.

SUMMARY and Concepcion Industrial Corporation Tearsheet

As our Uniform Accounting tearsheet for Concepcion Industrial Corporation (CIC:PHL) highlights, the company trades at a Uniform P/E of 39.0x, which is above the global corporate average of 24.0x and its historical P/E of 22.3x.

High P/Es require high EPS growth to sustain them. In the case of Concepcion Industrial, the company has recently shown an 48% 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 Philippine Financial Reporting Standards (PFRS) earnings and convert them to Uniform earnings forecasts. When we do this, Concepcion Industrial’s sell-side analyst-driven forecast is to see Uniform earnings decline of 4% and 1% in 2021 and 2022, respectively.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Concepcion Industrial’s PHP 21.00 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to shrink 9% over the next three years. What sell-side analysts expect for Concepcion Industrial’s earnings growth is above what the current stock market valuation requires in 2021 and 2022.

However, the company’s earning power is 2x the long-run corporate average. Moreover, cash flows and cash on hand are 4x its total obligations—including debt maturities, capex maintenance, and dividends. Together, this signals a low dividend risk.

To conclude, Concepcion Industrial’s Uniform earnings growth is in line with its peer averages, but it currently trades above its average peer 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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