Financial Adviser: 5 Reasons Why SM Prime Holdings Remains a Strong Blue-Chip Stock and How to Profit from It

The Philippine stock market faces renewed fears of inflation after the Central Bank’s recent decision to cut interest rates. Instead of easing concerns, the move caused the US dollar exchange rate to rise from P57 to nearly P59 to a dollar.

This sparked fresh worries about higher prices, which caused the 10-year Philippine bond yield to climb from 5.7 percent in early October to as high as 6.11 percent recently. The sharp increase deepened market concerns and unsettled investors, particularly in the property sector, where higher yields indicate rising costs and weaker demand.

The Property Index fell by 18 percent since interest rates rose again, a significantly larger decline than the Philippine Stock Exchange (PSE) Index’s loss of 13 percent.

Investors appear concerned that higher risks from rising bond yields could reduce property demand and impact financing. Slower GDP growth and weaker consumer spending added further pressure to market sentiment.

One of the biggest losers in this meltdown is SM Prime Holdings (PSE: SMPH), which declined by 21.8 percent from its recent high of P33.40 in October to a low of P26.10 per share last week. As one of the largest foreign-owned stocks in the market, SMPH suffered foreign selling.

With the increasing risks of elevated inflation and high interest rates, SMPH could face another round of foreign selling if the stock market declines to historical lows in the coming weeks.

Despite these concerns, moments like this can present opportunities for those who focus on fundamentals. SMPH, with its broad portfolio of malls, residential properties, and office spaces, remains a key player in the Philippine property market. Its steady cash flows and diverse revenue sources give it a strong foundation to weather economic challenges.

Investors now face two key questions: How much lower can SMPH’s stock price go, and does the current drop offer a buying opportunity?

History shows that strong companies like SMPH often recover from market downturns. The market prices in a worst-case scenario, which creates room for potential upside. Even modest growth in cash flows may push the stock back to its intrinsic value.

As Warren Buffett wisely said, “Be fearful when others are greedy, and greedy when others are fearful.” SMPH’s current price reflects deep market fear. For investors willing to look past the noise and focus on the company’s core strengths, this may be a rare chance to buy a high-quality stock at a bargain price.

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

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1| Solid track record of consistent earnings and revenue growth

SM Prime Holdings (PSE: SMPH) is the largest mall operator in the country with 87 malls occupying a total of 9.4 million square meters of gross floor area (GFA) and eight shopping malls in China with 1.7 million square meters GFA.

SMPH has established a strong presence in Metro Manila, with its malls covering almost all key cities in the area. These Metro Manila malls account for 42 percent of the company’s total gross floor area (GFA) in the Philippines.

Beyond the capital, SMPH focuses its expansion efforts on the provinces, targeting Northern Luzon, Visayas, and progressive cities in Mindanao. By 2025, SMPH plans to open four new malls in La Union, Laoag, Zamboanga, and Sta. Rosa, with a combined Gross Floor Area (GFA) of 506,000 square meters.

SMPH generates about 56 percent of its revenues from rental income, while the remaining 44 percent comes from real estate sales and other sources.

Since 2007, SMPH's net income has grown at an average annual growth rate of 12.6 percent, rising from P5.9 billion to P40 billion in 2023. This impressive growth was driven by strong revenue performance, which consistently increased by 13.9 percent per year over the past 16 years.

This year, SMPH’s net income for the first nine months rose by 12.2 percent to P34.6 billion, up from P30.7 billion in the same period last year. Meanwhile, total revenues increased by 7.7 percent to P99.7 billion from P92.6 billion a year ago.

If we use the historical contribution of SMPH’s nine-month income to its full-year earnings at 75 percent, we estimate that SMPH’s net income by year-end will reach about P46 billion, which represents a 15 percent growth from last year.

SMPH’s recent stock price decline to P27 per share has reduced the company’s market valuation to levels last seen in 2016, when its net income was only P23.8 billion—around half of what it earns today.

With projected net income of P46 billion this year, far exceeding the P23.8 billion from 2016, SMPH’s current valuation appears unjustifiably low and warrants a higher market valuation.

