BUSINESS DESCRIPTION: (Source: URC SEC 17-A 2016)
“Universal Robina Corporation (URC) is one of the largest branded food product companies in the Philippines, with the distinction of being called the country’s first “Philippine Multinational”. URC has established a strong presence in ASEAN and has further expanded its rweach to the Oceania region through the acquisition of Griffin’s Food Limited, the number one snackfoods company in New Zealand. URC was founded in 1954 when Mr. John Gokongwei, Jr. established Universal Corn Products, Inc., a cornstarch manufacturing plant in Pasig. The Company is involved in a wide range of food-related businesses, including the manufacture and distribution of branded consumer foods, production of hogs and day-old pullets, manufacture of animal feeds and veterinary products, flour milling, and sugar milling and refining. URC has also ventured in the renewables business for sustainability through Distillery and Cogeneration divisions. In the Philippines, URC is a dominant player with leading market shares in Salty Snacks, Candies and Chocolates, and is a significant player in Biscuits. URC is also the largest player in the Ready-to-Drink (RTD) Tea market and Cup Noodles, and is a respectable 2nd player in the Coffee business. With the acquisition of Balayan Mill last February 2016, URC Sugar division is now the largest producer in the country based on capacity.”
FISCAL YEAREND: September 30
COMPANY STOCK PRICE: (PSE Ticker: URC)
URC listed in the Philippine Stock Exchange (PSE) on March 25, 1994. The company is part of the “Industrial” sector and “Food, Beverage & Tobacco” subsector. As of April 2017, URC is one of the 30 companies in the PSE Index with a market capitalization of PHP 168.7 billion and free float of approximately 44%. Notice from the two charts below the positive correlation of URC stock price vis-a-vis the PSE Index. To a certain extent, this would be expected given the type of product that URC produces. For more information, visit the PSE website and the company’s investor relations link.
PHILIPPINE STOCK EXCHANGE INDEX (PSEi):
For more information on the PSEi and other indices, visit the PSE website.
KEY OPERATING ASSETS:
URC is a typical snack-food manufacturing company with the following key operating assets (refer to the charts below):
- Cash and cash equivalents (as well as the investments in financial instruments)
- Accounts receivable
- Inventory
- Biological assets
- Property and equipment
- Intangible assets
Not all companies have biological asests. To help you appreciate the nature of biological assets, here is an excerpt from the Annual Report of URC:
“The biological assets of the Group are divided into two major categories with sub-categories as follows:
Swine livestock:
- Breeders (livestock bearer)
- Sucklings (breeders’ offspring)
- Weanlings (comes from sucklings intended to be breeders or to be sold as fatteners)
- Fatteners/finishers (comes from weanlings unfit to become breeders; intended for the production of meat)
Poultry livestock:
- Breeders (livestock bearer)
- Chicks (breeders’ offspring intended to be sold as breeders)
Agricultural produce is the harvested product of the Group’s biological assets. A harvest occurs when agricultural produce is either detached from the bearer biological asset or when a biological asset’s life processes cease. A gain or loss arising on initial recognition of agricultural produce at fair value less estimated costs to sell is recognized in the consolidated statement of income in the period in which it arises. The agricultural produce in swine livestock is the suckling that transforms into weanling then into fatteners/finishers, while the agricultural produce in poultry livestock is the hatched chick and table eggs.”
What do you think about the growth trends of the key operating assets? Don’t they look good? Trade receivables, inventory, and PP&E exhibited smooth upward trajectories consistent with a steadily expanding business. Biological assets likewise increased, though at a more erratic pace.
The chart of intangible assets stands out because of the huge spike heading into fiscal year end Sept 2015. This spike was due to URC’s acquisition of Griffin’s Foods Ltd. (the leading snack food manufacturer in New Zealand) for around NZD 700 million (approximately PHP 26 billion). You can read further about the acquisition here and here. In 3Q 2016, URC completed another major deal with the acquisition of Snack Brands Australia (SBA) for AUD 600 million. Now before you get too excited, take a step back and think about it: on the one hand, these two acquisitions are impressive and significant on several fronts: increased geographic footprint, expanded product lines, and incremental sales, profits, and cash flows. On the other hand, not all acquisitions work out as intended. Acquisitions sometimes result to indigestion. Given that we do not have a crystal ball to predict the future, where can we turn to get some idea about how these acquisitions could work out? Simple answer: the track record of management. More on this later.
Up to this point, it’s clear that URC expanded its business in line with the growth of the Philippine economy (as represented by the PSE Index) and that the stock market liked what it saw (as can be seen from the stock price chart of URC).
PRODUCTIVITY OF KEY OPERATING ASSETS:
Asset acquisition is not always a perfect science, specially for a large multi-billion Peso company like URC that has operations in several countries. Sometimes, some assets turn sour for one reason or another, in the same way that some fruits and vegetables inside your refrigerator can turn bad if you forget about them. Within reasonable limits, this should not cause panic. Ideally, however, most key operating assets should be productive enough to generate benefits that exceed costs (as well as soured assets) for the company on a consistent basis year after year. As the key operating assets increase, so too should the benefits increase. These benefits can be quantified in several ways. Let’s take a look at popular measures of benefit taken from the Income Statement and Statement of Cash Flows:
- Sales
- Gross profit (GP)
- Operating income (or loss), as measured by EBIT (or Earnings Before Interest Expenses and Taxes)
- Net income (or loss)
- Operating cash flows (OCF)
You probably noticed that the charts of sales, gross profit, and EBIT are nearly identical and exhibited the same smooth upward trajectories of the key operating assets. This tells us an important message: as URC expanded, costs did not spiral out of control. Management was able to grow the business while keeping a good grip on expenses. Further down the line, net income and operating cash flows likewise increased, though at a more erratic pace initially.
