Philippine Markets Newsletter

This diversified conglomerate is powering its way to growth despite economic woes, reaching a Uniform ROA of 5%, not 3%

August 16, 2023

This diversified conglomerate didn’t let the 2022 supply chain disruptions get in the way of executing its strategic initiatives for its many business segments.

Despite the company’s drive for improvement, as-reported metrics still show insufficient returns, when in reality, its TRUE profitability shows otherwise.

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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By their nature, conglomerates are generally protected from industry-specific concerns. The diversity of their portfolio of companies provides them with alternative sources of income, especially when they’re also invested in industries benefiting from another industry’s problems.

However, conglomerates are not immune to broad macroeconomic issues, such as recessions. These large companies are also not exempted from cost pressures and global supply chain issues.

Fortunately, for one of the Philippines’ largest conglomerates, it was able to get past those issues in 2022.

San Miguel Corporation (SMC:PHL) has its operations spread out in several sectors to thank for its PHP 1.5 trillion consolidated group revenue in 2022. This was a 60% growth from PHP 941 billion recorded in 2021.

Its focus on investments and innovation allows it to address consumers’ ever-growing needs.

For one, its food and beverage subsidiary San Miguel Food and Beverage (“SMFB”) has invested in state-of-the-art technologies and achieved food security, quality, and affordability at the same time.

These improvements, especially for San Miguel Foods (“SMF”), paved the way for increased distribution and the launch of new products, which were developed under the Purefoods native line and Magnolia salad aids. This helped the segment achieve a 16% growth in consolidated revenues from PHP 151 billion in 2021 to PHP 175 billion in 2022.

The subsidiary has also already started to develop the San Miguel Food Complex facility in Davao, which will further enhance the company’s food security and lessen its dependence on poultry imports.

Moreover, another significant part of San Miguel’s strategy is its focus on regional development, and one important segment that can boost regional progress is power.

It has various planned projects and investments in transition technologies and reconfiguration of coal facilities for its power segment San Miguel Global Power (“SMGP”)—which include the Battery Energy Storage System, 1,313.1-MW Batangas Combined Cycle Power Plant, and the construction of a new coco-methyl ester (“CME”) facility—to name a few.

On top of that, the commercial operations for this subsidiary’s 20-MW Kabankalan Battery Energy Storage System facility has already commenced, contributing to the 66% increase in consolidated revenue from PHP 133.7 billion in 2021 to PHP 221.4 billion in 2022.

All in all, San Miguel’s focus on innovation has paved the way for the company’s sustainable success. However, looking at its as-reported data, it doesn’t seem to be the case.

In reality, the company’s drive for growth amidst economic turmoil has actually led to Uniform ROAs reaching 5%.

One of the said distortions stems from how Philippine Financial Reporting Standards (PFRS) classify interest expense.

According to PFRS, interest expense can be classified as an operating cash flow. In reality, interest expense represents the cost of debt and is rightfully only a financing cash flow. As such, in Uniform Accounting, interest expense is added back to earnings.

As a firm that made a lot of investments through debt, San Miguel recognized interest expense from its debt.

Specifically, in 2022, it recorded a PHP 57.1 billion interest cost. Adding back this expense because it is not an operating expense, with many other necessary adjustments made by Valens, leads to a PHP 61.8 billion net income and 5% Uniform ROA, higher than the PHP 13.0 billion as-reported net loss and 3% as-reported ROA.

San Miguel’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 that the company is a weaker business than real economic metrics highlight.

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 2022, but its Uniform ROA was actually higher at 5%.

SUMMARY and San Miguel Corporation Tearsheet

As our Uniform Accounting tearsheet for San Miguel Corporation (SMC:PHL) highlights, the company trades at a Uniform P/E of 27.2x, above the global corporate average of 18.4x, but around its historical P/E of 26.0x.

High P/Es require high EPS growth to sustain them. In the case of San Miguel, the company has recently shown a 173% 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, San Miguel’s sell-side analyst-driven forecast is to see Uniform earnings shrinkage of 100% in 2023 and immaterial growth in 2024.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify San Miguel’s PHP 97.00 stock price. These are often referred to as market-embedded expectations.

The company is currently being valued as if Uniform earnings were to grow by 13% annually over the next three years. What sell-side analysts expect for San Miguel’s earnings growth is below what the current stock market valuation requires through 2024.

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

To conclude, San Miguel’s Uniform earnings growth is below its peer averages, but above 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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