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PAVING THE ROAD TO SUCCESS
We initiate our coverage on Metro Pacific Investments Corporation (MPI) with a buy. MPI is an investment holding company that focuses on infrastructure companies with vast growth potential. Recognizing that the countrys infrastructure is critical to its economic development, the government has engaged in highly favorable concession agreements with MPI to deliver major infrastructure transformation. While such regulatory advantages add to MPIs attractiveness, the company itself is fundamentally strong, headed by outstanding line of management and aided by strategic partner companies. Using the sum-of-parts and DCF valuation methods, we arrive at an intrinsic price of PHP5.01, a 41% upside from its Nov 26 10 price of PHP3.56. MPI adds value to its subsidiaries As MPI is headed by Mr. Manuel V. Pangilinan who turned PLDT into the largest company in the Philippines, the company's management prowess and experience will add value to its subsidiaries. MPI currently assists in achieving its subsidiaries full potential by helping in strategic planning, by finding invaluable partnerships, and by actively looking for growth opportunities. In addition to paving new roads and improving of water and energy distribution operations, MPI is eyeing more bold ventures that can potentially bolster its value. Large-scale projects that are still in their early stages include the acquisition of MRT and the entry to power generation. If fully accounted for, these projects will stretch our current valuation, reaching a lofty upside of 46%-108%. Maynilad growth upsurges through NRW reduction Aided by partner companies expertise, Maynilad is to take full advantage of the government-guaranteed return through high-capex NRW reduction projects. Increasing its total billed volume by 11% and decreasing its NRW level by 4.1% last year, Maynilad is poised to beat Metropolitan Waterworks and Sewerage Systems (MWSS) concession requirements by FY12. As such, the 9.3% guaranteed rate of return is expected to be realized until FY12, the next rate-rebasing period. Based on total planned capex, opex and other expenses, and the concession areas projected water consumption growth, we project Maynilads earnings to grow at CAGR of 17% in the next five years. MER in initial stage into power generation Revenue contribution from distribution segment is expected to stabilize based on DOEs forecast that energy sales will grow at a slower CAGR of 4%. Meanwhile, the countrys unfulfilled energy demand makes entry to power generation very attractive. In light of these, we see that it is highly probable that MER will pursue its entry to power generation. Employing a conservative probability of 75% entry into power generation, we forecast a Php12.7Bil earnings for FY10, growing at 13% CAGR in the next five years.
TOL capitalizes on PPP infrastructure opportunities The governments heightened spending on infrastructure development will boost TOLs earnings growth, as we expect TOL to have major participation in the governments Private-Public-Partnership (PPP). Particularly, the government commits Php180Bil exclusively for road constructions, 25% of which we expect TOL to participate in. Our estimated percentage can be justified in view of TOLs formidable advantage given its size and its track record with NLEX. Without these key projects, we believe TOLs earnings growth will level off at CAGR 0.4% for five years. .
Net Income (in PhP Mil) FY09 FY10 FY11E FY12E FY13E FY14E CAGR
Maynilad 3,027 3,618 3,791 4,490 5,433 6,529 17% TOL 1,538 1,272 1,417 1,459 1,521 1,561 0% MER 12,728 13,927 14,494 17,027 19,661 23,467 13% MPI after minority 2,299 3,255 3,488 3,696 4,399 5,134 17%
Market capitalization (Php Bil) 74.98 52-week high (Php) 4.34 52-week low (Php) 2.20 Shares outstanding (Mil) 20,155 Free-float level 44% Average daily value (Php mil) 33.60
FY10E FY11E FY12E FY13E FY14E ROE (%) 8.8 8.2 9.3 9.6 10 ROA (%) 4.1 3.9 4.4 4.7 2 EBITDA Growth (%) 8 12 12 14 13 Net Income Growth (%) 39 5 19 17 17 EPS 0.11 0.16 0.17 0.18 0.22 EPS Growth (%) 38.8 5.0 19 16.6 16.7 P/E 17.9 16.7 15.7 13.2 11.3 P/B 1.6 1.4 1.4 1.2 1.1
% Ownership Maynilad Water Services, Inc. 58 Metro Pacific Tollways Corp. (TOL) 99.8 Manila Electric Co. (Meralco) 34.8
Metro Pacific Investment Corporation
Philippine Conglomerate
BUY Target Price (Php): 5.01 Price, Nov 26 10 (Php): 3.56 Upside(%) 41
PSE Ticker: MPI Bloomberg: MPI:PM Reuters: MPI.PS
Stock Information
Key Ratios
Historical Chart (%)
0
25
50
75
JulFY10
AugFY10
SepFY10
OctFY10
NovFY10
DecFY10
MPIPSEi
Investment Research Challenge December 10, 2010
ME Investment Advisors
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5,000
10,000
15,000
20,000
25,000
2009 2010 2011E 2012E 2013E 2014E
Earnings Growth
Maynilad TOL MER MPI (after minority)
Major Subsidiaries
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Metro Pacific Investment Corporation Despite its regulatory frameworks limiting its pricing strategies across its businesses, we believe MPI will exhibit impressive returns and will grow rapidly in the next few years. Our belief is grounded on the idea that the economic environment where the company operates presents a rich set of opportunities for growth in key business segments, and that MPIs remarkable skills at execution are strong enough to take full advantage of these. COMPANY PROFILE Metro Pacific Investments Corporation (MPI) is a Philippine-based holding company with investments in infrastructure development and management. Listed in 2006 in the Philippine Stock Exchange, it was established as the infrastructure-arm of First Pacific Company, a Hong Kong-based investment and management company with operations located in Asia. It is changing the groundwork of basic services to a whole new level of systems and organizational initiatives, giving testament to its vision and mission in meeting the growing demand of Filipinos need for vital services. MPI's major subsidiaries are DMCI-MPIC Water Company which has an 84% interest in Maynilad Water Services Inc. (Maynilad), 99.8% in Metro Pacific Tollways Corporation (TOL) and Beacon Electric which has a 50% interest in MER. (refer to appendix to see First Pacifics and MPIs business structures) INDUSTRY ANALYSIS Philippines in dire need of infrastructure Poor infrastructure has hampered the