Financial Adviser: 5 Things to Know About Andrew Tan's Empire East Land Holdings and How to Profit from It

ILLUSTRATOR WARREN ESPEJO

Market history tells us that interest rates have an inverse relationship with property stocks around 60 percent of the time.

This means that when interest rates go up, property stocks go down and when interest rates go down, property stocks go up. 

When the 10-year Philippine bond yield started fall in October last year following its peak at 7.4 percent, the fall in interest rates initiated a sharp rise in property stock prices, which enabled the Property Index to recover by 19.9 percent by end of 2022.

Today, property stocks continue to do well, rising further by 6.6 percent, as interest rates fell with 10-year bond yield sinking to 6.2 percent.

More than two-thirds of all listed property stocks in the PSE have recovered from their lows last year led by Ayala Land (PSE: ALI), which gained by 42.9 percent, SM Prime Holdings (PSE: SMPH), 27.4 percent and Filinvest Land (PSE: FLI), 18.4 percent.

Despite the encouraging progress of the Property Index, some property stocks have yet to regain their previous levels.

One of these is Empire East Land Holdings (PSE: ELI), which has been on a long-term downtrend, losing about 83 percent of its value from P1.21 per share in 2013 to P0.205 per share today.

Contrarians love to say that investing during bad times can be potentially rewarding because it offers investors the chance to buy stocks at substantial discounts to its intrinsic values.

ELI’s current situation could offer a once-in-a-lifetime value investing opportunity, as its share price could be a result of possible mispricing.

Legendary investor Warren Buffett once said, “Be fearful when others are greedy, and greedy when others are fearful.”

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Here are the five things every investor needs to know about Empire East Land Holdings and how we can profit from it:

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1| Know the background of the company

Empire East Land Holdings (PSE: ELI) is one of the leading low-to-middle income property developers in the country. The company is 81.7 percent owned and controlled by business tycoon, Andrew Tan through his property company, Megaworld Corporation (PSE: MEG).

Some of ELI’s current projects include Empire East Highland City, an elevated 22.8-hectare township at the boundary of Pasig City; The Paddington Place, four-tower high-rise condominium in Mandaluyong City; Mango Tree Residences, a two-tower condominium in San Juan City; and The Sonoma, a 50-hectare horizontal development in Santa Rosa City, Laguna.

ELI used to be a stock market darling when it was listed in 1996, but when the Asian financial crisis struck in 1997, the stock went downhill from a high of P8.77 per share to a low of P0.10 per share in 2003.

Share price of ELI has never recovered since then despite the steady growth of the company after the crisis. The highest that it has reached over the next 20 years was only P1.21 per share in 2013, which incidentally marked the beginning of its 10-year downtrend.

The fall in ELI’s stock price shrank its market capitalization from P13.5 billion to only P3.0 billion today, while its net income grew by 13 percent per year from P299 million in 2013 to P806 million in 2021.

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2| Know the earnings outlook of the company

Last year, ELI reported that its total revenues for the first nine months of 2022 grew by 9.1 percent to P3.4 billion from P3.1 billion in the same period last year.

ELI’s net income, however, grew only by 2.3 percent to P499 million from P487 million last year due to higher cost of real estate sales, which increased from 50 percent in 2021 to 60 percent last year.

If we annualize ELI’s net income based on its historical averages, we can expect it to reach P814 million by end of 2022.

Although this would represent only a minimal growth from 2021, this income level would be the highest the company has ever achieved since it went public in 1996.

It is also interesting to know that ELI’s quality of earnings has consistently improved in the past years.

We know that earnings are important drivers of share prices, but not all share the same quality because companies can manipulate earnings using creative accounting techniques.

Because of this, we want to choose companies that can generate good operating cash flows to lower risk of manipulation. The higher the operating cash flows than the reported net income, the higher the earnings quality of the company.

One of the reasons for the downtrend of ELI’s share price in the past 10 years could be due to the poor quality of its earnings. Since 2013, ELI has consistently generated negative operating cash flows against positive net income.

But this amount of negative operating cash flows have steadily declined from negative P2.9 billion in 2013 to negative P142 million in 2019.

