San Miguel Corporation - Credit Suisse

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01 June 2011Asia Pacific/Philippines

Equity ResearchConglomerates (Conglomerates)

San Miguel Corporation (SMC.PS / SMC PM)

INITIATION

Philippines Incorporated ■ Dominant and diversified. We initiate coverage of SMC with an

OUTPERFORM rating and a target price of P135. SMC is a diversified conglomerate with dominant exposure to the Philippines beverage, food, packaging, oil refining, and power and utility sectors. Its traditional businesses consist of iconic, market-leading food and beverage brands that have weathered competition and volatile economic cycles for decades. Utilising its stable cash flows from its traditional businesses, SMC has taken advantage of rare privatisation opportunities over the past three years to invest in strategic companies in the energy, power generation and infrastructure sectors.

■ Expansion paying off. We expect the expansion and diversification programme to provide SMC with a 2009-2013 EBITDA CAGR of 35%—levels far superior to the market’s estimated EBITDA CAGR of 14% for the same period. Moreover, SMC’s conglomerate structure has allowed for expansion with risk mitigation. As of end 2010, SMC’s net gearing ex finance leases stood at 0.88x—roughly at par with average gearing levels for the Philippines companies in the power and infrastructure space.

■ Target price of P135 represents 22% potential upside. Our NAV determined TP incorporates base-case valuations for SMC’s businesses, a 20% conglomerate discount, and full share dilution resulting from the US$970mn combined equity and exchangeable bond issue concluded on 5 May 2011. SMC is currently trading at 14.3x 2011E EPS, at par with market valuations, notwithstanding better than market EPS growth of 31% for 2011 and 36% for 2012. Note that SMC is among the top-five Philippine stocks by market cap but currently has zero weighting in the Philippine MSCI index. This should change going forward, as both free float and share liquidity have significantly improved after the 5 May fund raising.

Share price performance

050

100150200

Jun-09 Oct-09 Feb-10 Jun-10 Oct-10 Feb-110100200300400

Price (LHS) Rebased Rel (RHS)

The price relative chart measures performance against the PHILIPPINE SE COMPOSITE INDEX which closed at 4244.64 on 31-05-11 On 31-05-11 the spot exchange rate was P43.19/US$1

Performance Over 1M 3M 12M Absolute (%) -25.5 -33.7 62.2 Relative (%) -24.6 -45.5 31.0

Financial and valuation metrics

Year 12/10A 12/11E 12/12E 12/13ERevenue (P mn) 246,109.0 561,606.1 593,114.6 642,016.2EBITDA (P mn) 44,234.0 76,991.6 89,349.7 98,682.5EBIT (P mn) 34,777.0 62,569.6 72,461.8 80,683.7Net income (P mn) 13,739.0 19,138.7 26,823.6 33,388.0EPS (CS adj.) (P) 5.90 7.73 10.53 13.11Consensus EPS (P) n.a. n.m. n.m. n.m.EPS growth (%) 133.3 31.2 36.2 24.5P/E (x) 18.8 14.3 10.5 8.5Dividend yield (%) — — — —EV/EBITDA (x) 12.9 7.3 6.3 5.4P/B (x) 0.92 0.91 0.86 0.78ROE 4.9 6.6 8.5 9.7Net debt/equity (%) 118.2 104.0 94.4 77.4

Source: Company data, Thomson Reuters, Credit Suisse estimates.

Rating OUTPERFORM* Price (31 May 11, P) 110.80 Target price (P) 135.00¹ Chg to TP (%) 21.8 Market cap. (P mn) 255,769 (US$ 5,923) Enterprise value (P mn) 559,113 Number of shares (mn) 2,308.39 Free float (%) 16 52-week price range 185.0 - 67.0 *Stock ratings are relative to the relevant country benchmark. ¹Target price is for 12 months.

Research Analysts Dante Tinga, Jr.