growth of the Philippines. As a matter of fact, with only 3.2% of 2009 GDP spent on infrastructure, the country fared poorly in comparison to its neighboring countries. As such, opportunities abound companies that desire to venture into the infrastructure industry. Barriers to entry are high since the industry necessitates extensive capital spending. We examine the correlation between government spending on infrastructure and infrastructure ranking in the table on the left. Soaring population drives demand for public utilities The rising demand for public goods has been of concern to Philippines, the 12th most populous country in the world (Asian Development Bank Ranking). The demand for water, electricity, basic health care and inter-city roads has clearly outpaced supply. In terms of water service, National Capital Region (NCR), in which 21% of the entire population resides, still has an approximately 4 million under-served/unserved out of the total 20-million population. Road networks, in addition, have not been able to keep up with the surging 4.7% compounded annual growth rate of registered motor vehicles. Growth in government infrastructure spending and improved policies to spur MPI growth MPI will benefit directly from the increasing government infrastructure spending, as we expect the government to call for private companies help in improving the countrys infrastructures. Government spending on infrastructure has substantially increased since 2007, accompanied by a projected climb of 15% in 2010. Accordingly, Pres. Aquino is eyeing on PHP248Bil worth of infrastructure projects in 2011 as a part of the plan to boost economic growth. Because of large budget deficits, the administration has also started tapping private organizations through the Public-Private-Partnerships (PPP) to boost infrastructure development. PPP is a means of the government to improve the countrys infrastructure without shouldering its entire costs. The government makes PPP mutually beneficial to private companies by guaranteeing them an agreed rate of return. COMPANY ANALYSIS Transformative change through strategic partnerships Besides investing in infrastructure companies, Manny Pangilinan-led MPI also taps strategic partners in its respective subsidiaries. For an instance, MPI engages with DMCI to jumpstart massive NRW reduction efforts and turn the nearly bankrupt Maynilad into a multi-billion peso revenue generator. It is also tied up with Egis Projects, a France-based infrastructure company, in planning for the connector road bridging the North Luzon Expressway (NLEX) and South Luzon Expressway (SLEX). Egis Projects is one of the more prominent infrastructure companies in France. Benefiting from parent company As one of First Pacifics principal investments, MPI enjoys international presence and remarkable reputation in the financial market. First Pacifics listing in the Hang Seng Index, for an instance, grants MPI recognition from foreign investors. With First Pacific in its periphery, MPI would not have a difficult time raising capital in the event that it finds the necessity to do so. Company still on the lookout for infrastructure projects Albeit having a diversified portfolio of assets, MPI is still on the lookout for opportunities to increase the value of its portfolio. It is eyeing on acquiring additional shares in the Metro Rail Transit (MRT)-3, which runs along Epifanio de Los Santos Avenue (EDSA), in order to have the
Infrastructure Rank and Spending in 09 139 countries As % of GDP
Philippines 113 3.20 Indonesia 90 6.20 Malaysia 27 10.90 Thailand 46 7.30 Vietnam 123 5.20
Source: World Economic Forum, World Bank
61.6
127.6145.2 149.6
171.6
2006 2007 2008 2009 2010E
Government Spending(in PhP Billions)
Revenue Contribution
Maynilad TOLMER Hospitals
FY08FY09
FY10E
Source: MEIA Estimates
Source: Department of Budget and Management
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sole right to appoint new directors. Such move would help strengthen MPIs relationship with the government, which is vital especially in obtaining building licenses and permits, and right-of-way grants. The government promises a 15% return for 25 years if MPI chooses to close the deal.
FINANCIAL ANALYSIS Capex-related strategies administers long-term growth MPI looks into spending more than Php7Bil in cash for its projects in FY10 and steadily increasing it by 10% annually until FY12. The said budget consists of building new roads that will boost traffic in the tollways, laying new pipelines that will swell customer base and embarking on further reducing NRW. Not included in the budget, however, is Meralcos plan in venturing into power generation. While the company may already reap its rewards from its capital expenditures, their full profit potential will be felt in the medium- and long-runs. Our estimates confirm this lag effect as it shows revenue-to-capex ratio increasing exponentially from 1.7x in FY07 to 3.6x in FY12 to 4.3x in FY37, which is the end of the concession period.
Horizontal analyses, key ratios reveal improving financial position With a debt-to-equity (D/E) ratio of 1.76x and times-interest-earned (TIE) ratio of 1.8x, MPI started out in FY08 with a weak and highly leveraged financial position. With the retention of recent years earnings, however, MPI solvency levels are now gearing towards its target capital structure of 1x D/E ratio. As a matter of fact, the 38%-expected rise in MPIs 2010 net income would drive down its leverage below 1x. Also, MPIs TIE ratio, which measures its ability to meet debt obligations, strengthened to 2.1x in FY09 and is forecasted to be further amplified to 3.3x in 2010 due to escalating EBIT.
High operating cash flows affirm earnings quality MPIs operating-cash-flow-to-EBIT ratio confirms the quality of its earnings. The negative PHP3Bil operating cash flow (OPC) in FY08 is more than justified by the PHP15Bil-swell in OPC the following year, immensely improving its OPC-EBIT ratio from negative 130% to positive 150%. We expect some decline in OPC-EBIT ratio, however, in FY10 as substantial part of FY09s OPC comprised of extraordinary income. As such, the expected decline in OPC-EBIT ratio is not of material concern. As a matter of fact, following FY10, the rise of operating cash flow is expected to go hand-in-hand e with earnings growth, with OPC-EBIT ratio hovering at 90% level.
