Ayala Land’s (ALI) share prices closed Friday at a new record.
Record High Courtesy of Index Managers
In terms of milestone highs, ALI has been one of the late bloomers. Index managers have torridly been pushing ALI’s share prices vertically so as to align with the rest of the price actions of the top 15 biggest market cap
As proof, Friday (August 12)’s “marking the close” was essentially responsible for the new highs. (see below)
Of course, the string of historical highs has been framed by the consensus as having been representative of G-R-O-W-T-H. Well, but that’s an illusion.
As of Friday closing price, ALI’s annualized Price Earning Ratio (PER) based on the 1H of 2016 eps was at 31.21. Based on 2015 eps, ALI’s comparable PER was at 34.33. 1H 2016 eps translated to only a 9% deduction. Well, that’s not G-R-O-W-T-H. Instead that’s a symptom of severe mispricing or the widening detachment of share prices with reality.
Yet higher prices are being justified from the same fictional reasons.
As a matter of entertainment, let me demonstrate some very valuable charts provided by the firm’s 1H 17Q to disabuse readers from the mainstream spin.
ALI’s Topline Have Been Falling Sharply
Yes, official numbers show that ALI registered a 16% eps growth. From the headline view, that’s great. Butwhat seems and reality are different things.
A broader view tells of a different scene: a stunning story of decay.
Aside from real estate, ALI’s other income constituents were NEGATIVE for the 2Q and the 1H. These are interest income (-13.51% and -6.69%), equity in net earnings (-845.24%, and -429.6%), and other income (-12.71% and -8.44%). Nonetheless, these are inconsequential to ALI’s performance because the real estate category accounted for the meat or 93% of total ALI’s nominal revenues for both stated period.
Now to the unpublished story of entropy affecting the firm’s core business.
The % change of real estate growth (property development, leasing and services) has been TRENDING DOWN over the past 4 years (or more). [see above chart]
Most importantly, the rate of decline has STEEPENED over the last 2 years!
2016’s 8.49% (1H), 8.97% (2Q) and 2015’s 10.38% (1H) 8% (2Q) have more than HALVED the (average and nominal) growth rates of 2013 and 2014 at about 20% and above!
And generally speaking, ALI’s topline determines, or has fundamentally tracked its eps.
1H 2016 has proven to a slight exception. Despite the sustained downward trend in the topline, eps growth creeped higher. Said differently, 2016’s 16% eps growth was largely a function of cost side accounting improvements more than it represented economic conditions.
The other possible angle to this could be that ALI’s 1H eps growth may been a work of an accounting chef.
ALI’s other numbers tells us why
Now let us move on to the specifics.
ALI’s management does not provide a detailed accounting breakdown of its real estate category sales. They only mention this as part of the ‘management discussion’.
For property development
1H 2016: Total revenues from Property Development amounted to P33.66 billion, 6% higher than the P31.85 billion reported in 2015.
1H 2015: Total revenues from Property Development amounted to P31.85 billion in the first six months of 2015, 9% higher than the P29.30 billion reported in the same period in 2014.
For commercial leasing (malls and retail outlets)
1H 2016: Total revenues from Commercial Leasing amounted to P12.76 billion, 12% higher than the P11.40 billion reported in the same period in 2015.
1H 2015: Total revenues from Commercial Leasing amounted to P11.40 billion, 10% higher than the P10.36 billion reported in the same period in 2014.
Regressing back to 2012, here are the segment growth numbers from ALI’s management discussion.
So there you have it, growth rates in property sales, the largest contributor of ALI’s income, have essentiallyCOLLAPSED from over 20% to single digits in the past 2 years! In 1H 2016 it plunged to just 6%!
It’s all about framing. From a narrow time frame perspective, because numbers are still POSITIVE, they are presented as G-R-O-W-T-H. But such has been devoid of dimensional depth. Because from the long view, the picture changes—radically
ALI’s Massive Inventory Buildup
Of course, crashing property growth comes even as ALI continues to massively add to its real estate inventory inputs on their portfolio.
The management discussion section doesn’t deal with the specifics though.
But inventory growth conditions can be seen in the current account segment of the firm’s balance sheet.
Aside from club shares, the only other component is real estate which accounted for 98% of the firm’s inventories in 1H. This includes commercial leasing inventories.
Thus the compounded annual growth rate of ALI’s property inventories over the 4 years has been at a staggering 35%!!!
So in spite of the consensus blandishment, this tell us not only of the diminishing returns that has been plaguing ALI’s business model but of the increasing risk exposure undertaken the firm by engaging in a furious race to build supply in order to capture market share.
These shows too that top officials of ALI have shown little appreciation of basic economics. They don’t see, or perhaps refuse to see, that increasing competition on its own right will lead to a reduction in the company’s profits—as more entrants pile into the market to grab a share of the pie.
Yes the market pie is a dynamic pie. It is not fixed. It is driven by price signals. Therefore, competition is fundamentally pillared by price signals, whereby rising prices, which implies of higher profits, induce the entry of more competitors.
And part of such process may have possibly been manifested through company’s diminishing share of revenues and or profits relative to the industry. Revenues conditions may be a symptom of competition or economic conditions or both.
