Confirmed: SMIC’s EPS ‘Improvement’ Have Been Due to a Deluge of Debt and Inventory!

Last weekend, I demonstrated how prices of Philippine stocks have risen vertically from an earnings placebo effect—panic buying over the delusion of G-R-O-W-T-H even when reality shows that fundamentals have almost nothing to do with it.

Fundamentals have really provided nothing but entertainment value.

But let me add to this entertainment.

This afternoon the largest listed company holding firm SM Investments released their 2Q and 1H 17-Q (financial statement).

The 17 Q Management discussion section divulged: “SM Investments Corporation and Subsidiaries (the Group) reported Revenues of P151.1 billion and Net Income Attributable to Owners of the Parent of P15.0 billion in 2016. This represents an 8.5% growth in Revenues and 11.1% growth in Net Income Attributable to Owners of the Parent.”

The actual numbers for the 1H were 8.75% for revenue growth and 10.28% eps growth, the highest in two years!

Nice recovery right? Well that’s what the surface says.

Last weekend I also propounded that subsidiary SMPH’s earnings have “largely emerged from accounting artifices, surging inventories, and importantly, skyrocketing leverage.”

Well the performance of the parent firm SM just confirmed on my suspicions.

 

Inventory.

The above chart shows of the % change of revenue contribution during the 1H by the largest segments of SM’s business units. Sales of retail (70% share), rental (13% share) and real estate (9% share) which constituted 91% share of 1H 2016 revenues, posted growth rates of 8.64%, 9.93% and 5.34% in the 1H respectively.

Now to the retail segment’s inventory.

For 1H 2016: “As of June 30, 2016, SM Retail had 328 stores nationwide, namely: 55 SM Stores, 47 SM Supermarkets, 147 Savemore stores, 45 SM Hypermarkets and 34 WalterMart stores.”

In 1H 2015: “As of June 30, 2015, SM Retail had 289 stores nationwide, namely: 51 SM Stores, 41 SM Supermarkets, 127 SaveMore stores, 43 SM Hypermarkets and 27 WalterMart stores.”

So for the year 2016, the inventory or number of stores in the retail segment grew by 13.49%!

 

In terms of relative growth performance, growth in retail outlets has surpassed by a huge margin growth in retail sales in the past 3 of the last 4 years.

The numbers: 2016 stores 13.49% versus sales 8.64%, 2015 stores 16.06% versus sales 6.07% and 2013 25.14% vis-à-vis 13.24%. Inventory grew by about double the sales growth in 2015 and 2013!

For 2016, 1.56% inventory growth generated 1% sales growth.

It’s only in 2014 where sales outclassed inventory 9.1% in contrast to 8.73%.

In short, the marginal additions of retail stores have critically driven retail sales. Yet the mammoth difference between growth rates of new stores and sales reveals of the huge unused capacity! This is a conspicuous sign of inefficiency in SM’s capacity utilization.

Now to the shopping malls.

1H 2016: “As of June 30, 2016, SM Prime had 58 malls in the Philippines and 6 malls in China”.

1H 2015: “As of June 30, 2015, SM Prime had 52 malls in the Philippines and 5 malls in China”.

It would have been more accurate if the company actually made their presentations in the context of number of malls PLUS actual gross selling area. Unfortunately this doesn’t seem to have been incorporated in the FS.

Nonetheless in 2016, the inventory of SM Malls expanded by 11.54%!

But sales grew by just 9.93%!

 

Now the above chart should be a better picture, or if not, a more splendid depiction of SM’s faltering business growth paradigm.

Yet has it not been a paradox to see the LARGEST increase in the rate of mall inventory growth in 1H of 2016 COINCIDE with the SMALLEST revenue growth in the past 4 years?

That’s right. SM’s magnificently growing surplus capacity or huge additions to malls have doneLITTLE to enhance on the marginal growth of the firm’s overall mall sales! In short, the trends above reveals of SM Malls suffering from DIMINISHING returns!!!

And there you have it folks…the rapid turnover and vacancies as illustrated by the widening abyss between performances of the topline and capacity!

Accounting gymnastics.

And one more thing, same store sales as reported by the company, for the past four year have surprisingly been steady or unwavering at 7%! (see chart above) Topline and bottom line numbers have changed but same store sales look like a numerical tautology or incantations by SM.

Such are signs of accounting acrobatics which seem to validate my earlier insights: “I have deep reservations when SMPH claims that there was a 7% same store sales in rent revenues. Reason? SM Malls have now plagued by massive store churning and rising accounts of vacancies.”

Astounding leveraging.

And we are not even talking about real estate (vertical condos) projects.

Nevertheless, the incredible rate of capacity expansions translates to SM spending MORE than it has been earning.