Maynilad Water Services Inc. With returns guaranteed by the government, Maynilad is expected to attain accelerated growth through exceptional execution of high capex-related projects. COMPANY PROFILE Maynilad is the water and wastewater services provider for the 17 cities and municipalities that comprise the West Zone of the greater Metro Manila area. Maynilad, as a contractor, is allowed to operate, to maintain and to invest in the fixed assets of MWSS to handle the entire process from water treatment and delivery to sewage and sanitation. Also under this agreement, MWSS guarantees the company a steady supply of raw water at no cost until the end of the concession period in FY37. Maynilad was granted the 25-year exclusive concession in 1997. As its first owners did not prove successful in the business, the company went through a reprivatization in FY07, with the consortium of DMCI Holdings, Inc. and MPI winning 84 percent of the water companys shares in a public bidding. In 2010, MWSS approved a 15-year extension of concession of agreement, which will now last until 2037 instead of 2022. INDUSTRY ANALYSIS With a rapidly growing population and the MWSS inability to service Metro Manila, the burden of distributing water was transferred to the private sector through The Water Crisis Act of 1995. The act basically split the service area into two zones: West Zone concession was won by Maynilad initially through the tandem of Benpres Holdings Corporation (BPC:PM) and France-based Lyonaisse des Eaux. East Zone concession was acquired by the partnership of Manila Water Company (MWC:PM) and British utility firm United Utilities.
2008 2009 2010E2015E2020E2025E2030E2035E
Revenue CAPEX
1.760.95 0.97 0.90 0.93
1.80 2.08
3.33 3.53 3.82
2008 2009 2010E 2011E 2012E
D/E TIE Ratio
(5,000)
-
5,000
10,000
15,000
20,000
25,000
2008 2009 2010E 2011E 2012E
Operating Cash Flows
Revenues Net Income
Operating Cash Flow
NRW stands for Non-Revenue Water which is the amount of water lost in operations due to pipe leakage and illegal connections.
Source: Company Data and MEIA Estimates
Source: Company Data and MEIA Estimates
Source: Company Data and MEIA Estimates
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Dynamics of NRW: Key to higher bottom-line NRW reduction plays a special role in the water utilities industry. First, NRW reduction enhances operational efficiency. Although the supply of raw water is free, variable costs are present in water distribution; specifically, the electricity used to pump in water comprises a considerable amount (about 10%) of its opex. Second, since water shortage commonly occurs, conserving the limited supply is vital, or else there would be no water to distribute. Third, MWSS requires its concessionaires to meet specific NRW levels every 5 years. If such requirement is breached, the concessionaires will have to suffer the penalty of receiving lower returns. Finally, high-capex projects other than NRW reduction are dependent on the success of its NRW reduction programs. Note that utility companies have two major ways of expanding and improving service: pipe-laying projects and NRW reduction. However, in an environment where raw water is sourced from a single dam and water shortage commonly occurs, which is the case for Maynilad, it is futile to start reaching unserved areas through pipe-laying projects as there is no surplus water to distribute. In the same sense, although the raw water supply is free, there is a critical need to maximize limited water supply, which makes everything else second priority to NRW reduction. To get a better of view, we compare Maynilads NRW levels to that of Manila Water Company, its closest peer, in the table on the left.
Minimal competition in the water utilities sector The Public Utilities sector in the Philippines is characterized as a regulated monopoly. Players in the industry enjoy economies of scale, with lower marginal costs and more efficient use of assets. Because of the threat of controlling prices to their favor, the government regulates the companies under their respective industries. Although this may be the case, Maynilads agreements still pose an attractive growth potential. Maynilads rates, also, are reviewed every 5 years to take into account annual inflationary adjustments, foreign exchange losses and extraordinary expenses. To stimulate capex spending, regulators assure Maynilad of guaranteed rates of return on their investment. Other than this, the fact that a substantial percentage of West Zone concession is still underserved presents a solid ground for future expansion. COMPANY AND FINANCIAL ANALYSIS Favorable concession agreement ensures stable earnings growth The concession agreement between Maynilad and its regulator assures it a guaranteed rate of return equal to 9.3% until the next rebasing period in FY12. The 9.3% guaranteed rate is called the Appropriate Discount Rate (ADR), which is re-computed every 5 years. The ADR, which is the return on the concessionaires opex, capex, concession fees and taxes, is derived from estimates of Maynilads cost of capital and adjustments to reflect country risk, exchange rate risk, and other business-associated risks as agreed upon by Maynilad and its regulator. Its adjustment mechanism also ensures that if the company realizes a return short of the agreed return, the water tariff rates will be higher in the next rate rebasing period, increasing future returns to make up for the past return discrepancies. On top of this, formula-driven tariff mechanism provides automatic annual CPI adjustments and quarterly foreign differential adjustment which protects the company from forex fluctuations. Higher capex translates to higher earnings growth Under the current concession agreement, a higher capex will necessarily translate to higher earnings since a fixed rate of return of 9.3% is guaranteed to Maynilad. Maynilad will be investing PHP6.6Bil in FY10 to improve its distribution network and service levels, higher than the annual average of PHP4.7Bil in the previous 3 years. Of the said amount, PHP1.7Bil will be allocated for the expansion of its service coverage and improvement of service levels, another PHP1.7Bil will be spent to build new pumping stations and reservoirs, PHP1.5Bil will be budgeted for its water recovery and reallocation programs that seek to reduce nonrevenue water, and the remaining amount will be dispensed for pipe laying and repair projects. The funding of the said capex will be sourced from internally generated cash as well as debt. Key operational efficiency measures ahead of regulatory targets To be able to realize its guaranteed rate of return, Maynilad has to adhere to a set of Key Performance Indicators (KPI) and Business Efficiency Measures (BEM), set forth by its regulator, including the reduction of NRW level to 4%, expansion of service coverage to 9 percent and effecting a 100% provision of 24hr water service and 7psi water pressure by FY12. Since MPIs acquisition of Maynilad in FY07, the latters NRW level has been reduced by 12 percentage points to 54% (as of 1H10), while service coverage improved from 77 percent to 85.6%. In addition, provisions of 24hr water service and 7psi water pressure have since soared from 46% and 53%, respectively, to 65% and 79%. Based on the total amount of the companys committed capex and the visible success of its on-going service improvement projects, we expect NRW level to reach 3%, concession coverage to expand to 95% and provisions of 24hr and 7psi water service to both reach 100% at the end of FY12.
