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Financial Adviser: 5 Things to Know About Edgar Saavedra's Megawide Preferred Shares Offering and How to Profit from It

The construction company is raising up to P5 billion through preferred shares.
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Infrastructure conglomerate Megawide Construction Corp (PSE:MWIDE) is raising up to P5 billion by selling up to 50 million preferred shares at P100 each to the public.

The offering period of the preferred shares shall run from November 10 to 17 with a target listing date on November 27, 2020.

Preferred shares are a special class of stocks that have features of a debt instrument because of its fixed dividend payments. It offers a steady stream of dividends, similar to interest income, regardless of the company’s earnings.

But unlike debt, preferred dividends can be suspended in case of cash flow problems. Because of these risks, preferred dividend yields are always higher than the interest rates offered by debt securities.

Preferred shares are also less volatile than common shares due to its stable returns. Pricing of preferred shares is more dependent on interest rates than its company’s growth outlook.

A rising interest rate can lower the market value of preferred shares, but if interest rate declines, the value of preferred shares can go up.

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In a market environment like this where yields are low due to falling interest rates, it may be a good investment strategy to diversify into preferred shares.

But before you invest, just make sure that the company is financially capable of paying its dividends on time. Just like buying an IPO, you should review the company’s profitability and financial performance.

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Always ask yourself: what is the probability that the company will fulfill its promise to pay dividends consistently? Can it generate enough cash flow to cover the projected dividends aside from the existing interest expenses?

Here are the five things you must know about the preferred share offering of Megawide Construction Corp and how you can profit from it:

1| Know the structure of the offering

MWIDE is selling up to 50 million preferred shares called Series 2, which are broken down into two subseries: Series 2A and Series 2B.

Series 2A preferred shares (PSE: MWP2A) will pay quarterly dividend at 4.75 percent per annum, while Series 2B preferred shares (PSE: MWP2B) at 5.75 percent.

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MWP2A has lower dividend rate because it has a shorter redemption period of 2.5 years, as compared to MWP2B, which has longer redemption of five years.

The redemption period, which works like the maturity date for bonds, mandates the company to buy back its preferred shares from its investors at the original offering price.

If, for any reason, MWIDE is not able to redeem the shares on the expected date, the company shall pay a minimum dividend rate of eight percent on any of the subseries from there on.

Moreover, if the company fails to pay dividends on time, because the preferred shares are cumulative, such dividends shall be considered in arrears and must be paid before any other dividends.

2| Know the financial background of the company

MWIDE is one of the largest infrastructure companies with significant interests in construction, property development, airport and terminal operations and renewable energy.

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Bulk of the company’s revenues, about 77 percent of total, is primarily contributed by its engineering and construction business.

This is followed by its airport operations in Cebu-Mactan International Airport, which contributes about 20 percent, and its landport operations in Parañaque Integrated Terminal Exchange (PITX), which contributes about three percent.

Last year, total revenues grew by 24 percent to P19.9 billion from P15.9 billion in 2018, but higher depreciation and interest expenses dragged down total net profits to P1.1 billion, 41 percent lower from P1.9 billion in the previous year.

This year, with the outbreak of the coronavirus pandemic, total revenues for the first six months fell by 21 percent to P6.4 billion from P8.1 billion in 2018.

The sharp fall in revenues resulted to a net loss of P449 million from profits of P731 million in the same period last year.

With the gradual reopening of the economy in the second half, the company should be able to recover its revenues and trim its losses to below P300 million by year end.

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3| Know how the company will invest the proceeds

MWIDE plans to use the funding from the preferred share offering to partially finance its long-term infrastructure projects in preparation for post-covid economic recovery.

The company is preparing to expand its development in the PITX with bus staging area, office and commercial complex.

It also plans to double its pre-cast plant capacity in selected locations in the country to take advantage of the increased demand for pre-fabricated construction materials.

MWIDE has allocated initial capital budget of P1.4 billion to redevelop the existing NAIA Terminals to remove decongestion and increase total passenger handling capacity.

The company is also eyeing to put up the Cebu Integrated Transport Hub by rehabilitating the existing Carbon Market into a new public market, including construction transport and ferry terminals.

Completion of these projects should complement MWIDE’s construction and engineering revenues with a stronger recurring income base in the future.

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4| Know the financial risk and opportunities

MWIDE has relatively high financial leverage with almost 60 percent of its total assets financed by debt, but the company has managed to stay liquid with current ratio of 1.27 by end of 2019.

This year, after the offering of its preferred shares, the company can improve further its liquidity position with current ratio of 1.42.

If we want to assess that the company’s cash flows can repay its interest expenses and the projected dividends, we can simply compute for the company’s EBITDA or Earnings Before Interest, Taxes, Depreciation and Amortization.

Based on depreciation expenses of P772 million as of the first half of this year, we can estimate that its total depreciation for the year should be P1.545 billion. If we add the projected operating profit for the year at P1.6 billion, we should get an EBITDA of P3.1 billion.

We know the challenge of high debt-to-equity financing is high fixed interest expenses. If we estimate total interest expense based on finance costs of P996 million as of June this year, we should derive a total of P1.9 billion.

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Now, MWIDE is also paying about P281 million from its first preferred shares offering in 2014. If we add this to the projected dividend payments from the series two offering, assuming all will get 5.75 percent dividend, the total dividend commitment shall be P568 million.

If we add the total interest plus the dividends, we shall get a total of P2.5 billion, which can be fully covered by the company’s EBITDA of P3.1 billion or ratio of 1.23 times.

Next year, if we assume revenues from construction and airport will recover at least 80 percent of pre-Covid 2019 level, the company should be able to generate positive net income of P150 million.

But more than this, higher operating profit will result to higher EBITDA, which should cover the company’s interest expense and dividend payment commitments by more than 2.5 times.

5| Know your investment strategy

Given the company’s dividend payment track record in the past, MWIDE should be able to support its financing obligations.

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If you want to apply a more conversative investment approach, you can invest in MWP2A, which offers a shorter redemption period of 2.5 years at 4.75 percent per annum.

At offering price of P100 per share, you can simply multiply this amount by 4.75 percent to get your expected dividend of P4.75 per share.

If we assume your opportunity cost is the prevailing three-year Philippine bond yield, which has a current rate of 2.267 percent, and let’s say we add a premium of two percent to cover your risk, we get total opportunity at 4.267 percent.

We can simply compute the projected share price of MWP2A by dividing P4.75 with 4.267 percent to get P111 per share or 11 percent target capital gain.

If you are willing to take more risk, you can buy MWP2B with longer redemption period of five years that pay 5.75 percent per annum.

Again, we assume your opportunity cost is the five-year Philippine bond yield, which has a current rate of 2.804 percent. If we add two percent premium to get 4.804 percent, we can project the target price of MWP2B at P119.7 per share or 19.7 percent capital gain.

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If we expect interest rates to go down further as the Central Bank continues to ease monetary policy to stimulate the economy, lower interest rates should support higher preferred share price valuations.

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Henry Ong
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