Wednesday, August 31, 2022

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TODAY’S TOPICS
IN FOCUS CNVRG is the worst performing index stock, plagued by stalling net income
_____________
and subscriber growth, higher expenses, and uncollected receivables.
Consensus estimates remain too optimistic in our view, and our advice is to
underweight the stock.
CNVRG
P17.96, -3.44% MBT's dividend yield has now risen to 5.67%, well above that of its two
biggest peers. This is another reason to overweight the stock.
Odds of a 75 bps hike from the US Fed have risen significantly, and we believe
BSP Gov Medalla will stick to his guidance of only one or two more hikes of 25
bps. This likely means that the peso will weaken further.
KEEPR plans to buy up to 50% of Williams & Humbert, which we expect to be
positive for the stock.

: CNVRG

Converge is the worst performing index stock YTD (-44%) and is down 60% from
its all-time high. And for many investors, it had one of the most disappointing Q2
results given that it was still considered a growth stock at the start of the year. Net
income in H1 was only 41% of consensus estimates which had already been

financial performance to see if there is any room for optimism.

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Stalled. Masked by strong revenues and lofty YoY growth figures, CNVRG actually
IN FOCUS started stalling a few quarters ago. As the chart above shows, operating income has
_____________ been practically unchanged for three quarters and even peaked in 3Q21. Net income,
on the other hand, has plateaued for the past four quarters. This is even more
remarkable given that the company got a boost from lower effective corporate tax
CNVRG rates in recent quarters. But it is not just net income that has stalled. Quarterly
P17.96, -3.44% additional subscribers appear to have peaked as well in 3Q21 and net new users in
2Q22 was the lowest since the company went public in 2020. More importantly,
Converge has fallen behind PLDT in terms of subscriber take up over the past twelve
months. Management tried to arrest the decline in new users by waiving upfront
fees late last year. However, this promotion apparently backfired as it attracted low-
quality accounts that caused churn to dramatically increase.

Higher expenses
quarters so this is not the source of weakness in terms of earnings. Operating
margin, on the other hand, averaged 40% in the first nine months of 2021 and
peaked at 43% in 3Q21 but this has since dropped substantially to 34% as of 2Q22.
A chunk of this is due to bad debts (discussed in more detail below) but other
operating expenses also increased to 22% of revenues from only 16% in 3Q21. The
17-Q does not break down opex but we believe that the expansion to Visayas

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and Mindanao is beginning to eat into margins. Investors can think of this as
IN FOCUS necessary investments for future growth but it remains to be seen if this regional
_____________ expansion will significantly boost subscriber take up. Another drag is from financing
charges. With net debt increasing by Php14.0B YTD, Q2 interest expense jumped to
Php442M, 85% higher QoQ and more than triple YoY.
CNVRG
P17.96, -3.44%

Bad debts. Our biggest concern relates to uncollected receivables. As the chart
above shows, Php2.14B worth of receivables from residential users were more than
90 days past due at the end of June, nearly 150% higher compared to the same
period last year. Corporate accounts were less delinquent but there was also a large
increase YoY in accounts more than 90 days overdue. Looking at it another way,
only 34% of residential accounts were current at end-2Q, a big deterioration from
45% 12 months ago. This may have been partly due to the higher churn in the past
several months but it may foreshadow further increases in bad debt provisions from
Q3 onwards. We expect more pressure because of: a) higher inflation which affects
affordability, b) the return of face to face classes which reduces the need for home
broadband, c) the low ratio of subscribers who are current in their payments, and d)
increased competition. The last is relevant especially when looking at the chart
below. The shrinking market share of CNVRG in terms of wired net adds should be
a red flag for investors.

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IN FOCUS
_____________

CNVRG
P17.96, -3.44%

Downgrades. Looking back, we highlighted the same issues mentioned above just
after the company listed. We said the pandemic had pulled forward a lot of the
demand for home broadband and that net adds will slow down significantly. We also
mentioned that Converge was pushing into income groups that have lower capacity
to pay, increasing the likelihood of bad debts. Lastly, we warned that PLDT and even
Globe were not pushovers in this space and that competition was likely to heat up.
It took longer than we expected but our predictions are finally coming true. This is
being reflected in earnings downgrades for 2022 (-10.3% in six months) and 2023
(-11.7%). Consensus estimates remain too optimistic, in our view, and further
adjustments are necessary. The median profit forecast for this year, for example, is
still at Php9.2B whereas 1H22 annualized is only Php7.9B. For 2023, the consensus
is at Php11.6B which implies growth of +26% despite the fact, as shown above, that
earnings have been flat for four straight quarters. Our advice, therefore, is to
underweight CNVRG.

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SIGNIFICANT DIGITS
IN FOCUS
_____________ -month yield has now risen
to 5.67%. This is the second highest among the nine universal banks we follow and
well above that of its two biggest peers. We believe the high yield was made possible
MBT by the b
P53.45, 0.00% latter may not sound relevant but it differentiates MBT from most of its peers
because it protects the bank from a potential surge in bad loans (i.e. possibly from
Monetary the effects of high inflation) that could eat into profits and capital. In any case, this
Policy is another reason why clients should overweight the stock.

Exchange Rates

RANDOM THOUGHTS

1.
than most people thought it would be. It should be very clear now that taming
inflation will come at the cost of economic growth and equity prices. One of the
few winners in this scenario is the US dollar. Odds for a 75 basis point hike from
the Fed next month have risen significantly and there is even talk that the
terminal rate could be as high as 5.0%. This is likely to pose problems for central
bankers in emerging markets, including the BSP. Even after increasing the RRP

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rate by a total of 125 basis points, the peso has appreciated by a mere 0.09%
IN FOCUS and is underperforming both the Indonesian rupiah and Indian rupee despite
_____________ much smaller hikes from these countries' central banks (25 bps and 50 bps since
July 13). Given that Gov. Medalla has flagged only one or two more hikes of 25
bps each until the end of the year, and previously said that surprise monetary
Monetary announcements only work once, we believe that he is going to stick to forward
Policy guidance. This likely means that the peso will weaken further and hit a new low
soon.
Exchange Rates

KEEPR
P1.27, +3.25%

2. KEEPR disclosed yesterday that it plans to buy up to 50% of Williams & Humbert
(W&H). We predicted this potential acquisition back in November (just before the
FOO) and s
brandy which accounts for about 60% of sales. The terms of the acquisition are
subject to the results of the fairness opinion that will be done by Isla Lipana & Co. To
reiterate, we expect this to be positive for KEEPR although the exact value to be
created for shareholders will depend on pricing of the deal. The benefits may also
accrue over a longer time horizon that we initially thought as inflation has surged in
Europe since we made the prediction. In any case, it may take a few more quarters
of strong growth to convince the market that the stock is a bargain at current levels.

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Unit 2904-AEast Tower, Philippine www.mytrade.com.ph asc.research@abacus-sec.com.ph 8667-8900 (63.2) 634-5206

Stock Exchange Centre, Exchange
Road, Ortigas Center, Pasig city 1600

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