But even if ALI manages to maintain or even increase her market share in terms of general revenues, competitors will exploit on various opportunities (pricing, market positioning or segmentation, packaging, distribution channels, product innovation and promotion to name some) to close the profit gap. In short, to maintain profits, entrepreneurs must work round the clock to find new ways to please the consumers.
The numbers above reveals to us how economics have been at work applied to ALI.
Competition is a wonderful market process. However since competition is driven by the price mechanism, it is when such pricing signals have become distorted by monetary conditions whereby imbalances accrue.
In the context of the real estate sector, credit fueled price surge in properties has impelled for a race to build supply.
And this has not just been about ALI but likewise SM and subsidiary SMPH. Yet both of which have served as the generic template for the real estate industry. Yet the sector’s business volume have largely dependent on leveraging.
Also ALI’s (and the industry’s) race to build supply seem to have been founded on Keynesianmisinterpretation of Say’s law, “supply creates its own demand”.
ALI officials probably see its slowing performance in the context of anomalies rather than of real economic trends. They likely believe that either a slowdown or downturn is unlikely or that if this should happen, they are in position to seize even more market share.
And it’s not just real estate, even commercial leasing has manifested on the same symptoms.
From 1H 2016: Total gross leasable area (GLA) of Shopping Centers registered at 1.51 million square meters as of June 30, 2016 due to the opening of Ayala Malls Legaspi and a new phase in UP Town Center.
In 1H 2015: Total gross leasable area (GLA) of Shopping Centers registered at 1.37 million square metersas of June 30, 2015
ALI doesn’t provide the statistical details of its malls, except for the above.
In essence, commercial inventories have grown by 10.22%, yet ALI’s commercial leasing revenues only grew by 12%.
This means that growth in ALI’s commercial leasing revenues has been derived either from principally new stores or from a weak take up of a combination of existing stores and new stores.
Such signifies a basic symptom of inefficient use of resources.
Ironically, the company even implicitly admitted to this.
The stated average occupancy rate was at 93% in 1H 2016 as against 95% in 1H 2015. To apply the same numbers to the given GLA, vacancies would be around 105,700 sqm (.07 x 1.51) as against 68,500 sqm (.05 x 1.37). I apply the vacancy rather than the occupancy rates.
So if a typical ALI retail store has an average of 100 sqm, then this would postulate to 1,057 store vacancies in 2016 as against 685 in 2015—for an incredible 54% surge in store vacancy!
So ALI’s own numbers now square with developments in the field.
As a side note, the company didn’t provide the same details in their over two year reports
Again the race to build supply means inventory keeps mounting even as sales slow.
ALI’s Build and They Will Come Model Financed by Debt
But here is the crux: how has present dynamics (inventory surge amidst falling topline) been financed?
The answer AGAIN has been DEBT.
ALI’s long term debt surged by 16.22% in 2016. Including short term debt, the growth rate swelled to an astounding 31.52%!
The compounded average growth of long term debt over the past 4 years has been at a whopping 29.52%*!
* As a side note, the firm has foreign loans worth USD 34.9 million end of June which seems to have been excluded from the above (see Note 7). Yet the good news has been for ALI to substantially trim by (81%) reduction in foreign debt denominated from a high of USD 182 million in 2013 to just USD 34.9 m as of June. Nevertheless the size of foreign debt remains puny to the overall debt.
Yet let us see ALI’s seemingly parlous business model from 4 year CAGR perspective based on 1H performances.
ALI’s nominal revenues: 19.34%
Inventory: 35%
Financing gap bridged by debt: 29.52%
So it takes Php 1.52 of borrowing by ALI to produce Php 1 of revenue growth. To apply to balance sheet gearing to income, ALI borrowed Php 1.54 to generate Php 1 of income for 1H 2016.
This comes even as the variance between revenue growth and inventory growth has massively widened: only 55% take up/absorption rate on inventories! Stunning.
For property companies leveraging works in both supply/backend/inventory and demand/frontend/sales. Companies provide free lunch to their clients via zero interest rates vendor financing installment schemes. And the same companies build on the inventory which they sell through leverage too.
Again the risk has not just been about escalating overcapacity but also about overcapacity financed by debt. And this has not just been about ALI but about the industry.
Real Estate Industry’s Increasingly Fragile Debt Financed Build and They Will Come Model
These maladjustments cannot occur on a sound money environment. The BSP’s credit subsidies have allowed the proliferation of unsound business models as seen in the increasing leveraging/gearing of the real estate-retail-hotel industries in the race to build supply model.
Unknown to most, this “build and they will come” paragon serve as cornerstone to economic and financial crisis. Again I am not talking only of ALI, but of the industry and the economy.
The real estate sector (NGDP 11.56%), construction (6%) and retail industry (17.7%) has accounted for the largest share or a combined at 35.26% of the government’s 1Q statistical GDP. Yet many other segments of the economy have been significantly anchored on them.
Hence a downturn in the real estate-retail segment will easily cause a tremor that would ripple across the Philippine economy.
Yet continuation of the said unsustainable “supply creates its own demand/build and they will come” model by the industry, eventually will lead to losses, illiquidity, insolvencies and liquidations.
And this shows why the BSP had to launch a silent stimulus in 4Q of 2015
Record stocks, soaring PERs and vertical price actions in the face of decaying fundamentals inflated by credit, shows more signs why history has indeed been in the making!
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