Win or Lose, Manila Water (MWC – P10.25) Wins

Strong price movement this week
I bought MWC again this week when the stock broke out of P9.50. I do believe that after consolidating for 4 months between P8.80 – P9.50 range, MWC is now ripe for a big move. Today, its share price rose to as high as P10.75, before correcting back to P10.25. I am certainly not afraid of the “shake-out”. Instead, I would take advantage of any weakness to add more to my position.

The price movement of MWC is a "textbook case" of a breakout. As a rule, if a stock broke out of a price range by at least 8%, it is a signal that its share price is heading to new levels. I guess, MWC is firmly supported at the P9.20 – P9.50 levels. So my downside is pretty much limited to 10%. On the other hand, a stock that makes new “highs” has better odds of reaching further “highs”. We have seen how Seacem (CMT – P.90), Holcim (HLCM – P7.20) and Republic Cement – (RCM – P3.70) make new highs after breaching their 52-week highs. I think this will be the same scenario for MWC.

Still undervalued
I firmly believe that MWC cannot continue to trade at these levels. As it is, MWC is only trading at 9.9x PER to 12/06 earnings. This undermines the value of the company. Currently, the market is trading at 15x PER to 12/06 earnings. Fairly valued, MWC should approximate the market PER. This should bring MWC to at least P15.0/share.

I do believe that If investors are paying market PER on companies that are generating less than 10% earnings growth, pretty soon they will realize that MWC is a bargain at single digit PER generating 25% earnings growth. Obviously, there is a valuation disparity that has to be corrected.

Win-win stock
Lastly, there are a lot of uncertainties on the upcoming bid for the West Zone franchise of Maynilad Water. MWC is one of three companies short-listed to bid for the concession. I guess this is partly the reason why its share price has underperformed the market.

However, I see it otherwise. In fact it is a win-win situation for MWC.

Note that MWC is an experienced player in the industry. They will not bid more than the “reasonable” economic return of the concession. So, if they do win, this will be an added bonus for MWC. Perhaps this will finally push the valuation of MWC at par with the market. If they lose, the only reason is that the other bidders overpaid. But this will also increase the implied value of both concessions including the East Zone that MWC currently owns.

So win or lose, MWC wins!

One More Round for Ionics Circuits (ION - P2.06)

Ionics is a “sleeper” in my portfolio of recommended stocks. The stock has declined by 5% since I first recommended it last June. It even hit a low P1.80 last month despite the buoyant market. However, after several false starts, I do believe that investors should start looking at the stock again. The risk/reward of owning the stock at this point is very tempting. Let’s see how the odds stack up.

3Q06 results affirms turnaround
Ionics reported that earnings for 3Q06 reached US$ 1.1m. Excluding, one-off gains, recurring earnings reached US$ 820k. The 3Q06 number also shows that its 75% owned contract manufacturing subsidiary Ionics-EMS (IONI – SG$0.55) reported a net income of US$ 196k. This is a significant turnaround from the US$ 2.9m loss incurred in 3Q05. Essentially, Ionics derives 90% of its revenue from Ionics-EMS.

Running through the numbers of Ionics, we can safely say that a US$ 1.0m recurring income target per quarter is achievable. Thus, base case earnings for 2007 can reach US$ 4.0m or roughly P200m (EPS = P0.46). At these levels, Ionics is trading at 4.5x PER.

This is the 3rd straight quarter that the company reported significant revenue growth and earnings improvement. In viewing any turnaround situation, a “three-quarter” winning streak is key. Three straight quarters of significant earnings improvement would signify an inflection point in the company’s performance. Note that the company has reported 12 straight quarters of losing performance prior to 2Q06.


Valuations cannot stay this low
I do believe that valuations cannot stay this low. On the back of a turnaround scenario, I do think that valuations should slowly reflect the fundamental change in the company. Besides, a turnaround situation would normally deliver earnings surprise. Assuming, Ionics-EMS continues to deliver, earnings can probably breach the US$ 2.0m per quarter mark. Thus, on the upside, full year earnings can potentially hit US$7m or roughly P350m (EPS = P0.81).

So how far can Ionics go?
Recently, Alliance Tuna (TUNA – P2.55) was offered at 13.0x PER and is now trading at almost 26x PER after the recent price appreciation. On the other hand, Chemrez (COAT – P5.10) will be offered at 13x PER. These two stocks are similar to Ionics in a sense that all of them are single product/service company. My argument is that if the market is willing to pay as much as 26x PER, this makes Ionics “dirt cheap” at current levels. I will be happy to see Ionics at 8.0x PER or P3.68/share.