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In 2020, ELI achieved a positive operating cash flow for the first time in 10 years at P1.1 billion against its reported net income of P531 million.

This turnaround in earnings quality was sustained in 2021 with large positive operating cash flow of P1.3 billion against reported net income of P806 million.

Last year, ELI also reported a positive operating cash flows of P202 million for the first nine months of 2022, although it is lower than its reported net income of P499 million.

The improvement in ELI’s quality of earnings, being an indicator of risk, should eventually reflect in higher share price valuation.

3| Know the pricing multiple of the stock

If we get the net income of ELI for the past 12 months, which means we get the sum of its fourth quarter earnings in 2021 and the nine-month earnings in 2022, we will derive a trailing income of P814 million.

By dividing ELI’s current market cap of P3.0 billion with its trailing income of P814 million, we will derive a Price-to-Earnings (PE) multiple of 3.68 times.

This is 20 percent lower than the historical average PE multiple achieved by ELI in 2021 at 4.64 times.

If we will price ELI at its fair PE ratio, we can use equate its PE to its compounded annual growth rate of 13 percent, which it achieved from 2013 to 2021.

Interestingly, ELI’s average PE ratio prior to the pandemic was also 13 times. If ELI’s share price is valued at 13 times PE ratio, its stock price could up to P0.70 per share, which represents more than three times its current share price.

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4| Know the book value of the stock

If we divide ELI’s book value of P30 billion as of September 2022 by its shares outstanding of 14.6 billion shares, we will derive a book value per share of P2.05 per share.

But ELI’s current share price of P0.205 represents only 10 percent of its book value, which means that it offers a huge 90 percent discount to its accounting net worth.

At a Price-to-Book ratio of 0.10, ELI is trading at 27 percent discount to its average Price-to-Book ratio of 0.137 in 2021, which is the minimum multiple that we can expect the stock to trade given its earnings achievement.

If we get the pre-pandemic average Price-to-Book ratio of ELI from 2017 to 2019, we will derive a ratio of 0.30 times. If ELI were to trade at its pre-pandemic ratio of 0.30, its stock price should rise by threefold to roughly P0.60 per share.

One of the determining factors of Price-to-Book ratio is the return on equity. In theory, a company with rising return on equity should be accompanied by increase in Price-to-Book ratio.

ELI’s historically low Price-to-Book ratio could be due to its low return on equity, which averaged only in 2.0 percent level since 2013. In 2021, ELI’s return on equity improved to 3.0 percent from 2.04 percent in 2021, but its average Price-to-Book declined to 0.137 from 0.176 in 2020.

Last year, ELI’s trailing return on equity was 2.7 percent, still higher than its average return in 2020, but its Price-to-Book today is at its historical low since 2013.

5| Know the intrinsic value of the stock

During the Great Depression, Benjamin Graham, known as the father of value investing, developed a valuation method called the “net-net strategy.”

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According to Graham, if you a buy a stock at least 67 percent discount to its “net-net” value, there is a good chance that you can make money in the long-run.

Graham computes the “net-net” value of a stock by deducting the total liabilities of the company from its current assets.

By investing in the “net-net” value of the stock, you would be buying the company for its current assets only, net of all its liabilities and taking its fixed assets for free.

If we apply this method to ELI, we can get the total current assets of the company as of September 2022 at P41.9 billion. If we deduct its total liabilities of P16.8 billion, we will get net current assets of P25 billion.

By dividing this with total shares outstanding of 14.6 billion shares, we will get a “net-net” value of P1.70 per share for ELI.

ELI’s share price of P0.205 offers a huge 88 percent discount to its “net-net” value, which fully satisfied Ben Graham’s 67 percent discount cut off.

Buying ELI at P0.205 or lower means that you will be paying for the company’s current assets only net of all its liabilities, not counting its fixed operating assets.

If 88 percent discount is too much, we can conservatively estimate ELI’s discount to eventually correct to 67 percent discount as minimum cut off of Ben Graham.

For ELI’s discount to go down from 88 percent to 67 percent, its stock price must go up by roughly three times to about P0.60 per share.

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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 

 

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