8990 Holdings (ticker: HOUSE PM) is a developer of mass market housing in the Philippines. It has become a market darling thanks to its revenue growth profile and its charismatic CEO, Januario Jesus Atencio. The company is promotional and owes much of its success to an aggressive use of debt and misleading accounting. My guess is that the company will be facing major write-downs on its lending receivables portfolio, and possibly go bankrupt if rates ever rise to historical averages.
8990 Holdings was incorporated in 2005 as “IP Converge Data Center, Inc”, and was later taken over by a consortium of real estate investors in 2012 as part of a reverse merger. These investors later injected real estate assets and a property development business into the holding company and sold the 8990 story to investors. This real estate business started as Deca Homes in 2004 and grew strongly, almost doubling sales every two years.
A favourable market climate helped 8990 Holdings raise PHP 6.5 billion through the issuance of primary shares in 2013 and also helped the funders sell down part of their ownership of the company.
The company focuses on development of residential property through its brand name “Deca Homes”. Most of the housing sold by the company is horizontal units and mid-rise buildings. The company prides itself on being able to build townhouses and single-detached units in only 8-10 days. The company’s has the capacity to build 12,900 per year, which, given total revenues of PHP 7.8 billion means an average selling price of PHP 600,000 or US$12,500. If the company is truly able to sell units this cheaply at 60% gross margins, then it is an extraordinary company indeed – perhaps too good to be true.
Does the company have any unique franchise, or unique capabilities? It does not seem to be the case. Homes costing less than $15,000 tend to be simple, and should be easy to replicate by any competent contractor. The problem with low-income housing is that a low budget for maintenance or security causes developments to lose their lustre. Customer feedback via social media has shown that a development called “Deca Phase 1” has turned into a bit of a shanty town:
“I just don’t get it why they allow Deca Phase 1 open for business? … They have the impression already [of being a] 1st class squatter compound… That could impact the business and the image of 8990 Housing”
If the environment of a development is the same or worse than outside, then in the absence of special licenses or relationships with contractors, the value-add of the developer is called into question.
What does separate Deca Homes from other developers in the Philippines is that it offers extensive in-house financing to their customers. All potential buyers need to qualify for a loan via Deca Homes’ CTS Gold Scheme is:
- Down payments of 2-5% vs industry averages of 15-20%. In absolute terms the down payment tends to be less than PHP 20,000 (less than US$415)
- Incomes of at least PHP 35,000 per month (US$726 per month)
- Borrowers with little to no savings
- 25 year repayment term
- Stated interest rates of 9.5-11% pa
The company presentation summarises the business model very well by emphasising three aspects of their operations:
- Fast pre-cast panel wall construction
- Accessible in-house financing
- Pro-active credit and collection platform
In other words, what 8990 brings to the table is building walls, financing and financing. So how sustainable is their financing anyway?
The Financing Arrangement
It is unusual for a property developer to be the only lender available to the company’s customers. It makes you wonder why Filipino banks aren’t willing to lend – they clearly have the capital, reserves and loan-to-deposit ratios to expand their loan books. Banks tend to be much better in their assessment of credit risks than developers, as we have seen in many other jurisdictions.
The company has PHP 17.5 billion in bonds and interest-bearing loans against PHP 17.6 billion in receivables. Using the interest income number from the income statement and average total trade receivables during the year for the past three years, we get an average interest income of 7-7.5% pa – much lower than the 9.5-11% interest rate stated in the company’s marketing material. Is it possible that this discrepancy is due to early defaults, meaning that defaulted-upon loans make up almost a third of total loans?
|Average trade receivables||16746||12218||7485|
Their peso-denominated bonds are trading at close to par, yielding an average of roughly 6% pa. So what the company is essentially doing is to borrow at 6% (thanks to a cyclical boom in the Filipino economy) and to then lend to non-creditworthy customers at just above 7% – not a great business, if you ask me.
Importantly – loan receivables offer fixed interest rates to their customers, whereas interest rates on borrowing is either variable or relatively short-term. 25 years is a long time to lend to non-creditworthy customers. What happens if, at any time, during those 25 years bank lending rates in the Philippines revert back to 10%+? The credit risk profile of the company would be crushed and spreads over the prime rate would widen further, potentially leading to a bankruptcy.
Provisioning for credit losses depends on the “judgment by management” with regards to future cash flows of their receivables. So far, the charges have been relatively modest at around 1%:
|Average trade receivables||16746||12218||7485|
|Allowance for credit losses||235||127||3|
|Provisioning for credit losses||1.4%||1.0%||0.0%|
Past 90 days due numbers are also low and improved in 2015:
|Year end receivables||19068||14425||10011|
|Past 90 days due||101||183||18|
|% of year-end receivables||0.5%||1.3%||0.2%|
What might keep credit losses low is the fact that property prices have risen continuously over the past decade. So buyers defaulting on their payment obligations can without much problems sell their properties in a rising market and pay back their debt. Much more likely, however, the numbers are manipulated to fit management’s interest. The discrepancy between an interest income of 7% versus stated interest rates of almost 11% indicates that someone isn’t paying his mortgage. Given modest provisioning for credit losses thus far, any major write-down will have to be taken against equity.
