San Miguel Corp’s Fabulous Trillions!

Should the American economy ever achieve permanent full employment and prosperity, firms should look well to their auditors. One of the uses of depression is the exposure of what auditors fail to find. Bagehot once observed: ‘Every great crisis reveals the excessive speculations of many houses which no one before suspected’— JK Galbraith, The Great Crash, 1929

In this Issue

San Miguel Corp’s Fabulous Trillions!

-The First Trillion: Revenues

-The Next Trillion in the Making: Debt Hits Php 802 Billion in 2018!

-As the Poster Child of the Bubble Economy, SMC’s Share Prices Nearly Reaches Record Heights

San Miguel Corp’s Fabulous Trillions!

The low interest rate environment greatly encouraged the search for yield as greater risks were taken in exchange for higher returns—Financial Stability Coordinating Council, Financial Stability Report 2017

The First Trillion: Revenues

Mesmerized by a milestone, the CNN Philippines reported: “San Miguel Corporation (SMC) exceeded the ₱1-trillion mark in its 2018 revenues. Consolidated revenues form all its businesses, which include San Miguel Food and Beverage, Inc. (SMFB), SMC Global Power Holdings Corp., Petron Corporation, and SMC Infrastructure, reached ₱1.02 trillion last year, up by 24 percent from 2017. Factoring in expenses such as operating costs and taxes, resulted in a net income of ₱55.2 billion, up by one percent from 2017. "Income growth for the conglomerate was tempered by the sharp decline in crude prices resulting in inventory losses for its fuels and petrochemical business during the 4th quarter of 2018. This was compounded by forex translation losses for the year," SMC said in a statement. SMFB, which has subsidiaries San Miguel Brewery Inc., Ginebra San Miguel Inc. and San Miguel Pure Foods, had a net income of ₱30.5 billion. SMC also said that its big-ticket construction projects, which fall under SMC Infrastructure, remain on track, including the construction of Skyway Stage 3 and MRT-7.”

Sure, San Miguel’s (PSE: SMC) 24.07% or Php 198.9 billion revenue spike lifted 2018’s total to Php 1.025 trillion, doubling its 7-year CAGR to 5.6% from 2017’s 6-year CAGR revenue of 2.8%.

And despite such a marvelous headline number, the firm’s net income dropped 11.25% to Php 48.65 billion from 2017’s Php 54.814 billion and was 6.9% lower than 2016’s Php 52.24 billion.

Income growth was “tempered”, supposedly, from the sharp decline in crude prices, as well as, forex transaction losses.

However, as part of other income (charges), gains from dividend income and PSALM monthly fees reduction partially covered the forex losses of Php 9.714 billion. As such, including construction profits (revenues-costs) and gains on derivatives, other charges accounted for Php 5.628 billion reversing last year’s gains of Php 154 million. 

It was big, but not considerable enough to "temper" SMC's income growth. 

Figure 1

The spike in other charges (Php 5.474 billion) pales in comparison to the 27.39% surge in interest expense from Php 35.714 billion in 2017 to Php 45.5 billion or an increase of Php 9.8 billion last year. (see figure 1)

So what brought about the surge in interest rates?

The simple answer: SMC’s debt growth exploded in 2018!

The Next Trillion in the Making: Debt Hits Php 802 Billion in 2018!

Figure 2

As one can see in SMC’s Investor’s Briefing, Interest-bearing debt skyrocketed 45.92% to Php 802 billion last year from Php 549 billion! (figure 2 upper window)

Last year’s increase of Php 252 billion in marginal debt was 419% of published net income Php 48.65 billion! With net income lower by Php 6.16 billion last year, the corrosive effects of SMC’s soaring debt levels have become apparent in its bottom line.

It has been years since SMC has been borrowing far more than it earns. Since 2012, debt grew faster than published net income. Only in 2016 and 2017 did the debt-to-net income ratio fall below 100%. (figure 2, lower window)

Even without this year’s data, from 2012 to 2017 aggregate debt expanded Php 255 billion compared with an aggregate income of Php 253.5 billion.