FY07 FY08 FY08 Maynilad 66% 64% 60% Manila Water 23% 19% 16%
Source: Company Data
ADR Computation 1. Estimate the cost of debt in domestic and
international markets 2. Estimate the cost of equity for infrastructure
businesses in the Philippines and abroad 3. Adjust rate to reflect country risk, exchange rate
risk, and any other project risk
Source: Company Data
30%
40%
50%
60%
70%
2007 2008 2009 2010E 2011E 2012E
Non-Revenue Water Level
6,598 4,670 6,640 7,304
8,035
10,619 12,597
14,466 15,193
17,448
2008 2009 2010E 2011E 2012E
Total Capex Revenue
Source: Maynilad Data and MEIA Estimates
Source: Maynilad Data and MEIA Estimates
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Strategic partnerships facilitate capex-related projects success Maynilad tied up with DMCI, the largest construction and civil engineering company in the Philippines, for its expertise not only in building infrastructures but acquiring business permits and licenses as well. To address NRW levels at the primary level, the company utilizes Sahara Mobile in-pipe leak detection units and has recently added AquaScan, a non-invasive solar technology. On its secondary and tertiary pipes, on the other hand, Maynilad has tapped on the services of Miya Water, which is one of the premiere NRW reduction experts in the world. Results are nothing short of spectacular as Miya Water has reduced NRW in those areas it has surveyed to 30%. Elevated earnings ease debt burden High debt, which was carried over from Maynilads financial failure to DMCI-MPIC buyout, continues to burden the company Maynilads debt-to-equity ratio improved substantially to 9.15 in FY09 from 36.09 in FY08. As such, the companys current debt position hinders access to the credit markets, limiting their source of funds for its increased planned capex. However, its relatively weak financial position could be expected to improve rapidly due to magnified earnings growth. In fact, at the end of FY10 we expect their D/E ratio to plunge below the 4.0 level.
Manila Electric Company With its newly forged alliance with MPI, MER is set to enter into power generation which will add substantial value to the firm. The countrys unfulfilled demand for energy, MERs expertise in the power sector, and high margins in the power generation business make the perfect time for its entrance. COMPANY PROFILE MER is the countrys premier power distribution firm accounting for more than 70% of the electricity in Luzon. The franchise area covers Metro Manila, Bulacan, Rizal, Cavite, and the provinces of Laguna, Quezon, Batangas and Pampanga. Aside from its main operations of distributing, billing, and collecting, which constitutes 97% of its FY09 revenue, MER also develops real estate properties, provides engineering and construction consulting as well as information and systems technology services. As its revenue comes almost exclusively from power distribution, MER is considering entry to power generation in 2012. INDUSTRY ANALYSIS High margins entice entry to power generation As opposed to power distributions thin margin, high profit margin in the power generation makes entry extremely attractive. For an instance, in line with its goal to solve escalating energy demand, the Philippine government does not impose regulatory measures in power generation. This is contrasted to the regulated nature of power distribution, which prevents distribution companies from attaining high margin. To put things to perspective, this industrys operating profit margin hovers at 50% (Energy Development Corp., First Generation Corp., and Aboitiz Power average in FY09) compared to MERs historical operating profit margin of 5% in FY09. Expected downtrend in energy consumption to slow growth in energy distribution sales The declining energy consumption will cause MERs energy distribution sales to level off in the next few years. Specifically, the Department of Energy forecasts energy consumption to grow at a slow pace of 4.56% CAGR from 2010 to 2030. The sluggishness of this growth is seen when compared to the 8.9% CAGR of GDP in the next 5 years (International Monetary Funds forecast). COMPANY AND FINANCIAL ANALYSIS Entry into power generation to raise MERs value With minimal growth opportunities in power distribution, MER has to venture into another industry if it desires to further thrive. Power generation, characterized by high profit margins as explained in MERs industry analysis, is the sector where maximum growth opportunities exist for MER. Moreover, this sector suits MER well, as it can capitalize on its expertise on the field of energy. In fact, MER has already laid its initial plans of building a fossil fuel power plant, which has a capacity of 300MW (equivalent to 10% of MERs FY09 billed volume). Projecting a 75% probability of pushing through with the entry in our base case valuation, we value MER at PHP210Bil NAV, compared to a value of PHP149Bil NAV if the entry is abandoned altogether. Efficient operations making most out of performance-based metrics Since FY08, MER posted considerable profit growth through operational efficiencies under the implementation of the Performance Based Regulation (PBR) scheme. The PBR formulates MERs Maximum Average Price (MAP) to guarantee a return on its regulatory asset base, capex, opex and tax rates provided that it adheres to Guaranteed Service Level (GSL) requirements (refer to graph). The return also adjusts to any foreign exchange fluctuations and any changes in foreign exchange and inflationary changes. Accordingly, MER has been on track of beating regulatory benchmarks. System loss, for an instance, has gone down to 8.61% in FY09, already beating the 10.44% requirement at end of FY11. Additionally, Interruption Frequency Rate (IFR) improved from 6.53
9.28%8.61%
7.78%
7.5%7.29%
7.05%6.61%
2008
2009
2010
E
2011
E
2012
E
2013
E
2014
E
System Loss
0
0.5
1
1.5
2
Php/
kwh
Maximum Average Price (MAP) under PBR
Source: MER Data and MEIA Estimates
Source: MER Data and MEIA Estimates
14%
21%65%
Service Coverage
Unserved Customers (No connections)Underserved (No 24hr Coverage)Fully Served
Source: Company Data and MEIA Estimates
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6
times in FY08 to 6.01 in FY09, and we expect it to float on the 5 times in FY11, again surpassing its 5.90 regulatory requisite. Lastly, MERs YTD Cumulative Interruption Time (CIT) of 3.84 hours per year in FY10 is on the path of beating last years 4.58 YTD CIT. Generation as main source of growth Income from power generation will be MERs main source of growth for the next ten years. Although generation revenue as percentage of total revenue is projected to only be at 8% by 2020 its income contribution to the company reaches 35%. Power generation is projected to grow at CAGR of 22.45% for the next ten years. This projection is conservative at this point as it only considers a target capacity of 1500MW by 2016. MER would likely increase capacity to the regulated maximum limit of 2350MW.
