Philippine Markets Newsletter

This cement company produced rock-solid Uniform ROA of 11%, not 5%, even in a year of low demand

November 2, 2021

The cement industry has greatly benefited from the rapid demand in construction activities in the Philippines pre-pandemic, as a result of expansion activities in both public and private sectors. 

So when construction halted in most of 2020, even one of the largest players in the cement industry based on sales volumes saw its net sales massively decline.

But while as-reported return on assets (ROAs) show that this company is now struggling to break even, Uniform Accounting uncovers that the company’s real returns are not as bad as it seems.

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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As the Philippine government opens up the economy once more, construction activities are on the rise, resulting in demand for cement slowly picking up towards pre-pandemic levels.

Although this is a tailwind for the cement industry, recovery to pre-pandemic profitability levels for local companies may take longer based on market expectations. 

One major reason for this is the significant rise in imports in the past few years to support the construction boom. However, since local producers now have the capacity thanks to last year’s construction slowdown, any additional supply from imports will only put more pressure on local companies’ profits. 

In addition, no single company monopolizes on a particular cement type in the Philippines, resulting in tight competition in the industry. As such, the major cement companies in the Philippines rely on certain business strategies in order to capitalize on the cement demand.

In our previous Philippine Market Daily articles, we’ve discussed the strategies of two major contributors of construction materials: CEMEX Holdings (CHP:PHL) with its extensive distribution network and Holcim Philippines, Inc. (HLCM:PHL) with its product innovations.

Today, we will be talking about Eagle Cement Corporation (EAGLE:PHL) as it continues to concentrate on its end-to-end production strategy to enhance efficiency in its cement manufacturing operations.

What makes Eagle Cement uniquely poised for growth is the company’s preference to build one mega factory at the center of high-demand areas.

Manufacturing 7.1 million metric tons of cement per year, its Bulacan Cement Plant is the largest cement-producing plant in the country.

Furthermore, the factory is located between two regions with the highest construction activity, CALABARZON and NCR. About 63% of the country’s total cement demand comes from the Luzon region.

Due to this, Eagle Cement has established good market shares in NCR (20.6%) and Central Luzon (23.7%), regions that have high economic activities in the Philippines.

On the other hand, the rest of the competition have their plants spread out across the country. While the competition’s strategy may save on distribution costs, they do spend more on personnel costs and they face a harder time managing production efficiently.

On top of that, Eagle Cement recently acquired the limestone quarrying firm, Solid North Mineral Corp. (SNMC), which will consolidate a supply of raw materials for its operations. 

Also, some of the mineral production sharing agreements (MPSAs) of SNMC are strategically adjacent to Eagle Cement’s Bulacan Cement Plant. As a result of this, the company is able to improve its position to meet the growing demand.

Looking at the as-reported metrics, Eagle Cement has had returns near cost-of-capital levels, implying that the firm has generated little economic value for its stockholders since 2014.

However, looking at Eagle Cement’s real economic profitability, we see that the firm has actually produced better profits in the last seven years by almost double the as-reported ROA levels.

What as-reported metrics fail to do is to consider the company’s excess cash on the balance sheet. Companies inherently need cash to address liquidity issues and create long-term relationships with customers and suppliers. As such, some level of cash is critical to operating the company. However, the portion of that balance that is earning limited or no return—or excess cash—ends up diluting as-reported ROAs.

When 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. Removing excess cash allows investors to see through the distortions that come from management carrying much more cash on the balance sheet than what is operationally required.

For 2020, Eagle Cement had a significant amount of excess cash sitting idly in its balance sheet for up to 31% of its as-reported total assets.

Adding this back alongside the many other adjustments Valens makes, the company should actually be recognizing an 11% Uniform ROA.

Eagle Cement’s earning power is stronger 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 the company is a much weaker business than real economic metrics highlight.

Eagle Cement’s Uniform ROA has been nearly 2x as higher than its as-reported ROA in the past seven years. For example, as-reported ROA was 5% in 2020, significantly lower than Uniform ROA of 11%. 

When Uniform ROA peaked at 25% in 2016, as-reported ROA was only at 14%. Eagle Cement’s Uniform ROA for the past seven years has ranged from 11% to 25%, while as-reported ROA ranged only from 5% to 14% in the same timeframe.

Eagle Cement’s asset turns are more efficient than you think

Trends in Uniform ROA have been driven by trends in Uniform asset turns. Since 2013, as-reported metrics have significantly understated Eagle Cement’s asset utilization, a key driver of profitability.

As-reported asset turnover has remained at 0.4x-0.5x levels through 2019, before fading to 0.3x in 2020. Meanwhile, Uniform asset turns sustained 0.6x-0.8x levels from 2013-2019, before compressing to 0.5x in 2020.

As-reported metrics have been making Eagle Cement appear to be a less efficient business than real economic metrics highlight.

SUMMARY and Eagle Cement Corporation Tearsheet

As our Uniform Accounting tearsheet for Eagle Cement Corporation (EAGLE:PHL) highlights, the company trades at a Uniform P/E of 23.8x, around the global corporate average of 24.3x, but above its historical P/E of 21.1x.

Low P/Es require low EPS growth to sustain them. In the case of Eagle Cement, the company has recently shown a 50% 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, Eagle Cement’s sell-side analyst-driven forecast is to see Uniform earnings shrink by 3% and 4% by 2021 and 2022, respectively.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Eagle Cement’s PHP 14.40 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to grow 2% annually over the next three years. What sell-side analysts expect for Eagle Cement’s earnings growth is below what the current stock market valuation requires through 2022.

Furthermore, the company’s earning power is 2x above the long-run corporate average. Moreover, cash flows and cash on hand are 5x above total obligations—including debt maturities, capex maintenance, and dividends. Also, intrinsic credit risk is 150bps above the risk free rate. Together, this signals a low dividend risk with moderate credit risk.

To conclude, Eagle Cement’s Uniform earnings growth is in line with its peer averages, and currently trades in line with its average peer valuations.

About the Philippine Market 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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