SMC , PF – The winners and losers in the re-creation of the San Miguel Food & Beverage giant

On November 3, 2017, San Miguel Corporation (SMC) disclosed to the public the re-creation of the San Miguel Food & Beverage giant.  (For a copy of the PSE disclosure please click – PSE-SMC-Consolidation of Food and Beverage Business [11.03.17]).

SMC will swap its 7,859,319,270 shares of San Miguel Brewery Inc. (SMB) representing 51.16% of SMB and its 216,972,000 shares of Ginebra San Miguel (GSMI) representing 78.26% of GSMI for an additional 4,242,549,130 shares of San Miguel Pure Foods Company Inc. (PF) with a total value of 336 Billion Pesos based on an expert valuation report of ING Bank N.V.  The transaction will raise SMC’s ownership over PF to 95.87% from 85.37%.

After the share swap PF will rename itself into San Miguel Food & Beverage Inc. after which SMC will sell up to 30% of PF to raise 150 Billion Pesos as reported (Inquirer Business Report 08Nov2017 and BusinessMirror Report 18Jan2018).

Prior to the announcement, PF was trading at a 300 level. After the disclosure, PF went as high as 640 a share and as of 24Jan2018 was trading at a range of 602-612.  We believe it is time to sell and unlock the value.  It is now trading at twice the value of where it was once, so reap the reward.

PF will be the loser in this consolidation game. PF will be buying SMB and GSMI at a hefty price and its balance sheet will be saddled with intangibles/goodwill.  The 336 Billion price of SMB (GSMI valuation is neglible if lumped with SMB) will translate to 37X Price to Earnings (PE) ratio. In 2016 SMB earned 17.7 Billion of which 9 Billion is attributable to SMC’s 51% ownership. 336 Billion divided by  9 Billion results to around 37X.  Please see SMC 2016 IR Briefing.

The hefty price for the assets will erode future earnings of the company in the form of goodwill impairments.  We believed that their will be impairments as cash flows from the units will be roughly the same (beer/beverage is a mature market) but the price paid for such cash flows are higher. Future returns will be lower as the asset-based is overvalued with goodwill. The net assets of the recreated food and beverage giant will be inflated with goodwill as a result of the hefty price it paid to acquire the said assets. The overprice/goodwill could have been deployed to acquire other earnings and cash flows accretive assets so growth might be slower in the future as resources have been tied up in goodwill. This will shrink the value of PF. Don’t wait for it, encash your gains now.

SMC is also setting a new 52-week high when it reached 141 on 23Jan2017 trading.  But its gain is not as remarkable as that of PF.  SMC is only up 39.39% in a one year period while PF is up 142.04% in the same period.  SMC has still more room to grow.  After the execution of the share swap, SMC will sell 30% of PF to comply with the float requirement for a total of 150 Billion Pesos.  The 150 Billion will be new money for SMC that can be used to grow further its earning assets.  SMC will be able to invests more in high profit margin and fast growing industries such as power and infrastructure and this will expand SMC’s earnings.  Currently SMC’s PE ratio is low at 19.84 as compared to Ayala Corp.’s (AC) 23.26, Aboitiz Equity Venture’s (AEV) 20.45 and JG Summit Holding’s (JGS) 62.11. We conclude that SMC at 140 is still a good buy given its new fire power.

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