Metro Pacific Tollways Corporation With the growth in the infrastructure industry through aggressive Public Private Partnerships, we believe that TOL through its vast experience and proven track record will be able to take advantage of this opportunity. Apart from the stable earnings contribution from the steady increase of motor vehicles, we anticipate significant cash flow in the future from these prospective road projects. COMPANY PROFILE Metro Pacific Tollways Corporation takes on projects that are responsible in the construction, operation, and maintenance of toll facilities in the North and South Luzon Tollways and the Metro Manila Expressway. Revenues are generated from the collection of toll fees from motorists coming from the Central and North Luzon to Manila and vice-versa. The Company owns stakes in Luzon Tollways Corporation, Tollways Management Corporation and Manila North Tollways which is the concession holder of NLEX, the second longest expressway in the Philippines. After the turnover of SCTEX, TOL has almost doubled its existing network of 95.2 km to 189.2 km making it the road concessionaire holding the longest road network. INDUSTRY ANALYSIS The infrastructure industry is one that comes with large capital requirements thus presenting a strong barrier to new entrants. Though there is little or no competition within the industry, it is highly regulated as the government has a high degree of control over tariff pricing. Though toll roads in the Philippines are usually managed by private organizations, these organizations are more often than not in partnership with and regulated by the government. The large capital requirements are invested into the construction and maintenance of new roads and toll ways.
Underdeveloped Philippine toll roads present opportunities The Philippine road network can still be considered underdeveloped. Though the Philippines has a large road network in comparison with its Southeast Asian counterparts such as Vietnam and Indonesia, in terms of paved roads as a percentage of total roads, the Philippines ranks as one of the lowest in the region. The figures suggest a largely underdeveloped road network. With this room for growth and TOLs experience, we believe TOL has the ability to seize the opportunity to expand its current network. More roads in the future through Public-Private-Partnership projects Due to the importance of the road network in economic development, the current Aquino administration emphasizes toll road development as one of its priority Public-Private Partnership (PPP) projects in the next 6 years. The countrys road network handles around 90% of passenger movement and 50% of freight movement. With the increase in the population in Greater Manila Area and GDP, substantial increase in traffic in the Greater Manila Area will be expected assuming no road improvements will be undertaken. Philippine road network has a big impact on the Philippine economy since an efficient transport system would obviously lead to greater access to economic opportunities such as business transactions and social services.
COMPANY AND FINANCIAL ANALYSIS Increasing motor vehicle sustains earnings contribution In terms of motor vehicles per 1,000 people from 1990 to 2007, the Philippines grew by 356% from 9 to 32. We estimate that this trend of increasing traffic volume will continue in the next years due to a healthy population growth and positive economic outlook. Being as such, we believe that toll revenues will also grow steadily. We estimate that toll revenue CAGR will be at 6%. Moreover, the increase in traffic volume through the growth in motor vehicles would be matched by the expansion of the current TOL network of roads and highways, the development of real estate and economic zones in Northern Luzon and the recovery from the 2008 financial meltdown. The financial scare of 2008 resulted in an erratic movement of fuel prices, fewer goods traded and less disposable income for travel up north; and thus left TOL with negative growth for that particular year. Furthermore,
SE Asia Km of road per 1000 km2 Paved roads (% of total roads)
1990 Latest Year 1990 Latest Year
Indonesia 159.4 215.8 45.1 55.4 Malaysia 164.3 283.4 70.0 79.8 Philippines 538.5 670.9 16.6 9.9 Thailand 141.3 352.4 55.3 98.5 Vietnam 295.2 516.3 23.5 47.6
Source: World Bank
9
10
11
12
13
303540455055
2009 2010P 2011P 2012P 2013P
NLEX traffic
Mil Vehicle Entries Bil Km travelled
Source: Company Data, MEIA Estimates
0%
20%
40%
60%
80%
100%
2010
E20
11E
2012
E20
13E
2014
E20
15E
2016
E20
17E
2018
E20
19E
2020
ENon-Generation Income Generation Income
Source: Company Data and MEIA Estimates
-
7
200
400
600
800
1000
1200
1400
1600
4400
4800
5200
5600
2007 2008 2009Revenues Net Income
Core Income
EBITDA margins are estimated to be preserved at 64% in 2010 and 63% at 2011 through the control of operating expenses. Expansion of road network points to growth OLs strategy to expand and connect the major toll roads in the country is being achieved through construction and new concession agreements. In the next 5 years, TOL is planning to spend PHP25Bil of capex in the construction of its roads. There have also been speculations regarding a connector road that would link NLEX and SLEX. TOL is a prospective contractor for this road and would give it an opportunity to further boost revenues and help in further gaining expertise with regard to toll operations. Should TOL not be able to contract the rights to build and operate the connector road, it would still benefit from the traffic growth into NLEX. Robust investment opportunities stretch TOLs growth potential In the next years, the government is planning aggressive infrastructure projects for the country. TOL is eyeing projects in Cavite-Laguna Expressway and Ninoy Aquino International Airport road; and increasing its stake in the Skyway construction. Given TOLs vast experience and proven track record, TOL is in a good position to grab these additional proposed construction contracts that would add more value to the company. With the aggressive planned PPP projects of the government and assuming that TOL will win 25% of the bids for the projects, we estimate a 35% upside to PHP4.8 from its current price. This price is based on the assumption that TOL will overcome its hurdle rate of 18% and maintain its D/E of 70/30. This upside in our valuation justifies the exciting growth opportunity for TOL. Stable core income to carry TOL to future projects Despite the decreasing net income from FY07 to FY09, core income has been relatively stable. The substantial decrease in net income is due to the nonrecurring expenses such as the Foreign exchange gain of PHP603Mil in FY07 as oppose to the Foreign Exchange loss of PHP399Mil in FY08 and the PHP1.2Bil provision for potential losses on input VAT in FY09. TOLs future net income is expected to be unaffected by these nonrecurring expenses.
