St Andrews Investment Society

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1 St Andrews Investment Society PROVEN GROWTH STRATEGY WITH FAVOURABLE MACRO ENVIRONMENT AND SOLID MARKET POSITION. Investment Rationale Solid, sustained market position and bargaining power in the mall segment: SMPH is the largest mall developer in the country, allowing them to set rent at premium levels. The resulting high margins of over 50% allow SMPH to grow their business aggressively. A lack of major competitors combined with high barriers for market entry enable them to maintain strength in the long-term. Synergy with other SM businesses: SM Group s other businesses include market-leading supermarkets, department stores, and cinemas, as well as Banco de Oro - the largest bank in the country. Any SM mall automatically has these as anchor tenants, drawing in even more foot traffic and demand for retail spaces. Favourable macro environment: A young demographic combined with an untapped commodities industry ensure strong growth potential, which will lead to growth of consumers, property demand and purchasing power strength. Strong management, aggressive and proven growth strategy: Management is well established in the country, intensely focused, shrewd and tireless. They have commonly beaten growth expectations in recent years. The strategy is clear - dominance. SMPH owns large landbanks for residential and leisure property development. They have a structured plan to develop real estate in the coming decade, which is far stronger than any of their competitors. Strong financial performance and position: SMPH s strong cash position (largely from tenant deposits) and conservative debt to equity ratio indicates they are funding their growth at little risk. Company Overview, founded in 1994, is an integrated property development company listed in the Philippines Stock Exchange (PSE), under the ticker SMPH:PHS. Shortly after its IPO on July 5, 1994 it grew to be the largest listed company on the PSE. The firm operates in four segments including malls, housing development, commercial office spaces as well as hotel and convention centres. It is the largest mall operator in the Philippines and the second largest firm in the residential real estate market. The company was founded and is managed by the wealthiest and most influential man in the country Henry Sy, Sr. Business Model Malls SMPH:PHS Price ( ) Mkt. Cap. (mil.) 15. April PHP PHP Real Estate Investment & Services Price Target 26 Investment Horizon 36m 12m performance: 0 13/04/15 13/07/15 13/10/15 13/01/16 Market Data: 52- Week Range Shares Out. (mil.) 28,789 Div./Yield. $0.005/0.95% Financial Data: Revenue (mil.) 71,511 Long-Term Debt 125,952 Net Debt/EBITDA 2.87 ROE 13.8 Book Value/Share 7.36 P/E 23.3 FCF/Share 0.45 SM Prime is the largest mall operator in the Philippines. They own 56 SuperMalls in the Philippines and 6 SuperMalls in China. Market research is conducted internally; this is how they are able to determine the best land acquisitions. SMPH buys vast plots of land and hires the most competitive contractors to build their malls. Anchor tenants are installed, such as their namesake department store, cinema, and supermarket. In addition, they have amusement Page 1 of 5

2 centres and hold both high profile and small local events. This creates enough foot traffic to result in extraordinarily high demand among tenants wishing to sell their goods in the SuperMalls, as they have an average occupancy rate of 94%. Competition for space is fierce in the SuperMalls, demonstrated by a year-long waiting list for potential tenants. High demand for space enables SMPH to enjoy favourable terms in contracts. Tenants are required to pay a sixmonth deposit; SMPH has grown their business using this interest-free money. Rent varies according to the percentage of the tenant s sales. A rent floor has been set for tenants, which enabled remarkably stable earnings growth for the past 10 years. The sales dependent rent model also ensures that any growth in purchasing power is passed onto SMPH, even in the long term. Recurring revenue from the SuperMalls accounts for ~70% of the profit. Residential The SM Development Corporation (SMDC) sells affordable condominium units located in the Manila metropolitan area as well as leisure homes on the coast and in the mountains. SMDC has 27 condominium projects throughout the Philippines. In addition to condominiums, SMDC has two major leisure residences: Pico de Loro and Tagaytay Highlands. Costa del Hamilo Inc is SM Prime s developer of Pico de Loro. Highlands Prime Inc is the upscale property developer building the Tagaytay Highlands mountain resort and residential complex. Residences make up 30% of total revenue. Commercial The Commercial Properties Group primarily handles the development and leasing of office buildings in Manila's metropolitan area and other strategic regional locations. In addition, the group handles the operations and management of these sites. Commercial leasings are geared mainly toward the BPO industry. Business Process Outsourcing is a rapidly growing industry in the Philippines. SM Prime is responding to this growth by continuing to develop buildings, which enable IT to flourish. Hotels and Convention Centers SM Prime Operates 5 hotels, 4 convention centers and 2 megatrade halls. SM Hotels and Conventions Corporation (SMHCC) is the subsidiary, which develops and operates hotels and convention centers throughout the archipelago. These sites are popular for both local and high profile international events. Page 2 of 5

