- By Gene Chan, CFA
With markets at or near all-time highs, particularly in the U.S., a value investor often needs to venture far and wide to find attractive investment opportunities.
Emerging markets would be a place that deserves such a venture, given their massive underperformance versus the U.S. market in recent years. The chart below compares Vanguard's Emerging Markets (VWO) exchange-traded fund and the Total Stock Market ETF (VTI), which covers only the U.S.:
The intrinsic value of VWO
One emerging market in particular has caught my attention. The Philippines is a briskly growing Asian economy. In addition, it has a large population in the younger demographic groups:
As a result, the country's middle class is growing rapidly. It is expected to become a upper-middle income country this year, three years ahead of schedule. As a result, the Philippines seems like an ideal market to invest in.
But as a card-carrying value investor, I am not satisfied with just buying the country's ETF (EPHE). I went through the hard (but rewarding) work of scouring through many undervalued names in the Philippine stock market, coming across Empire East Land Holdings Inc. (PHS:ELI).
Empire East is a real estate developer and a subsidiary of Philippine real estate giant Megaworld (PHS:MEG), which owns roughly 82% of its shares. The company focuses mostly on mid-market real estate, which is ideal for investors who want to capitalize on the Philippines' burgeoning middle class.
The company's balance sheet is mostly made up of residential and condominium units and other real assets such as land. A quick calculation gives us a net current asset value of 1.09 Philippine pisos per share:
# of Shares
NCAV per Share
(In thousands of pisos, except per-share data, as of third-quarter 2018.)
As of time of writing, Empire East was trading at 0.50 pisos - less than half of its current assets, net of all debt. This means investors looking to buy property in the Philippines could do much better by buying Empire East instead and owning its real estate at half price.
Now it is probably not realistic to assume the savvy sales people at Empire East would liquidate their real estate portfolio quickly or within a single year, lest they saturate the market and transact at unfavorable prices. So we need an estimate of how much time they'll need to liquidate the holdings.
Currently, the company's annual revenue is running around a 2 billion pisos clip, which is about one-eighth of NCAV. Base on this assumption, it will take Empire East eight years to sell its portfolio without reinvesting the cash. After eight years, there will be no cash flow. We will aslo conservatively assume the properties will be sold at book value without any profit (despite the fact Empire East has been achieving a profit margin for most of its existence). This cash flow stream results in an internal rate of return of 22% based on today's market price of 0.50 pisos.
In summary, Empire East allows investors to indirectly own real estate in one of the world's fastest-growing economies at less than half the price. As a business, it is trading at a depressed valuation, thus potentially offering high future returns. Whichever way we look at it, Empire East is an attractive investment for the patient value investor.
Disclosure: I am long PHS:ELI and VWO.
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This article first appeared on GuruFocus.
The intrinsic value of VWO