Financial Adviser: 5 Reasons Why Henry Sy Jr.'s Synergy Grid Is the Most Undervalued Power Company Today and How to Profit from It

Energy-related stocks have been one of the hardest-hit sectors in the stock market since inflation and interest rates began to rise early this year.

The total market capitalization of listed energy companies in the Philippine Stock Exchange has lost as much as -10.2 percent during the height of market sell-off last June, but has since recovered to a year-to-date loss of -5.6 percent.

This recovery, however, is still short of the Philippine Stock Exchange Index’s current loss of -3.6 percent, making the energy sector one of the most underperforming industries so far, along with properties (-4.36 percent) and services (-11.6 percent).

One reason why energy stocks have done poorly is because a rise in interest rates tends to lower their valuation, causing their stock prices to fall. But market history has shown that energy stocks tend to do well during periods of high inflation and interest rates in the long-term because demand for electricity will remain the same regardless of the price.

Higher electricity price, as a result of inflation, increases the returns of energy companies.

This is not to mention energy companies in general also have high operating leverage, which helps them deliver high profit margins over time.

Among the energy-related stocks in the market, transmission system operator Synergy Grid (PSE: SGP) is one of the most promising to recover strongly, being the most undervalued power company.

SGP, which has successfully raised P13.8 billion last year following its follow-on offering, has fallen by as much as 33.3 percent from its 52-week high of P16.50 per share this year.

Although the stock has recovered recently to P13.36 per share, its share price is still far from its fundamental market value.

As in any value stock, it is always good to spend some time understanding the business of the company and evaluate its long-term potential.

The more you know about the fundamentals of the company, the better your chances in handling your investment risk and returns.

Here are the top five things every value investor needs to know about Synergy Grid and how you can profit from it:

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1| Strong earnings growth

Synergy Grid and Development Philippines (PSE: SGP) is the investment holding company owned equally by Henry Sy, Jr. and Robert Coyiuto, Jr. which controls 60 percent of the National Grid Corporation of the Philippines (NGCP).

NGCP is the sole and exclusive operator of the country’s nationwide transmission network linking power generators and distribution utilities that deliver electricity to end-users across Luzon, Visayas and Mindanao.

SGP-controlled NGCP generates about 94 percent of its revenues from power delivery services, while the remaining six percent comes from system operation and metering services.

NGCP derives about 46 percent of its revenues from Meralco alone, the biggest distribution utility customer in the country, while the balance of 63 percent comes from other customers, which include electric cooperatives, private and government utilities, and economic zones.

Total revenues of NGCP have been growing by an average of three percent from P45.4 billion in 2018 to P48.6 billion in 2020, which enabled SGP to grow its share in NGCP’s total net income by six percent per year from P8.36 billion in 2018 to P9.4 billion in 2020.

Last year, SGP’s net income fell slightly by 2.9 percent to P9.1 billion despite a flat revenue growth due to foreign exchange losses and lower operating income.

But this year, NGCP’s total revenues for the first six months recovered strongly by 46.8 percent to P35.5 billion from P24.2 billion in the same period last year.

This is after the Energy Regulatory Commission granted NGCP’s request to implement its Interim Maximum Allowable Revenue (iMAR) for 2020, which was suspended during the outbreak of coronavirus pandemic.

The implementation of its iMAR allowed NGCP to increase its transmission charges, which helped improve its operating margins to 71.7 percent this year from 63.1 percent last year.

This recovery in NGCP’s total revenues increased SGP’s share in total net income by 78 percent to P9.08 billion from P5.1 billion in 2021.

At P9.08 billion net income for the first six months, SGP already has 99 percent of its 2021 full year net income of P9.2 billion.

If we annualize SGP’s first half earnings, we can expect total net income at the end of the year at P16.5 billion, which represents a huge 81 percent earnings growth.

2| Priced at low earnings multiple

If we compute NGCP’s last 12 months’ net income from June 2021 to June 2022, we will find that its trailing income will amount to P32.9 billion.

By multiplying SGP’s 40.2 percent economic interest in NGCP, we can derive a net income at P13.2 billion.

Using this actual profit figure against SGP’s market capitalization at current price of P13.36 per share, we can estimate the stock’s Price-to-Earnings (PE) ratio to be at 5.32 times only, which is attractively low compared to the energy sector’s average PE of 13.5 times.

SGP’s current pricing at 5.32 times PE is also comparatively low among listed transmission system operators in the world.

For example, Terna SpA, which is an electricity transmission system operator that owns virtually all of the Italian National Transmission Grid similar to NGCP, is trading at 19.1 times PE ratio.

National Grid Plc, the largest transmission system operator in the United Kingdom, is currently priced at 18 times PE ratio, while Power Grid Corporation, one of the largest players in the power transmission sector in India, is trading at 10.9 times PE ratio.