3 Market Position SM Prime s major competitors are Ayala Land and Robinsons Land. The competition between Ayala Land and SM Prime is the primary point of focus. Looking at the graph, SMPH dominates the malls market and comes second in the residential sector. These two markets account for most of the firm s and its two competitors revenue (more than 90% for SMPH). SM Prime is by far the largest shopping mall retailer in the Philippines with over 8.3 million sqm of floor space. After SM Prime, the second largest mall operator is Robinsons Land with 3.3 million sqm of mall space, while Ayala Land is the third with 1.4 million sqm. The returns for these companies have substantially increased in the past year. Even though Ayala Land s revenue (PhP 75 billion) is higher than SMPH s (PhP 52 billion), their net income is much lower (PhP 15 billion to PhP 23 billion respectively). This is because the profit margin for shopping malls is much higher than that for residences and while 59% of SMPH income comes from the malls and 30% from residences, the split for Ayala land is 14% and 53% respectively Revenue (in PhP MM) SM Prime Ayala Land Malls Residences Commercial Hotels & Convention Centres Robinsons The table below shows that the gross profit margin of SM Prime far exceeds those of both Ayala Land and Robinson s Land. SM Prime has higher recurring revenues from rental-income, which constitutes 70% of their total revenue. Only 38% of Ayala Land s revenue is made up of recurring revenues, as their business model relies on the sale of development. In the Philippines, land is limited and hard to acquire therefore SM Prime has an advantage over its competitors by operating with a less land-dependent business model. This is a more advantageous strategy for their long-term cash flow and income. PhP MM Revenue 2015 (2014) Net Income 2015 (2014) Malls revenue 2015 (2014) Sqm of malls in the Philippines Gross Profit Margin P/E (Industry av ) SM Prime 52,199 (47,795) 23,306 (13,814) 30,878 (28,187) 8.3 m 71.6% Robinsons Land 14,589 (13,065) 4,354 (3,879) 6,753 6,052) 3.3 m 53.7% Ayala Land 75,047 (68,316) 15,206 (13,131) 9,240 (8,260) 1.40 m 40.7% Page 3 of 5

4 Macroeconomic Outlook The Philippines consumer sector has shown to be resilient in the face of a Chinese economic slowdown and is undergoing robust growth; out of all Southeast-Asian countries in 2014, the Philippine retail sector was the only one to grow in both volume and value terms. Household consumption currently makes up 71.5% of the nation's GDP, with 30% of this total consumer-spending happening inside malls. In 2014, 36.3% of GDP was generated in the National Capital Region (NCR), where SM Prime dominates the retail market. The World Bank s expected economic growth of 6.5% in 2016 makes the Philippines a very favourable climate for retail and property development. Interest rates in the country have been at 4% since September 2014 and are expected to remain steady in the near future. The rise in consumer growth can be explained in part by the demographics of the Philippines. With an average of five members, the Filipino family is Asia s youngest and largest in size; more than half of Filipinos are under 25 years old. By the year 2045, the Philippine population is projected to increase to 142 million according to the latest 2010 Census-based population projections. Around 50 million people will be added to the population in a span of 35 years. The urban population in the Philippines increased on average by 4% annually in recent years. The rise of urbanization outside the NCR has spread the mass consumer culture to a much larger segment of the population, while within the NCR the average consumer has become increasingly sophisticated and more likely to invest in luxury goods and big-ticket items. Growth Prospects & Risks Growth Retailing in the Philippines is expected to significantly grow alongside the continued improvement in the economy, infrastructure and the increasing disposable income of Filipinos. Furthermore, the young population (near 50% are 25 or under) will result in an increasing demand for residential real estate, a sector that has been steadily growing for the past few years. Additionally, the high barriers for entry and legal constraints in the industry (high initial investment, good location, etc.) are beneficial to keep new players and foreign competition out. High remittances and expat investment are also expected to help contribute to property demand alongside the expanding economy. Throughout the past SM Prime has followed a very aggressive expansion model. SMPH has aggressive expansion plans for 2016 mirroring their expansion in 2015, where they added 752 km # floor space to their supermalls. For this fiscal year 7 malls are scheduled to be unveiled. This year their major mall expansions are focused outside of Manila, still an unsaturated market, where 76% of total consumer spending is reported. They are expanding their hotel division, but in terms of investment required this is drastically smaller than their mall divisions. Additionally, they are adding convention centres to existing malls in Cebu, Taigu, Davao, and Bacoland. SM Prime are planning on anchoring their new lifestyle cities on their existing mall complexes, due to them owning the excess land around these malls. The lifestyle cities will include the pre-existing malls, apartment blocks and some office space. These types of developments have already been proven to be successful in the Philippines by Ayala Land Inc. and Megaworld Corp. Risk The biggest external risks to our valuation are a slowdown in mall and residential rollout, drop in rental or lease rates, increase in interest rates and margin pressure. Amongst these, slowdown in mall rollout and residential rollout would be the most impactful. If SM Prime were unable to continue to complete more mall space that would lead to a drop in liquidity, cutting their expansion capabilities. Residential expansion is not new to the company, although the rate at which they plan to expand, 69% in 3 years, is higher than previous targets. The units seem to be selling well and the operating income on residential properties grew by 13% in the previous year without the expansion. There is very little actual concern towards liquidity risk, given that SMPH s financing model is based on continuous income and sustained revenue growth. The company is susceptible to fluctuations in the exchange rates between the PHP to the USD as well as the PHP to CNY. To protect themselves from inadvertent losses the company enters into hedging. They employ foreign currency swap contracts, cross-currency swaps, and call options. The company s debt is structured with floating Page 4 of 5

