Philippine Markets Newsletter

Despite this mining company’s cyclical headwinds, Uniform Accounting shows a consistent ROA almost 2x its as-reported

June 23, 2020

According to WorldAtlas, the Philippines is the second largest nickel ore producer and exporter in the world after Indonesia. This base metal was one of the best performing metals in 2019, and is the seventh top export of the Philippines with 1.8% share of its total exports.

This firm is one of the largest nickel ore miners in the country, and has largely benefited from strong nickel prices in the past. Uniform Accounting reflects how well the firm performed contrary to what as-reported metrics show.

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

Philippine Markets Daily:
Tuesday Uniform Earnings Tearsheets – Philippine-listed Focus
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Nickel is a versatile metal used every day. Its ductility and corrosion resistance has made it highly attractive for modern use.

Rarely utilized in its purest form, nickel is widely used in alloys for the production of stainless steel, coins, and batteries.

The Philippines holds one of the largest nickel deposits in the world, second only to Indonesia as the world’s largest producer and exporter.

Most of the country’s nickel mining activity can be attributed to Nickel Asia Corporation (NIKL:PHL), which is among the largest producers of lateritic ore in the world.

The company primarily exports its saprolite and limonite ore to China, the largest nickel ore consumer. China then processes these ores for their stainless steel production.

As lucrative as the nickel business might sound, companies in the materials sector are often sensitive to the business cycle since they heavily rely on their commodity’s market conditions. In economic downturns, mining companies face cyclical headwinds on top of contending with any company problems.

Nickel Asia and its peers suffered in the past decade as nickel prices dramatically dropped from historical highs in 2007.

In 2012, Nickel Asia incurred a PHP 2.22 billion loss due to a stronger peso and low London Metal Exchange (LME) prices.

The company rebounded in 2014 as a result of nickel ore prices recovering and record volume sales. This price rally was short-lived as China’s growth started to slow down, leading to a decline in its stainless steel production and nickel demand.

The mining industry hit several headwinds shortly after.

In 2017, the local mining industry was placed under massive scrutiny as the Department of Environment and Natural Resources (DENR) began its campaign to preserve the country’s natural resources.

Open-pit mining was banned, while several other mining companies were shut down due to environmental concerns and violations of the law.

Hinatuan Mining Corp, a unit of Nickel Asia, was one of those affected by the government’s mining shutdowns.

Furthermore, in 2019, the US-China trade war generated greater uncertainty to commodities, particularly in stainless steel.

Now with the COVID-19 pandemic, shipments of nickel ores have been temporarily banned, forcing the company to halt mining operations. The suspension of its mines resulted in a net loss of PHP 84 million in Q1 2020.

Despite these issues, long-term tailwinds remain for Nickel Asia if it can overcome near-term headwinds.

Just last year, the Indonesian authorities banned all of its nickel mining companies from exporting nickel. Due to this, the international nickel market lost its largest supplier and created a massive growth opportunity for the Philippines to capitalize on.

If China’s nickel demand improves, the Philippines is poised to dominate the nickel market with Nickel Asia spearheading the effort.

When focusing on Nickel Asia’s financial performance, Uniform accounting has reflected stronger profitability each year than what as-reported metrics have highlighted.

As-reported numbers show that Nickel Asia has only had profitability near cost-of-capital levels since 2015, reflecting a 7% ROA in 2019. However, when making the necessary adjustments for accounting distortions, Nickel Asia’s Uniform 2019 earning power is nearly double that number.

Much of the difference between as-reported and Uniform accounting lies in how the minority interest or the non-controlling ownership of subsidiaries is treated.

As a form of equity, minority interest occurs when companies other than the parent company gain less than 50% ownership of a subsidiary, in exchange for capital.

As such, any transaction that takes place related to non-controlling interest is a financing cash flow and is not part of the core operations of the business. Hence, minority interest expense is added back to earnings.

In 2019, the company’s minority interest expense of PHP 1.14 billion is 40% of as-reported net income of PHP 2.7 billion. Adding this back and with the many other adjustments Valens makes, we arrive at the firm’s TRUE earning power of 13%.

Nickel’s earning power is stronger than you think

As-reported metrics distort the market’s perception of the firm’s recent profitability. If you were to just look at as-reported ROA, you would think the company is a much weaker business than real economic metrics highlight.

For example, as-reported ROA was 7% in 2019, significantly lower than its Uniform ROA of 13%.

Through Uniform Accounting, we can see that the company’s true ROAs have actually been higher than its as-reported ROA in each of the past eleven years. Since 2010, Uniform ROA has been more than 2x the as-reported numbers. Additionally, when Uniform ROA reached a peak of 65% in 2014, as-reported ROA was only at 29%.

After rising from 12% in 2009 to 62% in 2011, Uniform ROA dropped to 20% in 2013 as nickel ore prices weakened. Thereafter, Uniform ROA rebounded to a peak of 65% in 2014, before deteriorating to 9% in 2016 and subsequently recovering to 13%-15% levels through 2019.

Nickel Asia has a more efficient business than you think

Similarly, as-reported metrics significantly distort the firm’s asset utilization, a key driver of profitability.

In 2019, as-reported asset turnover was 0.4x compared to Uniform asset turns of 0.8x, making the company appear to be a less asset efficient business than real economic metrics highlight.

Moreover, as-reported asset turnover has been lower than Uniform turns each year for the past 10 years, distorting the market’s perception of the firm’s historical asset efficiency levels.

Similar to the company’s ROA trend, Uniform turns historically improved from 0.5x in 2009 to 1.2x in 2011, before fading to 0.8x in 2013 and jumping to a 1.5x high in 2014. Then, Uniform turns compressed to 0.7x in 2016, before stabilizing at 0.8x-0.9x levels in 2017-2019.

SUMMARY and Nickel Asia Corporation Tearsheet

As the Uniform Accounting tearsheet for Nickel Asia highlights, the Uniform P/E trades at 3.3x, which is far below corporate average valuation levels and its own history.

Low P/Es require low EPS growth to sustain them. In the case of Nickel Asia, the company has recently shown a 11% Uniform EPS decline.

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, Nickel Asia’s sell-side analyst-driven forecast calls for 66% and 8% Uniform EPS growth in 2020 and 2021, respectively.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Nickel Asia’s PHP 2.00 stock price. These are often referred to as market embedded expectations.

The company can have Uniform earnings shrink by 26% each year over the next three years and still justify current prices. What sell-side analysts expect for Nickel Asia’s earnings growth is far above what the current stock market valuation requires.

The company’s earning power is 2x the long-run corporate average. In addition, cash flows are significantly higher than its total obligations—including debt maturities, capex maintenance, and dividends. Together, this signals low credit and dividend risk.

To conclude, Nickel Asia’s Uniform earnings growth is above peers in 2020, while the company is trading below peer valuations.

About the Philippine Market Daily
“Tuesday 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 Tuesday, 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 Daily
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