If we price NGCP at the most conservative pricing multiple at 11 times, which is equal to India’s Power Grid’s earnings multiple, SGP’s share price should appreciate to P27.52 per share, which is roughly double the current share price.

3| Rising cash dividends

SGP has been paying increasing cash dividends in the past three quarters since its follow-on offering last year.

The company first paid P0.20 per share in December. It then increased it by 10 percent in March to P0.22 per share before it raised further by 18.2 percent to P0.26 per share last July.

If we will conservatively assume that SGP will pay the same cash dividend of P0.26 per share in the next quarter, we will expect a trailing total cash dividend of P0.94 per share, which gives 7.0 percent dividend yield at the current share price.

Prospectively, if we assume that SGP will pay the same P0.26 per share in the next four quarters, we can simply multiply the current cash dividend by four to get P1.04 per share.

At this projected cash dividend, we can derive a dividend yield of 7.8 percent at the current share price, which is attractively high compared to the energy sector’s average dividend yield of only 1.8 percent.

Now, because NGCP’s earnings have considerably increased during the first half, which practically covered its 2021 net income, and are expected to increase further this year, there is great likelihood that dividends may also be increased in the coming quarters.

For example, if we annualize NGCP’s first half net income at P22.6 billion, we can estimate that its total net income by year end to be at P41.1 billion.

Let’s assume that NGCP will declare only 50 percent of its net income as dividends, we can simply multiply the projected net income by 50 percent to estimate cash dividends of P20.5 billion.

By virtue of SGP’s 40.2 percent economic interest in NGCP, we can derive a potential cash dividend of P8.25 billion, which translates to a full year cash dividend of P1.56 per share or an average of P0.39 per share per quarter.

At this estimated cash dividend, SGP’s prospective cash dividend yield at current share price to be at 11 percent.

If we equate SGP’s projected cash dividend of P1.56 per share at the prevailing 7.0 percent dividend yield, we should expect the stock’s share price to appreciate to P22.28 per share, which offers a potential return of 66 percent.

4| Trading below book value

There is a common notion that when a stock is trading below its book value, it means that the stock is considered a bargain.

But this is not necessarily true if we consider the earnings potential of a company’s assets. If a company cannot generate enough earnings to justify its fixed asset investment, its stock price may be considered expensive if it is trading above its book value.

On the other hand, if company is generating good returns on fixed asset investments, its stock price may be considered cheap if it is trading below its book value.  

This is the case of SGP, where its market price does not reflect the earnings power of its assets.

If we apply SGP’s 12-month trailing income of P13.2 billion against the book value of its equity of P90.4 billion, we will derive a return on equity (ROE) of 14 percent, which is higher than the energy sector’s average ROE of 10.4 percent.

At 14 percent ROE, SGP’s share price must trade above its book value or a Price-to-Book Value (PB) ratio of at least 1.0.

But if we will compare SGP’s current share price against its book value of P17.16 per share, we will find that it is trading at 22 percent discount, indicating that the stock is undervalued.

If we compare this to the energy sector’s average Price-to-Book Value (PB) ratio of 1.20 times, SGP share price must eventually trade at a minimum of P20.59 per share, which offers a potential upside of 54 percent at current share price.

5| Deep discount to intrinsic value

It has been said that a company creates value for its shareholders when it generates a return on invested capital (ROIC) that is higher than its weighted average cost of capital (WACC).

The higher the residual spread between a company’s ROIC over its WACC, the higher the share price of the stock should be as reflected in its high Enterprise Value (EV) to Invested Capital (IC) ratio.

In theory, the ratio of ROIC-to-WACC should be equal to EV-to-IC ratio so that when a stock’s ROIC-to-WACC is higher than its EV-to-IC ratio, it means that the stock is undervalued, and vice versa.

If we apply this theoretical valuation to SGP, we will find that the stock has ROIC of 12.2 percent against its WACC of only 7.2 percent, which is very good.

An ROIC higher than the cost of capital means the company is healthy and growing, while an ROIC lower than the cost of capital suggests the company is unsustainable and destroying value.

If we take the ratio of SGP’s ROIC-to-WACC, we will derive a multiple of 1.69 times.

At SGP’s current share price of P13.36 per share, SGP’s projected Enterprise Value is estimated at P258 billion.

If we compare this against the SGP’s invested capital of P323 billion, we will derive an EV-to-IC ratio at only 0.80 times.

Because SGP’s ROIC-to-WACC ratio at 1.69 is higher than its EV-to-IC ratio of 0.80, the stock is deemed very undervalued.

If we equate SGP’s EV-to-IC ratio to its ROIC-to-WACC ratio at 1.69 times, we should theoretically derive target market capitalization for SGP at P358 billion or P68.12 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