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

Infrastructure conglomerate Megawide Construction Corp (PSE:MWIDE) is raising up to P4 billion by selling up to 40 million preferred shares at P100 each this month.

The offering period of the preferred shares shall run from October 13 to 19 with a target listing date on October 29, 2021.

What are preferred shares

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.

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.

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 40 million cumulative, non-voting, non-participating, non-convertible, perpetual preferred shares, the fourth in a series of preferred share issuances.

Last year, MWIDE successfully raised P4.4 billion from its series 2 preferred shares offering. The series 2 comprises of two sub-series, Series 2A preferred (PSE: MWP2A) that pays a quarterly dividend of 4.75 percent per annum and Series 2B preferred (PSE: MWP2B) at 5.75 percent.

MWP2A has a redemption period of 2.5 years while MWP2B has a longer redemption period of five years.

This year, MWIDE’s series 4 preferred share (PSE: MWP4) will pay a quarterly dividend of 5.3 percent per annum. The rate is slightly lower than MWP2B because its redemption period will be shorter at 3.5 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 in the Philippines with significant interests in construction, property development, airport and terminal operations, and renewable energy.

Bulk of the company’s revenues, about 92 percent of total, is primarily driven by its engineering and construction business.

The balance comes from its landport operations in Parañaque Integrated Terminal Exchange (PITX), which contributes about five percent, and its airport operations in Cebu-Mactan International Airport, which contributes about three percent.

Last year, MWIDE’s incurred a net loss of P874 million from a net profit of P1.1 billion in 2019 as its total revenues fell by 35 percent to P12.9 billion from P19.9 billion in the previous year, due to the outbreak of the coronavirus pandemic.

This year, with the gradual reopening of the economy, MWIDE’s total revenues for the first six months recovered by 18 percent to P7.6 billion from P6.4 billion the same period last year.

Although gross margins were lower this year at 17.2 percent compared to 20.7 percent last year as its airport and landport operations remain weak, MWIDE was able to generate a positive operating income of P585 million, 7.1 percent higher than P546 million in 2020.

This improvement helped MWIDE lower its net loss for the first half at P52.8 million, lower than P449 million losses incurred in the same period last year.

With the economy slowly improving, MWIDE should be able recover further and end the year with a net profit.

3| Know how the company will invest the proceeds

MWIDE plans to use the funding from the series 4 preferred share offering to redeem its outstanding series 1 preferred shares.

In 2014, MWIDE raised P4 billion from selling 40 million series 1 preferred shares to the public at P100 per share.

The series 1 preferred share (PSE: MWP) pays a quarterly dividend of 7.025 percent and has a redemption period of seven years that is due this year.

MWIDE primarily used the proceeds from the series 1 preferred share to invest in Mactan-Cebu International Airport and Parañaque Integrated Terminal Exchange.

With the redemption and issuance of series 4, MWIDE will be able to save about 1.7 percent or P69 million per year in financing costs.

4| Know the financial risk and opportunities

MWIDE has relatively high financial leverage with almost 55 percent of its total assets financed by debt, but the company has managed to stay liquid with current ratio of 1.38 as of June 2021.

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 P812 million as of the first half of this year, we can estimate that its total depreciation for the year should be P1.6 billion. If we add the projected operating profit next year at P1.5 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 P1.2 billion as of June this year, we should derive a total interest expense of P2.4 billion.

Now, MWIDE is also paying roughly P224 million for its series 2 preferred shares. If we add the total dividends from series 4 assuming the company was able to redeem series 1 preferred shares, we can estimate total annual dividend payments of P436 million.

If we add the total interest plus the dividends, we shall get a total of about P2.8 billion, which should be fully covered by the company’s EBITDA of P3.1 billion or ratio of 1.1 times.

As the economy slow reopens in the years ahead as COVID cases fall, we can assume revenues from its construction and airport to recover significantly.

Let’s say the company recovers 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.

MWP4’s preferred share offer at 5.3 percent is relatively higher than Jollibee’s JFCPA preferred share offering at 3.28 percent, which has a similar redemption period at three years.

If we assume the opportunity cost to be equivalent to the prevailing three-year Philippine bond yield, which has a current rate of 2.636 percent, and let’s say we add a premium of two percent to cover your risk, we can get a total opportunity cost at 4.636 percent.

Because MWP4’s yield at 5.3 percent is much higher than the opportunity cost of 4.636 percent, we can expect its share price to trade at a slight premium.

To compute for the projected share price, we can get the annual dividend per share of MWP4 at P5.30 per share and divide this by rate of 4.636 percent to get target price of P114.3 per share or 14.3 percent potential capital gain.