To put this into better perspective, here are three important margins from the Income Statement:
- Gross profit margin (GPM)
- Operating profit margin (as represented by EBIT) (OPM)
- Net profit margin (NPM)
The GPM is important because it should be more than enough to cover for all types of expenses during the fiscal year. Expenses can be recurring, non-recurring, operating, or non-operating. You probably noticed that the GPM increased steadily from 2011 to 2016. On the one hand, this is impressive. On the other hand, this begs the question, “how did this happen?”. Take a step back and think about it: for five consecutive fiscal years, URC increased its GPM…wow!!! This is every CFO’s dream come true!!! So…how can GPM increase? There are three ways to do this:
- Increase the selling price per unit (PHP) without changing the cost of good sold per unit (PHP) ; or
- Do not change the selling price per unit (PHP) but reduce the cost of good sold per unit (PHP) ; or
- Simultaneously increase the selling price per unit (PHP) and reduce the cost of good sold per unit (PHP).
Up to this point, one interesting and impressive takeaway is that GPM increased at the same time that Sales increased.
WORKING CAPITAL MANAGEMENT:
Let’s turn our attention now to URC’s working capital management. In this section we take a look at how well URC managed the following resources that affect day-to-day operations:
- Collection of (trade) accounts receivable
- Selling of inventory
- Payment of (trade) accounts payable
The three items above are combined into the following useful metrics:
- Operating cycle (OC)
- Cash conversion cycle (CCC)
Both OC and CCC improved from 2006 to around 2011, then deteriorated from that point onwards. The CCC started at around 80 days in 2006, improved graduaally, then went back to around 80 days by the end of fiscal year 2016. Drilling down into the components of CCC, the average number of days to collect trade receivables and to sell inventory increased steadily. These should concern investors. However, these were offset by the increase in the average number of days to pay the suppliers, which is either a good or bad thing. If a company starts to delay the payments to suppliers, it’s usually either one of two things: a) the company has cash flow problems and is unable to pay on time, or b) the company has the cash (and cash flow) but is able to exert influence over the suppliers to extend the payment terms. Looking at the balance sheet of URC, it’s clear that the company has the cash to pay suppliers. Take a step back and think about it: wouldn’t it be nice to have the cash (and cash flow) to pay the suppliers, and still be able to extract extended payment terms?
ECONOMIC PROFIT
So far, all the items we have looked at were taken directly from the financial statements without much fanfare. We have looked at numbers reported in accordance with Philippine Financial Reporting Standards (PFRS). It’s time to take these numbers and turn them inside out in order to get other perspectives about URC’s historical performance. To do this, we use the Economic Profit (EP) framework.
In our analysis, we estimate two EP levels for URC using 10% and 15% WACC. Our analysis does not focus on valuation, hence there is no need to waste time calculating an exact WACC. In addition, we estimate the first round number WACC that would yield an EP just slightly above zero; i.e. a “WACC for breakeven EP”.
Using the 10% WACC, the trend of EP increased gradually and started to turn positive sometime in 2010. In 2015 and 2016, the value created exceeded Php 6 billion. What does this tell us? As the business expanded and sales increased, the company generated not just accounting profits, but also created value. The value creation showed steady growth for several years and validated the company’s investments during this time period. By 2015 and 2016, even if URC’s WACC reached 20% (which is highly unlikely), the company would still have created value.
INVESTED CAPITAL
One of the key inputs in estimating EP is Invested Capital (IC). URC’s expansion spiked in 2014 and 2015 due to the acquisitions of Griffin’s Foods Ltd. and Snack Brands Australia. These expansions were accompanied by increasing ROIC and positive EP.
EXECUTIVE VALUE CREATION (ExVC)
Now let’s take a look at something that doesn’t usually receive too much attention: executive compensation and productivity. The ExVC framework compares executive compensation against several metrics to assess the productivity of management from various perspectives. The next several charts summarize the following information for ExVC:
- Executive compensation (ExPay)
- Sales vs. ExPay
- EBIT vs. ExPay
- Net income vs. ExPay
- OCF vs. ExPay
- Economic profit (EP) vs. ExPay
- Invested capital (IC) vs. ExPay
Except for the spike between 2013 and 2014 (when the figure doubled), there was generally a steady increase in annual executive compensation every year, reaching a high of Php 103 million in 2016. Think about it: Php 103 million for five persons in one year. If that seems like a lot of money…yes it is. But what’s more important is to see what happened to the business under the leadership of these executives.
Both Sales and ExPay steadily increased from 2006 to 2016. However, from 2012 to 2016, the rate of increase in ExPay was faster than that of Sales, resulting to an inverted “v” curve for Sales vs. ExPay. This means that from 2011 to 2016, each Peso of Executive Compensation generated less Sales than the year before. The declining trend is concerning because most analysis will simply highlight the impressive growth trajectory of Sales.
What could this be telling us? Is management being rewarded for past, present, or anticipated future performance? Was management slacking off, or was it a case of a saturated market with little room for revenue growth? If there is little room for revenue growth, why increase executive compensation? To be fair, the numbers by themselves are impressive: each Peso of Executive Compensation generated more than Php 1,000 in Sales. However, the declining trend is a source of concern.
EBIT, Net Income, and OCF vs. ExPay generally exhibited trends similar to Sales vs. ExPay, though with a bit more volatility.
EMPLOYEE VALUE CREATION (EmVC)
- Employee compensation (EmPay)
- Sales vs. EmPay
- EBIT vs. EmPay
- Net income vs. EmPay
- OCF vs. EmPay
- Economic profit (EP) vs. EmPay
- Invested capital (IC) vs. EmPay
