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.

S&P 500 and Global Equities: Behind The Best 71-Day Returns Since 1987; China’s Credit Rockets! Continued Ascent of US Primary Dealer Holdings of T-Bills

A delirious stock-exchange speculation such as the one that went crash in 1929 is a pyramid of that character. Its stones are avarice, mass-delusion and mania; its tokens are bits of printed paper representing fragments and fictions of title to things both real and unreal, including title to profits that have not yet been earned and never will be. All imponderable. An ephemeral, whirling, upside-down pyramid, doomed in its own velocity. Yet it devours credit in an uncontrollable manner, more and more to the very end; credit feeds its velocity—Garet Garett

S&P 500 and Global Equities: Behind The Best 71-Day Returns Since 1987; China’s Credit Rockets! Continued Ascent of US Primary Dealer Holdings of T-Bills

Figure1

This first chart shows that the S&P 500 has registered the fourth-best return in 71 days and the best return since 1987. (chart courtesy of Charlie Bilello)

But here’s the rub. Beneath the surface, of the top four best returns in 71-days, namely, 1975, 1930, 1987 and 1943, yearend returns were either strikingly single digit or stunningly negative.

Said differently, by the close of the year, the gains of the top four were completely or mostly reversed.

The possible reasons:

-1975 signified the tail end of 1973-1975 recession.

-1930 represented the onset of the Great Depression

-1987 saw the horrific Black Monday crash and

-1943 may have been the prelude to the post World War 2 the short recession of 1945.

Will the SPX follow the same path?

Figure 2

The next chart (also from Charlie Bilello) shows the intensifying euphoria that has engulfed global equity markets.

Forty-six of the forty-eight national ETFs including the Philippines have posted positive returns! The average returns have been an astounding 12%, the best start since 1987! (returns in USD)

1987 again!

Will global equity markets share the same fate of the SPX?

The third chart comes from Ed Yardeni’s Country Briefing: China

It shows how the Chinese government has panicked to have incited the unleashing a tsunami of credit at a scale never seen before!

Figure 3

The perspicacious Doug Noland with the nitty gritty:

China’s Aggregate Financing (approximately system Credit growth less government borrowings) jumped 2.860 billion yuan, or $427 billion – during the 31 days of March ($13.8bn/day or $5.0 TN annualized). This was 55% above estimates and a full 80% ahead of March 2018. A big March placed Q1 growth of Aggregate Financing at $1.224 TN – surely the strongest three-month Credit expansion in history. First quarter growth in Aggregate Financing was 40% above that from Q1 2018. 

Over the past year, China's Aggregate Financing expanded $3.224 TN, the strongest y-o-y growth since December 2017. According to Bloomberg, the 10.7% growth rate (to $31.11 TN) for Aggregate Financing was the strongest since August 2018. The PBOC announced that Total Financial Institution (banks, brokers and insurance companies) assets ended 2018 at $43.8 TN.

March New (Financial Institution) Loans increased $254 billion, 35% above estimates. Growth for the month was 52% larger than the amount of loans extended in March 2018. For the first quarter, New Loans expanded a record $867 billion, about 20% ahead of Q1 2018, with six-month growth running 23% above the comparable year ago level. New Loans expanded 13.7% over the past year, the strongest y-o-y growth since June 2016. New Loans grew 28.2% over two years and 90% over five years. 

China’s consumer lending boom runs unabated. Consumer Loans expanded $133 billion during March, a 55% increase compared to March 2018 lending. This put six-month growth in Consumer Loans at $521 billion. Consumer Loans expanded 17.6% over the past year, 41% in two years, 76% in three years and 139% in five years. 

China’s M2 Money Supply expanded at an 8.6% pace during March, compared to estimates of 8.2% and up from February’s 8.0%. It was the strongest pace of M2 growth since February 2018’s 8.8%. 

South China Morning Post headline: “China Issues Record New Loans in the First Quarter of 2019 as Beijing Battles Slowing Economy Amid Trade War.” Faltering markets and slowing growth put China at a competitive disadvantage in last year’s U.S. trade negotiations. With the Shanghai Composite up 28% in early-2019 and economic growth seemingly stabilized, Chinese officials are in a stronger position to hammer out a deal. But at what cost to financial and economic stability?

Beijing has become the poster child for Stop and Go stimulus measures. China employed massive stimulus measures a decade ago to counteract the effects of the global crisis. Officials have employed various measures over the years to restrain Credit and speculative excess, while attempting to suppress inflating apartment and real estate Bubbles. Timid tightening measures were unsuccessful - and the Bubble rages on. When China’s currency and markets faltered in late-2015/early-2016, Beijing backed away from tightening measures and was again compelled to aggressively engage the accelerator. 

Credit boomed, “shadow banking” turned manic, China’s apartment Bubble gathered further momentum and the economy overheated. Aggregate Financing expanded $3.35 TN during 2017, followed by an at the time record month ($460bn) in January 2018. Beijing then finally moved decisively to rein in “shadow banking” and restrain Credit growth more generally. Credit growth slowed somewhat during 2018, as the clampdown on “shadow” lending hit small and medium-sized businesses. Bank lending accelerated later in the year, a boom notable for rapid growth in Consumer lending (largely financing apartment purchases). And, as noted above, Credit growth surged by a record amount during 2019’s first quarter. 

China now has the largest banking system in the world and by far the greatest Credit expansion. The Fed’s dovish U-turn – along with a more dovish global central bank community - get Credit for resuscitating global markets. Don’t, however, underestimate the impact of booming Chinese Credit on global financial markets. The emerging markets recovery, in particular, is an upshot of the Chinese Credit surge. Booming Credit is viewed as ensuring another year of at least 6.0% Chinese GDP expansion, growth that reverberates throughout EM and the global economy more generally.

So, has Beijing made the decision to embrace Credit and financial excess in the name of sustaining Chinese growth and global influence? No more Stop, only Go? Will they now look the other way from record lending, highly speculative markets and reenergized housing Bubbles? Has the priority shifted to a global financial and economic arms race against its increasingly antagonistic U.S. rival? 

Chinese officials surely recognize many of the risks associated with financial excess and asset Bubbles. I would not bet on the conclusion of Stop and Go. And don’t be surprised if Beijing begins the process of letting up on the accelerator, with perhaps more dramatic restraining efforts commencing after a trade deal is consummated. Has the PBOC already initiated the process?

April 12 – Bloomberg (Livia Yap): “The People’s Bank of China refrained from injecting cash into the financial system for a 17th consecutive day, the longest stretch this year. China’s overnight repurchase rate is on track for the biggest weekly advance in more than five years amid tight liquidity conditions.”

Figure 4

US primary dealer holdings of T-Bills and Floating Rate Notes have been spiraling upwards. Why? Have they been accumulating USTs for their account or on behalf of clients? Have these intensifying accumulation been about the growing scarcity of risk-free collateral?

Four different charts that are related (see Garet Garrett excerpt)

The year of the pig.