Financial Adviser: 5 Things to Know About Andrew Tan's Megaworld Corporation and How to Profit from It
Rising interest rates can have a significant impact on property stocks, as these companies often rely heavily on debt financing to fund their operations.
When interest rates rise, it becomes more expensive for buyers to borrow money, which can result in decreased profitability and reduced cash flow. This can lead to a decrease in the stock price of property companies as investors become more cautious about the company's future earnings potential.
Additionally, rising interest rates can lead to a decrease in demand for real estate, as higher borrowing costs can make it more difficult for potential buyers to afford property.
This can result in lower occupancy rates and rental income for property companies, further reducing their profitability and potential for growth.
Last year, over 80 percent of property stocks listed on the Philippine Stock Exchange saw a decline in value, ending the year with losses as a result of high interest rates.
One of the top three biggest losers in the sector was Megaworld Corporation (PSE: MEG), which saw a 36.5 percent decline in its stock price.
This year, MEG’s stock price continued to weaken after being removed from the PSE Index last February. The removal of MEG from the index could result in decreased demand for the stock.
Investors who track the index may be required to sell their shares in the company, which can result in increased selling pressure and a decrease in the stock price.
MEG's stock price has fallen to its lowest level in 52 weeks, reaching P1.98 per share. If selling pressure persists, the stock could decline even further to its pandemic low in 2020, which was P1.86 per share.
Contrarian investors often suggest that investing during challenging times can be a lucrative opportunity as it provides investors the possibility to purchase stocks at significant discounts to their intrinsic values. The current circumstance of MEG could present a unique value investing prospect as its share price may have been affected by potential mispricing.
Here are five essential facts that every investor should know about Megaworld Corporation and how we can capitalize on them:
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1| Know the earnings outlook of the company
Prior to the pandemic, MEG’s net income had been growing by an average of 11 percent per year from billion P8.0 billion in 2011 to a high of P17.9 billion in 2019, driven by consistent revenue growth that rose by 13 percent annually.
About 61.9 percent of MEG’s total revenues comes from real estate sales with the balance of 26.3 percent from rental income and 11.8 percent from hotel operations.
But during the 2020 pandemic, MEG’s total revenues plunged by 37 percent, which caused its total net income to fall by 45 percent to P9.9 billion, bringing the company’s earnings close to the level it had in 2013 for the first time in seven years.
In 2021, despite the ongoing pandemic, MEG's total revenues began to show signs of recovery, increasing by 18 percent from the previous year's low of P39 billion to P46 billion. That led to a 36 percent increase in the company's total net income to P13.4 billion.
Last year, MEG's total revenues continued to recover, growing by 18.8 percent to P55 billion, but its total net income hardly increased at P13.5 billion, due to higher interest and tax expenses.
This year, with the full reopening of the economy, MEG’s net income should be able to meet, if not surpass, its 2019 earnings at P17.9 billion.
Despite the revenue and earnings recovery over the past two years, there has been no corresponding appreciation in MEG’s share price. Instead, MEG’s stock price has been on a downtrend, causing it to approach its lowest point in 2020.
2| Know the pricing multiple of the stock
Based on MEG’s 2022 net income of 13.5 billion, MEG is trading at a Price-to-Earnings (PE) multiple of only 4.6 times, which is comparatively low against its pre-pandemic historical PE average of 10 times.
At 4.6 times PE ratio, the market was valuing the stock at its 2011 level where the company’s net income was at P8.0 billion.
Given MEG’s latest income at P13.5 billion, which represents an increase of 69 percent from its 2011 level, MEG’s PE ratio should be appropriately adjusted, at the minimum, to 7.8 times.
We should note that this target PE ratio of 7.8 times is just about the same with its average PE in 2021 and is 22 percent lower than its pre-pandemic PE average of 10 times.
Now, if we will price MEG at 7.8 earnings multiple, given its current income of P13.5 billion, then we should expect its stock price to recover eventually to P3.40 per share.
The other way to look at this is by comparing MEG’s PE to its historical earnings growth. According to legendary investor Peter Lynch, a stock is considered fairly valued if its PE ratio is equal to its growth ratio, meaning its PEG ratio is equal to 1.0, but when a PEG ratio falls below 1.0, the stock is deemed undervalued.
If we get the compounded annual growth rate of MEG’s total earnings as a company for the past 10 years from 2012 to 2022, we will derive an average growth of 7.57 percent.
By equating MEG’s PE ratio to its historical earnings growth of 7.57 percent, or 7.57 times, we should derive a conservative target price of P3.26 per share.
