Philippine Markets Newsletter

With only 1% Uniform ROA, this company needs to sustainably dig up more value to turn profitable

April 27, 2021

Mineral resources made up 7% of Philippine exports in 2019. Among these metallic minerals, nickel, gold, and copper are the most in-demand commodities in the country. Copper specifically is one of the world’s most versatile metals and the third most used behind iron ore and aluminum.

Despite the Philippines’ abundance of mineral resources, with several of the world’s largest copper and gold mines in the country, this mining company has struggled to reach cost-of-capital returns.

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

Philippine Markets Daily:
Tuesday Uniform Earning Tearsheets – Philippine-listed Focus
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During the 2000s, the mining industry enjoyed strong demand due to the rapid growth of emerging markets, particularly in Asia.

In addition, when the global supply fell behind demand, commodity prices surged to historical highs. For metal-exporting countries, this meant a high potential income, leading to more companies exploring opportunities in the industry.

One such company that benefited from this boom is the Philippines’ 2nd largest producer of copper and gold, Philex Mining Corporation (PX:PHL).

Philex Mining enjoyed stable profitability during the mining boom. However, the 2008-2009 global financial crisis caused metal prices to crash, resulting in a 20% revenue decline in 2008.

Although Philex Mining partially recovered in the next two years as both the global economy and demand improved, local regulation issues disrupted the company’s operations.

For one, in August 2012, disaster struck when a massive mining spill at the Padcal Mine caused the release of 20.6 million tons of toxic tailings into water bodies—the biggest mining disaster in Philippine history. This resulted in the suspension of the mine’s operations for the next two years.

The Padcal Mine, which was the largest copper-gold mine in the Philippines, has been in operation for 63 years and was able to launch massive exploration activities—namely, the Bumolo Project, Desert Storm, and Tapsan.

Given that 96% of Philex Mining’s business relies on its Padcal operations, its profitability took a major hit. Revenues dropped 43% from PHP 16.1 billion in 2011 to only PHP 9.1 billion in 2012.

While profitability briefly improved in 2016 due to the resumption of the company’s Padcal business, the Department of Environment and Natural Resources (DENR) suddenly issued an industry-wide open pit mining ban in 2017 due to environmental violations. As a result of this ban, Philex Mining suffered a 28% decline in revenue from PHP 9.4 billion in 2016 to PHP 6.8 billion in 2019.

On top of that, the pandemic gravely hit the industry in 2020, causing supply chain disruptions, reduced mining production, and limited workforce. This also slowed down any further development of Philex Mining’s Silangan Project. Nonetheless, thanks to rising commodity prices, the company’s sales still grew 15% year-on-year amidst the chaos.

Overall, with the series of industry-related issues it continues to face, it would seem like the company has been struggling to improve its business. However, looking at its as-reported metrics, it appears its focus on its exploration developments resulted in somewhat profitable years, with ROAs ranging from 0% to 41% in the past sixteen years.

In reality, all industry and regulatory headwinds have actually buried the company’s chances at profitability, with Uniform ROAs only reaching a peak of 23% in the same timeframe.

What as-reported financials have gotten wrong is the depreciation of the company’s fixed assets.

Depreciation expense is a non-cash expense, meaning it does not represent an actual outlay of cash. Also, it can be easily manipulated by changing the asset’s life. As such, depreciation expense should be removed from earnings.

In the case of Philex Mining, given that it is a capital-intensive firm, the company needs to spend on maintaining its facilities. However, for other industries, this expense barely shows up on the balance sheet.

To arrive at an estimate of the firm’s maintenance capex, what is done instead is smoothing as-reported depreciation expense over a few years, adjusting for inflation and asset impairments.

In 2020 alone, Philex Mining recorded PHP 1.27 billion of depreciation expense, but its substantial growth in assets that year warranted PHP 725 million in maintenance capex.

Adding back depreciation expense and subtracting maintenance capex, along with the many other adjustments made leads to just PHP 413 million in Uniform earnings and a 1% Uniform ROA in 2020, lower than as-reported earnings of PHP 1.23 billion and 3% ROA.

Philex Mining’s earning power is weaker than you think

As-reported metrics distort the market’s perception of the firm’s historical profitability. If you were to just look at as-reported ROA, you would think that Philex Mining’s profitability is stronger than real economic metrics have highlighted.

In reality, Philex Mining’s true profitability has generally been lower than its as-reported ROA for the past sixteen years. Specifically, as-reported ROA was 3% in 2020, but Uniform ROA was only 1% that year.

As-reported ROA rose from 12% in 2005 to a peak of 41% in 2007, before declining to 7% in 2009 and subsequently improving to 17% in 2011. Since then, as-reported ROA has compressed to 0%-4% levels from 2013-2020.

Meanwhile, after expanding from -2% in 2005 to a peak of 23% in 2007, Uniform ROA dropped to 3% in 2009, before recovering to 9% levels in 2010-2011. Thereafter, Uniform ROA receded to 1% levels in 2019-2020.

Philex Mining’s margins are weaker than you think

Trends in Uniform ROA have been primarily driven by trends in Uniform earnings margin. However, Uniform margins were lower than as-reported EBITDA margins in each of the past sixteen years.

As-reported margins improved from 38% in 2005 to a peak of 63% in 2007, before compressing to 38% in 2009. As-reported margins did rebound to 58% in 2011, but has since slowly contracted to 37% in 2020.

Meanwhile, after jumping from -6% in 2005 to 43% in 2007, Uniform margins declined to 10% in 2009. It then soared to 31% in 2011, before stabilizing at -1% to 2% levels in 2012-2015 and then recovering to 20% in 2016. Since then, Uniform margins have diminished to 6% in 2020.

Looking at the firm’s margins alone from 2005-2020, as-reported metrics make the firm appear to be a more cost-efficient business than is accurate.

SUMMARY and Philex Mining Corporation Tearsheet

As the Uniform Accounting tearsheet for Philex Mining Corporation (PX:PHL) highlights, it trades at a Uniform P/E of 39.9x, above the global corporate average of 23.7x but slightly below its historical average of 41.5x.

High P/Es require high EPS growth to sustain them. In the case of Philex Mining, the company has recently shown a 10% 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 PFRS earnings and convert them to Uniform earnings forecasts. When we do this, Philex Mining’s sell-side analyst-driven forecast calls for a 85% Uniform EPS growth in 2021 and a 4% Uniform EPS decline in 2022.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Philex Mining’s PHP 5.27 stock price. These are often referred to as market embedded expectations.

Philex Mining is currently being valued as if Uniform earnings were to grow 28% annually over the next three years. What sell-side analysts expect for Uniform earnings growth is above what the current stock market valuation requires in 2021, but below that requirement in 2022.

The company’s earning power is below the long-run corporate average. On the other hand, cash flows and cash on hand are almost twice its total obligations—including debt maturities and capex maintenance. Together, this signals a low dividend and credit risk.

To conclude, Philex Mining’s Uniform earnings growth is forecasted to be well above its peers, but currently trades well below its average peer valuations.

About the Philippine Markets Daily
“Tuesday 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 Tuesday, 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 Daily
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