Going back to my risk/reward argument, my downside is essentially at P1.80 or roughly 12% from current levels, whilst my upside can potentially be 80%. At 4:1 risk/reward ratio, the odds are too tempting to ignore.

Manny (Many) Thanks To My Readers

I would like to take this opportunity to acknowledge all the readers of Big Big Trade who wrote thanking me for my recommendations. It was indeed a profitable year (so far) for most of us. I am happy that in my own little way, I was able to help investors with their investment decisions.

My ultimate goal is to see the Philippine stock market mature into a more investor friendly marketplace. I will continue to write about what stocks to buy/sell/avoid; teach investors how to properly value companies and above all expose the shenanigans in the corporate world.

However, we have to keep in mind that we only have the market to thank for. Please remember the quote from Yra Harris – “ The market is always right. You’re not.”

Some Questions From My Readers

Jack Galt,

Is it true that your target for CMT is P1.50

Victory Joe

I never mentioned any target price for Southeast Asia Cement (CMT – P0.71). All I said is that the proper way to value CMT is to divide the share price of RCM by 4.3. Currently RCM trades at P3.30. This means that the fair value for CMT is around P0.76 per share.

I am still bullish on Republic Cement (RCM – P3.30). I strongly believe that there should not be any valuation disparity between Holcim (HLCM – P7.20) and RCM. It defies logic since both companies have 1/3 each of the local cement market carved out between them. What’s good for HLCM is good for RCM. What’s good for RCM is good for CMT.


Sir Jack,

I love your blog! I find it a very informative and well-researched view of the current market situation. KUTGW! Your views made me go invest in MWC. Over the past year, my timing was almost always off. I can never properly time my trades cuz I am only a part-time stock trader. That's why I guess MWC is a good bet, doesn't need much following unlike the speculative bets I've made. ... I'm learning though.

Maybe you can also share your views on the current situation of URC and PCOR. Thanks a lot for your blog.

William Antonio

Universal Robina (URC – P19.25) is a well-managed company. It has several winning brands under its stable. Most notable are Jack N’ Jill and C2. I love how Gokongwei manages his companies. He runs a tight ship and generates tons of cash. However, it will take a lot more convincing for the market to pay a premium on Gokongwei owned companies. As it is, URC is already trading at 16.0x PER to 09/07 earnings. Upside might be limited considering that the market is trading at 15x PER to 12/07 earnings. Please note that Gokongwei related stocks used to trade at 30–50% discount to average market multiples.

Petron (PCOR – P4.05) has been battered by series of bad press lately. First the company did not manage the Guimaras oil spill properly. Second, 3Q06 earnings came in below expectations. I think these issues are just a hiccups for the company. In the long run, I do believe that Petron will be trading at better valuations. Petron is currently trading at 6.5x PER to 12/06 earnings. The valuation reflects the cyclical nature of its business but it does not take into the account the franchise value of the company. Petron has the widest distribution reach in the country and owns almost 38% of the domestic petroleum market. The stock might continue to underperform in the short term but in the long run things will definitely be ok.

The Megaworld Boo-boo!

I was surprised by the announcement of Megaworld (MEG – P2.10) that it will undertake a 1:2 rights offering. Based on the figures released by the company, Megaworld is looking to raise P12-P15bn from its existing shareholders. The move cheapens the equity and I will not be surprise if its share price corrects back to the P1.60 levels.

I guess the company should come clean and explain clearly the purpose of the rights offering. There is absolutely no reason to issue equity at this stage. Here are my arguments:

1.) Equity is expensive vis-à-vis debt. Amidst the declining interest rate environment and surging stock market, Megaworld could have issued debt. I don’t think Megaworld will pay more than 10% coupon on its debt. Conversely, issuing new equity will have an implied (equity) cost of at least 13-15%. The close to 20% plunge in the share price of Megaworld should send a clear signal to Andrew Tan that investors don’t buy the idea.

2.) Balance sheet has zero gearing. Based on its 09/06 F.S., Megaworld has a net cash position of P5.0bn. So obviously the company can add debt to its balance sheet. Besides, interest cost is a perfectly legal way to manage income tax payments.

Last August, Megaworld successfully raised US$100m from its bond offering. According to the company, the issue is 10x oversubscribed. So, there is no reason why Megaworld cannot tap the debt market again.

3.) Capital call is “contra” the rosy scenario pictured by the company. If indeed, the company is doing (very) well, why would it need to raise funds from existing investors? A more logical scenario is for the company to issue dividends.

4.) Mixed signals. Last summer, Empire East announced a P2.0bn stock re-purchase program. So, if Megaworld needs additional funds to pursue its expansion, then Empire East should have earmarked the P2.0bn as cash dividend.