That said, in my opinion, SMC may have been UNDERSTATING its debt servicing cost or interest expenses, thereby, OVERSTATING its bottom line.

With the incredible gorging of Php 252 billion of debt, it would be a complex and an extraordinary challenge for SMC to camouflage it on their Financial Statements.

Think about it, even without interest, the sheer scale of such debt acquisition should spur a proportional increase in amortizations of the principal unless offset by significant gains of revenues or margins. That’s not about to happen. It takes time for grand infrastructure projects to go online.

So the dramatic rocketing of debt has yet to reveal itself on SMC's interest expenses.

Furthermore, with the published capex doubling in 2018 to Php 109.07 billion from Php 51.925 billion a year ago, much of SMC’s massive debt expansion could be deduced as having been channeled to debt refinancing.

Like the banking system, not only will SMC’s insatiable desire for debt continue, it is likely to accelerate. Example, SMC’s Global Power launched a Php 30 billion offering this April.

To that end, the spectacular debt growth of 2018 means that SMC's forthcoming trillion peso debt would likely EXCEED its trillion peso revenue soon!

As the Poster Child of the Bubble Economy, SMC’s Share Prices Nearly Reaches Record Heights

Of course, SMC’s phenomenal debt expansion has been justified or rationalized on the populist political-economic theme of “build, build and build” to “connect, connect and connect” which has all been about “spend, spend and spend”.

Even if we assume that SMC’s massive infrastructure spending will deliver the expected revenue streams in the future, it won’t likely be sufficient to cover the carrying cost of debt servicing. 

And if such Panglossian expectations wouldn’t be met, what would happen next?

When a firm becomes entirely dependent on debt rollovers or asset sales because operating income has been insufficient to cover debt servicing, such is known as Ponzi Finance as conceptualized by neo-Keynesian economist Hyman Minsky.

If easy money has radically debased Jollibee's formerly solid business model, then SMC would qualify as the poster child of the nation’s credit bubble! See Jollibee’s Fantastic Paradigm Shift: From Consumer Value to Aggressive Debt-Financed Pacman Strategy, March 3, 2019

The maladjusted economy, embodied by SMC, has been stoked mainly by the easy money policies of the Bangko Sentral ng Pilipinas, and secondarily, the passionate embrace of the perverted interpretation of Say’s Law of "Supply Creates its Own Demand" as the nation's economic development model by the political leadership.

Before closing, a noteworthy development has been that share prices of SMC have almost hit an all-time high to close at Php 181.4 last April 12 on the same rationalizations of build, build and build. SMC’s record high was set on January 13, 2011 at Php 182.5.

Figure 3

Declining net income, rocketing debt and debt servicing have been all forgotten in the frantic chase for yields on San Miguel’s share prices. 

In their Financial Stability Report, the Financial Stability Coordinating Council admonished,

Stock market price-to-earnings ratios, on the other hand, have been persistently well past their textbook warning thresholds but there seems no evidence that investors believe the stock market to be overvalued. Whether this is a Minsky moment waiting to happen is certainly an important thought but the absence of clear-cut valuation measures for the market as a whole leaves the issue without an empirical resolution.

Has part of the Php 252 billion of the 2018’s debt hoard been diverted to pump SMC’s share prices?

SMC’s soaring share prices have exemplified the striking misperception, the grotesque deformities in the pricing system, excessive and rampant speculation, possible price manipulations, and massive malinvestments.

The Lehman and Bear Stearns episodes show how wrong assumptions that sky-high share prices represent evidence of stability, soundness, and prosperity. (see figure 3, lower window)

The obverse side of every mania is a crash.

