Using three different, but related valuation models. I arrived at some very conservative MER intrinsic values.
Manila Electric Company (MERALCO; PSE ticker: MER)
“Ang liwanag ng bukas.”
As of 11/26/2015
124 year old company
The Philippines’ largest distributor of electrical power
65 Billion Php in market capitalization
P/E ratio 17
Some of the known competitors: Aboitiz Power Corp. (ticker AP), First Gen Corp. (FGEN), SPC Power Corp. (SPC), and Energy Development Corp. (EDC).
A recent Business Mirror (Philippine newspaper) article stated the following:
“POWER distributor Manila Electric Co. said it will spend P154 billion in capital expenditures (capex) from next year through 2020 as part of business expansion and the improvement of its infrastructure to withstand inclement weather.”
Let’s compare that with its (MER) historical capital expenditure numbers:
8-year average stands at: 7 Billion Php CAPEX annually, while 8-year median stands at: 9 Billion Php CAPEX annually.
Approximately, that should at least ensue to another 35 to 45 Billion Php CAPEX annually for 2016-2020. (7 x 5 years; 9 x 5 years).
BUT! MER wants to do 154 Billion Php instead. And that is roughly 3 to 4 times my expected CAPEX budget.
Holding some exposure to MER as I have held for the past three years, I’m wondering how much this CAPEX budget (if successfully implemented) affect its owner’s earnings (or free cash flow).
Owner’s earnings is a critical number when performing discounted cash flow model or when trying to figure out the intrinsic value of a company is.
*Owner’s earnings or Free cash flow is calculated by deducting CAPEX from cash flow from operations.
Before heading straight to discounted cash flow, let’s see how my ‘most-basic’ method of valuing company values MER based on its current earnings per share (EPS).
Php 211.90/share will be at P/E ratio of 12. So using this simple model, I’d be buying MER only in the range of Php 212-265 and holding it for >3-5 years as long as the fundamentals are intact.
Let’s see how MER’s profits and owner’s earnings have grown over time using computed annual growth (CAGR):
Looks just right, comparing it with other growth numbers that can be found in its financial statements brings a different picture:
MER’s revenue appear to have minimal to moderate growth at only ~5% in the 7-year CAGR, while CAPEX outgrown each metric at ~33%.
This just means that MER is in a very high capital-intensive business and profits may regress further if other companies became more successful in reducing MER’s market share–which I certainly doubt.
Looking at MER’s competitors’ numbers, it seems that only EDC had demonstrated a better second choice whenever MER would not meet my investment checklist.
In addition, it does look like EDC is demonstrating good growth numbers (such as tamed CAPEX growth and amazing profit growth over the past 7 years).
Interestingly, EDC had spent 87% of its cash flow in CAPEX for the past 7 years while FGEN had spent 76% in the past 4 years, AP with 63% in the past 6 years, and MER with just 24% in the past 7 years.
Although EDC’s ‘minimal’ CAPEX growth in the chart above–it’s MER who is the ‘most conservative’ capital spender among its peers. Next will be AP, FGEN, and EDC for last.
Now, let’s just take a peek on their D/E ratios:
I struggled to look for AP and FGEN’s D/E numbers for this years (2015), but overall it appears that only MER is well below this group’s average followed by AP.
Interestingly, for the past nine years, MER and AP has just been trailing the local bourse’s (Philippine Composite) performance:
While EDC and especially FGEN have been laggards.
-Discounted cash flow-
I’ll be doing the Discount Cash Flow Model using Capital Asset Pricing Model (CAPM):
Using Investopedia’s outline:
it will be easier to identify these variables prior to running the company’s (MER) numbers:
Earlier, the most-basic valuation formula provided a Php 212/share value (scroll up).
With Php 271/share resulting from my calculation using a CAPM discounted cashflow approach, that gives me roughly PhP241.50/share.
Using Margin of Safety of 30% discount approach strictly, I’d start buying around Php170/share. Something to take note of is that MER has not even touched the Php200/share mark since 2010.
Finally, factoring in the Php154 Billion CAPEX budget for the next five years may be a little bit challenging, but obviously it will reduce MER’s value.
Points to remember prior to diving into another DCF:
I am doing a 10-year DCF, so technically that will be a period of year 2016 to 2025. 2016-2020 CAPEX has already been provided by the company (154 Billion Php). To calculate 2021-2025’s CAPEX I used a 9% CAPEX growth (yup, pretty conservative). In addition, I used cash flow from operations CAGR growth of 12% for 2016-2025 period and WACC of 11.32%.
Resulting intrinsic value is Php181.87/share.
This is just a low valuation, but that’s how I see MER if it were to continue its business operations and deliver its average historical growth for the next decade.
If I were to average all those three intrinsic value calculation I’d get Php221.62/share of intrinsic value.
With 30% discount, my then preferred buying price today will be at Php155/share, that’ll just be too conservative, right?
I guess this is when an investor decides for himself whether or not to jump on Meralco’s shares at its current daily price.
Disclosure: I have shares in MER, but don’t plan to initiate purchase within the next 24 hours. I would not receive any compensation for doing this article. I am not a professional financial analyst. This is just a hobby. Lastly, my work is not error-free, but I strive for it to be. Do not consider as a buy or sell advice. Invest at your own risk.
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