Philippine Markets Newsletter

Direct board involvement is this family-controlled company’s strategy to outperform the market and Uniform Accounting is showing its success

October 20, 2020

Family-controlled businesses have historically been interesting stocks to invest in because of how they have outperformed the market. This business became the largest food ingredient company in the Philippines, driven by its founding family’s direct and hands-on management.

The family-oriented management strategy has generated robust earnings in the last nine years. However, as-reported metrics continue to make the firm appear as a weaker business, inconsistent with what Uniform metrics see.

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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One of the factors that investors should look at when investing in a company is how management runs the business. This can be especially relevant for family-controlled corporations, where a founding family’s wealth is tied up to the company.

In the Philippines, one of the most successful family-controlled businesses has been D&L Industries, Inc. (DNL:PHL), a manufacturer of specialty food ingredients and chemicals.

D&L Industries was founded by brothers Dean and Leon Lao in 1963, selling colorants to the plastic industry. The business was so successful that several years later, three other Lao brothers joined the company to grow the business.

Today, Alvin Lao, the son of co-founder Leon Lao, serves as the company’s CEO. Three out of seven of D&L Industries’ board of directors are family members, while other members of the Lao family, each with more than 20 years of experience in sales, are senior managers.

With the Lao family owning a 70% combined stake of D&L Industries, a significant portion of the family’s wealth is tied to the company. As such, they are highly incentivized to use their management influence in generating value for the company.

The family’s overwhelming control means that the longevity of the company must also be ensured. This was accomplished when D&L Industries diversified and ventured into the food ingredients businesses in 1987.

The expansion gave D&L Industries the opportunity to partner with consumer businesses in the country. It also helped them become one of the leading B2B2C companies in the country, with long standing customer relationships where 70% of them are consumer companies. Today, over 50% of the firm’s revenue comes from its food ingredients segment.

After improving its portfolio, D&L Industries sales grew every year. This gave them the ability to acquire all outstanding shares of Chemrez Technologies Inc in 2014, a manufacturer of environment-friendly powder coatings. Later on, Chemrez became one of the leading industrial and construction-related chemicals suppliers in the country, and now contributes 30% of the firm’s revenue.

All of these are the reasons why D&L Industries continue to outperform the PSEi since its IPO in December 2012.

Although D&L Industries has been rewarding its investors with this outstanding performance, it was not spared from the COVID-19 pandemic that caused the Philippine market sell-off beginning in March.

Investors are right to be concerned given that part of the firm’s business is specialty chemicals, whose customers are mainly automotive businesses. With the disruption in this industry, D&L Industries margins were dragged down during the first half of the year.

The market is still negative on D&L Industries, but it may not be the case for long. First, the reopening of the economy, easing of the lockdown, and increasing demand may position the company to deliver better results for H2 2020.

Second, D&L Industries’ food business contributes about 50% of the firm’s revenue on average. With the business still operating at around 50%-60% plant utilization, it is likely that the company would be able to recover its sales as its food industry customers gradually reopen.

Lastly, D&L Industries remains committed to paying cash dividends worth PHP 1.3 billion, as it has in the previous years, with the company liquid enough to do so.

However, investors’ fears were not only fueled by the impact of the coronavirus crisis but also by representation of the firm’s profitability using as-reported numbers. Specifically, D&L Industries’ ROA only ranged from 6%-11% in the last nine years. In 2019, its as-reported ROA was only at 10%.

On a Uniform accounting basis, however, its TRUE ROA has actually ranged from 12%-18% over the same time frame—much higher than what as-reported metrics show.

One reason behind the distortion in the as-reported figures comes from the accounting treatment of goodwill. Since its acquisitions in 2014, D&L Industries has been recording PHP 3.3 billion worth of goodwill, representing 15% of its as-reported assets.

Goodwill is purely accounting-based and is not actually used in the company’s operations.This falsely inflates the asset base and makes D&L Industries appear to be a less profitable business.

If we remove PHP 3.3 billion goodwill from D&L Industries’ asset base and apply the many other necessary adjustments that Valens makes under Uniform Accounting, we arrive at a 14% Uniform ROA for 2019, significantly greater than its 10% as-reported ROA.

D&L Industries’ earning power is stronger than you think

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

D&L Industries’ Uniform ROA has actually been higher than its as-reported ROA in each of the past nine years. For example, as-reported ROA was 10% in 2019, but its Uniform ROA was actually higher at 14%.

From 2012-2017, as-reported ROA improved from 6% to 11% levels, before declining to 10% in 2019.

Meanwhile, after jumping from 12% in 2012 to 17% in 2013, Uniform ROA dropped to 13% in 2014. Thereafter, Uniform ROA rebounded to a peak of 18% in 2015, before slowly fading to 14% in 2019.

D&L Industries’ margins are weaker than you think, but its strong Uniform asset turns make up for it

Trends in Uniform ROA have been driven primarily by trends in Uniform asset turns, slightly offset by weaker Uniform earnings margins.

Uniform turns fell from 4.0x in 2010 to 1.2x in 2012, before recovering to 1.5x in 2013 and subsequently contracting back to 1.2x in 2014. Thereafter, Uniform turns improved to 1.5x in 2015, before gradually fading to 1.3x in 2019.

Meanwhile, from 2010-2011, Uniform margins dropped from 11% to 9%. Though Uniform margins rebounded to 12% in 2013, it has fluctuated from 11% to 12% through 2019.

SUMMARY and D&L Industries, Inc. Tearsheet

As the Uniform Accounting tearsheet for D&L Industries (DNL:PHL) highlights, the Uniform P/E trades at 22.0x, which is below corporate average valuations and its own history.

Low P/Es require low EPS growth to sustain them. In the case of D&L Industries, the company has recently shown a 25% 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 Philippine Financial Reporting Standards (PFRS) earnings and convert them to Uniform earnings forecasts. When we do this, D&L Industries’ sell-side analyst-driven forecast calls for a 33% decline in 2020, followed by an 18% Uniform EPS growth in 2021.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify D&L Industries’ PHP 5.48 stock price. These are often referred to as market embedded expectations.

The company can have its Uniform earnings shrink by 6% each year over the next three years and still justify current prices. What sell-side analysts expect for D&L Industries’ earnings growth is below what the current stock market valuation requires in 2020 but above its requirement in 2021.

In addition, the company’s earning power is 2x the long-run corporate average. That said, cash flows and cash on hand are slightly below its total obligations—including debt maturities, capex maintenance, and dividends. Together, this signals moderate credit and dividend risk.

To conclude, D&L Industries’ Uniform earnings growth is below peer averages in 2020, and the company is trading well above its peer average valuations.

About the Philippine Markets 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.


Angelica Lim
Research Director
Philippine Markets Daily
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