Since they have been spending more, then the financing gaps must be filled. So exactly how will this quandary be bridged?

 

Well, by DEBT of course.

SM’s use of gearing has steadily grown. Debt CAGR has been at 14.91% over the past 4 years! That would be 57% faster than the SM’s topline growth rate during the same period at 9.5%! Or SM has generated Php 1.57 for every peso revenue growth!

If debt has been growing faster than sales, then how much in terms of eps? In short, if such trend will continues this translates to lesser and lesser free cash to service debt, operations and expansions.

Eventually the accelerating size of SM’s debt will also contribute to the profit squeeze via higher debt servicing costs, aside from the ongoing deterioration in topline performance via diminishing returns and from growing surplus capacity (not limited to SM but to the industry).

Such kind of businesses models would hardly transpire under a sound money environment. Said differently, the BSP’s trickle down negative real rates policies have only been subsidizing unproductive engagements as this.

SM has already been hooked on this model. They cannot stop. The rate of expansions needs to grow faster, otherwise the chink in their armor will be revealed.

However, despite aggressive expansions, fierce industry competition expressed also via massive capacity acquisitions would also translate to weakening performance ahead for SM and for the industry as a whole. Or the law of diminishing returns on the industry points to even more inefficiencies and wastages that will be revealed in the form of even more store vacancies.

Nonetheless, since the rate of expansion has to be financed, then SM’s debt will likely swell as fast—as it has been doing today.

Such debt for growth models eventually hit a wall. Signs are already present in both numbers (widening chasm between topline and supply growth rates) and in the ground—turnovers and vacancies.

As with Troy, Achilles was exposed as vulnerable after all…through the unshielded heels. Lesson: what seems as insuperable isn’t. 

SM would need to pray for a miracle to reverse the current trend.

But not to worry because SM prices have been drifting at all-time highs.

 

Finally, I don’t know if the PSE has become inept or has purposely neglected the required adjustment of SM’s PER ratio as part of their cheering propaganda campaign.

SM declared a 50% stock dividend that had a record date in August 3. It’s been 6 days from the announcement, yet the PER reflected at today’s closing price of Php 697 a share have been from the pre-dividend eps. Divide 697 by 35.68 to get the PER of 19.53.

Nonetheless at today’s close, 2015 based PER should be at 29.3. If based on 1H annualized earnings, SM’s PER should be at 28.01.

It’s bad enough for the PSE to have been converted into a grand casino den. It’s even worse when the PSE can't or won't do basic jobs.

Yet more signs of pivotal history in the making.

PSEi’s Vertical Price Pumping: Earnings Placebo in the Face of Dismal Performance!

Placebo. A substance having no pharmacological effect but given merely to satisfy a patient who supposes it to be a medicine (Dictionary.com).

Five of the PSEi issues belonging to the top 15 reported their 2Q and 1H results for 2016.

 

The numbers above tells you why price actions at the PSE have been totally unanchored from reality.  Or rising stocks, which has been presented by the consensus as signifying G-R-O-W-T-H, have merely represented a placebo effect or popular delusions.

Moreover, the slump in the growth Philippine tax revenues to just 1.1% in the 2Q seem to have also been reflected on the above numbers. Based on IMF 2013 data, Philippine taxes (76%) largely accrue from Corporate Income, Personal income and VAT which accounted for 28.1%, 16.1% and 31.9% shares of total revenues collected, respectively. So in spite of tax leakages due to the administration’s collection lapses, the plunge in tax growth most likely has extrapolated to a cascade in economic activities which has been manifested on corporate and personal incomes and or NGDP or both.

Price Action Premised on the Earnings Placebo

Regardless of earnings, still the delirious price pumps.

Example SMPH.  Even if we take into consideration the “core” income growth in both 1Q and 1H at 2016 at 12% apiece as presented by the company, just what justifies a gargantuan 3.15x surge in price returns at 12% core growth???  Because 2H income growth will soar by more than 60%???!!! As a side note, 2Q eps growth (net of extraordinary items in 2015) was only 10.24%.

It has been such furious vertical price pumping that has caused the firm’s PER to explode to 30.45 (based on 2015) and 34.21 (based on 1h 2016 earnings, annualized)!

And it’s not just SMPH. Metrobank has also shown an almost equally vicious price pump, yet for all the massive price inflation, 1H eps growth tanked by 8%!

See? Declining EPS has now served as a fuel for furious price pumping!

TEL and GLO also shows how stocks have been elevated by false premises. TEL’s crash in eps growth in 1H 2016, which has signified an extension of 2015’s 35.34% eps collapse, has only produced a shallow downside of just 5.83%.

TEL appears as being supported by index managers to “buoy” the headline index.