5 and fixed interests rates. To manage the difference between the two rates the company utilizes interest rate swaps in an effort to hedge the risk. Financial Position Average year-on-year revenue growth of 9% since 2013 means SM Prime finishes the first quarter of 2016 with revenues totalling 69.2B PHP. These increases are mostly attributable to a 12% increase in rental value, with a similar increase in cinema ticket sales. Meanwhile, real estate sales remained largely intact, totalling 22.8B PHP for the past year. Tighter monitoring of construction costs allowed SM Prime to turn an 8% rise in revenue in the last year into a 13.6% rise in net income, which totalled 20.9B PHP for the same period. SM Prime has been outperforming an unstable Asian market over the past year. SM Prime s financial situation has been stable enough to have a comfortable current ratio of 1.78 as of March This has been largely due to prepaid expenses being made and accounts payable decreasing 6% since Whilst long-term debt has increased 19% over the past year to 152.3B PHP (due to issuance of bonds in Nov 2015), investment properties have also taken a hike of 14% in the same period, and sit at just over 230B PHP as of March Main areas of investment in the last year include on-going new mall projects located in Cagayan de Oro, Cavite City and Bulacan in the Philippines and Tianjin in China, whilst the on-going expansions of SM Mall of Asia and SM Xiamen have generated significant expenses. ROE have been maintained at 10%, whilst interest coverage has increased by 35% in the last year, standing at as of March Meanwhile, the profit margin has been increasing steadily since 2012, currently at a very respectable 29%. Long term debt has increased SM Prime s debt to equity ratios, however the increase in its EBITDA margin and its interest coverage have more than made up for this. Cash dividend per share sat at 0.23 PHP by the end of 2015, up from 0.18 PHP in 2014, with total capital stock issued and outstanding equalling 28.8 billion. Management Structure & Integrity The firm strives to maintain strong integrity within all of its operatives and aims to maintain stable growth and conservative borrowing. SM Prime is fundamentally a family run business founded by Henry Sy, Sr. aged 91 who is a Chairman Emeritus. As the richest person in the Philippines, Sy has a strong presence in country s economy. The majority of the company s directors have served on the board since its inception with the responsibility, to ensure that the company s vision and mission are upheld. Shareholder Structure The company only has one class of shares issued; Common shares, listed on the Philippine Stock Exchange under the ticker SMPH:PHS. Since the majority of the stake of the company is in the hands of the management, the potential of agency problems are averted, we can be sure that management is to act in the interest of shareholders. The biggest shareholders of the company are listed in the table below. Other shareholders of the company include large asset managers. Name Number of Shares % SM Investments Corp. 14,353,464, % Henry Sy 1,268,999, % OppenheimerFunds Inc. 744,870, % Hans Sy 685,163, % Page 5 of 5