Ready access to debt markets support development of new projects The ability of TOL to tap debt capital to fund their projects indicates confidence and trust of debtors in TOLs ability to sustain its improving core net income as well as free cash flows, allowing it to generate a large amount of debt and remain solvent. In the past three years Debt/Equity ratio has been relatively stable. However, D/E ratio is expected to increase as TOL plans to employ leverage in its future projects, such as the expansion of NLEX and the connector road. These new projects will be funded mostly with debt that will be repaid in the future from the steady stream of cash flows from operations.
Healthcare
Currently, MPI has investments in Medical Doctors Inc. (Makati Medical Center), Davao Doctors Hospital, Colinas Verde Medical Center (Cardinal Santos) and Riverside Medical Center. After the increase in heavy investments in medical equipments and hospital facilities, the healthcare group achieved financial milestones such as all-time high revenue growth. With the robustness of the health care industry, it is expected that the health care group would experience further growth. However, the contributions from this sector will not have a substantial influence over MPIs earnings in the near future.
Investment Risk Analysis OPERATIONAL RISK Government delays slowing down implementation of growth projects The increase in value of MPI is largely dependent to the companys ability to implement the growth projects of the different subsidiaries. Local governments postpone permits for the constructions to improve nonrevenue water for Maynilad because of the road traffic it creates. The right of way for the construction of toll roads are usually delivered late due to the inefficiency in the Philippine governments process for acquiring lands. However, we believe that the ability of the companys management to negotiate with the national and local government will hasten the implementation of these new projects.
MPI capable of answering challenges due to increasing competition in infrastructure Although TOL, Maynilad, and Meralco are monopolies in their own industries, competition may arise from bidding for the control of each subsidiary and new infrastructure projects. Though there is an expected increase in the Philippines infrastructure investments, this increase will be diluted as more conglomerates such as SMC and JG Holdings have entered the infrastructure industry. However, we believe that MPIs prior experience in bidding for projects and managing the business will definitely give the company the advantage in winning these new projects.
In PHP Billions 2011 2012 2013 2013+
PPP budget Roads 27.6 23.3 15.9 39.2
Source: NEDA, MEIA Estimates
103%107%
110%113%
119%
2009 2010P 2011P 2012P 2013P
D/E ratio
Source: NEDA, MEIA Estimates
Source: Company Data and MEIA Estimates
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REGULATORY RISKS Government pressures to accomplish operational requirements MPIs businesses involve public goods such as utilities and transportation. Thus, the government sets strict operational standards for the different subsidiaries. If ever Maynilad, TOL, and Meralco may not be able to fulfil the agreements with the operational targets set each year, this will entail rate reductions, postponement of rate increases, and fines. However, we believe that MPIs businesses, based from their operational track record are more than capable to achieve and even outperform the standards set.
Tariff control by the government gives less control on the earnings MPIs businesses are regulated so tariffs are heavily controlled by the government. During an economic crisis, the current tariffs which may be inauspicious to the company may not be easily adjusted. To ensure tariffs are aligned with the economic environment, adjusting mechanisms are in place. Maynilad undergoes rate rebasing every 5 years, TOL adjust its rate every two years to reflect inflation and Meralco .
FINANCIAL RISKS Foreign denominated loans pose a threat to earnings In FY09, MPIs Foreign exchange losses amounted to PHP900Mil. The US denominated debts of MPI pose a threat to earnings when the Peso depreciates However, MPIs vulnerability to foreign exchange changes will be lessened as it pursues local debt financing. MPI decreased its USD-denominated debt by PHP 1.5B and increased Peso debt by PHP 16.9B.
Valuation
Based on our estimates, MPI has NAV of PHP101Bil or PHP 5.01/share. This leads us to a recommendation of BUY on MPI Shares. Rather than using the subsidiaries unique WACCs, we used MPIs WACC to appropriately reflect the risks that MPI shareholders are actually exposed to.
Peer Valuation Among Philippine Holding Firms, MPI is most comparable with Ayala Corporation and San Miguel Corporation as they are also major players in the infrastructure industry. MPI is currently trading at a P/E multiple of 21.85x, a 16.3% discount from peer average of 26.14x. When compared to our estimated P/E, Bloomberg estimate of 21.85 P/E suggests that MPI is overvalued.
Scenario Analysis
Given the base case of our valuation, we assumed different scenarios for each subsidiary that will substantially modify MPIs valuation. With best case scenario, we expect the price to go up as high as PHP6.33 empowering our buy rating for MPI. Considering the worst case scenario, we expect the price to decrease to PHP3.71, still maintaining a 4% upside to the current price of MPI.
Risk Mitigating Factors Government delays
on implementation of new projects
Ability of MPI to coordinate with the
government Increasing
competition in the infrastructure
industry
MPIs experience gives them the first mover advantage
Fines may be paid due to stringent
operational requirements by the
government
Subsidiaries are expected to operate within regulatory
standards
Tariff control by the government gives less
control on the earnings
Tariff adjustments are done regularly
Foreign denominated loans pose a threat to
earnings when the Peso depreciates
Refinancing of US denominated debt
MPI-holding level WACC Computation Rate Basis
Weight of Equity 50% Target Capital Structure Cost of Equity 14% CAPM Risk-free rate 6% 10-year T-bond yield Market Premium 6% Bloomberg Country Risk Premium Beta 1.22 Bloomberg Weight of Debt 50% Target Capital Structure Cost of Debt 9% Risk-free rate + Debt Spread After-tax Cost of Debt 7% RP Corporate Tax Rate WACC 10% WACC Formula
Sum of Parts Valuation (all in thousands) Basis Ownership NAV
Maynilad DCF 58% 38,478,716 MER DCF 17% 42,724,662 TOL DCF 99.8% 30,003,882 Healthcare Relative PE - 3,222,000 Parent net debt (13,550,000) Total NAV 100,879,260 Shares outstanding 20,128 NAV per share 5.01
Country P/E Trailing KPJ Healthcare Malaysia 17.281 Faber Group Malaysia 8.006 Samitivej Thailand 13.782 Indraprastha India 11.681 Average 12.6875
Peers 2010 P/E Ayala Corp 25.04 San Miguel Corp 31.51 MPI 21.85 Average 26.13 Expected PE 17.90
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Scenario Quantitative Change Value
Maynilad TOL MER Maynilad TOL MER MYD TOL MER Price Best Case
Guaranteed return increases due to
impressive performance. CAPEX also
increases.
