The pandemic seems to have little effect on the country’s consumer discretionary industry, with shareholders gaining P21 billion of wealth over the past weeks and Jollibee Foods Corp. taking the biggest pie with a P9 billion jump.
The consumer discretionary sector is made up of businesses that offer nonessential goods and services that consumers do not necessarily need, which means avoiding them will not affect their well-being.
According to US-based International Investor chief and hedge fund manager Eric Jurado, this has taken the industry’s performance to a 12-month return of +29 percent. Looking ahead, he says, that industry’s earnings are forecast to grow by 32 percent annually.
Consumer confidence is crucial in the consumer discretionary sector. The University of Michigan’s consumer sentiment index provides a gauge of how optimistic consumers feel about the state of the economy and their expected spending habits.
Higher wages or decreases in prices of other goods are among the other factors that contribute to the improvement of not only consumer spending power, but to the economic prospects for the consumer discretionary sector. The sector also faces secular trends that create headwinds, including a continued shift to online shopping and consumers’ pursuit of healthier lifestyles.
The Philippine discretionary sector currently trades at price earnings (PE) ratio of 12.8x, much lower than its three-year average PE of 22.2x. But Jurado contends that the industry is significantly undervalued compared with its three-year average PE, indicating that the market is underestimating the industry’s future earnings. “An industry is attractive,” he points out, “when the market underestimates the earnings it will make in the future.”
Records show that earnings of businesses in the industry have grown significantly from a Covid-19 lockdown loss of P22 billion in March 2021 to a profit of P8.6 billion to date.
Revenues have also grown 23 percent from P252 billion in the second quarter of 2021 to P311 billion to date. This means overall sales from these businesses are rising fast and profits are subsequently rising as well.
Most analysts are optimistic about the industry overall, and more so about the hospitality industry, expecting earnings growth of 32 percent and 37 percent per year over the next five years, respectively.
In the case of Jollibee, which currently trades 34 percent above its fair or intrinsic value estimate, the market is overestimating the amount of cash the business will make in the future. Jurado says, “The share price of a business is attractive when the market underestimates the amount of cash it will make in the future.”
Jollibee (PSE:JFC) develops, operates and franchises fast food restaurants globally. It now has around 150 branches in Vietnam alone. Its market capitalization stands at P247 billion. People who were able to invest weeks prior have received a seven-day return of +3.7 percent, a one-year return (with dividends) of +26 percent and a three-year return (with dividends) of -28.7 percent.
Jollibee’s earnings per share is at P5.30, up from a P10.45 loss in 2020. Its revenue is P153.6 billion (up 19 percent from 2020); its net income is P5.98 billion (up P17.5 billion from 2020), and its profit margin is 3.9 percent (up from a net loss in 2020). The company’s move to profitability was driven by higher revenue. Its free cash flow (referring to cash from operations minus capital expenditures) is at P12 billion (up from -P6.43 billion in 2020). While its revenue is in line with analyst estimates, its earnings per share surpasses analyst estimates by 77 percent.
Jurado says revenue is forecast to grow 19 percent, compared to a 30 percent growth forecast for the restaurant industry in the Philippines, while free cash flow is forecast to grow to P14.8 billion this year.
Over the last three years on average, earnings per share has fallen by 47 percent per year but the company’s share price has only fallen by 11 percent per year, which means it has not declined as severely as earnings.
Another company that performed creditably well despite the pandemic is PLDT Inc. (PSE:TEL). The company’s shareholders gained some P9.7 billion of wealth and exceeded the returns of the Wireless Telecom industry and the overall market over the past seven days. PLDT also exceeded the returns of the Wireless Telecom industry and the overall market over the past year.
It should be noted, however, that in the short term, prices and returns may not reflect the true long-term value of PLDT’s business. Its earnings have grown 8.3 percent per year over the past five years, and are forecast to grow 7.1 percent per year over the next three years.
While PLDT’s free cash flow has declined from P12.3 billion in 2018 to -P12.0 billion in 2021, it is forecast to grow to P28.5 billion in 2024. Jurado says increasing long-term free cash flow results in higher shareholder value and prices.
Worthy of noting is that insiders (the company‘s directors, officers, or employees) have bought more shares than they have sold in the past three months, accumulating P96.6 million worth of shares, an indication of confidence in the business’s future prospects.
The company, however, is not entirely risk-free. Its net debt (or debt minus cash) to equity ratio of 162 percent is high. The debt to equity ratio (without cash) has increased from 157 percent to 186.7 percent over the past five years.
However, its debt is well covered by operating cash flow (36.4 percent), with its debt interest payments well-covered by earnings before interest and taxes (4.7x coverage).
“A net debt to equity ratio above 40 percent is considered high and financially unhealthy,” notes Jurado. “Operating cash flow should be at least 20 percent of debt and earnings before interest and taxes should be at least 3x interest payments.”
PLDT’s dividends, he adds, have been volatile, falling over the past decade from P222 in 2011 to P84 on April 10, 2022. Its dividend yield has likewise been volatile, falling from 9.7 percent in 2011 to 4.6 percent. A drop of over 20 percent in annual dividend payments is considered unstable.
According to Jurado, “Fair or intrinsic value is an estimate of how much cash a business will make in the future. A discounted cash flow valuation model is used to determine whether a business is fairly valued, overvalued, or undervalued.” This industry standard is used by analysts from the most reputable banks, brokers, institutions, and research firms around the world. Adds Jurado, “PLDT is undervalued compared to its fair or intrinsic value. It is trading 42.5 percent below its fair or intrinsic value estimate. This indicates that the market is underestimating how much cash the business will make in the future.”
Similar to Jollibee’s situation, where the market is underestimating how much cash it will make in the future, PLDT’s share price is an attractive one.
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