Description

Analyst question: “Hi I just want to check on GSMI again, a very strong performance, but what is the plan for actually realizing the value for this business?  Because it’s still trading separately and if you look at the market valuation for that company it’s trading at like 5x earnings now based on the numbers you have reported… so the market is seriously undervaluing this company basically… profit has grown so strongly over the last two years but the stock price has not really reflected that and now it’s trading at a price/earnings multiple of 5x… so what is the plan, how do you really help shareholders realize the value of this business which has done so well even in difficult times?” 

Management answer: “Well the stock has done quite well this year relative to the lows it experienced right after COVID happened and I hope that the liquidity and trading interest continues to increase for GSMI, and management will always be open to ways in which we can further unlock value for the GSMI shareholders. So hopefully it continues, I think that the market has rewarded GSMI in terms of its stock price, hopefully liquidity and interest in the stock continues to build for GSMI.” 

-          November 5, 2020 San Miguel Corporation group wide results briefing, which also fielded questions on GSMI. GSMI’s share price has more than doubled since thanks in part to the first special dividend in its history.

Helpful background information (pages 114-118): https://www.sanmiguel.com.ph/storage/files/reports/Prospectus%20relating%20to%20the%20Shelf%20Registration%20of%20533,333,334%20Series%202%20Preferred%20Shares.pdf

I have to give credit where credit is due: zyos, many many thanks for your GSMI writeup from October 2020 – the stock price more than doubled (excluding dividends) since, so all GSMI shareholders owe you a big one for putting this on the map!  I’ve also been following GSMI closely since last summer and agree with pretty much everything you wrote in your original post.

I’m doing a follow-up GSMI post because, in my humble opinion, the re-rating to date (i.e. leaping from a disgustingly cheap EV < historical cost of the PP&E to ~2x today) only reflects part of the potential re-rating that could still materialize thanks to more shareholder-friendly way the company has been managed over the last few years.  

Why?  If management has turned over a “new leaf” like I suspect they have – no more cash dividends based on a fair payout ratio, no more asset purchases from the parent company, no more overseas “diworsification” to places like Thailand, no more domestic “diworsification” into non-alcoholic products, proper investor relations befitting a “national champion” brand, etc. – then there is no major reason why GSMI should still trade at <50% of the P/E multiple of Emperador (EMP), the country’s only other pure-play spirits stock.  If that conclusion ever gets reflected in GSMI’s stock price then there could be another doubling of its stock price from here onwards without any additional profit growth if we peg fair value at EMP's P/E ratio.

Excluding a one-off non-cash impairment charge, GSMI’s current market cap (ex-treasury shares) of PHP 28.5 billion (USD 577 million) implies a TTM P/E of 8.4x (or 7.1x ex-cash) NPAT of PHP 3.4 billion (USD 69 million), versus EMP’s current market cap of PHP 191.9 billion (USD 3.9 billion) for a TTM P/E of 22.4x (or 25.3x including net debt) NPAT of PHP 8.6 billion (USD 174.33).[1] 

Yes, it’s true: EMP has only 2.5x the TTM NPAT of GSMI, but 6.7x the market cap.[2]  This valuation disparity is more puzzling when you consider:

-          EMP actually has a lower % public float (i.e. shares not owned by the parent co) than GSMI: 15.73% for the former and 24.05% for the latter.  Granted, EMP’s YTD 2021 average daily share turnover is USD 471,000 versus USD 181,000 for GSMI but there have been several days YTD where <USD 100,000 EMP shares changed hands.  

 -          EMP’s 2016-2020 average return on tangible assets was only 8% (2020: 8%) with zero EBIT growth, versus 9% (2020: 18%) and 4x EBIT growth for GSMI.  Eventually, EMP shareholders could start to ask why their financials are now showing less than half the returns on tangible assets GSMI has been reporting recently.

 -          EMP has lost volume market share over the year ending March 2021 to… you guessed it, GSMI: see the below market share estimate (taken from the 2021q1 IR presentation of LT Group, which owns Tanduay, the third major spirits company in the country).