3| Know the financial strength of the company
One of the qualities of a financially stable company is having a low debt-to-equity ratio. Companies with low debt-to-equity ratios have a lower risk of defaulting on their debt.
MEG has a low debt-to-equity ratio of 0.39 as of end of 2022, which is a slight decrease from the previous year’s ratio of 0.41. This is also significantly lower than the property sector’s average debt-to-equity ratio of 0.73.
MEG's debt-to-equity ratio compares favorably to other property stocks in the market, such as Ayala Land (PSE: ALI) with a ratio of 0.89, and SM Prime Holdings (PSE: SMPH) with a ratio of 1.04.
Over the years, MEG has also maintained a liquidity ratio. One of the key indicators of liquidity is the current ratio, or the financial ratio that measures a company's ability to pay its short-term obligations with its current assets. It is computed by dividing a company's current assets by its current liabilities. The resulting ratio indicates whether a company has enough current assets to cover its current liabilities.
A current ratio of 1 or higher typically indicates that a company has enough current assets to meet its short-term obligations. A ratio below 1 may indicate that a company may have difficulty paying its bills on time.
As of end of 2022, MEG’s current ratio stands at 2.98, which is higher than the property sector’s average current ratio at 2.49. MEG’s high current ratio also compares well to other leading property stocks in the market such as ALI, which has a ratio of 1.89 and SMPH with ratio of 1.50.
4| Know the book value of the stock
If we divide MEG’s shareholders’ equity of P209 billion as of December 2022 by its shares outstanding of 31.2 billion shares, we will derive a book value per share of P6.70 per share.
MEG’s current share of P1.98 per share represents only 29 percent of its book value, which means that the stock offers a huge 71 percent discount to its accounting net worth.
Based on market experience, the Price-to-Book (P/B) ratio of a stock is positively correlated with the Return on Equity (ROE) ratio. This means that the higher the ROE of a stock, the higher its P/B ratio should be.
In the case of MEG, its ROE as of end of 2022 was 6.37 percent, which is higher than the property sector’s average ROE of 5.46 percent, but its P/B ratio of 0.29 is miserably lower than the sector’s average of 1.81 times.
Moreover, MEG also compares well to the leading property stocks in the market such as ALI, which has ROE of 5.45 percent but has high P/B ratio of 1.74 and SMPH with ROE of 6.25 percent at P/B ratio of 2.91.
MEG's current P/B ratio of 0.29 is relatively lower compared to its average P/B ratio of 0.64 over the past three years. However, if we take into account MEG's average P/B ratio during pre-pandemic years, the average ratio would be higher at 0.94.
Given the negative sentiment in the market, let’s just say MEG’s P/B ratio will only regain up to 70 percent of its pre-pandemic average. At 70 percent, MEG’s target P/B ratio is 0.66.
If we apply 0.66 against MEG’s book value of P6.70 per share, we will derive target price of P4.40.
5| Know the intrinsic value of the stock
During the Great Depression in the U.S., Benjamin Graham, known as the father of value investing, developed a valuation method called the “net-net strategy,” which primarily uses the net current asset value per share (NCAVPS) as a measure to assess the worth of a stock.
The net-net strategy posits that a business's true value proposition lies in its ability to generate revenue from its current assets.
Graham computes the “net-net” value of a stock by deducting the total liabilities of the company from its current assets and dividing it by its shares outstanding.
The resulting “net-net” value of a stock is then compared to its share price to compute for possible discount.
If we apply this method to MEG, we will find that its current assets of P224 billion is greater than its total liabilities of P168 billion, resulting to a net current asset value of P56 billion.
If we divide this value by its shares outstanding of 31.2 billion shares, we will derive a “net-net” value of P1.80 per share.
Currently, MEG's share price of P1.98 is trading at an 11 percent premium over its "net-net" value. This 11 percent premium is the lowest that MEG has historically traded at, as the company has never traded below its "net-net" value.
If we compare MEG’s premium over its “net-net” value in the past years, the historical premiums were comparatively higher. In 2021, MEG’s premium was 68 percent. In 2020 during the height of the pandemic, its premium was 174 percent. Prior to the pandemic in 2019, MEG’s premium was 183 percent.
If we get the average of MEG’s premium from 2019 to 2021, we will derive an average of 142 percent or price-to-net-net value ratio of 2.42 times.
If we apply this to MEG’s net-net value of P1.80, we will derive a target price of P4.36 per share.
Henry Ong, RFP, is an entrepreneur, financial planning advocate and business advisor. Email Henry for business advice [email protected]financialadviser.ph or follow him on Twitter @henryong888