Philippine Markets Newsletter

This company is famous for spreading joy through its chicken, although only at a 3% Uniform earnings margin

June 16, 2020

Last Wednesday, we talked about how a “big bath” scenario is likely to occur in other parts of the world. We focused particularly on one Chinese stock.

The Philippines is also not exempt from such an event. With quarantine measures in place for most of the second quarter, many analysts are expecting earnings to fall as companies report their quarterly results in the coming months.

The largest fast food restaurant in the country is taking advantage of the low expectation environment to transform the business. Yet accounting distortions may make its results appear worse than it actually is, artificially creating a larger payoff in the future.

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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Eating at Jollibee is considered by many Filipinos as part of their cultural identity. It is so heavily embedded in our culture, that the fast food chain was able to outperform other fast food giants like McDonald’s and KFC in the Philippines.

The company was also able to expand to other countries where large Filipino communities developed.

However, Jollibee Foods Corporation (JFC:PHL) has been experiencing troubles lately. Due to COVID-19-related headwinds, its most recent quarterly sales has declined year-over-year for the first time since 1999.

Although quarantine restrictions were only implemented starting March, the company reported that its international business was already experiencing economic pressures beforehand.

The slowdown in business has come at a bad time for the company.

Jollibee has made risky moves in the recent years by acquiring money-losing stores such as Smashburger and Coffee Bean & Tea Leaf Co.

Now, second quarter results are expected to be drastically worse, with more than 3,000 stores across the country either partially operating or completely closed. Analysts are expecting Jollibee to operate at a net loss for the fiscal year 2020.

Jollibee itself is already abandoning the hopes of a full 2020 recovery, focusing instead on its 2021 operations. For the rest of the year, the company is embarking on a PHP 7 billion global restructuring program.

The company is aiming to streamline non-performing stores and expand on its food delivery and take out capabilities. With operations not at full force, conducting a restructuring program today is a timely choice for management to do so.

However, it does have the unintended consequence of revealing major accounting flaws. Valens Research President and CEO Joel Litman discussed this in his latest Forbes article on the next big bath.

The “Big Bath” occurs when a collapse in actual cash earnings is compounded by a financial reporting anomaly. In the U.S. during the Great Recession of 2008, companies took massive amounts of non-operating unusual item charges in Q4.

Market expectations suffered due to investors wrongfully thinking that companies now had a lower chance of generating profitability.

In reality, GAAP rules helped companies pile all expenses needed to reset its books over one or two quarters so that companies could further exceed market expectations in the succeeding quarters.

Similarly, the rules of the Philippine Financial Reporting Standards (PFRS) allow companies to make net losses look more severe than they actually are, in order to make future results appear better.

Expenses related to restructuring are allowed to be charged in the current quarter, even if the actual cash outlay of such costs occur in future quarters. In addition, assets that are valued beyond its recoverable amount can be charged for impairment even without any cash transaction.

For Jollibee in particular, unusual items have been the largest earnings distortion for the past three years. In 2019 alone, unusual gains made up more than half of its as-reported net income.

According to PFRS, the company recognized a one-time gain of PHP 3.2 billion from its Coffee Bean & Tea Leaf acquisition, leading to an as-reported EBITDA margin of 7% and a net income of PHP 6.4 billion.

However with Uniform Accounting, the acquisition gain does not actually affect the company’s real earnings. The gain is reversed because it is not part of the company’s core business.

Therefore, along with the many other changes Valens makes, Jollibee’s 7% as-reported EBITDA margin and PHP 6.4 billion net income are adjusted to reveal a TRUE Uniform earnings margin of 3% and Uniform earnings of PHP 5.3 billion.

With Jollibee’s history of non-operating unusual item expenses and its planned global restructuring program, it is likely that as-reported results will reflect a “big bath” scenario. So far, analysts are forecasting Jollibee to generate an as-reported net loss of PHP 5.5 billion in 2020, though Uniform earnings are only indicating a PHP 2.4 billion loss.

Jollibee may not be the only one though. Other companies in the Philippine Stock Exchange will likely be reevaluating their businesses as well over the coming months.

Jollibee’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 the company is a much weaker business than real economic metrics highlight.

Jollibee’s Uniform ROA has actually been higher than its as-reported ROA in the past four years. For example, as-reported ROA was 2% in 2019, but its Uniform ROA was actually twice that at 4%.

Through Uniform Accounting, we can see that the company’s true ROAs have actually been stronger. Since 2016, Uniform ROA has reached as high as 8%, while as-reported ROA has never exceeded 6% over the same timeframe.

After ranging from 9%-11% levels from 2004-2007, Uniform ROA gradually declined to 5% in 2014. Thereafter, Uniform ROA recovered to 8% leves in 2016-2017, before deteriorating to a low of 4% in 2019.

Jollibee’s earnings margin is weaker than you think

Recent strength in Uniform ROA has been driven by recent strength in Uniform asset turns, though offset by historically weak Uniform earnings margin. Since 2004, as-reported EBITDA margin has been at least 1.5x higher than Uniform margins each year.

From 2004 to 2011, Uniform margins sustained 5%-6% levels, before improving to 7% levels in 2012-2013. Thereafter, Uniform margins compressed back to 5%-6% levels through 2017, before eroding to 3% in 2019.

Meanwhile, as-reported EBITDA margin maintained 12% levels from 2004-2007, before contracting to 9%-10% levels in 2010-2018 and falling further to 7% in 2019.

Looking at margins alone, as-reported metrics are making the firm appear to be a much stronger business than is accurate.

SUMMARY and Jollibee Foods Corporation Tearsheet

As the Uniform Accounting tearsheet for Jollibee highlights, the Uniform P/E trades at 721.4x, which is far above corporate average valuation levels and its own history.

High P/Es require high EPS growth to sustain them. In the case of Jollibee, the company has recently shown a 57% 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 PFRS earnings and convert them to Uniform earnings forecasts. When we do this, Jollibee’s sell-side analyst-driven forecast calls for 365% and 203% Uniform EPS decline in 2020 and 2021, respectively.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Jollibee’s PHP 145 stock price. These are often referred to as market embedded expectations.

To justify current market valuation, the company would need to grow its Uniform earnings by 29% each year over the next three years. What sell-side analysts expect for Jollibee’s earnings growth is far below what the current stock market valuation requires.

The company’s earning power is below the long-run corporate average. In addition, cash flows are significantly lower than its total obligations—including debt maturities, capex maintenance, and dividends. Together, this signals high credit and dividend risk.

To conclude, Jollibee’s Uniform earnings growth is the lowest among peers in 2020, despite trading the highest among peer valuations.

About the Philippine Markets 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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