But I digress – the main opportunity for GSMI shareholders today has little to do with EMP, it’s simply that GSMI management has decided to do the “right” thing for all shareholders going forward.  Recent examples include:

-          On May 6^th, 2021 GSMI declared the first special dividend in the history of the company going back to its 1995 IPO.  This not only doubled the full year dividend GSMI normally pays, but it took the after-tax payout ratio to nearly 20%, higher than it’s been in over a decade.  Should GSMI raise the dividend payout ratio up to their publicly stated policy limit of 50%, then GSMI shares could be yielding a 6% dividend at today’s price, making it one of the highest (if not the highest) dividend yielding stock in the country.  Objectively, this is very possible given how much excess cash has already built up on the balance sheet (approaching 20% of market cap today), and the fact that management has already publicly stated there is no immediate need for further expansion capex.

-          On December 1^st, 2020 GSMI decided out of the blue to redeem the only potentially dilutive, more senior security to the common stock: the 32.8 million preferred shares (dividend-paying) held by the parent company San Miguel Corporation.[3]  There is now no potential equity dilution, and no traded security more senior in the capital structure than the common stock.

-          During the fourth quarter of 2020, GSMI wrote-off the remaining PP&E related to its ill-fated diworsification adventure into Thailand conducted under prior management.

And that brings us to the topic of current management, because anyone looking at the pre-2018 and post-2018 financials should see a totally different GSMI.  Based on our research, it seems clear that the more focused, more “normal” management of GSMI in recent years is directly linked to the 2018 IPO of San Miguel Food and Beverage (ticker: FB).  This restructuring exercise took GSMI shares out of the hands of San Miguel Corporation (or SMC, ultimate parent company that operates as a conglomerate in various industries) and, via a series of stock swaps, put them into the hands of FB, a newly created 100% F&B-focused subsidiary that gave global investors access to San Miguel’s top market share F&B brands in the Philippines.  FB, in turn, has been managing themselves in line with what one would expect of an owner of top market share F&B brands: dividend payout ratios consistently >50%, with OP margins and ROE maintained in the teens % or higher. In my opinion, that new FB culture has clearly filtered down into GSMI.[4]  See below for graphical representation of the structural changes:

                To me, now that GSMI is being managed in a “normal” way, it will become harder for the market to ignore the fact that this is:

a)        a) a unique ~200 year old heritage brand that is part of the cultural fabric of a demographically young country of 108 million that still consumes less per capita (especially in $ terms) than neighboring countries, and[5]

b)      b) the world’s largest gin spirits company by volume (2020: 38.6 million annual cases sold, 2021q1: 11.5 million cases sold) whose 2 core brands (GSMI and Vino Kulafu) have 91.5% and 69.2% volume share, respectively, as of June 30, 2020 and an obvious track record of successful price increases (see below).[6]

                Granted, like many other spirits companies globally that don't rely on on-premise channels, COVID-19 lockdowns have provided a nice boost to at-home consumption of GSMI products that management can’t deny.  So a post-COVID snap-back in sales volumes is a risk one has to watch out for.  The amount of the stay-at-home COVID benefit, however, will only be known in the coming year or two but it is my sense that GSMI’s organic market share increases thanks to geographic expansion (i.e. gin is only consumed heavily in Luzon, where less than 1/2 the population reside) and bottoms-up brand awareness growth will keep GSMI profits well above 2019 pre-covid levels.  After all, the Philippines is a young country (median age: ~25) that still has millions of new drinkers entering the market each year.  Also, the pace of the immediate future increases in excise tax hikes from the government will slow down considerably, so GSMI should be facing a relatively lower price hike “hurdle rate” (i.e. % price increases required to cover excise tax hikes) than it has faced in the last 1-2 years.[7] 

                One could argue whether the “right” price for GSMI is 12x ex-cash P/E, or 15x ex-cash P/E, etc. but the current 7.1x ex-cash P/E looks way more wrong than right to me.[8]  Assuming management continues to do the right things for all shareholders, the current 7.1x ex-cash P/E still appears to offer a nice margin of safety and upside potential to the 20x multiples EMP consistently enjoys.

Catalyst

1) Continued profit and dividend growth.

2) Attract more foreign investors -- current foreign shareholding just 7% despite superior recent performance to EMP (10% foreign shareholding).