Philippine Markets Newsletter

This UITF has outperformed the PSEi since its inception by investing in companies that are 2x more profitable under Uniform Accounting.

June 19, 2020

This universal bank in its 100th year is offering a fund that invests in companies listed in the Philippine Stock Exchange index (PSEi).

While this fund has outperformed the PSEi since its inception, it is not evident that the fund invested in high-quality companies when looking at as-reported metrics.

However, Uniform Accounting reveals that the fund’s top holdings are actually 2x more profitable than as-reported values show.

In addition to examining the fund’s portfolio, we are including fundamental analysis of one of the fund’s largest holdings, providing you with the current Uniform Accounting Performance and Valuation Tearsheet for that company.

Philippine Markets Daily:
Friday Uniform Portfolio Analytics
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China Banking Corporation (China Bank), established exactly a century ago in 1920, is one of the country’s largest universal banks. It offers products and services such as deposits, investments, and bancassurance services.

One of China Bank’s investment products is its unit investment trust funds (UITFs). The bank offers multiple UITFs with different classifications: bond funds, equity funds, money market funds, and balanced funds.

This week, we are focusing on one of the bank’s UITFs called China Bank Equity Fund.

China Bank Equity Fund was launched on June 11, 2013, with a strategy of achieving capital appreciation by investing in companies listed in the Philippine Stock Exchange Index (PSEi).

At inception, China Bank Equity Fund had a net asset value per unit (NAVPU) of PHP 1.00. The fund’s NAVPU rose to PHP 1.27 in April 2015 before dropping back down to PHP 1.02 in January 2016 due to the oil price crash.

Even with a 20% loss, the fund still outperformed its benchmark, the PSEi, which incurred a loss of 25% during the same period

Thereafter, China Bank Equity Fund’s NAVPU soared to a peak of PHP 1.45 in January 2018, before falling to PHP 1.14 in November that same year, a 21% loss due to concerns about Brexit and the U.S.-China trade war. The PSEi had a loss of 24% over the same period.

After ending 2019 with a NAVPU of PHP 1.29, China Bank Equity Fund’s NAVPU plummeted to a historical low of PHP 0.82 in March 2020 amidst the COVID-19 pandemic. However, it has since recovered to PHP 1.08 YTD. The fund and its benchmark had similar YTD losses with 16% and 17%, respectively.

Since inception, China Bank Equity Fund’s 8% gain has outperformed the PSEi’s 6% loss. However, when looking at the fund’s investments using as-reported metrics, it is not apparent that the fund invests in high-quality companies.

As-reported metrics would have investors believe that this fund’s portfolio comprises companies that do not generate economic profit. However, Uniform Accounting easily reveals the truth behind these companies.

The table below shows the top non-financial holdings of China Bank Equity Fund along with their Uniform return on assets (ROA), as-reported ROA, and ROA distortion—the difference between Uniform and as-reported ROA.

Several companies in this fund show as-reported ROAs that range around and below global cost-of-capital level, suggesting that they are not generating economic profit. However, Uniform Accounting reveals that these companies have strong returns, with an average Uniform ROA 2x the as-reported returns.

The Uniform Accounting framework addresses financial statement inconsistencies attributable to the flaws present in the Philippine Financial Reporting Standards (PFRS). This enables investors to determine the true underlying performance of companies and avoid distorted financial analysis and valuation.

As such, it should not be surprising that when analyzing the non-financial holdings of China Bank Equity Fund, the figures that easily stand out are the large discrepancies between Uniform ROA and as-reported ROA for these companies.

While at a glance, the difference between as-reported ROA and Uniform ROA may not seem that great, the distortion in percentage ranges from 30% to 197%, with Ayala Corporation (AC:PHL) and Aboitiz Equity Ventures, Inc. (AEV:PHL) having the greatest distortions.

As-reported ROA understates the profitability of AC, suggesting a below-average company with an as-reported ROA of 4%. In reality, this leading conglomerate is an above-average company with an 11% Uniform ROA, almost thrice the as-reported number.

Similarly, AEV is not a 5% ROA firm like the as-reported numbers show. It is, in fact, a high-quality company with a 13% Uniform ROA.

By focusing on as-reported metrics alone, China Bank would never pick most of these companies because they look like anything but profitable businesses.

