Philippine Markets Newsletter

Humanizing technology proves it’s working for this company, generating a Uniform ROA 16x higher than as-reported!

July 29, 2020

The continuous evolution of technology paved the way for the birth of artificial intelligence, virtual reality, and the internet of things (IoT).

This Chinese company is a firm believer of “humanizing technology.” It offers top-of-class home appliances and has a unique business model that helps the company achieve this goal.

As-reported metrics do not translate this in the company’s returns. On the other hand, Uniform Accounting shows that the company’s innovative efforts resulted in robust Uniform return on assets (ROA).

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

Philippine Markets Daily:
Wednesday Uniform Earnings Tearsheets – Asia-listed Focus
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Technology has transcended beyond what many might have imagined.

Throughout the years, humans have become accustomed to relying on technology for entertainment or to get certain tasks done. As a result, artificial intelligence, IoT, virtual reality, and the like have become deeply entrenched in people’s lives.

As technology continues to rapidly evolve, consumers have learned to constantly look for products that they believe would provide them with better experiences. This is what is known as “humanizing technology.”

Humanizing technology to some means to incorporate artificial intelligence with human-like qualities or intelligence. It could also be described as personalizing interfaces for humans to better enjoy their experiences, or technology that has the ability to easily recognize human factors such as emotions.

The consensus remains to be that humanizing technology means to progress humanity or to develop technology that generally works better with humans.

This holds true for this Chinese electrical appliance company that defines humanizing technology as making technology “a more seamless interface for human use,” claiming that it is at the core of everything the company does.

Midea Group is a world leading technology company that specializes in robotics, industrial automation, HVAC systems, consumer appliances, and smart logistics.

Midea has developed tools and management methods to enhance its efficiency across its entire value chain. The company calls this business method the Midea Business System, which is exclusive only to Midea Group. This has helped the company mitigate its costs and deliver satisfaction to its customers all around the globe.

For the company to respond to its end users’ true needs, Midea has tailored its business model by carefully studying its customers’ demands. The company has developed the T+3 business model, which also promotes the efficiency goals of Midea Business System.

This business model has a 12-day target to complete a customer’s order, from order placement (T0), material preparation (T1), product creation (T2), and to product delivery (T4).

Because of this, Midea is one of the world’s largest manufacturers of home appliances. It continuously invests a portion of its profits in research and development to further innovate its product portfolio. The company handles 20 research centers in nine countries, working with over 10,000 R&D personnel and 300 leading academics and senior experts globally.

Considering the company’s efforts to improve its products through technology and promoting cost efficiency, its as-reported returns of 6% in 2019 is weaker than what it should really be.

Midea’s real economic profitability is better reflected with Uniform Accounting adjustments, which shows its TRUE earning power.

What as-reported metrics fail to do is to consider the company’s excess cash on the balance sheet. While most companies inherently need some level of cash to operate, the portion of that balance that is earning limited or no return—or excess cash—ends up diluting as-reported ROAs.

If excess cash remains included in the company’s asset base in computing its performance metrics, the company’s profitability and capital efficiency may appear weaker than it actually is.

From 2012 to 2019, Midea has had a significant amount of excess cash sitting idly in its balance sheet, ranging from 10% to 33% of its unadjusted total assets.

After excess cash and other significant adjustments are made, the company actually had a 93% Uniform ROA in 2019, which is more than 16x stronger than their as-reported ROA of 6%.

Midea’s valuations are cheaper than corporate averages

Midea Group Co., Ltd. (000333:CHN) currently trades below corporate averages at an 18.0x Uniform P/E (blue bars), with an as-reported P/E of 18.9x (orange bars).

At these levels, the market is pricing in expectations for Uniform ROA to decline to 55% in 2024, accompanied by 7% Uniform asset growth going forward.

However, analysts have less bearish expectations, projecting Uniform ROA to slightly decline to 89% levels in 2021, accompanied by a 11% Uniform asset growth.

Midea’s profitability is much better than you think it is

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 highlight.

Midea’s as-reported ROA has been significantly lower than its Uniform ROA in the past eleven years. For example, as-reported ROA is 6% in 2019, drastically lower than its Uniform ROA of 93%. Uniform ROA reached an all-time high of 140% in 2016, that is 20x stronger than the as-reported ROA of just 7%.

The company’s Uniform ROA for the past eleven years has ranged from 15% to 140%, while as-reported ROA ranged only from immaterial levels to 7% in the same timeframe.

From 30% in 2009, Uniform ROA gradually decreased to 15% in 2012, before reaching peak 140% levels in 2016. Afterwards, Uniform ROA fell to 68% in 2018, before recovering to 93% in 2019.

Midea’s Uniform earnings margins are weaker than you think but its robust Uniform asset turns make up for it

Volatility in Uniform ROA has been driven by trends in both Uniform earnings margins and Uniform asset turns, with peaks and troughs lining up historically with that of Uniform ROA.

Uniform earnings margins decreased from 6% in 2009 to 4% in 2012, before rising to 10% in 2014. Uniform earnings margins gradually faded to 9% in 2019.

Meanwhile, Uniform asset turns fell from 5.3x in 2009 to 3.5x in 2012, before reaching a peak of 14.3x in 2016. It then decreased to 8.4x in 2018, before recovering to 10.9x in 2019.

SUMMARY and Midea Group Co., Ltd. Tearsheet

As the Uniform Accounting tearsheet for Midea Group Co., Ltd. (000333:CHN) highlights, the Uniform P/E trades at 18.0x, which is below corporate average valuation levels, but above its own recent history.

Low P/Es require low EPS growth to sustain them. In the case of Midea, the company has recently shown a 14% 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 Chinese Accounting Standards (CAS) earnings and convert them to Uniform earnings forecasts. When we do this, Midea’s sell-side analyst-driven forecast is a 5% earnings shrinkage in 2020 followed by 17% earnings 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 Midea’s CNY 66.50 stock price. These are often referred to as market embedded expectations.

The company can have Uniform earnings shrink by 8% each year over the next three years and still justify current prices. What Wall Street analysts expect for Midea’s earnings growth is above what the current stock market valuation requires in 2020 and 2021.

The company’s earning power is 15x the corporate average. Also, cash flows are higher than its total obligations—including debt maturities, capex maintenance, and dividends. Together, this signals low credit and dividend risk.

To conclude, Midea’s Uniform earnings growth is below with its peer averages in 2019. Also, the company is trading above average peer valuations.

About the Philippine Markets Daily
“Wednesday Uniform Earnings Tearsheets – Asia-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: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 UAFRS, 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 company listed in Asia that’s relevant to the Philippines and 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 Earning Tearsheet on an Asian company interesting and insightful.

Stay tuned for next week’s Asia company highlight!


Angelica Lim
Research Director
Philippine Markets Daily
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