2| Strong balance sheet ensures lower financial risks

A strong balance sheet is important, especially in times of economic slowdown and uncertainty, as it provides a company with the financial flexibility to weather challenges and seize opportunities.

Ample liquidity ensures the company’s ability to meet short-term obligations without strain, while manageable debt levels reduce the risks associated with rising interest rates or declining revenues.

A solid equity base offers stability and confidence to investors, which enables the company to maintain operations and invest in growth even during downturns.

In uncertain times, companies with strong balance sheets are better positioned to adapt to market shifts, protect shareholder value, and emerge more resilient in the long run.

SMPH continues to demonstrate financial resilience, underpinned by a robust balance sheet that effectively minimizes financial risks. As of September 30, 2024, total assets increased by six percent to P998.8 billion, with investment properties growing by seven percent to P581.2 billion, which comprises 58 percent share of total assets.

This highlights SMPH’s ability to grow its core revenue-generating assets sustainably. Simultaneously, total equity rose by seven percent to ?422.8 billion, which reflects a strong capital base.

SMPH’s balanced approach to debt management further reinforces its low-risk financial profile. Total debt grew modestly by five percent to P385.7 billion, including a P1.3 billion impact from foreign exchange translation.

Despite this, the company maintained its debt-to-equity ratio at a healthy 48:52, which shows prudent leverage levels. Net debt rose by just three percent to P346.3 billion, with a stable net debt-to-equity ratio of 45:55.

These figures underscore SMPH’s disciplined financial strategy, which ensures that its borrowing remains well-supported by its equity and operating cash flows.

Liquidity and solvency metrics also affirm SMPH’s strong financial position. The current ratio of 2.12 and an acid test ratio of 1.13 reflect ample liquidity to meet short-term obligations.

Meanwhile, the solvency ratio, which improved slightly to 1.74, indicates a strong capacity to cover long-term liabilities. These metrics highlight SMPH’s ability to manage market uncertainties with minimal financial strain.

SMPH’s strong balance sheet provides a solid foundation for sustained growth while effectively mitigating financial risks. By maintaining a prudent balance between equity and debt and delivering consistent profitability, SMPH positions itself as a low-risk investment choice with significant growth potential.

3| Low accruals reflect healthy cash flow focus and high earnings quality

Earnings play an important role in driving share prices, as investors rely on them to project a company’s future valuation. However, not all earnings are created equal, as they often include accruals recorded under accounting principles.

Accrual accounting allows companies to report revenues and expenses before cash is exchanged to provide a fuller picture of financial performance. While useful, this method relies heavily on management judgment and can distort a company’s true cash-generating capacity.

Richard Sloan, a professor from University of Michigan, highlighted the importance of cash flow over accruals in earnings. He argued that companies with low accruals tend to outperform those with high accruals because cash flow is a more reliable indicator of future growth.

According to Sloan, investors often overvalue earnings with high accruals, which inflates stock prices. When these inflated expectations are not met, stock prices tend to fall, leading to poor performance. Conversely, companies with low accruals, initially undervalued, often deliver strong returns over time.

Sloan developed a ratio to measure accrual exposure by subtracting free cash flow from net income and dividing the result by total assets. A Sloan Ratio within the range of -10 percent to 10 percent indicates a safe level of accruals, while ratios outside this range signal potential risks. High accruals can indicate earnings manipulation or unsustainable growth expectations.

When applied to the Philippine Stock Exchange (PSE) Index, Sloan’s findings showed that stocks with higher Sloan Ratios often underperformed, while those with lower ratios delivered higher returns.

Historical data revealed a decline in the average Sloan Ratio during market downturns, which emphasizes the importance of cash-based earnings in volatile conditions.

For investors, understanding accrual exposure can help identify undervalued opportunities and avoid overvalued traps, making it an essential tool for sound investment decisions.

If we calculate the Sloan Ratio for SMPH, the stock averaged between 4.0 and 5.0 percent over the past three years, which falls within the safe level criteria.

In 2021, SMPH’s Sloan Ratio was 4.38 percent. This increased to 5.42 percent in 2022, and improved to 4.75 percent in 2023. These low ratios indicate that SMPH has low accrual levels, which reflects high earnings quality.

