Philippine Markets Newsletter

Taking advantage of surveillance industry trends, this company garnered a Uniform ROA of 13% instead of 7%

June 9, 2021

This company has been able to ride the boom in the global surveillance industry. It has remained the top security solutions company in its home country due to its focus on investments in new analytics and maintenance.

However, as-reported metrics do not seem to reflect the impact of these efforts. Uniform Accounting shows that the business has a better Uniform return on assets (ROA) than what you might think.

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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One of the earlier solutions proposed and implemented to contain the spread of the novel coronavirus was contact tracing. This entailed creating a detailed map of everyone’s movements—one miss could cause a butterfly effect, leading to a superspreading event.

While many industries are buckling under the impacts of the pandemic, some are standing out, especially the security service industry. In fact, this industry is actually seeing a boom during this crisis as governments and institutions turn to surveillance technology for contract tracing.

The security service market went from USD 93.0 billion in 2019 to currently being valued at USD 195.3 billion. The market is even expected to significantly grow to USD 376.3 billion by 2028.

Asia, in particular, is forecasted to be the fastest-growing security services market globally due to increasing manufacturing bases in emerging economies. It has also grown to be the second largest security service market in recent years.

One company benefiting from this trend is Korean security service company, S-1 Corporation.

Established in 1977 as an affiliate of Samsung, S-1 Corporation started the first security monitoring business in Korea. Since then, the company has evolved into the largest security solution provider in Korea, with offerings like physical security, integrated security, information security, building management solutions, and others.

While being directly connected to a global household name helps S-1 Corporation’s technology take over South Korea’s surveillance system, the company continues to perform thanks to its dedication to quality and innovation.

The company is able to thrive in a very competitive industry by investing in security solutions with new analytics such as systems that allow for access control. This technology is now essential with unmanned stores in South Korea now on the rise.

S-1 Corporation’s research center has also developed a video surveillance solution aided by anti-environment hazard features. All security measures are sent to the company’s command center, which have video display systems and wireless network systems that provide crucial safety information especially for manufacturing plants.

To ensure the quality of these systems, the company emphasizes systematic maintenance. The company uses their national service network to visit sites and take proper action when need be and have acquired global partners that assist with technology and maintenance.

Looking at S-1 Corporation’s efforts to maintain the quality of their systems, one would assume that they would have strong profitability.

However, as-reported metrics show that the company’s performance has been weak, showing an ROA of just 7% to 13% in the past sixteen years.

With Uniform Accounting, a different perspective is revealed. Specifically, the company’s Uniform returns are actually significantly higher than its as-reported metrics in recent years. In 2011, while as-reported ROA was only at 11%, Uniform ROA was actually 20%.

The distortion between Uniform and as-reported ROAs comes from as-reported metrics failing to consider the amount of goodwill on S-1 Corporation’s balance sheet. In recent years, goodwill sits at about 17% to 24% of its total assets in recent years, stemming from the company’s acquisitions.

Goodwill is an intangible asset that is 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 S-1 Corporation’s earning power. Adjusting for goodwill, we can see that the company isn’t actually performing poorly. In fact, it has been the complete opposite, with returns that are nearly 2x greater.

S-1 Corporation’s profitability is much more robust than you think

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 reveal.

S-1 Corporation’s Uniform ROA has been higher than its as-reported ROA for the past 16 years. For example, when Uniform ROA was at 20% in 2011, as-reported ROA was only 11%.

The company’s Uniform ROA for the past sixteen years has ranged from 8% to 20%, while as-reported ROA has ranged only from 7% to 13% in the same timeframe.

Specifically, Uniform ROA improved from 16% in 2005 to 20% in 2011, before falling to 8% in 2018. It then rebounded to 13% in 2020.

S-1 Corporation’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 margin and Uniform asset turns, with peaks and troughs lining up historically with that of Uniform ROA.

After trending at 11%-12% levels in 2005 to 2008, Uniform margins declined to 8% in 2009 before peaking at 13% in 2011. Then, Uniform margins fell to 4% in 2018, before stabilizing at 6% levels from 2019-2020.

Meanwhile, Uniform turns trended at 1.5x-1.7x levels from 2005 to 2013 before peaking at 2.4x in 2015. It then fell to 2.2x in 2020.

SUMMARY and S-1 Corporation Tearsheet

As the Uniform Accounting tearsheet for S-1 Corporation (012750:KOR) highlights, the Uniform P/E trades at 16.2x, which is below the global corporate average of 23.7x and its own historical average of 20.5x.

Low P/Es require low EPS growth to sustain them. In the case of S-1, the company has recently shown a 1% 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 Korean International Financial Reporting Standards (K-IFRS) earnings and convert them to Uniform earnings forecasts. When we do this, S-1 Corporation’s sell-side analyst-driven forecast is a 15% and an 10% EPS growth in 2021 and 2022, respectively.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify S-1 Corporation’s KRW 81,200 stock price. These are often referred to as market embedded expectations.

S-1 is currently being valued as if Uniform earnings were to shrink 2% annually over the next three years. What sell-side analysts expect for S-1 Corporation’s earnings growth is above what the current stock market valuation requires in 2021 and 2022.

Furthermore, the company’s earning power is 2x above the long-run corporate average. Also, cash flows and cash on hand are 3x its total obligations—including debt maturities, capex maintenance, and dividends. All in all, this signals a low credit and dividend risk.

To conclude, S-1 Corporation’s Uniform earnings growth is in line with its peer averages, and the company is also trading in line with its 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:

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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