That said, looking at profitability alone is insufficient to deliver superior investment returns. Investors should also identify if the market is significantly undervaluing the company’s earnings growth potential.

China Bank Equity Fund also invested in companies with unreasonably low earnings expectations.

This table shows the earnings growth expectations for the major non-financial holdings of the fund. It features three key data points:

  1. The 2-year Uniform EPS growth represents the Uniform earnings growth the company is likely to have for the next two years. The earnings number used is the value of when we convert consensus sell-side analyst estimates to the Uniform Accounting framework.
  2. The market expected Uniform EPS growth represents what the market thinks Uniform earnings growth is going to be for the next two years. Here, we show by how much the company needs to grow Uniform earnings in the next two years to justify the current stock price of the company. This is the market’s embedded expectations for Uniform earnings growth.
  3. The Uniform EPS growth spread is the difference between the 2-year Uniform EPS growth and market expected Uniform EPS growth.

On average, Philippine companies are expected to have 6% annual Uniform earnings growth over the next two years. Meanwhile, China Bank Equity Fund’s top holdings are forecast to lag that with 5% projected Uniform earnings growth in the next two years.

The market, on the contrary, is seeing a decline in earnings for these companies with Uniform EPS shrinkage of 1% over the next two years.

Among these companies, AEV and SM Investments Corporation (SM:PHL) have the highest Uniform earnings growth dislocation.

The market is seeing AEV’s uniform earnings shrink by 12%, but analysts are projecting a strong 17% earnings growth for the company in the next two years.

Similarly, the market is mispricing SM’s Uniform Earnings to plunge by 11% in the next two years. However, sell-side analysts are seeing the company’s earnings to accelerate by 11% moving forward.

Overall, as-reported numbers would have investors incorrectly conclude that this portfolio consists of low-quality companies with negative earnings growth expectations. However, it is clear as day that China Bank invests in quality companies with above-average profitability and undervalued earnings growth potential.

SUMMARY and SM Investments Corporation Tearsheet

Today, we’re highlighting one of the largest individual stock holdings in China Bank Equity Fund—SM Investments Corporation (SM:PHL).

As the Uniform Accounting tearsheet for SM highlights, it trades at a Uniform P/E of 19.9x, around global corporate averages and its historical averages.

Moderate P/Es require moderate EPS growth to sustain them. In the case of SM, the company has recently shown an immaterial shrinkage in its Uniform EPS.

Sell-side analysts provide stock and valuation recommendations that poorly track reality. However, sell-side analysts have a strong grasp on near-term financial forecasts like revenue and earnings.

We take sell-side forecasts for PFRS earnings as a starting point for our Uniform earnings forecasts. When we do this, SM’s sell-side analyst-driven forecast shows that Uniform earnings will shrink by 18% in 2020, and grow by 49% in 2021.

Based on the current stock market valuations, we can back into the required earnings growth rate that would justify PHP 951.00 per share. These are often referred to as market embedded expectations.

The company can have Uniform earnings shrink by 11% each year over the next three years and still justify current price levels. Sell-side analysts’ expected 49% earnings growth for SM is well above what the current stock market valuation requires.

The company has an earning power double global corporate averages—based on its Uniform ROA calculation. However, with cash flows and cash on hand falling below its obligations over the coming years beginning 2022, SM has a high dividend risk.

To conclude, SM’s Uniform earnings growth is around peer averages. Moreover, the company is trading around average peer valuations.

About the Philippine Markets Daily
“Friday Uniform Portfolio Analytics”

Investors who don’t engage in the buying or selling of securities for a living oftentimes rely on professionals to manage their own investments within the scope of their investment policies.

With so many funds and managers out there, it can get confusing and difficult to decide which one best suits your needs as an investor.

Every Friday, we focus on one fund in the Philippines and take a deeper look into their current holdings. Using Uniform Accounting, we identify the high-quality stocks in their portfolio which may not be obvious using the as-reported numbers.

We also identify which holdings may be problematic for the fund’s returns that they would need to reconsider from a UAFRS perspective.

To wrap up the fund analysis, we highlight one of their largest holdings and focus on key metrics to watch out for, accessible in our tearsheets.

Hope you’ve found this week’s focus on China Bank Equity Fund interesting and insightful.

Stay tuned for next week’s Friday Uniform Portfolio Analytics!


Angelica Lim
Research Director
Philippine Markets Daily
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