The following is a sample equity research report, presented here for illustrative purposes only.
Company Overview
Double Dragon Properties is a real estate development company in the Philippines. It is a joint venture between Edgar Sia, founder of Mag Inasal, and Tony Tan, founder of Jollibee. They each own 37% of the company while the rest is public float. Double Dragon seeks to build a strong recurring revenue base by 2020 where 90% of its total revenue is from recurring rental income and hotel operations. The goal is to build 100 Citymalls, 5000 hotel rooms, 280,000 sqm of commercial office space, and 200,000 sqm of warehouse space throughout the Philippines. Double Dragon created a joint venture with SM Investments for its Citymalls business. SM Investments holds 34% of the joint venture while Double Dragon holds the rest.
Investment Thesis
1. Capitalizing on consumerism in rural Philippines: Double Dragon’s Citymalls business aims to build a regional mall in every 2nd and 3rd line city in the Philippines. There are about 140 such cities in the Philippines. These small towns are far away from the large sized malls, which mean that the consumer demand in these smaller towns are not fully tapped. Citymalls generally are much smaller than SM Malls, and Robinson Malls in larger cities, but aims to unlock the untapped demand by bringing the same retail and consumer businesses into the smaller towns. Citymalls is bringing what was
previously only available in large cities to smaller towns and municipalities.
2. Strong brand recognition and support from local business giants: By partnering with
both Jollibee (largest fast food operator in the Philippines) and SM (largest conglomerate in the Philippines), Double Dragon has a strong competitive moat around its Citymall business compared to other regional mall operators. Every Citymall will have Jollibee related fast food eateries as well as the all rounded retail format SM brings along, including its banking business, BDO, which is the largest bank in the Philippines. With two major business groups anchoring every Citymall, Citymall can meet every consumer need of Filipinos. From eating out to shopping for groceries, toy stores, electronics and banking, Citymall will become rural Philippines’ gateway to modern consumerism. In addition, Citymall partnered with ABS CBN, the largest media conglomerate in the Philippines, to bring cinemas to its malls. This further enhances the stickiness of Citymalls as it can meet the entertainment needs of rural Philippines. Essentially, Citymalls will become the focal point of consumer spending in rural Philippines. With such strong brand recognition and anchoring support from local business giants, other smaller regional mall operators cannot compete effectively as their tenants are smaller business entities with lower brand recognition.
3. Capitalizing the strong economic growth of the Philippines: The economic growth in
the Philippines over the past six to eight years has lead to increased demand for commercial office and hotel needs. Double Dragon aims to cater to the increased demand by building office towers and hotels in Metro Manila, where the bulk of the demand is. The properties are located in the CBD areas of Metro Manila.
4. Anticipating the growth of e-commerce in the Philippines: As e-commerce is penetrating deeper into South East Asia, modern warehouses adhering to internal standards are essential to for logistical support. Right now, there is a lack of warehouses in the Philippines that adhere to the logistical standards required by e-commerce players.
Double Dragon is building warehouses throughout the Philippines to cater to this need. Current warehouses are mostly 6m in height, while e-commerce players require at least
14m. Double Dragon enjoys the first mover advantage by entering into the space before other property players.
Valuation
As we can see below, Double Dragon is the most expensive company on all three valuation metrics (alongside SM Prime Holdings on P/E metric) despite that Double Dragon is still early in its growth phase, and has yet established a strong recurring revenue stream like the other property giants in the Philippines. Although Double Dragon’s share price fell from 67.75 pesos in June 2016 to the current 21.50 pesos, the market is still very bullish on Double Dragon, and has fully priced in its growth. I modeled Double Dragon’s operating numbers and based on the current share price, the valuation is even more absurd. 2017 price to net earnings ex. revaluation gains attributable to shareholders would be 895. Double Dragon’s earnings are highly distorted due to the revaluation gains on the value of its investment property assets. It does not represent the true operating performance of the company. Based on the price to earnings ex. revaluation gains attributable to shareholders, Double Dragon’s forward P/E for 2018 is 153. Using a discount rate of 12% on forward earnings, 2019 forward P/E would be 65, and 43 in 2020. Assuming a top end P/E of 35 on 2018 net earnings ex. revaluation gains attributable to shareholders of 332 million PHP, Double Dragon is only valued at 11.6 billion PHP. The current valuation is 51 billion PHP.
If we use P/B as a metric given that real estate companies have significant asset value, Double Dragon should at most have a valuation similar to Ayala Land and SM Prime Holdings. Both companies are perceived as the strongest players at generating recurring revenue from their malls, hotels, and office properties. With a P/B of 4, Double Dragon is only worth 8.05 PHP per share, or 19 billion PHP. Regardless of the metric used, Double Dragon is still highly overvalued compared to its earnings capability and asset base.
Risks
1. Construction delays will lengthen the cash flow cycle for property projects: The key
to standardizing the design for Citymall projects is to shorten the cash flow cycle so that construction companies can finish the projects in a short time frame, and Double Dragon can start generating rental revenue within a year from purchasing the land. This formula is heavily reliant on the timeliness of construction progress. Any delays will result in a longer cash flow cycle for Double Dragon, lower revenue, and impacting its operating performance negatively.
2. Double Dragon has a high debt load, and is reliant on the debt markets to fund its
expansion: Double Dragon has raised the bulk of the debt needed to fund 1 million sqm of gross area for recurring rental revenue. Double Dragon intends to build 1.2 million sqm by 2020. This means Double Dragon needs to tap the debt markets for the funds needed to build another 200,000 sqm of gross area. Interest rates are increasing and are expected to rise further. This will increase the interest expense of the company. The debt markets may also expect higher interest rates to compensate for the credit risk as a result of Double Dragon’s current high debt load. If Double Dragon experiences construction delays in its projects, Double Dragon may potentially face cash flow issues.
3. Double Dragon is reliant on Philippines macroeconomic conditions: The Philippines economy is reliant on consumer spending, which is driven by OFW remittance as well as BPO investments. OFW remittance is a function of the global macroeconomic environment. If the global economy experiences a deceleration or recession, OFW remittance will inevitably decrease, which will reduce domestic consumer spending. BPO is also highly reliant on the economic health of developed countries in the west. The current BPO boom in the Philippines came after the economic recession in 2008, hence
we have not seen how the sector performs when the west goes into recession.
4. The bulk of Double Dragon’s mall and warehouse assets are in rural Philippines: The asset values of City Malls and warehouses in rural Philippines are hard to value given the limited comparisons, and has low liquidity in a recession. Unlike prime real estate in large global cities where there is always demand at the right price, there is limited demand for such properties in rural Philippines. Furthermore, foreign investors cannot own land, and this reduces the pool of potential buyers. Given the scale of Double
Dragon’s assets, only local business giants with strong cash flows have the financial muscle to bail Double Dragon out. I expect this to be the case given Double Dragon’s partnership with SM and Jollibee. Many other local tycoons would be interested in its assets.
5. Oversupply of commercial office space in Metro Manila: There is a huge construction and property boom over the past six years has resulted in a large increase in commercial office space available. The current economic growth may slow down, especially when the central bank has to increase interest rates to 1. Fight against 7-10% inflation numbers 2. Slow down the depreciation of PHP. This will result in a lower occupancy rate for commercial office space as oversupply becomes apparent in Metro Manila.
- Gugnir and Partners
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