This year, SMPH’s Sloan Ratio improved further to 2.8 percent. A declining Sloan Ratio, as long as it does not exceed -10 percent, typically indicates that the company is relying less on accruals and more on cash flows to generate earnings.

This reinforces the reliability of the SMPH’s reported earnings, which reflects a stronger emphasis on cash flow over accrual-based components.

4| Valuation at attractive earnings multiple

SMPH’s pricing multiples have historically traded at a premium of at least two times over the market. For example, prior to the pandemic in 2019, the median Price-to-Earnings (P/E) ratio of Philippine Stock Exchange (PSE) index stocks was 15.7 times, while SMPH’s P/E ratio was significantly higher at 33.5 times.

In 2022, after the pandemic, SMPH’s average P/E ratio rose to 36.4 times, a premium of three times the market P/E of 12 times. However, in 2023, SMPH’s premium over the market regressed to two times, with its P/E ratio averaging at 24.8 times compared to the market P/E of 12 times.

This year, the premium declined to 61 percent, marking the first time in many years it reached this level. If we compare the earnings of SMPH for the past twelve months against its current market capitalization, we will derive a P/E ratio for the stock at 17.8 times compared to market P/E of 11 times.

This reduced premium provides investors with a rare opportunity to acquire a high-quality stock with strong fundamentals at a more attractive valuation, which makes an appealing option for long-term investment.

If SMPH is priced at a two-times premium over the market P/E of 22 times, the stock should recover to a minimum of P33.4 per share, representing a potential upside of 23.5 percent in the near term.

Another way to price SMPH is by using its historical P/E ratio. If we get the average P/E ratio for the past two years, from 2022 to 2023, we will get a historical P/E of 30.6 times. Applying this ratio to against SMPH’s current P/E ratio, we will derive a target return of 71.9 return or a price target of P46.4 per share.

5| Intrinsic Value offers large margin of safety and growth

Warren Buffett, one of the most successful investors in history, has consistently ranked among the world’s wealthiest individuals, with a net worth of over $80 billion.

Known for his value investing philosophy, Buffett focuses on companies with strong growth potential and high barriers to competition. He prefers businesses that can maintain consistent growth and predictability over the next 10 to 15 years, believing they can deliver superior long-term returns.

In 1997, Mary Buffett, Buffett’s former daughter-in-law, and investor David Clark introduced Buffettology, a method to quantify Buffett’s investment principles. This strategy focuses on identifying high-quality companies with strong fundamentals, predictable growth, and the ability to generate consistent long-term returns by using a Sustainable Growth Rate (SGR) to estimate future earnings of a company over the next ten years.

If we assume SMPH’s Sustainable Growth Rate (SGR) to be its minimum annual growth rate of 12.6 percent over the past 16 years since 2007, we can use this to project the company’s future earnings over the next ten years. Using the estimated earnings of SMPH at P46 billion for this year as the base, we calculate the company’s compounded earnings by 2034 to reach about P150 billion.

Let’s say we assume that in 2034, SMPH will have a 25 times P/E ratio, which is conservatively lower than its historical average of 30.6 times. At 25 times P/E, SMPH’s market capitalization is estimated to reach P3.76 trillion.

To bring this value to the present, we must discount it using today’s risk parameters. With the prevailing 10-year bond yield at 6.03 percent and SMPH’s beta at 1.07, we derive a discount rate of 11.38 percent.

Applying this rate, we calculate the present value of SMPH’s future market capitalization at P1.3 trillion. By dividing this value by SMPH’s current shares outstanding, we determine the stock’s intrinsic value to be P44.4 per share.

The intrinsic value of SMPH, calculated at P44.4 per share, underscores a substantial margin of safety, a principle central to Warren Buffett’s value investing philosophy.

By focusing on a company’s long-term growth potential, predictable earnings, and strong fundamentals, investors can identify opportunities where the market undervalues intrinsic worth.

SMPH’s high intrinsic value relative to its current share price offers a compelling case for long-term investment, which ensures both potential upside and a buffer against unforeseen risks.