CASE 6-1

Managerial Finance Concept: Success of management in its strategies and plans is reflected in performance

Financial Analysis Technique: Cash Flow Analysis

Decision Context: An investor wants to determine whether a real estate developer succeeded in managing the Resources of the company and his investment

Fernan Arellano was thinking about his shareholdings in one of the countrys leading real estate companies, Philippine Realty and Holdings Corporation(Philrealty). He received an invitation to to attend the annual stockholders meeting of Philrealty at a time when he was thinking whether to hold on to his shares in Philrealty or to sell them in the exchange. To help in his decision, Arellano wanted first to conduct an analysis of the financial statement of Philrealty.

Arellano saw from the 1993 annual report that Philrealtys strategy for the year 1993 influenced the financial performance of the company so drastically that financial ratios were very different compared to 1992. Arellano looked first at the cash flows statement for 1993. Next he planned on looking at the companys financial ratios so that he would know whether to keep his shares of stocks or not.

Background

Arellano worked as a financial analyst for a commercial bank in Iloilo City.

After earning his business degree from Central Philippine University in Iloilo City 5 years ago, he first worked a a commercial bank. After saving for four years, he decided to try his hand in stock market investing. Unlike other investors , Arellano realized that he could not attend to the investment because of work. He thus decided to invest in just one publicly listed company, Philrealty. His decision came after being impressed by what he saw in 1992 in Pasig, Metro Manila. Philrealtys two projects at the Ortigas Center, the Philippine Stock Exchange Center and the Alexandra, were successes, and he believed that Philrealty would be a main beneficiary of the development of the area as a business center.

When Arellano invested in Philrealty, he expected a maximum gain on his funds in one or two years. He kept money in real estate because he believed that it was there where high returns were possible in the next 5 years. Arellano believed that he was right in picking Philrealty as demonstrated by its success in selling Tower 1 of the Philippine Stock Exchange Center, the continuing increase in prices of its unsold units and the good prospects for Tower II. In analyzing the performance of Philrealty, he focused on the direction of its investment and financing. He believed that its stock price in the future would be determined by the companys ability to sustain its success in real estate projects.

Projects of Philrealty

Philrealtys main real estate projects were three residential condominium projects: The Alexis, The Alexandra and La Isla, and an office condominium, the Philippine Stock Exchange. The Alexis and The Alexandra were successful projects at the high end of the condominium market that were sold out prior to 1993. The prices of their units increased in an active resale market in 1994. La Isla condominium, the latest project of the company, featured modern facilities and state of the art security and maintenance systems. La Isla offered 4 types of residential units: 274 sq.m. two-bedroom units called Capri Menor; 310-sq.m. three-bedroom units called Capri Mayor; and two three-bedroom, one-den units called Mallorca (570 sq.m) and Ibiza (528 sq.m.). Ten units in La Isla were sold by year end 1993.

The largest project of Philrealty was the twin tower office and commercial condominium called the Philippine Stock Exchange Center. Originally named Tektite Towers, it was renamed after members of the unified Manila and Makati Stock Exchanges voted on March 20, 1993 to make it their principle office. It was later donated by Philrealty to PSE. By the end of 1993, all of the office and commercial units of Tower 1 had either been sold or leased. Buyers and tenants undertook the finishing and/or improvement of their units. A separate company managed the property which Philrealty turned over in March 1994.

Philrealty Management Strategies

In a letter to the stockholders in 1993, Chairman and President Walter W. Brown stated that the strategy of management for the year was one of consolidation in the face of uncertainties were due to the adverse electric power situation and the ongoing difficulties in unifying the 2 exchanges. Frequent brownouts disrupted factories and commercial activities but President Fidel V. Ramos acted quickly to build new power plants and solved the power problem by mid-1994. While there was agreement to unify the two exchanges and make Tektite Tower the principal office, members of the Makati Stock Exchange balked at transferring to the Ortigas Center. Eventually, the unification was achieved through an electronic link up of the two locations, resulting in common trading under a single price system which turned out to be acceptable to the government and the business community.

The comparative financial statements of Philrealty for 1992 and 1993 are shown in Exhibit 1.

The operating strategy of management in 1994 was to reduce the number of units for sale to the public in 1993 in expectation of better prices when business conditions improve. The volume of sales was only P420 million in 1993 compared to P1,090 million in the previous year. Management estimated that, as a result, the value of the units available for sale by year-end 1993 had gone up to P1,180 million. It also reported an increase in average selling price per unit by 33 percent, from P29,000 per sq.m. in 1993 to P38,500 per sq.m. in 1994. Management sought to increase operating cost efficiencies in 1993 and reported that expenses as a ratio of income were reduced from 86 percent in 1992 to 75 percent in 1993.

The long-term strategy of management, as stated in the 1993 annual report to the stockholders, was to sustain a favorable level of development and sales. Management reported that, in support of this strategy, it had taken such steps as: acquiring more property for its land inventory; declaring, with board approval, a 10 percent stock dividend and a 2-for-1 right s offer; and investing a portion of profits in oil exploration and development.

Management emphasized that its main business would continue to be real estate development where where its resources and expertise were concentrated. It also expressed its confidence in being able to identify and develop a continuing stream of real estate projects in the future. Diversification of investments, like the one in oil exploration, was to be done on a limited scale.

GUIDE QUESTIONS

c.) Calculate the financial ratios for 1992 and 1993. What are the strengths and weaknesses of Philrealty based on the cash flow and financial ratio analysis?

PHILIPPINE REALTY & HOLDING CORPORATION Balance Sheet December 31, 1993 & 1992 (In million pesos) 1993 1992 ASSETS REAL ESTATE HELD FOR SALE 162.2 162.2 Land held for development and sale Condominium units 294 538.4 994.6 15.4 34.7 258.7 Completed In-progress 761.2 1182.1 7.7 7.7 CASH TEMPORARY CASH INVESTMENTS RECEIVABLES Trade Others 413.6 20.8 434.4 707.0 21.0 728.0 INVESTMENTS 1.2 Shares of stocks of affiliated companies Others 3.1 37.6 40.7 4.0 9.3 16.9 18.1 3.5 18.2 PROPERTY AND EQUIPMENT OTHER ASSETS, PREPAYMENT AND DEFFERED CHARGES TOTAL ASSETS 1685.9 1812.5