Philippine Markets Newsletter

This company remained cool with its focus on its innovative capabilities, achieving a Uniform ROA of 5%, not 3%

November 9, 2022

Since 1962, this air conditioning and refrigeration company has served as the leading cooling solutions provider in the Philippines, innovating to address Filipinos’ comfort expectations.

However, as-reported metrics do not seem to show how this company’s efforts to innovate its products and business solutions services positively affect its returns.

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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In the Philippines where temperatures can soar to blistering levels, air conditioning has become an absolute necessity for households and commercial establishments alike. Thanks to the tropical climate and dry weather present in the country almost year-round, there is strong demand for these products.

This demand rose further during the pandemic as people had to upgrade their home setup to be conducive to working from home.

Aside from air conditioning, many Filipinos upped their refrigerator game during the pandemic, when home-cooked meals became more prevalent.

One manufacturer that benefited from the increase in demand for both air conditioning and refrigeration is Concepcion Industrial Corporation (CIC:PHL).

The company operates through six subsidiaries, including Concepcion-Carrier Air Conditioning Company (CCAC) and Concepcion Durables Inc. (CDI). It has achieved a market leader position in the air conditioning industry through developing and partnering with local and global brands like Carrier, Condura, Kelvinator, and so on.

Despite industry trends and available penetration opportunities in residential air conditioning, Concepcion Industrial experienced a 27% drop in net income in H1 2022 from the previous year.

The firm attributed its decline in profit to external issues such as inflation, COVID restrictions, supply chain disruptions, increased commodity and logistics costs, and unfavorable foreign exchange rates.

In response, the firm offset the effects of these issues through cost-reduction activities and strategic price increases. Sales-wise, Concepcion Industrial still grew 4% in net sales for H1 2022 against the same time period in 2021.

While profitability figures may have trended downwards, the firm was able to recapture normal demand. Particularly, a strong commercial segment in early 2022 allowed its March sales to grow and surpass even pre-pandemic levels.

On this note, Concepcion Industrial has made a number of strategic investments to prepare itself for a post-COVID business environment. Investments such as strengthening its brands, diversifying its channels, improving logistics capabilities, and spending on digital infrastructure are all examples of this, aside from further R&D.

In terms of product development and innovation, the company recently launched two new types of products targeted toward fighting COVID-19. These were the Carrier Opticlean, a purifying air machine aimed towards hospitals and healthcare facilities, and the Condura Vax Safe, a medical refrigerator used to store and preserve COVID-19 vaccines that we mentioned in the previous article.

For now, the company plans to address current challenges by continuing its strategy of managed price increases and carefully managing its working capital.

Overall, Concepcion Industrial has made the right strategic changes to pricing and costs to mitigate setbacks relating to COVID-19 and the economy while simultaneously making investments that will allow it to thrive in the future. However, as reported doesn’t seem to think so.

In reality, it comes as no surprise that Concepcion Industrial’s Uniform ROA has consistently outperformed as-reported ROA over the last decade.

What as-reported metrics fail to consider is how current liabilities are factored into the ROA calculation. Traditional ROA calculations for measuring a firm’s earning power only include current and long-term assets as part of the cost of investment.

However, a company’s ability to receive goods and services in advance of payments—the current operating liabilities—ought to be factored in as well.

Current liabilities (excluding short-term debt) are necessary for operations. Items such as accounts payable, accrued expenses, and others are used to maintain the firm’s current capital position. On the other hand, long-term liabilities are mostly just used to finance the business.

If a company has a ton of cash to service its current liabilities and we only factor in its cash, it would make the company look inefficient. In reality, the company is just being responsible by building liquid assets to meet short-term obligations.

As such, net working capital (current assets – current liabilities) is used for the firm’s ROA calculation. This shows a company’s real cash management ability and thereby, its true earning power.

In the case of Concepcion Industrials, the as-reported metrics’ asset base for ROA calculation is at PHP 12.3 billion in 2021, leading to a 3% as-reported ROA.

However, when subtracting current operating liabilities and applying other needed adjustments, we arrive at Concepcion Industrials PHP 6.5 billion Uniform assets, resulting in a 5% Uniform ROA.

Concepcion Industrial’s profitability is stronger than you think in recent years

As-reported metrics are distorting the market’s perception of the Concepcion Industrial’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.

Through Uniform Accounting, we can see that the company’s true ROAs have been understated over the past decade. For example, as-reported ROA was 3% in 2021, but its Uniform ROA was actually higher at 5%.

Concepcion Industrial’s Uniform asset turns are stronger than you think in recent years

For more than two decades, as-reported metrics have understated Concepcion Industrial’s asset turns, a key driver of profitability.

Moreover, as-reported turns have reached a peak of 1.6x. In comparison, Uniform turns have already reached 2.2x over the same time period, making the company appear to be a less efficient business than real economic metrics highlight.

SUMMARY and Concepcion Industrial Corporation Tearsheet

As our Uniform Accounting tearsheet for Concepcion Industrial Corporation (CIC:PHL) highlights, the company trades at a Uniform P/E of 18.9x, around the global corporate average of 17.8x, but below its historical P/E of 24.1x.

Moderate P/Es require moderate EPS growth to sustain them. In the case of Concepcion Industrial, the company has recently shown a 79% 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, Concepcion Industrial’s sell-side analyst-driven forecast is to see Uniform earnings grow by 54% in 2022, and shrink by 1% in 2023.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Concepcion Industrial’s PHP 16.00 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to shrink by 1% annually over the next three years. What sell-side analysts expect for Concepcion Industrial’s earnings growth is above the current stock market valuation in 2022, and in line with the requirement in 2023.

Moreover, the company’s earning power is below the long-run corporate average. However, cash flows and cash on hand are 3x total obligations—including debt maturities, capex maintenance, and dividends. Together, this signals low dividend and credit risk.

To conclude, Concepcion Industrial’s Uniform earnings growth is above its peer averages, and in line with 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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