EDC Stock Review: An Attractive Power Generation Company
I’m receiving a lot of valuation requests these past few days and I’m kind of overwhelmed of the positive feedback that I’ve received in my message inbox. I will try to give my best to fulfill all of the requests in my spare time.
For now, I just want to thank everyone for the kind words and I wish all of success in your investing journey.
For this post, I’ll talk about Energy Dev’t Corporation (EDC). EDC is one of the companies that explores, develop, operate and utilize geothermal energy and other indigenous renewable energy sources in the Philippines for electricity generation.
Here’s a snapshot of the management structure of EDC.
This is a lengthy post but I’ll try to keep this short, simple and easy to understand. There are things that I like and I don’t like in the company so I’ll go straight to the numbers to tell you what they are so let’s get started.
The following figures that I’ll present are based on seven years of financial statements. I found out some pretty good numbers on their Income Statement.
The 7-yr Net Profit Margin averaged at 20%. The previous 3-yr margin (2013 to 2015) is at 26%. The numbers indicate that EDC is very competitive in the power generation industry.
Even though EDC showed net losses of 167 Million Pesos in 2011, this doesn’t affect the overall nature of the business.
Further investigation revealed that the impairment assessment of Northern Negros Geothermal Project (NNGP) which amounted to 4,998.6 Million Pesos is the main cause of this decline.
The years starting from 2012 to 2015 showed high profit margins that almost reached 40% last 2014. To me, this may be an indication of good profits to come.
These profits can also be seen in the historical 7-yr earnings as shown in the chart below.
Although the EPS shows a decline in some of the years, it’s still evident that the trend is on the rise. The computed CAGR shows a value of 12% which is a good number. A 20% profit margin coupled with earnings that grow at 12% is a fantastic company to me.
From 2009 to 2015, EDC traded at around PHP 4.70 to PHP 8.20 per share which gives us an average P/E of 16.79 (I didn’t include 2011 to get a positive accurate number). EDC may still be considered as undervalued based on P/E alone.
The 7-yr Gross Profit Margins typically plays around 60% to 75% which means that EDC has very low Cost of Sales expenses.
Last year, EDC reported Cost of Sales expenses excluding Depreciation & Amortization amounting to 9.6 Billion and Revenues of 34.3 Billion which leaves the company gross profits of 24.7 Billion Pesos. Companies with competitive advantages usually have high Gross Profit Margins.
But a high margin doesn’t always translate into profitability. So I looked at how much of its Gross Profits are spent on Sales & Admin Costs.
The graph below shows that EDC spends around 23% on average of its Gross Profits to S&A expenses.
If you’ll notice, S&A costs almost remain the same compared to the Gross Profit which is increasing every year. It means that EDC can increase its income without adding more personnel, operations and maintenance costs.
This is an indication of a company with a competitive advantage.
EDC has a lot of power plant equipment that depreciate overtime. Having said that, we also need to know how much the company spends on Depreciation.
I found out that EDC spends about 17% on average of its Gross Profits to Depreciation Costs.
I compared EDC’s margin to other similar companies and it turns out that EDC is just in the average mark. First Philippine Holdings (FPH) 5-yr average is at 26%, Aboitiz Power (AP) at 12%, Trans Asia Oil & Energy Dev’t is at 13% and First Gen Corp. (FGEN) is at 16%.
Based on the comparison, I think EDC is spending just the right amount.
Apparently, EDC has a lot of debt in its books. Just last year, EDC reported a total debt of 74.5 Billion Pesos. On average, EDC pays 32% of their Operating Profit to Interest Expense.
The debts were used to fund capital expenditures and build more power plants.
To check if the company manages the debt effectively, I added all the Cash and Retained Earnings and checked to see if it can pay the total debt.
Turns out it can’t. Is this bad? Not exactly. As long as the company makes a lot of money every year, there will always be a way to pay it.
What’s bad is when the has no cash and makes little. In this case, I’m confident that it can manage its debt based on its earnings power.
The average D/E ratio is 1.90 which means that for every PHP 1.00 of equity there’s PHP 1.90 of debt. Is this bad? Yes. If it’s the other way around, then it’s good.