Yet more incredulous, TEL 4G partner Globe Telecoms performance. GLO’s eps growth crawled to a positive +2.88% in 1H 2016 yet share prices returned a massive 21.38% y-t-d for a shocking 7.42x return on eps growth! Or the market paid Php 7.42 for every 1% of eps growth!

And naturally the establishment, represented by the PSE, will continue to promote recklessness via record PSEi in the hope for G-R-O-W-T-H to just reappear.

Earnings recital has not only produced a placebo effect, but has also served as Pavlovian mental conditioning trigger to panic buy—regardless of the earnings outcome.

Just What Will Drive EPS G-R-O-W-T-H?

Since earnings are largely irrelevant to prices then its other function is to entertain.

So for more entertainment, read below…

Yet just what will provide the marginal factors that would bolster G-R-O-W-T-H to these companies?

4G for Telecoms?

Thailand’s 4G should be an example. Profits from Thailand’s 4G providers stumbled reportedly on intense competition for market share. From the Nikkei Asia, “Top Thai mobile carriers Advanced Info Service and Total Access Communication reported profit declines for the April-June quarter on higher marketing costs aimed at luring customers for fourth-generation services. The first quarterly earnings reported since a series of spectrum auctions ended in May suggest the carriers will need time to reach growth and enjoy returns from the new networks, which required hefty investments…The April-June period saw Thailand's three major carriers, including True, offer 4G services for a full quarter for the first time. Competition grew intense when AIS joined the 4G battle in January. The carriers' typical campaign involves the "free handset" distribution to encourage existing customers to subscribe to 4G service… The April-June results indicate that Thai carriers might need to diversify their profit source as long as the mobile campaign competition continues.” (bold added)

The problem appears to be—not limited to competition—but to restricted demand. And restrain in demand has been brought about by Thailand’s economic conditions, which competitors have been intensely vying for. As previously noted, 4G’s are NO free lunches. Not even if they are monopolies.

Will Massive Oversupply Bring About Real Growth in Shopping Malls and Real Estate?

How about SMPH’s malls, condos and hotel model?

While the BSP’s silent stimulus managed to reflate the firms’ 1H 2016 topline in terms of rent: 12.93% from 10.02% in 2015 and 12.47% in 2014; and in real estate: 6.11% in 2016 double from 3.15% in 2015 and -3.65% in 2014. Such has largely emerged from accounting artifices, surging inventories, and importantly, skyrocketing leverage.

1) Accounting Maneuvering

I have deep reservations when SMPH claims that there was a 7% same store sales in rent revenues. Reason? SM Malls have now plagued by massive store churning and rising accounts of vacancies.

Three months back I went to SM Megamall and counted 38 vacant stores with about 12 taken by new tenants but was under construction.

Last week, while about 85% of those vacancies have reopened or had tenants, new vacancies has sprouted (more than a dozen) in June and July, mostly in the new wing or in the Fashion Mall. Meanwhile, SM’s other lesser malls, SM Lights and Podium have only revealed of increases in vacancies rather than turnovers.

As I wrote way back in 2013 (Phisix 7,000: Why Asia’s Rising Star is a Symptom of Mania April 29, 2013): “Periphery to the core would mean initially fast turnover from retail tenants on stalls of lesser traffic areas and of marginal malls. Then the length of vacancy extends and the number of vacancy spreads.”

Such dynamic have precisely been happening today!

Photos taken last week.

Unless the sales rate of growth from existing stores has soared by significantly more, one can hardly generate the cited same store sales growth figures with the incredible number of either turnovers or vacancies or even both. I know, the turnover figures I talk about entails something in the range of anywhere 5-20% of the overall inventory depending on the mall. 

Yet fast turnovers and vacancies has basically been a problem NOT restricted to SM but to shopping malls within the locality.

As earlier indicated, vacancies and turnovers have also swelled in Robinsons Galleria, vacancies have spread to Edsa Shangrila’s East Wing (even as there have been slight improvements on the occupancy at the Main Mall) and vacancies have also percolated to Estancia’s Mall at the Capital Commons.

I haven’t been to Robinson’s Sogo, Starmall Shaw, Edsa Central, Greenfield’s Pavillion Mall and other lesser malls within the purlieu. And Ayala will soon open the Paradigm Mall as part of the Paradigm Corporate Center.

Just think of the massive supply of retail spaces that is bound to, or will overwhelm demand. Demand springs from demographic and income conditions of the population within the area.

And just think of the developing predicament at the Ortigas area in the spectrum of a nationwide phenomenon—as developers race to build supply, financed by credit, with the goal to capture market share. 

And will such overconsumption of resources generate eps or real economy (not GDP) growth? Or will it create excesses that will spur a downturn?

The bursting of fast turnovers and vacancies have been occurring almost simultaneously at various malls. Such phenomenon has only surfaced in 2015 and appears to be snowballing.