Until these issues are cleared, I think Megaworld will be a “dog” stock. I do hope that the company can clearly defend and define the rationale behind the move. For now, the minority stockholders are crying foul.

P.S. I do not have any holdings in Megaworld.

3 "Faces" of the Market

This is the first time that we see the 3 faces of the market come together. They are: foreign fund managers, local investors and the “re-born” players.

The movement of PLDT (TEL – P2,545.0) suggests that foreign funds are still loading up on Philippine stocks. You don’t usually see big-caps rose by 5% in one day. This move cannot be reversed overnight. What’s good for PLDT is good for other big-caps. I expect follow through buying on other index heavyweights in the coming weeks.

Local investors on the other hand have been pushing up select 2nd and 3rd liner stocks. This week, we saw Philippine Realty (RLT – P0.62) and Kuok Philippine Property (KPP – P0.58) take the front seat. Next week, I expect other 2nd and 3rd liners to follow. I am not too clear on what valuation measures investors are using in buying up these two counters. However, you can’t go against sentiment. These stocks will continue to run.

The third face of the market are the “re-born” players. Alliance Tuna (TUNA – P2.85) gained almost 100% from its offering of P1.34. This has brought back old players to the market.

So with all these coming into to play, expect the market to continue its run.

Bully!

We have a bull that is a “bully”! Just when you think the market is going to take a break, the bull comes roaring back with vengeance. Today the PSEi rose by 63.5 points to close at 2,818.0. I guess, old bets are off and new chips are on the table. The bull will not stop until it reaches 3,000.0. I was “bullied” as well. I was thinking that the PSEi would take a breather at the 2,700 levels. It turned out to be a mere “pit-stop” for the bull.

In fact, it will take a “bully” to push the market higher. As it is, share prices have moved up in an orderly manner. There are equal amount of transactions across the different price fluctuations. This means that investors sitting on significant profit gains have cashed in their chips whilst new players pile in. So what will the old investors do who where left in the pits? Buy-back and push the market higher.

As it is, the scenario is evolving into a textbook case of an early stage bull-run. This suggests that every sector will see significant increase in valuation regardless of the economic cycles they are in. It will simply be liquidity flow chasing every stock in the market. As I have mentioned before, this is a “value-creating” market. So sit tight and run your profits. This can be 1993 all over again when the PSEi reached 3,400.0.

Some stock stories: RCBC + CMT

RCBC (RCB – P21.0) Recapitalization and M&A play

The Philippine Star come out with a story saying that RCBC will issue P1.0bn preferred convertible bonds and that one if its major shareholder; Bank of Tokyo will be selling its 17% stake in the bank.

http://www.philstar.com/philstar/NEWS200611060709.htm

The writings are clearly on the wall. This gives me two more reasons to buy RCBC. First, I expect the conversion price for the preferred convertible bond offering to be much higher than RCBC’s current share price. Second, Bank of Tokyo (BOT) will not likely sell at these levels.

RCBC is trading at 1.0x Price to Book (PBV). Relatively, It is the cheapest bank in the sector. While the bank has a below average asset quality, the recent recapitalization will likely drive valuations higher. Last month, the bank successfully raised US$100m (P5.bn) Tier 1 capital. This effectively expands its capital base by 40% therefore easing any short-term capital crunch.

So my gut feel is that for any deal – either a convertible bond offer or divesture by BOT, to materialize RCBC should be priced near 1.6x PBV or roughly equivalent to the valuation of Equitable PCI (EPCI – P72.50) when the SM Group did a tender last month. At those valuations, RCBC is easily worth P28/share.

Seacem (CMT – P.54) and Republic Cement (RCM – P2.70) arbitrage

A lot of my readers are asking how to price CMT vis-à-vis RCM. So here is a simple computation.

CMT owns 1.55bn RCM shares. Effectively, the stake is worth P4.2bn with RCM trading at P2.70. So the implied value of RCM in CMT is about P.64/share. To put a ratio into the relationship, 4.2 CMT shares equals 1 RCM share. So you simple divide the prevailing price of RCM by 4.2 to get the fair value of CMT.

As mentioned in my previous entries, I am long on both RCBC http://bigbigtrade.blogspot.com/2006/07/why-cost-of-equity-matters-rcbc-rcb.htm
and RCM http://bigbigtrade.blogspot.com/2006/05/why-i-bought-republic-cement-rcm-p124.html . I believe that these two counters still have a lot of value waiting to be realized.