Jollibee’s Fantastic Paradigm Shift: From Consumer Value to Aggressive Debt-Financed Pacman Strategy

If a business is obliged to take on debt, where debt had not been necessary before, then that may be a sign that it has consumed its capital. Its capital is becoming negative. That is, investors are letting the company use their capital, in exchange for a diminishing return—Keith Weiner

In this issue

Jollibee’s Fantastic Paradigm Shift: From Consumer Value to Aggressive Debt-Financed Pacman Strategy

-Jollibee’s Amazing Headline Numbers!

-Benefit Entails Costs: JFC’s Hidden Costs

-JFC’s Debt-Financed Pacman Strategy

-BSP Fueled JFC’s Paradigm Shift to Minsky’s Financial Instability

-JFC’s Pricey PER: Product of 7-Years of Price Multiple Expansion!

Jollibee’s Fantastic Paradigm Shift: From Consumer Value to Aggressive Debt-Financed Pacman Strategy

From the Financial Stability Coordinating Council’s Financial Stability Report 2017: (bold original, underline mine) [p.24]

The low interest rate environment greatly encouraged the search for yield as greater risks were taken in exchange for higher returns. However, the change in market prices (i.e., rising interest rates and depreciating peso against the US dollar) could trigger negative outcomes which, if not properly addressed, would amplify into systemic consequences

Because the late BSP Governor Nestor Espenilla Jr, allowed such candid assessment of the risk conditions of the Philippine financial industry to be published at the FSC for their peers at the Bank for International Settlements, he is deserving of a post-mortem credit.

Jollibee’s Amazing Headline Numbers!

Back in 2010, I have written radiantly about the success ingredient of Jollibee Foods Corporation [PSE: JFC].  [See Why “Buy Philippines” Will Make Filipinos Poorer May 2, 2010]

In short, Jollibee is simply being rewarded, through profits which partly serves to fuel the company’s expansion programs, which incidentally also contributes to the nation’s economic growth, in the service of the needs of the Filipino consumers.

Jollibee, hence, exemplifies the Mises model of a consumer oriented enterprise!

Importantly, Jollibee adds to social service by providing satisfaction through continuous improvements and innovations on their products and services to adapt to changing times, which is why Filipino consumers keep going back to them. JFC uses its spare funds to also engage in community services.

Jollibee embodied, from my perspective, the ideal capitalist (market economy) entrepreneurship. 

Elsewhere, I noted that JFC also functioned as a nexus to the informal economy. That is, JFC served as luxury outlets for many in the informal economy.

In the context of the firm’s business model, its direct ownership of properties, which domiciled many of their outlets, provided them the exposure of leveraging their assets through real estate.

These are the solid foundations behind JFC’s success story.

Times have changed. So has JFC’s business model.

From ABS-CBN: (bold mine)

Jollibee Foods Corp. (JFC) reported higher sales and profits as it aggressively expanded by adding more stores last year, the company disclosed to the stock exchange on Thursday. 

Jollibee said its sales grew 23.5 percent to P212 billion while profits rose 17.1 percent to P8.3 billion last year as the company opened 502 stores worldwide. 

The company said 317 stores were opened in the Philippines, while 185 new stores were launched abroad in 2018. This is now the highest number of new stores opened in one year in Jollibee's 40-year history, the firm said.

The company said 317 stores were opened in the Philippines, while 185 new stores were launched abroad in 2018. This is now the highest number of new stores opened in one year in Jollibee's 40-year history, the firm said. 

Jollibee also benefited from its acquisition of Smashburger in North America. Smashburger has 351 stores, mostly in the United States… 

The company said that it has allotted P17.2 billion in capital expenditures for 2019, which will go to setting up new stores, renovation of existing stores, and investments in manufacturing plants. 

Most media reports, echoing press releases, operate like political projects that focus mostly on benefits. 

Figure 1

Who wouldn’t be mesmerized by blockbuster numbers like the above?