Yet when I reported a surge in Shangrila Mall’s vacancies as baptism of fire for the industry in early 2015, Shangrila’s disclosures hardly reflected on these.  It was only at their 2015 annual report where they admitted that “Business was also affected by increased competition from newly opened shopping centers in the nearby areas”

So perhaps many accounting chefs maybe working overtime to spruce up financial statements of many listed firms.

2) Surge in Inventories

Yet for SMPH, the most likely source of accounting income growth may have mostly emanated from new inventories.

SMPH reported 57 malls in 1Q 2016 with retail space of 8.4 million sqm. This became 58 malls with 8.5 million sqm in 1H 2016. That’s largely due to the “newly opened SM City San Jose del Monte in Bulacan, with a GFA of 101,000 sqm”. Yet more malls on the pipeline: “The company is scheduled to open two more malls this year namely Cherry SM Congressional in Quezon City and SM City East Ortigas in Pasig City. SM Prime is also expanding SM Center Molino in Cavite and SM City San Pablo in Laguna this year.”

As a side note SM Cherry is already operational. So far very few tenants.

And sales growth emanated from real estate projects where “SM Development Corporation (SMDC) projects launched from 2013 to 2015 such as Princeton Residences, M Place Residences, Mezza II Residences and Jazz Residences in the cities of Quezon and Makati.”

The odd thing has been that such massive supply growth has only been generating a rather miniscule, if not declining, rate of earnings growth.

3) Skyrocketing Leverage

What has not been told.

SMPH’s topline and bottomline performance have all depended on increased leverage.

While SMPH generated Php 12.9 billion of net income for the 1H 2016 for a core growth of 12%, it borrowed a stunning Php 43.33 billion or up 41.64% year on year. In short, SMPH borrowed Php 3.36 for every peso earnings growth it generated.

If SMPH will not borrow more going to the close of the year, and if 2016 ends at the current rate of income growth, then SMPH’s credit intensity will be reduced to Php 1.68 for every peso growth generated.

Understand again that real estate feeds, survives and thrives on leverage. Developers virtually give away their properties to buyers through zero percent vendor-financing specifically on downpayments.

Moreover, because of cash flow issues brought by the use of leverage to generate sales, supply or project completions also requires heavy leverage for funding.

Real estate constitutes about a third of SMPH sales.

Yet SMPH’s 2016 surge in borrowing hasn’t been a one-time event. As the upper chart showed, leverage continues to scale upwards. Debt growth soared by 50.9% in 2014 and then moderated to 9.1% in 2015 before exploding again to 41.64% this year.

That’s right, the CAGR of SMPH’s debt for the past 3 years has been a shocking 32.58%!

And about 34.7% of the company’s debt outstanding has been in US dollars. This shows SMPH’s “US dollar shorts” or vulnerability to currency risks.

Overall, SMPH’s profits have been puffed up—behind the scenes by humungous leverage.

Yet this demonstrates how such projects have invisibly been subsidized by the BSP’s negative real rates regime. Or how the BSP redistributes wealth in favor of the owners of SMPH and its (credit financed) customers.

Why has BDO Expanded Held to Inventory Assets?

And I also harbor big doubts on BDO’s recent earnings surge. Reason? For the first time in three years, BDO posted huge assets under “held to inventory”.

In fact, the size of 2016 position has represented the largest “held to inventory” assets since 2009!

Why such massive use of held to inventory given the sharp rally in Philippine assets?

Since “held to inventory” represents an accounting category where assets signify as investments that are intended to be held until maturity, they are reported at amortized cost and not subject to market price fluctuations.

The reason I bring this up is because, recall that in the middle of last year, the Commission on Audit (COA) accused the Philippine government’s Development Bank of the Philippines (DBP) in engaging in market manipulation via “wash sales” in order to shift the bank’s “long-dated ‘available-for-sale’ peso government securities worth P20 billion” to a ‘hold-to-maturity’ portfolio in order “to avoid increasing the mark-to-market losses and preserve the accrual income”

As I wrote then: (Phisix 7,600: 5.2% 1Q GDP Another Data Pump! DBP Accused of Market Manipulation; Scapegoating The US Dollar, May 31, 2015)

And not only that, if DBP’s actions have been representative of the industry, then a lot of those published ‘solid’ statistical numbers may have been a charade.

And why shouldn’t the DBP’s actions be illustrative of the many activities engaged by both public and private institutions?

So why the huge and sudden surge in assets that are “held to inventory” by BDO?

Has BDO used the same accounting gimmickry to bolster its eps growth by hiding losses?

Again what we are seeing has truly been monumental irony, vertical price actions as fundamentals stumble or erode!

History is in the making.