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!

Historic Moment Unfolding in the Philippine Financial System; More Free Lunch Policies

Since the BSP released its June data on domestic liquidity and the banking system’s lending condition, then this would just be an extension of the previous discussion.  [See 2Q and 1H Fiscal Deficit Surges to 2010 Levels! The Risks and Possible Consequences of the Current Fiscal Trend July 30, 2017]

BREAKTHROUGH HISTORY IS IN THE MAKING!

We are on a cusp of history.  The unfolding of an unparalleled process in the Philippine financial system has been happening real time!

The Philippine political economy now faces a TWIN Deficit!

MILESTONE fiscal deficit has now been accompanied by nearly a RECORD trade deficit. The latter represents an offshoot of the former. But since both require financing, the government has dealt these through UNPRECEDENTED monetary policies! 

To bridge the ballooning financing gaps, the BSP has resorted to HISTORIC low-interest rates and the awesome MONUMENTAL program of National Government (NG) debt monetization!

And both these factors have now spurred credit expansion beyond the banking system to include the government. Borrowing for both sectors, namely the banking system and the government which again based on nominal terms are at UNPARALLELED levels!

Yes, BREAKTHROUGH HISTORY is happening, right here, right now!

The BSP absorbed some Php 66.9 billion in NG debt last June. The BSP’s actions practically erased the 5 month slack. Year to date, the BSP acquired some Php 9.8 billion of NG claims. These numbers, which are published by the BSP, is accessible to the public (you and everyone else):  June data here and complete data from BSP’s financial system’s accounts.

Because the BSP’s depository survey data have hardly been discussed in the public, this would seem esoteric. But such activities signify a critical segment of the BSP’s activities.

Current process seems to be the following: NG issues debt to the public (mostly banks and financial institutions) to finance growing fiscal deficit, but such activities drain on the system’s liquidity. At the same time, the BSP buys some of the previously issued papers from the public which offsets the previous liquidity depletion.

At the end of the day, the BSP maneuvered to maintain the incumbent easy money policy IN SPITE of the ongoing crowding out process.

Again, despite the establishment’s overwhelming rhetoric that the Philippines is in good shape, still why the accelerated use of these emergency measures?

Why has the BSP been playing with an inflationary fire?

M3 growth, which spiked to 13.2% in June from 11.3% in May seem as a jump-start response to the BSP’s debt buying in the same month. And perhaps, part of the BSP’s implicit funding of the government may have arrested the recent fall in real economy prices. July’s CPI rose to 2.8% from June’s 2.7%. I am merely using government’s statistics for interpretation and not assuming its accuracy.

The BSP’s reacceleration of the domestic version of Quantitative Easing (QE) appears to have juiced up industry loans which at +17.88% in June was marginally higher from 17.57% in May.

However, growth in consumer loans lurched lower to register 22.54% in June compared to 23.56% in May.

While credit card loans have been in a turbocharged mode (June +16.97% versus May’s +15.63%), car loans dropped (+28.52% in June as against in 30.37% in May). The slowdown in car loans has resonated with car sales over the same period.

Meanwhile, payroll loan growth crashed to 24.51% in June from 40.3% in May. After a reaching a zenith at 63.06%, payroll loan growth continues to fall. So June’s downturn was hardly an anomaly.

Has the lower income spectrum been tapped out? Have financial inclusion or the migration from the informal economy to the formal economy reached a tipping point? Or could part of the payroll loan market have been diverted to the use of credit card? Or has the previous payroll borrowers opted to withhold spending thereby increase savings rate? Savings rate have been reported at all-time highs. Or could it have been a combination of the above?

For credit card, double digit growth rates begun in October. With higher consumer prices, the huge increase in credit card usage could mean that spending at present income levels may have reached its climax for them to resort to credit to augment spending.

Nevertheless, the ramifications of government’s actions have been incrementally percolating into the real economy.

These are truly interesting times!

The Economic Aftermath of Free Tuition Fees

And here’s more.

In defiance of his economic ministers, Philippine President Duterte signed a bill which puts into law the granting of tuition-free education in all state universities and colleges (SUCs).

Since I said that I would refrain from talking politics*, I can only make a prediction: this will blow a gargantuan hole in the government’s budget.

The article notes of budget estimates at Php 20 billion to Php 43 billion to Php 100 billion. I’d say that these numbers will be surmounted over time.

Reason? Basic Economics!

AT ZERO PRICE, DEMAND WILL OVERWHELM SUPPLY SUCH THAT SHORTAGES WILL OCCUR!

From the Revision Guru: (see chart in the lower pane above)

Zero pricing is an extreme form of maximum pricing; the maximum price is zero!  This means that goods and services are provided free of charge. This shows that, at a price of zero, there will be a shortage (excess demand) equal to QD QS.  This shortage will remain unless the price is raised to the equilibrium of Pe.

*I wrote about these before: I Am Not Alone: Economic Cabinet Members REJECT the Free Tuition Program! February 12,2007 and Wow, BSP Chief Sees The Rise of Populist Politics/Retreat from Multilateralism as Scary Developments, Scary Stuff for 2017! December 18, 2016

Let me just give a hint that the impact from free tuition will diffuse not only into fiscal balances but likewise to sociology to the government’s bureaucratic structures to other forms of social welfare.

And pray that free education won’t transform into an education crisis ala Venezuela.

Since one thing leads to another, expect more free lunch policies to be advanced.

Yet free lunch policies only assure the strangulation of the economy!

Finally, the Philippine peso posted its biggest (+.81%) rally since the week of April 14 (+1.3%). The USD peso closed at 50.16 from the other week’s 50.57.

However, such rally would not assume away the deleterious effects of the BSP’s inflationary policies as well as the expanding the free lunch populist politics.

To my mind, the peso merely responded to the US dollar’s general weakness. In short, a countercyclical rally. The peso has already been weak even as the US dollar has fumbled globally.

What happens more once the USD regains part of its legs even for just a bounce?

Use the current US dollar weakness to take a long USD-Php.