Philippine Markets Newsletter

Transforming waste to energy has led this company to produce robust returns, 7x stronger than the as-reported

August 11, 2021

Today’s company is a leading waste-to-energy (WTE) firm highly praised for its ESG initiatives.

However, as-reported metrics don’t seem to reflect how effective the company’s environment-friendly operations are. Uniform Accounting, on the other hand, shows how profitable the company really is.

Also below, Uniform Accounting Embedded Expectations Analysis and the Uniform Accounting Performance and Valuation Tearsheet for the company.

Philippine Markets Daily:
Wednesday Uniform Earnings Tearsheets – Asia-listed Focus
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The world produces a lot of solid waste.

In fact, it is estimated that more than two billion tons of trash is produced globally every year. This is equivalent to a single line of garbage trucks stretching from San Francisco to New York City every single day.

Once produced, most waste goes to landfills where they are left indefinitely with no clear plan on what to do with them. This is damaging to the environment because as waste decomposes, harmful gases and liquids are produced as a by-product, polluting our planet.

The pollution problems from landfills have prompted several environmental movements such as the zero-waste movement to lobby for waste reduction and elimination.

Today’s company offers a way to reduce the amount of solid waste that goes to landfills, lowering the degree of pollution caused by landfills. Furthermore, this firm also transforms these wastes for greener purposes.

Founded in 2003, Canvest Environmental Protection Group Company Limited is a renewable energy provider based in China with chief business interests in the development and operation of waste-to-energy plants. Essentially, the company converts solid wastes into usable energy for consumption.

The company does this by incinerating solid wastes to generate heat. This heat is then used to boil water and produce steam, which powers wind turbines and produces electricity.

This process produces by-products such as ash, non-toxic gas, and toxic gas, which the company utilizes as other sources of profit.

The ashes are sold to construction materials manufacturers who convert these to bricks and hollow blocks. The non-toxic gas, on the other hand, can be converted into methanol and ethanol.

However, the toxic gas cannot be used for anything and can only be dumped. Canvest’s toxic gas waste undergoes a treatment process that either makes it non-toxic or converts it into solids for proper disposal.

The company’s waste-to-energy business has proven to be effective, generating revenue growth ranging from 19%-45% in 2016 to 2020, showing increasing demand for renewable energy in China.

To address the rising interest in clean energy, the company is already planning and constructing new waste-to-energy plants such as the Machong WTE plant, Taizhou WTE plant, and Baoshan WTE Plant.

With its environment-friendly operations, the company is expected to generate robust profitability given the current sustainability trend.

However, as-reported metrics show that the company has weak returns, ranging only from 6%-12% in 2012 to 2020.

This is a misrepresentation of the company’s real profitability. Uniform Accounting shows that the company is actually generating greater profits from green initiatives.

For the past ten years, the company’s Uniform ROA ranged from 24% to 123%.

The distortion between Uniform and as-reported ROAs comes from as-reported metrics failing to consider the amount of goodwill and other intangibles on Canvest’s balance sheet. Since 2011, goodwill and other intangibles sit at about 28% to 55% of its total assets.

Goodwill and other intangibles are purely accounting-based and unrepresentative of the company’s actual operating performance. When as-reported accounting includes this in a company’s balance sheet, it creates an artificially inflated asset base.

As a result, as-reported ROAs are not capturing the strength of Canvest’s earning power. Adjusting for goodwill and other intangibles, we can see that the company isn’t actually performing poorly. In fact, it has been the complete opposite, with returns that are nearly 7x greater.

Canvest’s profitability is much more robust than you think

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

Canvest’s Uniform ROA has been higher than its as-reported ROA for the past ten years. For example, when Uniform ROA was at 35% in 2020, as-reported ROA was only 6%.

The company’s Uniform ROA for the past ten years has ranged from 24% to 123%, while as-reported ROA has ranged only from 6% to 12% in the same timeframe.

Specifically, Uniform ROA dropped from 123% in 2011 to 27% in 2013, before recovering to 50% in 2014. It then fell to 24% in 2017, before rebounding to 35% in 2019-2020.

Canvest’s Uniform earnings margins are weaker than you think but its robust Uniform asset turns make up for it

Volatility in Uniform ROA has been driven by trends in both Uniform earnings margin and Uniform asset turns, with peaks and troughs lining up historically with that of Uniform ROA.

After remaining at 39%-41% levels from 2011 to 2014, Uniform margins dropped to 30%-32% levels from 2015 onwards.

Meanwhile, Uniform turns dropped from 3.1x in 2011 to 0.7x in 2013 before rebounding to 1.2x in 2014. It then gradually declined to 0.8x in 2017, which eventually recovered to 1.2x levels from 2019 onwards.

SUMMARY and Canvest Environmental Protection Group Company Limited Tearsheet

As the Uniform Accounting tearsheet for Canvest Environmental Protection Group Company Limited (1381:HKG) highlights, its Uniform P/E trades at 10.2x, which is below the global corporate average of 23.7x but around its own historical average of 9.8x.

Low P/Es require low EPS growth to sustain them. In the case of Canvest, the company has recently shown an 18% 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 Hong Kong Financial Reporting Standards (HKFRS) earnings and convert them to Uniform earnings forecasts. When we do this, Canvest’s sell-side analyst-driven forecast is a 20% and 13% earnings growth in 2021 and 2022, respectively.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Canvest’s HKD 4.54 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to shrink 8% annually over the next three years. What sell-side analysts expect for Canvest’s earnings is above what the current stock market valuation requires in 2021 and 2022.

Furthermore, the company’s earning power is 3x above the long-run corporate average. Also, cash flows and cash on hand are almost twice its total obligations—including debt maturities, capex maintenance, and dividends. All in all, this signals a low credit and dividend risk.

To conclude, Canvest Environmental Protection Group’s Uniform earnings growth is above its peer averages. However, the company is trading in line with its peer valuations.

About the Philippine Markets Daily
“Wednesday Uniform Earnings Tearsheets – Asia-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 UAFRS, 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 company listed in Asia that’s relevant to the Philippines and 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 Earning Tearsheet on an Asian company interesting and insightful.

Stay tuned for next week’s Asia company highlight!


Angelica Lim
Research Director
Philippine Markets Daily
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