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

Construction company EEI Corporation (PSE:EEI) is raising up to P6 billion by selling up to 60 million preferred shares at P100 each to the public.

The offering period of the preferred shares shall run from December 9 to 15 with a target listing date on December 23, 2021.

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, you need to make sure that the company is financially capable of paying its dividends on time. Just like buying an IPO, you should also 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 EEI Corporation and how you can profit from it:

1| Know the structure of the offering

EEI is selling up to 60 million preferred shares, which shall be issued into two subseries: Series A and Series B.

Series A preferred shares (PSE: EEIPA) will pay quarterly dividends at 5.7641 percent per annum, while Series B preferred shares (PSE: EEIPB) at 6.9394 percent.

EEIPA has a lower dividend rate because it has a shorter redemption period of 3.5 years compared to EEIPB, which has a longer redemption of 5.5 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, EEI 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

EEI is one of the leading construction companies in the Philippines with the broadest range of construction and engineering services specializing in the construction of large-scale heavy projects, infrastructure, and property developments all over the world.

A bulk of the company’s revenues, about 92.7 percent of total, is primarily contributed by its construction business.

The rest of the revenues are contributed by services, merchandise sales, and real estate sales.

Last year, total revenues declined by 41 percent to P13.9 billion from P23.6 billion in 2019, resulting in a net loss of P2.0 billion from P1.2 billion the previous year due to the pandemic outbreak.

This year, with the gradual reopening of the economy, total revenues for the first six months recovered by 22.5 percent to P8.5 billion from P6.9 billion in 2020.

The recovery in revenues enabled the company to regain its net income to P324 million from a net loss of P700 million in the same period last year.

Assuming EEI will book the same percentage of revenues in the second half of 2021 as last year, total revenues should recover by 23 percent to P17.1 billion by year-end, while total net income improves to P654 million.

3| Know how the company will invest the proceeds

EEI plans to use 40 percent of its proceeds from the preferred share offering to partially finance its future projects.

The company is anticipating to undertake a substantial portion of the Metro Manila Subway Project, which has a total cost of P355.6 billion that will be completed in seven years.

It also expects to be one of the subcontractors of Malolos Clark Railway Project, which has a total construction cost of P21.4 billion.

EEI plans to use a significant amount of the allocated proceeds to support its working capital needed for subcontracting works.

The company is also bidding several packages of the South Commuter Railway Project as part of the government’s Build Build Build program, where it will need to spend some funding for working capital.

Because the company is preparing to work on big infrastructure projects, it also needs to build up its capacity. It is allocating 20 percent of its proceeds to finance its capital expenditure next year.

EEI is also allocating 30 percent of its proceeds to repay its short-term debt that used to support its working capital requirements. The repayment should be result to lower interest expenses and stronger balance sheet.

For the remaining 20 percent of the proceeds, the company plans to use it for general corporate purposes that will support costs expected to be incurred in the operations not specifically related to any single project.

4| Know the financial risk and opportunities

EEI has a relatively high financial leverage with about 62.2 percent of its total assets financed by debt, but the company has managed to stay liquid during the pandemic with a current ratio of 1.11 by end of 2020

This year, with the increase in the company’s construction activities, its total current ratio declined to 1.00 by the end of June 2021, but its liquidity position is expected to improve substantially after the preferred share offering.

If we want to assess if 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 EEI’s first half financials this year, its total depreciation expense was P321 million. If we add this amount to its operating income of P333 million, we can derive an EBITDA of P654 million.

If we annualize this amount, we can estimate a full year EBITDA of P1.3 billion.

If we compare this EBITDA against the company’s total interest expense of P247 million, we can estimate its full year interest costs at P494 million.

Because the preferred shares will require the company to cash out financing expenses too in the form of dividends, we also need to estimate it to the interest expenses.

Assuming everyone availed of higher rate preferred shares, EEIPB at 6.9 percent, we can estimate its total preferred share financing charges to amount to P414 million per year.

If we sum this amount together with interest expenses, we will derive a total financing cost of P909 million, which will be more than covered by the company’s estimated EBITDA of P1.3 billion, or a ratio of 1.43 times.

5| Know your investment strategy

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

If you want to apply a more conversative investment approach, you can invest in EEIPA, which offers a shorter redemption period of 3.5 years at 5.76 percent per annum.

At offering price of P100 per share, you can simply multiply this amount by 5.76 percent to get your expected dividend of P5.76 per share.

If we assume your opportunity cost is the prevailing three-year Philippine bond yield, which has a current rate of 3.578 percent, and let’s say we add a premium of two percent to cover your risk, we get total opportunity at 5.578 percent.

We can simply compute the projected share price of EEIPA by dividing P5.76 with 5.578 percent to get P103.3 per share or 3.3 percent target capital gain.

If you are willing to risk more, you can buy EEIPB with a longer redemption period of 5.5 years that pays 6.94 percent per annum.

Again, we assume your opportunity cost is the five-year Philippine bond yield, which has a current rate of 4.128 percent. If we add two percent premium to get 6.128 percent, we can project the target price of EEIPB at P113.3 per share or 13.2 percent capital gain.

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