Holding companies are often punished by the market with a conglomerate discount, which results in a perceived undervaluation of the parent company in relation to the combined value of its subsidiaries.
This discount stems from the assumption that a company becomes increasingly inefficient as its holdings become more diversified. This is especially true if there are underperforming subsidiaries thrown into the mix, or if the mix of businesses do not synergize well with one another.
When it comes to the Philippine stock market, there are a few exceptions to this rule.
The first to come to mind is DMCI Holdings (DMC), which has ownership stakes in Semirara Mining & Power (SCC), Cemex Philippines (CHP), Maynilad, D.M. Consunji Inc., and DMCI Homes.
The market currently values DMC at around P159 billion, which is 70 percent higher than the combined value of its stakes in listed subsidiaries SCC and CHP.
We can only assume that the market allows DMC this premium due to the significant value of its unlisted businesses Maynilad, DMCI, and DMCI Homes, as well as the perceived synergy amongst its business units.
At first glance, it would seem that the Ty Family’s GT Capital Holdings (GTCAP) is another exception to the rule.
GTCAP is the parent company of Metrobank (MBT), AXA, Toyota Philippines, and Federal Land. It also holds a significant minority stake in now-delisted Metro Pacific Investments (MPI).
The market currently values GTCAP at around P153 billion, which is 14 percent higher than its 37-percent stake in listed MBT. However, this premium disappears if one adds the P27-bilion value of GTCAP’s minority stake in MPI based on MPI’s tender offer price prior to delisting.
The discount widens further when one also considers that this computation does not even include GTCAP’s stake in auto giant Toyota Philippines, which accounts for almost half of all passenger vehicles sold in the Philippines and contributes around a quarter of GTCAP’s earnings.
There are other more extreme instances of the conglomerate discount in action, such as Ayala Corp. (AC), which has a controlling majority in four listed entities: Ayala Land (ALI), Bank of the Philippine Islands (BPI), ACEN Corp. (ACEN), and Globe Telecom (GLO). The combined value of AC’s stakes in these four companies alone amounts to around P815 billion or nearly double its current market cap of P450 billion.
Another example is JG Summit Holdings (JGS), which controls Robinsons Land (RLC), Universal Robina (URC), and Cebu Air (CEB).
The company also has significant minority stakes in Meralco (MER), PLDT (TEL), and BPI. Again, the combined value of JGS’ stake in these six listed companies is nearly P400 billion or almost double its market cap of P200 billion.
When trying to decide whether it’s better to invest in the listed subsidiary or in the holding company, we like to ask ourselves the following questions:
Is the parent conglomerate trading at a steep discount to the combined value of its operating units? If it is, does it have any underperforming subsidiaries that would justify this? If it seems that there are operating units that subtract rather than add value to the conglomerate, we would recommend looking at the listed subsidiaries instead.
Once we start looking at listed subsidiaries, we must also consider if the standalone company is trading at a discount, either to its historical valuation or the valuation of comparable companies.
If it seems that the market has already priced in the listed unit’s prospects, then it might be better to invest in its parent instead. Otherwise, we would recommend buying the listed subsidiary.
Our preference is usually to invest in standalone companies, as it allows for a more targeted approach to investing.
However, now that the stock market has been on a four-month winning streak, we find that some stocks are now very close to their fair values while their parent companies have been relatively unloved.
In particular, the Big Three banks are trading very close to their historical average P/B ratios while their parent companies SM, AC, and GTCAP still have wider-than-usual discounts to their net asset values. JGS has also been severely battered in recent years due to the underperformance of its operating units but has now become too cheap to ignore.
We find that a targeted approach to investing works best when only certain sectors are doing well. However, now that we appear to be on the cusp of a broad-based economic upturn, it would be best to get as much exposure to as many sectors as possible.
Buying into conglomerates can be a way to achieve that, without having to buy more than a dozen companies for your portfolio.
Financial market recommendations and comments on InsiderPH News belong solely to the analysts and institutions making them. They do not represent buy, sell or hold recommendations of InsiderPH News. Investments held by analysts or institutions may influence their recommendations. Investors should conduct their own research and carefully evaluate all relevant market information before making investment decisions. As always, the past performance of any investment does not guarantee its price appreciation in the future.