TOL wins 25% of the bids for the projects and
overcomes the hurdle rate of
return
ERC approves higher than
projected rates. Operational targets
are always met.
Return increases to 11.3% and
Total CAPEX increases by
10%.
CAPEX increases in the next 5
years. Return remains at
18%
Power generation margin increases. Premium of 5%
applied to base case projections.
45,565 44,391 47,737 6.33
Base Case
All of Maynilads requirements are
met. With the guaranteed return
realized and CAPEX goes as
planned.
CAPEX goes as planned and
increase of traffic
volumes are the same as the expected
values
ERC approves rates in line with our projection, a
discount from applied rates.
Operational targets are always met.
Return realized at 9.3%. Total
planned CAPEX = total
realized CAPEX.
Total planned CAPEX= total
realized CAPEX.
Return is at 18%
MAP is discounted from applied rate.
Average margins in power generation
segment.
38,478 30,004 42,603 5.01
Worst Case
Maynilad fails to meet concession requirements and Completion of the facilities for new water sources is
delayed.
Expected traffic
volumes are not actualized
and completion of projects are
delayed
ERC approves lower than expected
distribution rates. Continuously
falling short of operational
targets. Entry to Power Generation
did not push through
Return decreased to 6.3%. Total
CAPEX decreased by 20%. Billed
volume decreased by
10%
CAPEX still the same.
Return decreases
from 18% to 13%.
No contribution from power generation 31,715 22,923 30,265 3.71
Valuing Optionality
Given the bountiful opportunities in the infrastructure industry, MPI is eyeing bolder ventures that can shore up its value. These large-scale projects are still in their early stages and details for them are still not fully available. However, it is essential that these projects be incorporated to our valuation since the added growth potential they provide is substantial. If these projects are fully accounted for, price of MPI will grow as high as 7.40, 108% upside to the current price. This reinforces our BUY rating. MER: 100% successful in Power generation The current base price only accounts for the expected contributions of Meralco power generation with a 75% discount since the project is still in its early stages. With the help of MPI and its management, we firmly believe that it is highly probable that Meralco will successfully complete its entry into power generation.
MPI invests in railways MPI is eyeing on acquiring additional shares in the Metro Rail Transit (MRT)-3, which runs along Epifanio de Los Santos Avenue (EDSA), in order to have the sole right to appoint new directors. Details for the rehabilitation project of MRT-3 are still not fully available but assuming the project will be finished in FY11, USD700Mil will be invested based from MPIs initial analysis, the guaranteed 15% return will be maintained for 25 years of the Build Lease Transfer (BLT) agreement and the 50/50 D/E ratio would be maintained. We estimate that investments in MRT-3 will increase our valuation to PHP5.88, increasing our upside to 66%.
Base Case MRT-3 Contribution Power Generation Contribution Both MRT and Power Generation NAV NAV/share NAV NAV/share NAV NAV/share NAV NAV/share
Best Case 127,365 6.33 145,032 7.21 131,276 6.52 148,943 7.40 Base Case 100,757 5.01 118,424 5.88 103,476 5.14 121,143 6.02 Worst Case 74,575 3.71 92,242 4.58 87,213 4.33 104,880 5.21
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Appendix: Financial Statements
Metro Pacific Investments Corporation Consolidated Income Statement
in millions Php FY08 FY09 FY10E FY11E FY12E FY13E FY14E Revenues 5,041 16,108 18,830 21,357 22,542 25,284 28,312 Maynilad 4,326 10,619 12,597 14,466 15,193 17,448 19,673 Toll 715 5,489 5,824 6,451 6,885 7,316 8,057 Healthcare - - 409 439 464 520 583 Cost of Sales (2,371) (7,121) (7,640) (8,604) (9,046) (10,095
) (11,307
) Amortization (1,286) (3,105) (3,332) (3,752) (3,945) (4,402) (4,931) Others (1,085) (4,015) (4,308) (4,852) (5,101) (5,692) (6,376) Gross Margin 2,670 8,987 11,190 12,753 13,496 15,189 17,005 General and Administrative Expenses (1,443) (2,641) (2,777) (3,148) (3,324) (3,464) (3,876) Operating Profit 1,227 6,346 8,413 9,605 10,172 11,725 13,129 Interest expense (1,161) (4,012) (3,160) (3,305) (3,439) (3,780) (3,814) Share in net earnings of subs 144 432 2,216 2,425 2,524 2,964 3,423 FOREX gains/losses (500) (985) - - - - - Others 1,258 2,519 - - - - - Income before tax 968 4,300 7,469 8,725 9,256 10,909 12,738 Provision for income tax 63 70 (1,282) (2,096) (2,232) (2,550) (2,981) Net income before minority 1,031 4,370 6,187 6,629 7,024 8,359 9,757 Minority interest 505 2,070 2,931 3,141 3,327 3,960 4,623 Net income after minority 526 2,300 3,256 3,489 3,696 4,399 5,135
Metro Pacific Investments Corporation