The average Current Ratio is 1.82 which means that for every PHP 1.00 that flows out, there’s PHP 1.82 that flows in into the company. Is this bad? No.
I also checked if the Cash is greater than the Short-Term Debts each year and I found out that it has been like that since 2010. Same is true with The Long-Term Debts since 2009. The Property, Plant & Equipment is also greater than Total Debt since 2009.
All of these are good indications of debt that is managed effectively.
So far, I’ve shown that EDC’s high levels of debt is something a long-term investor should look at. To improve its financial health, EDC should increase its cash reserves.
If EDC can maintain its profit margins, then I think there’s nothing to worry. I also believe that the management is good at handling these debts as shown as below.
A summary of the ratios above tells me that EDC is a well-managed company. RoE, RoA and RoTC computed averages are 15%, 5% and 12%.
Another thing that I like about EDC is their dividends. Just look at the Dividend Payout Ratios and you’ll know how generous EDC is.
Last 2009, EDC paid 70% of its earnings to the investors. Just last year, the company paid around 51%. Holding 10,000 shares of EDC last year will give you dividends of PHP 2,100 excluding taxes. If I bought shares at PHP 6.20 at those times, that translates into a dividend yield of 3.39%.
Dividends have also increased since 2009. If you’ll ask me, EDC is a good source of steady passive income.
From 2009 to 2015, EDC traded at around PHP 4.70 to PHP 8.20 per share which gives us an average P/BV of 3.41. In Ben Graham’s words, this is already overvalued. Notice where the trend is going. This shows that the company is continuously growing its equity.
EDC made PHP 2.13 per share from 2009 to 2015. From that same period, EDC paid out dividends worth PHP 1.12 per share. This means that EDC retained earnings of PHP 1.02 per share.
From the same period, earnings increased from PHP 0.177 to PHP 0.407 per share. The difference is PHP 0.23. This increase may be attributed to the management’s effective utilization of the retained earnings thus producing that additional earnings. Getting the rate of return gives us a value of 22.66% (0.23/1.02) which is fantastic.
Free Cash Flow has been positive since 2009 except last 2014. Net Cash from Operating Activities has been always positive. They are also investing and paying out their debts. There’s nothing much to say here.
Consistent positive Cash Flows is a sign of a company that makes money.
I’m convinced that with all of the data presented above, EDC is a good company to invest in for the following reasons:
- The stock price is not that overvalued based on P/E and P/BV.
- The high profit margins, earnings growth and book value growth is attractive.
- The company is well-managed even though it has a lot of debt.
- The company pays out high dividends thus becomes a good source of passive income.
What you should look out in this company is:
- Increasing debt levels and the company’s ability to manage those debts.
- High capital expenditures using debt to finance its upgrades.
So what’s the right price to buy this stock? I’ll discuss below.
The Initial Rate Of Return
The 10-yr gov’t bond rate as of this writing is at 4.433%. The Net Income (TTM) of EDC is 8.4 Billion. Based on the gov’t bond rate, you could buy EDC at PHP 10.11 per share and expect a return similar of the bond.
EDC’s stock price as of this writing is PHP 5.75. Buying it at this price will give you an expected return rate of 7.79% within a year.
Projecting The Future Price After 10 Years
Using the Sustainable Growth Rate Model, the projected price was computed to be at PHP 11.65 per share.
Using the Historical Earnings Growth Rate Model, I arrived at a projected price of PHP 22.45 per share.
If you’re thinking of investing in a power generation company, you may want to consider accumulating shares of EDC. The company’s sustainable growth and its high dividend payouts is very attractive for long-term investors.
Do you think that Energy Development Corporation (EDC) is a good stock to buy and hold? I want to know your thoughts about this.
For questions and reactions or if you want to add additional information, please leave a comment below. This concludes my EDC stock review.
- Stock in Focus: EDC (11 Sept 2016) by RCBC Securities
- Stock in Focus: EDC (17 May 2016) by Angping & Associates Securities
- Stock in Focus: EDC (22 April 2016) by Unicapital Securities
- Stock in Focus: EDC (22 Mar 2016) by Angping & Associates Securities
- Stock in Focus: EDC (12 Nov 2015) by Angping & Associates Securities