Philippine Markets Newsletter

Uniform Accounting has dug up this mining company’s profitability, unearthing a Uniform ROA of 20%, not 10%

January 5, 2022

Other than depletion issues, one major concern mining companies are constantly faced with is strict government regulation, especially if these mines are located near communities.

As such, a recent regulatory tailwind may benefit the growth potential of this mining company given its market position and recovering profitability. Although its as-reported metrics do not show it, this mining company’s Uniform return on assets (ROA) reflects better how well this company had managed its costs amid the pandemic.

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 order to generate more revenue amidst the pandemic, the Philippine government has turned its attention to increasing activity in the mining sector.

In April 2021, the government lifted a nine-year moratorium on reviewing new and existing mineral agreements through an Executive Order (EO) No. 130, opening the discussion of the entry of new and existing mining applications.

The increased excise tax on minerals, mineral products, and quarry resources from the 2018 tax reform acceleration and inclusion (TRAIN) act is likely to translate to higher tax collection from the mining projects from this EO.

Then, before 2021 ended, the government lifted a four-year ban on the open-pit method of mining for copper, gold, silver, and complex ores in the country.

For Nickel Asia Corporation (NIKL:PHL), the largest producer of lateritic nickel ore in the Philippines—and one of the largest in the world—this could be an opportunity for growth.

Although the recent regulation on open-pit mining does not cover nickel mining, the aforementioned regulations are a clear indication of the government’s easing sentiment towards the mining sector as a means for profit.

In addition, the growth potential of nickel mining companies is elevated going forward.

Just last year, the Indonesian authorities banned all of its nickel mining companies from exporting nickel. Due to this, the international nickel market lost its largest supplier and created a massive growth opportunity for the Philippines to capitalize on as it became the world’s top nickel ore producer.

With nickel being an integral mineral for Electric Vehicle (EV) batteries, the coming EV production boom from developed countries will push the nickel demand as a result.

If the EV demand improves, the Philippines is poised to dominate the nickel market with Nickel Asia spearheading the effort.

However, mining companies like Nickel Asia are known to be highly cyclical in nature as ore sales are sensitive to the value of the US Dollar due to the export prices.

Meanwhile, unfavorable working conditions like typhoons and strict quarantine restrictions influence their profits as they can lower production volume.

Due to a weaker US Dollar compared to Philippine Peso and lower volumes in 2020, the company continued to produce returns near cost-of-capital levels, implying that Nickel Asia has generated little economic value for its stockholders since 2015.

In reality, the company’s real economic profitability has actually been seeing better recovery because of higher export prices from the current industry tailwinds, and even better success prior to 2020.

With Uniform ROA sustaining levels almost double as-reported ROA levels, the more important takeaway here is that accounting distortions can entirely change a company’s market valuation and, in turn, an investor’s stock decisions.

Historically, one of the largest distortions for Nickel Asia comes from the treatment of minority expenses or the income attributable to the non-controlling interests of a company’s subsidiaries.

The Philippine Financial Reporting Standards (PFRS) allows minority interest expense to be recognized under operating cash flow, misleading people to think that it is essential to the firm’s core operations.

In reality, it should always be classified as a financing cash flow. Minority shareholders provide capital to the subsidiary in exchange for a piece of the company’s profits. As a result, minority interest expense should not be subtracted from revenue when calculating a company’s real core earnings.

In 2020, Nickel Asia recognized PHP 1.42 billion in minority interest expense, resulting in a PHP 4.07 billion net income and a 10% as-reported ROA. Adding this back alongside the many other adjustments Valens makes, the company should actually be recognizing PHP 5.09 billion in Uniform earnings and a 20% Uniform ROA.

Nickel Asia’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.

For example, as-reported ROA was 10% in 2020, nearly half in relation to its Uniform ROA of 20%.

Through Uniform Accounting, we can see that the company’s true ROAs have actually been higher than its as-reported ROA in each of the past eleven years. Since 2010, Uniform ROA has been more than 2x the as-reported numbers. Additionally, when Uniform ROA reached a peak of 72% in 2014, as-reported ROA was only at 29%.

After rising from 12% in 2009 to 62% in 2011, Uniform ROA dropped to 20% in 2013 as nickel ore prices weakened. Thereafter, Uniform ROA rebounded to a peak of 65% in 2014, before deteriorating to 9% in 2016 and subsequently recovering to 20% by 2020.

Nickel Asia’s has a more efficient business than you think

Similarly, as-reported metrics significantly distort the firm’s asset utilization, a key driver of profitability.

In 2020, as-reported asset turnover was 0.4x compared to Uniform asset turns of 0.8x, making the company appear to be a less asset efficient business than real economic metrics highlight.

Moreover, as-reported asset turnover has been lower than Uniform turns each year for the past 10 years, distorting the market’s perception of the firm’s historical asset efficiency levels.

Similar to the company’s ROA trend, Uniform turns historically improved from 0.5x in 2009 to 1.2x in 2011, before fading to 0.8x in 2013 and jumping to a 1.7x high in 2014. Then, Uniform turns compressed to and stabilized at 0.7x-0.9x levels in 2016-2020.

SUMMARY and Nickel Asia Corporation Tearsheet

As our Uniform Accounting tearsheet for Nickel Asia Corporation (NIKL:PHL) highlights, the company trades at a Uniform P/E of 14.4x, below the global corporate average of 24.0x, but above its historical P/E of 9.6x.

Low P/Es require low EPS growth to sustain them. In the case of Nickel Asia, the company has recently shown a 95% 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, Nickel Asia’s sell-side analyst-driven forecast is to see Uniform earnings growth by 55% and 11% by 2021 and 2022, respectively.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Nickel Asia’s PHP 5.16 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to shrink 9% annually over the next three years. What sell-side analysts expect for Nickel Asia’s earnings growth is above what the current stock market valuation requires through 2022.

Furthermore, the company’s earning power is 3x above the long-run corporate average. Moreover, cash flows and cash on hand are 4x above total obligations—including debt maturities, capex maintenance, and dividends. Together, this signals a low dividend risk.

To conclude, Nickel Asia’s Uniform earnings growth is above peer averages, and currently trades 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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