Operating cash flows after deducting changes in working capital are consistently negative to the tune of PHP 2 billion+ per year while capital expenditures in slow-growth 2015 amounted to PHP 1.5 billion. In other words – in order to keep up current sales numbers, the company will probably need additional financing of roughly PHP 3 billion, assuming that the majority of 2015 capital expenditures comprised maintenance capex.
8990 Holdings hopes that it will be able to sell on these loans to Philippine’s “Pag-IBID”, also known as the “Home Development Mutual Fund”. This government-sponsored entity finances affordable housing for its members and sometimes also purchases loans from developers directly. The much larger Filipino property developer Vista Land was heavily reliant on financing from Pag-IBID before the Asian Financial Crisis, and almost went bankrupt when Pag-IBID encountered its own issues and had to withdraw its support for Vista Land.
8900 Holdings targets 70% of revenues coming from Pag-IBID. However, in 2014 the company only managed to sell PHP 1.9 billion of receivables to Pag-IBID, roughly 20% of that year’s revenues and 15% of 2014 average total receivables. It is difficult to imagine financing from such sources increasing further, given that the conditions for the property market hardly could have been better over the past few years. There is also a certain lag in payment, so announced purchases does not mean they will be processed in the near-term.
Perhaps thanks to the generous financing 8990 Holdings offers to its customers, the company has managed to achieve relatively high margins and a return on equity of 31% in 2014 and 23% in 2015, compared to 10-15% for Ayala Land, SM Prime and Vista Land.
It is worth noting that the inventory in 2015 grew more than twice as fast as cost-of-goods-sold. One possible explanation is that inventories were revalued upwards in a bid to keep cost of goods sold lower than it otherwise would have been, and hence boosting margins.
Key drivers of property development include interest rates and collateral values. The Filipino property market is not overvalued as it was pre-Asian Financial Crisis and may well have much further to run. Banks are not extended in any way, historical lending growth was limited until 2012. More concerning is the fact that Philippines has been a market darling for three or four years, with Christopher Wood of CLSA recommending a 3x overweight position in the Philippines and many others talking about it the next Asian miracle. While progress in the BPO sector is impressive, the story seems to be one of excellent demographics, Aquino politics and a sweet spot in the business cycle, rather than a multi-decade growth story. Duterte’s rhetoric seems to scare investors away, while the narrative about investing in the Philippines has not yet changed materially. Stocks are still expensive, and asset allocators still positive. I suspect the recent weakening in the currency is a sign of flows going outwards again, which will likely cause inflation to rise, bringing interest rates with it in a reflexive fashion.
The company made a net profit of PHP 3.8 billion over the past 12 months, and is down somewhat over the past two quarters. That would give the stock a run-rate PE ratio of 10x. But the earnings are illusory in my view, given that they finance customer purchases at ultra-low down payment requirements and interest rates. Seen from another perspective, you are paying 2.3x book value for a company whose primary business is to borrow at 6% and reinvest into mortgages that pay 7% in interest income in an already-booming economy. When the economy turns, the company will have to make major write-downs on their loans as their customers are not creditworthy and the collateral appears to depreciate very quickly.
8990 Holdings is sold to investors as a bet on the long-term potential for mass-market housing in the Philippines. The true story is somewhat different: a reverse merger to avoid typical IPO scrutiny, followed by a placing that enabled existing investors to sell down their stakes. Meanwhile, growth was boosted temporarily by generous lending to the company’s own customers, financed by borrowing from banks at multi-year low rates that had come down thanks to global QE.
To sum up, 8990 Holdings is a short for the following reasons:
- Customer reliance on in-house financing makes a large part of revenues illusory. Lenders should not want to lend at 6% to have those funds relent at just above 7% to customers with no assets and down payments of just 2%.
- A mismatch between the interest rate exposures of assets and liabilities
- Bulls claim that issues with Pag-IBID will sort themselves out over time, yet to date 8990 has not been able to get the receivables off its balance sheet. When a government-sponsored entity is the only way to get rid of loans that the company has made – we can probably assume that the loan quality is not the best.
- The history of the company, including the reverse merger and promotional nature of the management opens the question whether creating the current company simply was a way to cash out – at the expense of minority shareholders
- Signs of speculative excess. I have seen 8990 Holdings on more than a few conferences. It was a top pick of both UBS and CIMB a few years ago and group meetings with the company were more or less packed. They misunderstand the story – extrapolating growth where the conditions for further growth are fragile
- To my knowledge, no other hedge fund has made any bet against 8990. The risk of crowding should therefore be low
- The rhetoric of Duterte is likely to scare foreign investors away. Philippines is in the early process of being a stock market darling to what it used to be seen as – a corrupt third world country
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