Philippine Markets Newsletter

One of the country’s largest companies might just have it all, actually holding 2x its returns reaching a Uniform ROA of 9%, not 4%

August 10, 2022

Rising inflation is not too much of a concern for this company that has growth-accretive industries under its portfolio. However, its as-reported metrics do not seem to fully capture the company’s TRUE return on assets (ROA).

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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Originally a shoe shop, this company eventually evolved into one of the country’s largest companies in terms of market capitalization.

Now, the SM Investments Corporation (SM:PHL), or the SM Group, holds interests in various industries such as shopping mall development and management, real estate development through SM Prime Holdings, Inc. (SMPH:PHL), financial services through BDO Unibank, Inc and China Banking Corporation, and tourism.

However, even large companies like the SM Group are not immune to the negative effects of the pandemic. Despite its diversified portfolio, the SM Group took a hit as quarantine restrictions constrained consumer spending. This continued into 2021, albeit at a lesser degree.

In 2022, soaring prices brought by inflation have been the main growth risk for the company.

Nevertheless, the company’s profitability is approaching pre-pandemic levels as the banking segment of BDO and China Bank’s net income grew by 12% and 39%, respectively, for the first half of 2022.

The banks’ operational system proved resilient amidst global headwinds on loan activity. Because of this, the banking segment led the company’s charge as it contributed 48% to the SM Group’s net income. 

Meanwhile, its revenues in the retail segment improved to 18% as foot traffic and spending recovered from last year’s first half.

Although external risks such as global supply disruptions can affect the company’s retail inventories, the SM Group’s diversification strategy to acquire and grow its portfolio makes it positioned to withstand such risks.

For example, just last week, the company acquired a majority stake in Allfirst Equity Holdings Inc. In effect, SM Group became the sole owner of its subsidiary—Philippine Geothermal Production Company Inc. (PGPC), a business in the development of minerals, mineral oils, geothermal, and other similar products. 

This strategic acquisition could prove accretive to SM Group and its shareholders as the company continues to promote clean energy.

Looking at as-reported metrics, it appears that SM Group continues to generate profitability below cost of capital levels, with return on assets (ROAs) recovering from a historical trough amid the pandemic.

In reality, the company’s diversification strategy actually did better than presented, with Uniform ROAs performing above cost of capital levels at 19%.

The distortion between Uniform and as-reported ROAs comes from as-reported metrics failing to consider the amount of non-operating long-term investments on SM Group’s balance sheet.

These long-term investments are intangible assets that are purely accounting-based and unrepresentative of the company’s actual operating performance. When as-reported accounting includes this in a company’s balance sheet, it creates an artificially inflated asset base.

As a result, as-reported ROAs are not capturing the strength of SM Group’s earning power. Adjusting for non-operating long-term investments, we can see that the company’s displayed performance is actually misrepresented. In fact, the returns are better than it seems.

SM Group’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 that SM Group’s profitability has been stronger than real economic metrics highlight.

Through Uniform Accounting, we can see that the company’s true ROAs have been mostly understated over the past decade. For example, as-reported ROA was 4% in 2021, but its Uniform ROA was actually higher at 9%. 

SM Group’s asset turns are more efficient than you think

Trends in Uniform ROA have been driven by trends in Uniform asset turns. For more than two decades, as-reported metrics have understated SM Group’s asset efficiency, a key driver of profitability.

Moreover, as-reported asset turnover has reached a peak of 1.2x. In comparison, Uniform turns have yet to exceed 0.5x over the same time period, making SM Group appear to be a less efficient business than real economic metrics highlight.

SUMMARY and SM Investments Corporation Tearsheet

As our Uniform Accounting tearsheet for SM Investments Corporation (SM:PHL) highlights, the company trades at a Uniform P/E of 16.7x, below the global corporate average of 19.3x, and its historical P/E of 24.4x.

Low P/Es require low EPS growth to sustain them. In the case of SM Group, the company has recently shown a 172% 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 Philippine Financial Reporting Standards (PFRS) earnings and convert them to Uniform earnings forecasts. When we do this, SM Group’s sell-side analyst-driven forecast is to see Uniform earnings growth of 29% and 34% in 2022 and 2023, respectively.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify SM Group’s PHP 795.00 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to grow immaterially per year over the next three years. What sell-side analysts expect for SM Group’s earnings growth is well above what the current stock market valuation requires in 2022 and 2023.

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

To conclude, SM Group’s Uniform earnings growth is above 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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