Consolidated Balance Sheet in millions Php FY08 FY09 FY10E FY11E FY12E FY13E FY14E Currents assets 18,127 25,806 29,119 32,247 33,983 37,386 41,116 Cash and short-term investments 8,744 8,813 9,254 9,716 10,202 10,712 11,248 Other current assets 9,382 16,993 19,865 22,531 23,781 26,674 29,868 Noncurrent assets 73,437 103,594 120,011 131,260 140,152 152,429 166,629 LT investments 2,479 27,771 38,544 43,717 46,142 51,755 57,954 Concession assets 56,664 62,185 67,646 73,552 79,939 86,418 94,215 Goodwill 12,552 12,552 12,552 12,552 12,552 12,552 12,552 Others 1,743 1,086 1,269 1,440 1,519 1,704 1,908 Total assets 91,564 129,400 149,129 163,507 174,135 189,815 207,745 Current liabilities 17,847 11,659 13,629 15,458 16,315 18,300 20,492 Accounts payable 6,412 7,532 8,805 9,987 10,541 11,823 13,240 Current portion of long-term debt 3,551 3,664 4,284 4,859 5,128 5,752 6,441 Other current liabilities 7,884 462 540 612 646 725 811 Noncurrent liabilities 47,011 57,466 66,556 69,569 76,365 79,170 89,878 Long-term debt 38,033 50,900 59,990 63,003 69,800 72,604 83,312 Others 8,978 6,566 6,566 6,566 6,566 6,566 6,566 Total liabilities 64,858 69,124 80,184 85,027 92,681 97,470 110,370 Shareholders equity 26,706 60,276 68,945 78,481 81,454 92,345 97,375 Capital Stock 7,028 20,178 20,178 20,178 20,178 20,178 20,178 Additional paid-in capital 5,754 27,860 27,860 27,860 27,860 27,860 27,860 Others 7,105 341 341 341 341 341 341 Retained earnings (1,035) 2,886 10,355 19,080 21,524 31,323 35,104 Minority Interest 7,854 9,010 10,211 11,021 11,551 12,643 13,891 Total liabilities and equity 91,564 129,400 149,129 163,507 174,135 189,815 207,745
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Metro Pacific Investments Corporation Consolidated Statement of Cash Flows
in millions Php FY08 FY09 FY10E FY11E FY12E FY13E FY14E Operating cash flows (2,784) 12,678 8,446 10,002 11,324 12,651 14,770 Income before tax 968 4,300 7,469 8,725 9,256 10,909 12,738 Depreciation and amortization 1,407 3,291 2,062 2,285 2,540 2,834 3,239 Change in working capital (6,298) 2,878 (1,085) (1,007) (472) (1,093) (1,207) Other adjustments 1,140 2,209 - - - - - Investment cash flows (21,638) (26,346) (17,096) (12,553) (10,822) (13,834) (15,986) CAPEX (3,054) (5,045) (7,523) (8,190) (8,927) (9,313) (11,036) Change in long-term investments (18,584) (21,301) (9,573) (4,363) (1,895) (4,521) (4,950) Financing cash flows 26,397 17,844 9,090 3,013 (16) 1,694 1,752 Payments (additions) of: - - - - - - - Concession fees (3,744) (1,347) (1,780) (1,959) (2,115) (2,284) (2,467) Interest-bearing loans 26,247 5,145 10,870 4,972 8,912 5,089 13,175 Issuance of capital stock (net) 3,714 13,715 - - - - - Dividends paid 181 331 - - (6,812) (1,110) (8,956) Changes in FOREX rates (18) (2) - - - - - Net cash flow 1,958 4,174 441 463 486 510 536 Beginning cash 248 2,206 8,813 9,254 9,716 10,202 10,712 Ending cash 2,206 6,380 9,254 9,716 10,202 10,712 11,248
Metro Pacific Investments Corporation
Key Financial Ratios FY09 FY10E FY11E FY12E FY13E FY14E Liquidity ratio
Current ratio 2.2 2.1 2.1 2.1 2.0 2.0 Solvency ratio
TIE ratio 1.6 2.7 2.9 3.0 3.1 3.4 D/E 1.1 1.2 1.1 1.1 1.1 1.1 D/A 0.5 0.5 0.5 0.5 0.5 0.5
Return on investments ROE 7% 9% 8% 9% 9% 10% ROA 2% 2% 2% 2% 2% 2%
Profit Margins EBIT margin 0.4 0.4 0.4 0.5 0.5 0.5 EBITDA margin 0.6 0.6 0.6 0.6 0.6 0.6 Gross profit margin 0.6 0.6 0.6 0.6 0.6 0.6 Net profit margin 0.1 0.1 0.1 0.1 0.1 0.1
Market Ratio EPS 0.11 0.16 0.17 0.18 0.22 0.26 P/E 25.3 17.9 16.7 15.7 13.2 11.3 P/B 1.8 1.6 1.4 1.4 1.2 1.1
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Appendix: Corporate Structure
Metro Pacific Investment Corp
Metro Pacific Holdings (55.6%)
Intalink B.V. (26.7%) First Pacific International (13.3%)Enterprise Invesnt Holdings (60%)
First Pacific Company Ltd, via subs (40%)
Public Float (44.4%)
Metro Pacific Investment Corp
Water
DMCI-MPI Water Co. (55.4%)
Maynilad Water Services (94.1%)
Tollways
Metro Pacific Tollways Corp
(99.8%)
Metro Pacific Tollways
Development Corp (100%)
Manila North Tollways (67.1%)
Tollways Management (46%)
Electricity
Beacon Electric (50%)
Manila Electric Co. (34.8%)
Healthcare
Riverside Medical Center (51%)
Colinas Verdes (100%)
Davao Doctors Hospital (35.1%)
Medical Doctors Inc. (35.1%)
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DISCLOSURES Ownership and material conflicts of interest: The author(s) of this report does not hold a financial interest in the securities of this company. The author(s) of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation: Compensation of the author(s) of this report is not based on investment banking revenue. Position as an officer or director: The author(s) does not act as an officer, director or advisory board member of the subject company. Market making: The author(s) does not act as a market maker in the subject companys securities. Ratings guide: Banks rate companies as a BUY, HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater over the next twelve month period, and recommends t hat investors take a position above the securitys weight in the S&P 500, or any other relevant index. A SELL rating is given when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating implies flat returns over the next twelve months. Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warrant y, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with the CFA Philippines or the investment Research Challenge with regard to this companys stock.
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