Because of aggressive expansions, JFC’s annual total revenue growth in 2018 at 20.6% zoomed to its highest level! The marginal revenue, or the nominal peso variance of the topline numbers of 2018 and 2017, also spiked to landmark heights!

As such, peso NET income growth soared to a record Php 7.8 billion!

Magnificent right?

Benefit Entails Costs: JFC’s Hidden Costs

But the fun stops here.

Percentage net income growth in 2018 at 16.48% was lower than 2013’s 27.23% and 2016’s 19.96%. 2014’s 16.22% was within its proximity. The Earnings Per Share (EPS) % growth numbers share the same story: 2019’s 16.41% was overshadowed by 2013’s 24.41% and 2016’s 24.45%.

In marginal net income terms (variance of annual net incomes in peso), in 2018 Jollibee gained Php 1.1 billion, which was slightly higher than Php 1.010 billion in 2013 and Php 1.007 billion in 2016.

The irony: The gigantic boost to JFC’s revenues hasn’t resonated with its net income growth (both in % and in marginal terms)

The tremendous effort to prop up net income through the top line found leakages elsewhere.

Where might be the origins of such leakages?

Figure 2

To generate profits, entrepreneurs and investors deploy capital in the face of risks and uncertainty. Thus, every benefit entails costs.

What may have driven JFC to engage in an aggressive expansion program? Falling gross profit margins may have been a critical answer. Profit margins were 17.22% lower in 2018 from 18.18% in 2017 and from a high of 18.69% in 2014.

And attendant to profit margins, JFC’s operating margins have also been declining since 2013. Operating margin in 2018 was 4.98%, this was slightly down from 5.07% in 2017 and significantly lower from the 2013 high of 7.39%.

Remember the 10-consecutive months of 30% money supply growth in 2013-2014 that generated high street inflation? Such had influenced JFC’s margins.

Lately, JFC’s interest rate income turned into expense, which contributed to pressures on operating margins. Net interest expenses ballooned by 246% to Php 506.5 million in 2018 from Php 146.253 billion a year ago.

One major reason for the decline in profit margins must have been from price instability brought about by street inflation from the BSP’s easy money policies. And a second reason for pressures on JFC’s operating margins may have been from increasing debt burden again, a product of BSP’s policies.

The BSP's easy money regime has degraded JFC’s previous solid business model. 

JFC’s Debt-Financed Pacman Strategy

Jollibee’s growth paradigm has shifted from providing value-added benefits to the consumers to a debt-financed Pacman strategy.

Pacman is a famous Japanese arcade game of accumulating as many points as possible by collecting (and eating) the dots and eating ghosts. Here, the Pacman Strategy means to buy out the competitors.

Figure 3

In 2018, JFC’s total debts swelled by an astounding 62.96% to Php 26.264 billion from Php 16.117 billion a year ago! (figure 3, upper and middle windows)

How much did JFC make in 2018? Php 7.772 billion from Php 6.672 billion in 2017 or 16.5%

On a gross basis, JFC’s credit intensity was 3.38, or Php 3.38 of borrowings was made to generate ONE peso of JFC’s net income.

In 2018, JFC’s marginal net income of Php 1.099 billion, had been substantially dwarfed by the marginal increase in debt of Php 10.14 billion.  On that note, for every marginal net income peso generated, JFC borrowed a staggering Php 9.23!   

While JFC’s debt has been mounting every year since at least 2012, the company’s most audacious debt absorption had bankrolled JFC's most aggressive capacity expansion last year. 

Lunches aren’t free, not for Jollibee.

In the recent past, JFC has expanded aggressively through horizontal integration. That is, JFC bought out and tacked into its fold, its domestic competitors.  That’s JFC’s Pacman Strategy.

Now the thrust has been to expand also horizontally but externally.

JFC’s external recourse may be about the weak peso. As a means or a strategy to hedge against this, the company engaged in foreign FDI. However, JFC may be venturing into the unknown or to unfamiliar markets, where its competitive advantage may be deficient. It may not possess the same quality of knowledge and expertise in dealing with foreign consumers.

