Philippine Markets Newsletter

The ringing distortions suggest that this company’s earnings margins have not always been as good as you think

August 24, 2021

This company played a crucial role in Filipinos’ ability to work from home during the pandemic, and its efforts are paying off with margins at recent highs.

As-reported metrics show that the company has always been efficient in managing its costs. However, that hasn’t been the case when we look at Uniform Accounting metrics and what’s causing all the noise in the company’s financial statements. 

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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Competition generally brings out the best of participants as businesses strive to stand out through differentiated products, services, and strategies that aim to benefit the customers in the long run.

One way to remain competitive and ensure the sustainable growth of businesses is through investing heavily in capital investments such as research and development (R&D). 

Some of the industries that are known to have intense capital requirements are the automotive, semiconductor, real estate, as well as telecommunications industries.

However, at times, these high capital requirements, coupled with other obstacles including regulatory requirements, deter other players from entering the industry. 

Such is the case with the telecommunications industry in the Philippines, where only two major players—PLDT Inc. (TEL:PHL) and Globe Telecom, Inc. (GLO:PHL)—dominate the market.

However, the lack of significant competition in this duopoly, among other issues, has resulted in the Philippines having the slowest average internet speed and higher costs among ASEAN countries in 2014, according to an international study. 

As a response to this issue, the Philippine government decided it was time to introduce a third player in the telco industry. 

Though it may be a while before PLDT or Globe will lose market share to their newest competitor, Dito Telecommunity Corporation, PLDT has already begun further investing in capital spending.  

In order to fund its investments, PLDT sold assets such as Rocket Internet shares, its Smart Tower in Makati, as well as its non-strategic cell towers. 

From spending a total of around PHP 260 billion in the last five years on infrastructure investments, the company has allocated a record-high capex budget of PHP 92 billion in 2021 alone.

With businesses highly dependent on the internet now more than ever during quarantine restrictions, PLDT is preparing to meet this increased demand, especially for home broadband.

Moreover, the company is set to expand its fiber network infrastructure in the country by another 50,000 kilometers in 2021 to support its mobile network by providing “high-capacity links” for its base stations.

PLDT is also planning to increase the company’s international capacity for data traffic by investing in three cable projects in the last two years with the Jupiter Cable project, the Asia Direct Cable system, and the APRICOT cable project.

This international undersea cable system will improve local network connectivity with new cable landing stations in Luzon and Mindanao being part of the APRICOT system.

Looking at the as-reported metrics, PLDT’s EBITDA margins appear to be expanding since 2016 as a result of the high growth from the demand for home broadband, especially in 2020 during the pandemic.

In reality, the firm’s spending has been growing at a much faster pace than its sales, showing weaker margins. Uniform margins never reached above 20% since 2005, substantially distorting the market’s perception of the firm’s margin ceiling for more than a decade.

What as-reported financials have gotten wrong is the depreciation of the company’s fixed assets. 

Depreciation expense is a non-cash expense, meaning it does not represent an actual outlay of cash. As such, depreciation expenses should be added back to earnings. Also, it can be easily manipulated by changing the asset’s life. 

However, companies do spend cash on maintenance capital expenditures to ready the same assets for use in the following years. That said, this expense barely shows up in its entirety on the balance sheet.

To arrive at an estimate of the firm’s maintenance capex, what is done instead is smoothing as-reported depreciation expense over a few years, adjusting for inflation and asset impairments.

In PLDT’s case, PHP 41.6 billion of depreciation expense was charged in 2020, but its substantial growth in assets that year warranted PHP 9.9 billion in maintenance capex. 

Along with the many other needed adjustments made, subtracting the much larger maintenance capex number from earnings leads to just a 17% Uniform earnings margin in 2020, lower than its 49% as-reported EBITDA margin.

PLDT’s earning power is generally weaker 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 PLDT’s profitability is higher than what real economic metrics highlight in most years.

In reality, PLDT’s true profitability has generally been lower than its as-reported ROA since 2005.

After declining from 14% in 2005 to 13% in 2006, as-reported ROA rebounded to a peak of 16% in 2008, before gradually falling to 3% in 2018. Since then, as-reported ROA has improved to 5%-6% levels in 2019-2020.

Meanwhile, Uniform ROA contracted from 13% in 2005 to 5% in 2007, before expanding to 10% in 2009, and compressing to 2%-4% levels in 2013-2019. Thereafter, Uniform ROA recovered to 7% in 2020.

PLDT’s earnings margin is much weaker than you think, but general stability in Uniform asset turns make up for it

Trends in Uniform ROA have been driven primarily by trends in Uniform earnings margin, coupled with general stability in Uniform asset turns.

After contracting from 28% in 2005 to 10% in 2007, Uniform margins expanded to 23% in 2009, before declining to 6%-18% levels in 2011-2020.

Meanwhile, Uniform turns remained at 0.3x to 0.5x levels through 2020 and currently sits at the midpoint of that range.

At present valuations, the market is pricing in expectations for Uniform margins to decline and for continued stability in Uniform turns.

SUMMARY and PLDT Inc. Tearsheet

As our Uniform Accounting tearsheet for PLDT Inc. (TEL:PHL) highlights, the company trades at a Uniform P/E of 17.7x, below the global corporate average of 21.9x but around its historical P/E of 16.9x.

Low P/Es require low EPS growth to sustain them. In the case of PLDT, the company has recently shown a 154% 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, PLDT’s sell-side analyst-driven forecast is to see a Uniform earnings shrinkage of 31% in 2021 and a growth of 4% in 2022.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify PLDT’s PHP 1,249.00 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to shrink 10% annually over the next three years. What sell-side analysts expect for PLDT’s earnings growth is below what the current stock market valuation requires in 2021, but above that requirement in 2022.

However, the company’s earning power is below the long-run corporate average. Furthermore, cash flows and cash on hand are below total obligations—including debt maturities, capex maintenance, and dividends. Also, intrinsic credit risk is 40bps above the risk free rate. Together, this signals a high dividend and low credit risk.

To conclude, PLDT’s Uniform earnings growth is in line with peer averages, and currently trades well below average peer valuations.

About the Philippine Market 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. 

Stay tuned for next week’s Philippine company highlight!


Angelica Lim
Research Director
Philippine Markets Daily
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