Philippine Markets Newsletter

Due to how diverse its businesses are, this holding company is nearly generating returns above the cost of capital, at Uniform ROA of 5%, not 4%

September 21, 2022

Amid the franchise controversy it was involved in since 2020, this company was still able to register strong profitability because of its diversified portfolio. However, its as-reported metrics do not seem to fully capture the company’s strategy as its profitability is actually above the cost of capital.

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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Known as a leading business figure, Eugenio Lopez Sr. headed multiple conglomerates in his lifetime. In 1961, he led a group of Filipino investors and bought the Manila Electric Railroad and Light Company (MER:PHL), currently known as Meralco, from its American owners.

He would go on to lead other influential conglomerates such as First Gen Corporation (FGEN:PHL) and ABS-CBN Corporation (ABS:PHL), before his passing in 1975.

In 1993, Benpres Holdings Corporation was publicly listed in the stock market. Its name was an homage to his parents, Benito and Presentacion. Its main purpose was to consolidate the business interests of the Lopez family. 

Eventually, the company would be renamed in 2010 to Lopez Holdings Corporation (LPZ:PHL), which holds business interests in companies such as First Philippine Holdings Corporation and ABS-CBN Corporation.

However, despite its huge size and advantage in holding interests in power generation and distribution; real estate development; and broadcasting and cable, the Lopez group struggled through 2020 amid an economic slowdown and the ABS-CBN franchise renewal controversy.

This renewal controversy continued to affect ABS-CBN’s free-to-air business, resulting in a net loss of P1.46 billion for H1 2022.

Nevertheless, ABS-CBN persists in operating in businesses that do not require the franchise in the first place, such as international licensing and distribution, digital and cable businesses, and various streaming services on the internet. Furthermore, ABS-CBN has been improving as it registered an improvement in its net income by 57% from H1 2021.

Meanwhile, First Philippine Holdings Corporation boosted its attributable net income by 7% in the same period last year due to increased economic activity, effectively offsetting ABS-CBN’s losses. The Lopez group’s earnings grew by as much as 135% as of H1 2022.

Moreover, First Gen continues to expand its operations and pursue growth projects. Specifically, the company announced its plans to launch its own LNG import terminal by early 2023.

Looking at as-reported metrics, it appears that the Lopez group’s growing and diversified position helped in consistently generating low profitability since 2012, with return on assets (ROAs) remaining at 4% in 2021.

In reality, the company’s diversified strategies did better than presented, with Uniform ROAs performing nearly above cost of capital levels at 5%.

Historically, one of the largest distortions for Lopez Holdings 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) allow minority interest expense to be recognized under operating cash flow, leading people to incorrectly think 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 2021, Lopez Holdings recognized PHP 14.6 billion in minority interest expense, resulting in a PHP 1.5 billion net profit and a 4% as-reported ROA. Adding this back alongside the many other adjustments Valens makes, the company should actually be recognizing PHP 15.4 billion in Uniform earnings and a 5% Uniform ROA.

Lopez Holdings’ 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 that Lopez Holdings’ profitability has been recently weaker than real economic metrics highlight.

Through Uniform Accounting, we can see that the company’s true ROAs have been understated over the past decade. For example, as-reported ROA was 4% in 2021, but its Uniform ROA was actually higher at 5%. 

Lopez Holdings’ earnings margins are less profitable than you think

Trends in Uniform ROA have been driven by trends in Uniform earnings margins. For more than two decades, as-reported metrics have overstated Lopez Holdings’ earnings margin, a key driver of profitability.

Moreover, as-reported EBITDA margin has reached up to 41%. In comparison, Uniform margins have yet to eclipse 22% over the same time period, making Lopez Holdings appear to be a more profitable business than real economic metrics highlight.

SUMMARY and Lopez Holdings Corporation Tearsheet

As our Uniform Accounting tearsheet for Lopez Holdings Corporation (LPZ:PHL) highlights, the company trades at a Uniform P/E of 12.8x, below the global corporate average of 19.3x, but around its historical P/E of 12.0x.

Low P/Es require low EPS growth to sustain them. In the case of Lopez Holdings, the company has recently shown a 564% 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, Lopez Holdings’ sell-side analyst-driven forecast is to see Uniform earnings decline of 48% in 2022 and a growth of 3% in 2023.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Lopez Holdings’ PHP 3.00 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to shrink by 6% annually over the next three years. What sell-side analysts expect for Lopez Holdings’ earnings growth is below what the current stock market valuation requires by 2022, but above the requirement by 2023.

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

To conclude, Lopez Holdings’ Uniform earnings growth is below its peer averages, and in line with 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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