JFC’s domestic share of total assets dropped dramatically from 64.95% in 2013 to 55.15% in 2018. On the other hand, domestic sales to the total have declined from a high of 79.63% in 2016 to 74.23% in 2018. The domestic share to total CAPEX fell from a high of 82.27% in 2017 to last year’s 74.38%.

JFC’s increasing share of foreign business has yet to translate to the gains in the top line and the bottom line. 

BSP Fueled JFC’s Paradigm Shift to Minsky’s Financial Instability

Economist Hyman Minsky postulated that financing of firms evolve from hedge to speculative and finally to Ponzi where the use of credit initially had been meant for productive means which eventually morphs into chronic addiction (The Financial Instability Hypothesis).

Jollibee’s aggressive use of credit seems to undergo a similar path. By aggressively taking on debt, not only does it remove the firms’ margin of safety, but it takes on unnecessary risks. JFC operates with little room for error.

To re-quote the late BSP Governor Espenilla led Financial Stability Coordinating Council’s FSR (my intro),

“The low interest rate environment greatly encouraged the search for yield as greater risks were taken in exchange for higher returns.”

That’s exactly the case for JFC.

And as I have been pointing out repeatedly, not only does artificially low-interest rates subsidize big debtors at the expense of the savers, but it also crowds out debtors of lesser degree. Firms with liberal access to credit can buy out competing firms, and therefore, result in the concentration of the industry.

And there now is empirical evidence for this. In a paper by Ernest Liu, Atif Mian and Amir Sufi: (bold added)

This paper introduces the possibility of low interest rates as the common global “factor” that drives the slowdown in productivity growth. The mechanism that the theory postulates delivers a number of important predictions that are supported by empirical evidence. A reduction in long term interest rates increases market concentration and market power in the model. A fall in the interest rate also makes industry leadership and monopoly power more persistent. There is empirical support for these predictions in the data, both in aggregate time series as well as in firm-level panel data sets.

Ernest Liu Princeton University Atif Mian Princeton University and NBER Amir Sufi University of Chicago Booth School of Business and NBER, Low Interest Rates, Market Power, and Productivity Growth* SSRN January 22, 2019

And JFC’s monopolistic behavior, via its Pacman strategy, has been consistent with this.

Though the quality of JFC’s business model has been depreciating, it is more benign compared to her bigger PSYEi contemporaries.

JFC’s Pricey PER: Product of 7-Years of Price Multiple Expansion!

Finally, Jollibee remains one of the most expensively priced stocks of the elite index.

After a 15.34% return based on an eps growth of 16.41%, Jollibee closed 2018 with a Price Earning Ratio (PER) of 38.09. 

[As a side note, for unknown reasons or perhaps a glitch: the publication of the data on market cap share for the PSEi 30 members just vanished! Why?]

JFC’s pricey PER hasn’t emerged out of a vacuum; it signifies years of price-multiple expansion.

Figure 4

Since 2012, only in 2016 has earnings growth (+24.45%) meaningfully outclassed JFC’s stock market returns (-11.42%). 2018 was another (eps 16.41%, returns +15.34%). That is, the market pumped JFC share prices MORE than the eps growth it generated.  (figure 4, upper window). Years where eps growth beat returns were the exception.

Ever since the big leap to the 30s in 2013, the public has been made to believe that high PER ratio has been natural for the share prices of the food giant. Consistent with the EPS and stock market returns, JFC’s end of the year PER have grown in five of the seven years. (figure 4, lower window)

G-R-O-W-T-H has been its popular rationalization.  Yes, imbalanced growth, that is: JFC’s 6-year CAGR: Net income +11.69%, eps +13.52%, equity returns +19.15 and debt +30.06%

Markets eventually clear. PERs revert to the mean.

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