SM Prime’s Growth Model: In 1H 2017, Every Peso of Growth Was Funded By SIX Pesos of DEBT! SMPH Bought Php 4.9 Billion of Related Party Shares!

In this issue

SM Prime’s Growth Model: In 1H 2017, Every Peso of Growth Was Funded By SIX Pesos of DEBT! SMPH Bought Php 4.9 Billion of Related Party Shares!

-SMPH’s Intensive Borrowing To Generate Growth Model

-SMPH’s Leveraged Model is a Product of BSP’s Zero Bound Policies

-SMPH Bought Php 4.9 Billion of Related Party Shares!

SM Prime’s Growth Model: In 1H 2017, Every Peso of Growth Was Funded By SIX Pesos of DEBT! SMPH Bought Php 4.9 Billion of Related Party Shares!

SM Prime released its 1H 2017 quarterly report last week.

SMPH’s Intensive Borrowing To Generate Growth Model

As of Friday’s close, SM Prime’s annualized PER based on the 1H 2017 eps remains at a staggering 33.92!!!

Let me first start by exhibiting the subtle but highly significant changes in SM Prime’s Management’s Discussion and Analysis in their 17-Q.

2013: “This is largely due to rentals from new SM Supermalls opened in 2012 and 2013, namely SM City Olongapo, SM City Consolacion, SM City San Fernando, SM City General Santos, SM Lanang Premier and SM Aura Premier, with a total gross floor area of 698,000 square meters. Excluding the new malls and expansions, same-store rental growth is at 7%.”

2014: “The increase in rental revenue was primarily due to the new malls opened in 2013 and 2014, namely, SM Aura Premier, SM City BF Parañaque and SM City Cauayan, with a total gross floor area of 421,000 square meters. Excluding the new malls and expansions, same-store rental growth is at 7%.”

2015: “The increase in rental revenue was primarily due to the new malls and expansions opened in 2013 and 2014, namely, SM Aura Premier, SM City BF Parañaque, Mega Fashion Hall in SM Megamall, SM City Cauayan, SM Center Angono and SM City Bacolod Expansion, with a total gross floor area of 652,000 square meters. Excluding the new malls and expansions, same-store rental growth is at 7%.”

2016: “The increase in rental revenue was primarily due to the new malls and expansion opened in 2015 and 2016,namely, SM Seaside City Cebu, SM City Cabanatuan, SM City San Mateo, SM Center Sangandaan, SM San Jose Del Monte, SM Trece Martires and SM City Iloilo Expansion with a total gross floor area of 941,368 square meters In addition, retail podiums of Light, Shine, Shell and Green Residences also opened in 2015 and 2016. Out of the total rental revenues, 91% is contributed by the malls and the rest from office and hotels and convention centers. Excluding the new malls and expansions, same-store rental growth is at 7%.”

2017: “The increase in rental revenue was primarily due to the new malls and expansions opened in 2015, 2016 and 2017 namely, SM Seaside City Cebu, SM City Cabanatuan, SM City San Jose Del Monte, SM City East Ortigas, SM City Trece Martires, SM CDO Downtown Premier, S Maison, SM City Iloilo Expansion and SM Center Molino Expansion with a total gross floor area of 1.1 million square meters. Out of the total rental revenues, 88% is contributed by the malls and the rest from office and hotels and convention centers. Excluding the new malls and expansions, same-store rental growth is at 7%.

 

There appears to be an implicit rule of thumb for the company’s analysis:

One, current growth signifies largely a function of the recently installed capacity or inventory additions during the last two years.

Two, same store sales have accounted for a fixed number: 7%

As shown in the upper chart, SM Prime has embarked on an aggressive capacity expansion over the last two years.

For malls in the Philippines and in China, gross floor area has grown at 13.5% (1 million sqm.) and at 9.5% (.8 million sqm.) in 2016 and 2017, respectively.

Moreover, SMPH opened at a rate of 12.28% (7 malls) and at 9.375% (6 malls) over the same period. These growth numbers have been MORE than DOUBLE the previous years.

So if added inventory of the past year (2016) should signify this year’s growth numbers, including the growth rate of same store sales, then SM core revenues should register 20% and above!

