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Financial Adviser: 5 Things to Know Before Investing in D.M. Wenceslao and How to Profit from It

Let's focus on one of the most overlooked stocks in the PSE today.
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Integrated property developer D.M. Wenceslao and Associates (PSE:DMW) may be one of the most promising but overlooked stocks in the market today.

Since the company went public in 2018, DMW has been consistently underperforming the PSE Index despite positive revenue and earnings growth results year after year.

DM Wenceslao has briefly surpassed its initial public offering (IPO) price of P12 when it hit a high of P12.46 per share in 2019 before it went downhill, losing as much as 59.4 percent this year.

But lately, the stock has started to show signs of recovery after bottoming out at a low of P5.05 per share.

This rally, which started last October, has enabled DM Wenceslao to gain a total of 47.6 percent last week, making it the fourth biggest gainer among property stocks behind MRC Allied (PSE: MRC, +107 percent); Suntrust (PSE: SUN, +55 percent) and Vista Land (PSE: VLL, +52.7 percent).

Value investing dictates that there are potential investment opportunities to be made in unglamorous stocks like DMW for as long as their fundamentals remain strong.

Because investors in general follow the trendy stocks, which are mostly overpriced, buying unnoticed value stocks with good growth prospects often provide the greatest returns.

What are the possible factors that can help sustain the recovery of the stock? What are the growth drivers of the company? What is the intrinsic value of the stock based on current risk environment?

Here are five things that every investor must consider before investing in DM Wenceslao:

1| Predictable rental revenues to support growth

DMW owns one of the largest land holdings in Metro Manila with a total area of 569,000 square meters in Aseana City.

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The company derives about 67 percent of its revenues from leasing, while the balance of 33 percent comes from the sale of condominium units and construction contracts.

From the total rental revenues, about half comes from land rentals and the other half from building leases, which have 98 percent occupancy rate.

Ayala Land is one of the company’s largest tenants, occupying more than half of DMW’s leased land area.

Total revenues of DMW have been growing by an average of 21 percent per year from P1.6 billion in 2015 to P3.5 billion last year, driven mainly by consistent 12 percent growth in total rental revenues.

This year, because of the impact of the COVID-19 outbreak, total rental revenues for the first nine-months of the year slightly dipped by 0.3 percent but the company still managed to grow total revenues by 13 percent due to a 67 percent increase in residential sales.

The increase in revenues this year enabled DMW to increase its operating profits by 16 percent to P1.3 billion from P1.1 billion in the same period last year.

DMW also announced recently that it has acquired a 2,400 square meter building with active leases in Legaspi Village, Makati.

It will also complete its largest office building to date—8912 Asean Avenue—by the second quarter of next year and Parqal, its five-hectare mixed development project by the fourth quarter.

These three new buildings should further strengthen DMW’s recurring rental base by at least P1.2 billion in additional rental revenues on full year basis.

2| High earnings quality to boost share price valuation

Earnings are important drivers of share prices. Investors use earnings updates as basis to project how stocks are likely to be valued in the coming months.

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The problem is that not all earnings share the same quality.

Because of the accounting rules that often require management judgment, some companies manipulate their earnings using creative techniques to show positive results.

Historical studies of PSE stocks showed that there is an 18.5 percent positive correlation between quality of earnings and stock returns.

This means the higher the earnings quality of a stock, the higher the probability that the stock will generate positive returns in the long-term.

One way to evaluate the earnings quality is by looking at the ratio of operating cash flows to net income. The higher the ratio, the higher the earnings quality.

DMW’s operating cash flows to net income ratio has been increasing in the past years from 0.80 in 2017 to 1.47 in 2019.

For the first nine months of this year, DMW’s operating cash flows were higher than its net income with a ratio of 1.37, indicating high earnings quality of the stock.

Moreover, if we deduct the company’s annual capex requirements against its operating cash flows over the years, we find that its free cash flows have also been increasing.

Rising free cash flows mean that the company is generating enough cash to meet its future capex requirements, as well as satisfy all its debt and other obligations.

DMW’s free cash flow as a ratio of revenues has been increasing from 18.3 percent in 2017 to a high of 62.4 percent in 2019. This year, despite the pandemic crisis, DMW’s free cash flow ratio stood at high of 51 percent.

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DMW’s high earnings quality and free cash flow yield should merit high premium valuation over the long-term.

3| Strong balance sheet and large land holdings to secure future growth

DM Wenceslao has only allocated 46.6 percent of its total land holdings of 569,000 square meters in Aseana City for development.

The remaining 53.4 percent, or 299,000 square meters, have yet to be developed, which should sustain the company to grow its rental revenues in the long-term.

Given DMW’s strong capacity to generate operating cash flows, the company should be able to finance future property developments.

This is not to mention that DMW also enjoys a strong financial position with current debt-to-equity position of only two percent as of September this year.

Using median debt-to-equity ratio of 1.11 times among listed property companies at the PSE as basis, DMW can potentially raise up to P22 billion to finance its undeveloped land holdings in the years to come, in case its internal cash flows are not enough.

DMW’s current financial position with almost zero debt means the company has lower financial risks, which should translate to a high intrinsic value.

4| Low investment risk to generate high intrinsic value

Although the stock has recovered already by over 47.6 percent from its historic low of P5.05 per share this year, DM Wenceslao’s stock pricing based on Price-to-Earnings (PE) ratio is only 10 times.

This is comparatively low compared to the average PE ratio of companies belonging to the Property Index, which is 13.5 times.

If we price DMW based on the average PE ratio of the Property Index of the PSE, the stock should be priced at P10.14 per share, which offers 26 percent discount to the current share price of P7.50.

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We know that PE ratios are useful only for quick pricing comparison, but to compute for the intrinsic value of a stock, we must consider the risk and growth profile of the company.

Given the risk-free rate of 3.09 percent, which is based from the 10-year Philippine bond yield and the stock’s historical beta of 0.51, we can compute DMW’s cost of equity at 5.64 percent.

If we assume conservatively with zero growth for DMW, we can simply convert the stock’s cost of equity of 5.64 percent to derive an intrinsic PE ratio target of 17.7 times.

By applying this intrinsic PE ratio against DMW’s trailing earnings per share of P0.75, we can derive its target intrinsic value share price of P13.28 per share, which offers a huge discount of 43 percent to current share price.

5| Current share price to offer solid upside potential

The legendary Warren Buffett once said that he prefers businesses that he can predict in the next 10 to 15 years.

Buffett believes that companies that can grow consistently with a fair degree of certainty can deliver superior returns in the long-term.

Using this investment philosophy, let’s assume that DM Wenceslao’s net income, which historically has grown by 28 percent per year in the past, will conservatively grow by 15 percent per year based on its operating profits after tax over the next 10 years.

By 2030, we can estimate that DMW’s cumulative net income will have grown to P7.3 billion. If we apply the stock’s average historical PE ratio of 14x, we can derive a target market price of P30.36 per share after 10 years.

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Because this is a target price in the future, we can simply discount this price to the present using the stock’s discount rate of 5.64 percent where the value of the stock is computed at P17.53 per share.

Henry Ong, RFP, is president of Business Sense Financial Advisors. Email Henry for business advice [email protected] or follow him on Twitter @henryong888  

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