11th Day High

The PSEi recorded a rare 11-day winning streak. In total, the market rallied by more than 10% adding 268 points in two weeks, breaching the initial resistance level of 2,725.0. The move indicates that we are clearly in a bull market. So should we start to worry about excessive exuberance? I guess not at this stage. Here are my arguments:

Solid technical grounds
The 11-day rally provides a good “technical” foundation for further run-ups. Eleven days will surely make a definitive trend! I am no chartist, but I do observe closely the price movements. As it is, we saw an orderly movement in share prices. Index heavyweights such as PLDT, ALI, AC and SMPH rose steadily in the past week without any wild “surges”. Shares prices rose by 1 to 2 fluctuations each trading day thus giving buyers and sellers enough time to digest their orders.

Contrast this to the run-up that we saw last summer, when share prices rose sharply in 3 days. Clearly, the rally cannot be sustained. So, we are definitely in a much better footing this time around.

Value over price
While share prices have risen, there is still value in the market. So how did this happen? The Price Earnings Ratio (PER) of the market is driven by 3 factors: earnings, earnings growth and discount rate. So even if the market has risen by 30% in 2006, there is still room for PER to expand since earnings on the average are above consensus expectations while discount rate continue to come down driven by the recent upgrade by Moody’s. So my estimate is for overall market PER to expand from 14x – 16x. This should bring the PSEi to 2,900 by yearend or 1Q07.

(I will discuss (in another article) how Moody’s ratings outlook affect discount rates and therefore market valuation. Beyond, the sentiment play, these factors are important for foreign fund managers in deciding where to allocate their money.)

So what to expect in the coming weeks?

We should see some correction in the market as investors take profits from the recent rally. Market leaders like PLDT, ALI, SMPH and AC will likely take a breather while rotational buying is expected on other “cheaper” blue-chip counters. Please check http://bigbigtrade.blogspot.com/2006/10/blue-cheap.html I expect continued buying of Petron (PCOR – P4.30) and Manila Water (MWC – P9.40), which does not merit any valuation disparity at this point.

Also, local money will likely come in. The move of Philippine Realty (RLT – P0.55) and Kuok Properties (KPP – P0.42) today signifies that “tsupiteros” will not be left out of the market. As mentioned, this is a “value-creating” market. So, the market will unearth every inch of “unrealized” value that can be found.

Quotes from Yra Harris – “Trading God”, Principal, Praxis Trading

“The market is always right. You’re not.”

“The first thing I know in a trade is not how much I can make, but how much I can lose. So my No. 1 rule is using stop-losses.”

“I’d rather hit singles or doubles consistently. I do a lot of small trades. That keeps me focused and aware of trades going on around me.”

Inside Stories: “The Lolo Files” – Would You Trust Him With Your Money?

Lolo is a stockbroker who owns several listed mining companies. Lolo is on a roll! In the past 2 years he was able to raise additional capital from new and existing investors. If my numbers are correct, close to P2.0bn was raised. I guess Lolo really knows how to play the market to the hilt.

What puzzles me is why investors continue to be gullible despite the fact that Lolo has a spotty track record in creating shareholder value. One “Lolo-operated” company located in the Northern Philippines has a “remarkable” track record of reporting dismal earnings despite the fact that gold is trading at 25 year high. Based on its latest fillings, this “Lolo-operated” company has a forward hedge for his gold output at US$330!

But this earnings boo-boo is nothing compared to the scam he pulled with his other mining company. This story came from the horse’s mouth.

Last year, Lolo started buying out the overdue payables from its suppliers at 50% discount to face value. Lolo used a Cayman Island (or a British Virgin Island) registered company to buy the payables. Naturally, the suppliers could not have been happier since these payables are 3-5 years overdue! Most of these suppliers are based in Binondo.

But Lolo has a bigger plan for his supposed generosity. Recently, his other mining company raised new capital. This is perfectly fine except that part of the proceeds was earmarked for payment of advances and overdue payables. To put 1 and 1 together, you will see how skimming Lolo is. In effect, Lolo who already bought out the payables at 50% discount is now being paid in full. Amazing, how Lolo can play such a trick. If my computations are correct, Lolo easily pocketed P250 – 300m from the move. In other words, the company was “plundered” by Lolo. Had he been forthright, the discount from the buyout of the payables should have benefited the company and not him. I wonder why it’s auditors continue to sign-off the financial statements without doing proper due dilligence.

This situation sounds like the Enrons, Worldcoms and TYCOs of the past. Unfortunately, we cannot expect anything from our local SEC. They are clueless on how to "properly" enforce governance and transparency amongst listed company. Also, the current bull market will most likely bury this as a mere footnote in the overall boom of the mining sector. However, as an investor, it pays to know where you put your money.

So will you trust Lolo with your money? Think twice!