But SM’s rental revenues only registered 12.38% yoy in 1H 2017, slightly lower than 12.93% in 2016! To add real estate sales, which grew by 4.62% this year and 6.11% in 2016, SM’s core revenues moderated to 9.49% (2017) and 10.29% (2016). That would be less than half of the ideal rates.

It was the “other income” segment (+38%) that provided the gravy or which filled the gap between the core and the overall gross revenues. The other income category mostly came from “sponsorship income and hotels’ food and beverages income due to the opening of Conrad Manila”

Interestingly, SM’s cinemas posted a contraction of .91% in the 1H. (I know, part of this could be about NETFLIX on online movies)

Embedded fragility has appeared even in the management’s analysis.

Prior to 2017, revenue growth stemmed from two years of supply side expansion. In 2017, revenue growth expanded to include THREE years of supply, in particular, “due to the new malls and expansions opened in 2015, 2016 and 2017”.

So this represents an implied admission that SM has hardly filled the capacity additions of 2015!

As for same store sales, obviously given its fixity, such number seems hardly relevant to SM’s financial position.

Now the question is: how has such massive supply side growth been funded?

SM Prime’s posted nominal earnings of Php 19 billion in 2015, Php 12.9 billion in 2016 and Php 14.71 billion in 2017. The year on year difference in nominal context are negative Php 6.06 billion in 2016 and Php 1.82 billion in 2017.

 

Since these earnings numbers would be insufficient, the company resorted to mass borrowings for expansion. In 1H 2016, SM Prime added an incredible Php 43.3 billion to its long term debt! In 1H 2017, an astounding Php 11.4 billion of long term debt incorporated to its books.

Hence, FOR every peso of earnings generated by SM Prime in 2017, it borrowed Php 6.3 cents! And for every peso of revenue growth, the company borrowed Php 2.85! And these growth-debt dynamic has signified as SMPH’s tradition.

As a side note, the above represents only long-term debt which excludes loans payable and the current portion of long term debt.  And US dollar liabilities account for about 35% of long-term debt.

SMPH’s Leveraged Model is a Product of BSP’s Zero Bound Policies

To repeat, SM Prime’s core business model hardly depends on same store sales but from AGGRESSIVE supply side (market share) expansion.

And as the above evidence reveals, the company’s marginal sales growth, which has been derived mainly from newly installed capacity, has been financed by the company’s deepening exposure to leverage.

And in order to maintain current growth rates, SMPH would need to DOUBLE DOWN on its debt financed capacity expansion.

Thus, unless it changes the current dynamic, SM Prime’s business model ultimately leads to a “debt trap”. Such fragility will become apparent once occupancy rates fall, especially from systemic overcapacity. SM’s numbers have already begun to manifest these; three years of inventory to generate present revenue rate levels!

SM Prime’s current operating model represents an example of the redistributive effects of the BSP’s zero bound policies. SMPH have been a MAJOR beneficiary of such policy induced invisible transfers in favor of borrowers.

And many companies from the industry or related to the industry have massively borrowed to chase returns.

And such race to build supply, which has now become evident in the increasing share of the industry’s exposure to GDP, signifies misallocation of resources. Growing incidences of vacancies are manifestations of such systemic misdirection of resources.

SMPH Bought Php 4.9 Billion of Related Party Shares!

Finally, equity shares have “moneyness” functions. Aside from collateral, shares can be used for payments in mergers and or in acquisitions. Hence, many companies undertake measures to keep share prices up.

And perhaps for the upkeep of SM Group’s share status, we find this as part of 1H actions of SMPH.

Perhaps the string of record runs of parent SM and subsidiaries, SMPH and BDO can be traced to internal or group buying: SMPH bought an astounding Php 4.9 billion of related party shares which it categorized as Available For Sales (AFS) Investments!!! Wow!

Could it have been part of the “marking the close” consortium???

As of Friday, SM group now controls a stunning 26.63% of the PSEi 30’s market share. SM and SMPH have about 19.91% share.

So the company’s borrowing binge has not been directed at misdirection of resources in the real economy but also on misallocations to manage share prices of its interests.

Now, what happens when markets experience a severe downturn? Would these not add to SMPH’s increasingly fragile state?

Perhaps the SM group may have assimilated the notion that they own the market!