Philippine Markets Newsletter

This company built a solid foundation and constructed a diverse portfolio, reaching a Uniform ROA of 12%, not 7%

September 7, 2022

This holding company’s diversified portfolio allowed it to capitalize on economic tailwinds due to its position in the industry despite rising inflation. However, its as-reported metrics do not seem to fully capture the company’s strategy as its profitability continues to be understated.

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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A lot of the country’s largest companies started from manufacturing or retail businesses such as shoe stores with SM Investments Corporation (SM:PHL), ice cream parlors with Jollibee Foods Corporation (JFC:PHL), and cornstarch plants with JG Summit Holdings, Inc. (JGS:PHL).

Meanwhile, what made DMCI Holdings, Inc. (DMC:PHL) special is that it leveraged a construction company as a foundation before expanding to other industries.

Its roots can be traced back to its founder, David M. Consunji, who was a businessman, a transportation and public works minister, and – most importantly – an engineer.

In 1954, Consunji would establish a construction company named D.M. Consunji, Inc., before incorporating it in 1995 to consolidate the business interests of the Consunji family.

Now, the DMCI group has interests in construction; housing through DMCI Project Developers, Inc. (PDI); mining and exploration through Semirara Mining and Power Corporation (SMPC:PHL) and DMCI Mining Corporation (DMC); and power generation through DMCI Power Corporation (DPC).

However, despite its huge size and advantage in holding interests in construction, real estate, energy, mining and water industries, the DMCI group struggled in 2020 amid an economic slowdown and challenges from quarantine restrictions.

Nevertheless, the effects of the pandemic proved to be temporary as the company quickly rebounded afterward in 2021 thanks to economic tailwinds for its subsidiary, the Philippines’ largest coal producer – Semirara.

Although DMCI’s other subsidiaries’ performances had also improved in 2021, Semirara had been one of the largest contributors to DMCI’s total revenue—42% in 2020, 48% in 2021, and 64% in H1 2022.

In 2021, Semirara’s revenue more than tripled from 2020 as the economic recovery from China pushed index prices for coal. This continued in 2022 thanks to higher coal prices and improved demand due to external factors from the geopolitical conflict between Russia and Ukraine.

By H1 2022, Semirara’s revenue reached PHP 52 billion, near its full year contribution of PHP 52.4 billion in 2021.

Looking at as-reported metrics, it appears that the DMCI group’s diverse position in other industries helped in generating robust profitability, with return on assets (ROAs) reaching above cost of capital levels once more in 2021.

In reality, the company’s position actually did better than presented, with Uniform ROAs performing almost 2x above at 12%.

Historically, one of the largest distortions for DMCI Holdings comes from the treatment of minority interest expenses or the income attributable to the non-controlling interests of a company’s subsidiaries.

The Philippine Financial Reporting Standards (PFRS) allow minority interest expense to be recognized under operating cash flow, leading people to incorrectly think it is essential to the firm’s core operations.

In reality, it should always be classified as a financing cash flow. Minority shareholders provide capital to the subsidiary in exchange for a piece of the company’s profits. As a result, minority interest expense should not be subtracted from revenue when calculating a company’s real core earnings.

In 2021, DMCI Holdings recognized PHP 7.3 billion in minority interest expense, resulting in a PHP 18.4 billion net profit and a 7% as-reported ROA. Adding this back alongside the many other adjustments Valens makes, the company should actually be recognizing PHP 22.6 billion in Uniform earnings and a 12% Uniform ROA.

DMCI Holdings’ 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 DMCI Holdings’ profitability has been recently weaker than real economic metrics highlight.

Through Uniform Accounting, we can see that the company’s true ROAs have been inaccurate over the past decade. For example, as-reported ROA was 7% in 2021, but its Uniform ROA was actually higher at 12%.

DMCI Holdings’ earnings margins are less efficient than you think

Trends in Uniform ROA have been driven by trends in Uniform earnings margin. For more than two decades, as-reported metrics have understated DMCI Holdings’ earnings margin, a key driver of profitability.

Moreover, as-reported margins have reached up to 38%. In comparison, Uniform margins have yet to eclipse 27% over the same time period, making DMCI Holdings appear to be a more profitable business than real economic metrics highlight.

SUMMARY and DMCI Holdings, Inc. Tearsheet

As our Uniform Accounting tearsheet for DMCI Holdings, Inc. (DMC:PHL) highlights, the company trades at a Uniform P/E of 7.3x, below the global corporate average of 19.3x, and its historical P/E of 15.8x.

Low P/Es require low EPS growth to sustain them. In the case of DMCI Holdings, the company has recently shown a 2,783% 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, DMCI Holdings’ sell-side analyst-driven forecast is to see Uniform earnings growth of 8% in 2022 and a decline of 4% in 2023.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify DMCI Holdings’ PHP 9.92 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to shrink by 18% annually over the next three years. What sell-side analysts expect for DMCI Holdings’ earnings growth is above what the current stock market valuation requires through 2023.

Moreover, the company’s earning power is 2x the long-run corporate average. Furthermore, cash flows and cash on hand are 2x total obligations—including debt maturities, capex maintenance, and dividends. Together, this signals low credit risk.

To conclude, DMCI Holdings’ Uniform earnings growth is below its peer averages, and below 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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