Financial Adviser: 5 Reasons Why Edgar Saavedra's Megawide Is An Emerging Value Play and How to Profit It

Megawide Construction Corp (PSE: MWIDE) and its partner are selling off their shares in GMR-Megawide Cebu Airport Corporation (GMCAC), the developer and operator of Mactan Cebu International Airport, to Aboitiz InfraCapital for a total deal value of P25 billion.

MWIDE, which owns 60 percent of GMCAC will get a total of P15 billion, while its partner, GMR Airports International BV (GAIBV) will get the remaining P10 billion.

The structure of the deal will involve MWIDE and GAIBV selling a total of 33.3 percent of its equity in GMCAC for 9.5 billion to Aboitiz InfraCapital, a wholly owned subsidiary of Aboitiz Equity Ventures (PSE: AEV), so that each partner will own one-third a piece of GMCAC.

The balance of P15.5 billion, on the other hand, will be paid in the form of exchangeable notes, where MWIDE and GAIBV will transfer the remaining 66.7 percent of GMCAC upon its maturity on October 30, 2024.

MWIDE’s divestment of GMCAC is expected to improve its long-term corporate value, as it sharpens its strategic focus on its core business.

MWIDE’s share price has lost as much as 82 percent, from P16.72 per share in 2019 to a low of P3 per share this year due to continuing losses brought about by the recent COVID-19 pandemic.

Although MWIDE’s stock has been recovering slowly lately, its share price is still far from its ideal value created by its recent divestment.

How will the divestment of GMCAC enhance shareholder value of MWIDE? What are the earnings prospects of the company? How much should the market value the stock as MWIDE realigns its business model for growth?

Here are the five things every investor should know how MWIDE is emerging to be an excellent value stock with an overlooked catalyst and how to profit from it:

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1| Earnings turnaround underway

MWIDE has been incurring losses for the past two years due to mounting interest expenses and declining airport revenues caused by the COVID-19 pandemic.

In 2020, MWIDE registered a net loss of P398 million from a net income of P859 million in 2019 as total revenues slumped by 35 percent to P12.9 billion from P19.9 billion in the previous year.

Last year, MWIDE continued to incur losses at P342 million despite higher contract revenues, which increased by 32 percent from P10.8 billion in 2020 to P14.3 billion due to lower airport revenues and higher finance costs.

MWIDE’s airport revenues declined by 37 percent from P2.0 billion in 2020 to P1.3 billion last year, while finance costs increased to all time high at P2.8 billion, growing by 12 percent from the previous year.

MWIDE’s finance costs have been increasing by an average growth of 44 percent per year for the past 10 years from only P72.8 million in 2011 to P2.8 billion in 2021.

A significant portion of MWIDE’s finance costs, about 60 percent of the total, came from its debt used to finance the operation of its airport assets.

MWIDE’s divestment of its airport business will result to lower finance costs and highlight the recovery of its construction business to profitability.

A look at MWIDE’s first half performance this year will show that the company’s losses continued to worsen to P441 million from a net loss of P52.8 million in the same period last year due to rising finance costs, which increased by 28 percent to P1.5 billion from P1.2 billion last year.

But if we remove MWIDE’s airport business, total finance costs would decline significantly, resulting to a net profit of P356 million from its construction business.

Although the divestment will not completely remove the airport business as MWIDE will still retain 33 percent of the business as an equity investment until 2024, the risk of losses will be smaller and manageable.

If we will annualize MWIDE’s net income from its contract revenues, which is its core business, we can expect the company to achieve about P712 million this year.

Given the post-pandemic recovery in the economy, MWIDE’s net income should be able to turnaround organically to over P1.0 billion prospectively.

2| Stronger balance sheet lowers financial risk

The debt-to-equity ratio will tell us the amount of risk associated with the way the capital structure of a company is set up.

The higher the debt-to-equity ratio of a company, the higher the risk that it will default. Lenders and investors tend to favor companies with lower debt-to-equity ratios.

The optimal debt-to-equity ratio varies by industry, but in general, the ratio should not be above a level of 2.0.

A debt-to-equity ratio of 2.0 indicates that the company derives two-thirds of its capital financing from debt and one-third from shareholder equity.

MWIDE’s debt-to-equity ratio as of June 2022 stands at 2.79, which is way above the benchmark of 2.0, making the company financially risky.

Now, with the divestment of the airport business, the lowering of MWIDE’s ownership from 60 percent to 33 percent of GMCAC will practically remove the airport’s debt of P25.9 billion from its balance sheet.

As a result, MWIDE’s total debt will fall by 50 percent from P51.6 billion to P25.6 billion. The lower debt will also lower MWIDE’s debt-to-equity ratio to 1.59.

If we will consider MWIDE’s cash position of P3.9 billion plus its expected proceeds of P15 billion from the divestment, we can deduct this cash amount from its debt of P25.6 billion to derive a net debt position of P6.6 billion.

At a net debt of P6.6 billion, MWIDE will have a projected net debt-to-equity ratio of only 0.41, which makes the company financially strong in times of rising interest rates.

3| Large war chest to deal with uncertainties

With the expected cash reserves of P18.9 billion, MWIDE will have the financial muscle to pursue value creating opportunities for the company.

MWIDE can use its cash reserves to take advantage of any unexpected opportunity during this time of economic uncertainty.

Aside from bagging several big-ticket projects, such as the Malolos-Clark Railway Project and the Metro Manila Subway System Project, MWIDE can invest in high growth infrastructure platforms where it can leverage its engineering and construction expertise.

The company is currently exploring several transport-centric development locations that will follow its centralized hub model with the Paranaque Integrated Terminal Exchange (PITX).

Assuming a conservative return of 9.32 percent, which is MWIDE’s pre-pandemic average return on equity, the P15 billion proceeds as a capital for reinvestment should generate annual earnings of P1.4 billion in the long-term.

This should boost the company’s future earnings easily to over P2.0 billion assuming its existing core business can already generate P1.0 billion.

For reference, the highest net income that MWIDE achieved since it went public was P1.8 billion in 2017. During that year, MWIDE’s average share price was P18.00 per share.

Moreover, assuming opportunities become scarce, MWIDE can also return a portion of its cash reserves to shareholders through higher cash dividends or it can also buy back its shares from the market, which have fallen to historic lows, which should help enhance its market price.

4| Trading below book value

MWIDE’s current book value stands at P8.00 per share, which offers 33.9 percent discount to its current market price of P5.29 per share.

But after the divestment, the book value may increase further to an estimated amount of P9.56 per share due to possible booking on one-time gain on sale of its shares in GMCAC.

If we assume that MWIDE will receive 60 percent of the P9.5 billion expected proceeds from sale of shares, it should receive cash of P5.7 billion.

The book value of GMCAC as of December 2021 was P6.8 billion. Because of the airport losses of P788 million for the first six months of this year, we can adjust its book value to P5.9 billion.

We can multiply MWIDE’s 60 percent share in GMCAC to get the book value of its investment at P3.6 billion.

Since MWIDE will transfer 26.7 percent out of its 60 percent stake, representing 44.5 percent of the total, the book value of its equity sold to Aboitiz InfraCapital is estimated at P1.6 billion.

With selling price of P5.7 billion against book value of P1.6 billion, we can project that MWIDE’s equity book value will increase by P4.0 billion.

This adjustment will result to a projected book value of P9.56 per share, which offers 44.7 percent discount at current share price.

At a prospective Price-to-Book Value ratio of 0.55, MWIDE is still 30 percent below its pandemic PBV average of 0.775.

At 0.775 PBV ratio, MWIDE should trade at least at P7.40 per share.

5| Deep discount to intrinsic value

If there is a pricing multiple that values the equity of a firm, which is the price-to-earnings ratio, there is also a multiple that determines the entire worth of a firm.

This is the Enterprise value-to-EBITDA ratio (EV/EBITDA). This ratio is used on the belief that investors do not only pay for the residual earnings of the company but also for the cash flows of the whole business.

The Enterprise Value (EV) of a company is computed by simply taking the sum of the market value of its equity and debt minus cash.

The EBITDA, on the other hand, which stands for earnings before interest, tax, depreciation and amortization, represents the “cash earnings” of the company.

EBITDA, as a broad measure of cash flows, helps determine the true earnings potential of a company by adding back its financing costs and noncash expenses.

Currently, if we add the market capitalization of MWIDE at P10.6 billion and its total debt at P51.6 billion, we will get total amount of P62.3 billion.

By deducting its existing cash of P3.9 billion, we will derive an Enterprise Value or EV for MWIDE at P58.3 billion.

If we divide MWIDE’s EV by its estimated full year EBITDA at P3.3 billion, we will derive an EV/EBITDA ratio of 18 times, which makes the stock look very expensive.

The pre-pandemic EV/EBITDA average of MWIDE from 2017 to 2019 was only 14 times. This was the time when the company was generating an average of P4.5 billion in EBITDA per year.

But today, at a lower EBITDA of P3.3 billion against a high EV not due to high market cap but high levels of debt, the EV/EBITDA ratio is historically high at 18 times.

Now, with the divestment, MWIDE’s total debt will fall to P25.6 billion. Minus a cash hoard of P18.9 billion after the proceeds, MWIDE’s EV will fall to P17 billion.

If we compare MWIDE’s lower EV of P17 billion against an estimated lower EBITDA of P2.4 billion due to the absence of the airport business, we will derive an attractive EV/EBITDA of 7.06.

At EV/EBITDA of 7.06, MWIDE will be trading at roughly 50 percent discount to its pre-pandemic EV/EBITDA average of 14 times.

If we price MWIDE at 14 times after the divestment, the target market cap should be at P27.7 billion or share price value of P13.80 per share.

Henry Ong, RFP, is an entrepreneur, financial planning advocate and business advisor. Email Henry for business advice [email protected] or follow him on Twitter @henryong888