63 2 858 7751 [email protected]

Haj Narvaez 63 2 858 7752

[email protected]

Horace Tse 852 2101 7379

[email protected]

01 June 2011

San Miguel Corporation (SMC.PS / SMC PM) 2

Focus charts Figure 1: Iconic, dominant consumer brand Figure 2: Expansion into new businesses paying off

Brewery market share

SMC94%

Others6%

050

100150200250300

2007A 2008A 2009A 2010A

Revenues from new businessesRevenues from traditional businessSMC EBITDA

(Pbn)

Source: Canadean Beer Trends Report 2009, Credit Suisse Source: Canadean Beer Trends Report 2009, Credit Suisse

Figure 3: SMC increasingly diversified Figure 4: Four-year EBITDA CAGR of 35%

2011E EBITDA mix

Food12%

Packaging5% Bev erage

27%

Energy (Oil refining)

26%

Pow er Generation

30%

0

20,000

40,000

60,000

80,000

100,000

120,000

2009A 2010A 2011E 2012E 2013E

Beverages Food PackagingPower Generation Energy (Oil Refining) Others

EBITDA CAGR = 35%

(Pmn)

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Figure 5: ROEs rising, balance sheet deleveraging Figure 6: EPS is still growing

0.0

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2010A 2011E 2012E 2013E-2

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68

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12

Net D:E (w/o PV of PSALM lease)Net D:E (w/ PV of PSALM lease)

ROE (%)

Net Gearing x (%)

ROE

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ROE

30%

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SMC Real Estate Banks Conglos Power,Energy, &

Utilities

Telcos

2010 to 2013E EPS CAGR%(%)


01 June 2011


Philippines Incorporated San Miguel Corporation (SMC) is a diversified conglomerate with dominant exposure to the Philippines beverage, food, packaging, oil refining, and power and utility sectors. It is among the 5 largest Philippine companies in terms of market capitalization. SMC concluded a US$970m combined equity and exchangeable bond issuance last 5 May 2011 to raise funds for its continued expansion into the power, energy, and infrastructure space as well increase free float and share liquidity.

Dominant and diversified SMC’s iconic beverage, food and packaging businesses consist of traditional, market leading brands that have weathered competition and volatile economic cycles for decades. The stable cash flows produced by its traditional businesses serve as SMC’s platform to expand into energy and infrastructure. The company took advantage of rare privatisation opportunities over the past three years to acquire stakes in strategic and dominant on-going oil refining, electric utilities and power generation concerns.

Expansion paying off We expect SMC’s diversification programme to provide the company with EBITDA CAGR of 35% from 2009 to 2013—levels far superior to that of the overall Philippines market’s estimated EBITDA CAGR of 14% for the same period. Moreover, SMC’s conglomerate structure has allowed for expansion with risk mitigation. As of end 2010, SMC’s net gearing, excluding the present value of financial leases, stood at 0.88x. Note that this is not too different from net gearing for power and infrastructure companies and conglomerates that averaged 0.76x from 2007 to 2010.

Target price of P135 represents 22% upside Our NAV-determined target price incorporates base case valuations for SMC’s subsidiaries, a 20% conglomerate discount, and full-share dilution resulting from the recent share and exchangeable bond sale.

Figure 7: San Miguel Corporation – EBITDA by business group (in P mn)

0

20,000

40,000

60,000

80,000

100,000

120,000

2009A 2010A 2011E 2012E 2013E

Bev erages Food Packaging Pow er Generation Energy (Oil Refining) Others

EBITDA CAGR = 35%

(Pmn)

Source: Company data, Credit Suisse estimates

01 June 2011


Dominant and diversified San Miguel Corporation ranks #4 in terms of market capitalisation among all companies listed on the Philippines Stock Exchange. For most of its 120-year history, SMC has been an iconic Philippines food and beverage company. SMC, however, has undergone significant changes over the past three years. In an attempt to boost SMC’s growth trajectory, the company has utilised cash from its dominant and cash flow-rich beverage, food, and packaging businesses to fund acquisitions – the bulk of which are in energy and infrastructure.

Figure 8: Major SMC investments and divestments since 2007

2008

2007

2008

2007 - SMC s o ld a 35% s take in its domes tic pac kag ing bus ines s to Nihon Y amamura Glas s Co., L td

Oct 2008 - A c qu ired 27% of pow er d is tr ibu tor , Man ila Elec tr ic Company

2009 M ay 2009 - SMC s o ld a 43.3% s take in San Migue l Brew ery , Inc . to its long time s tra teg ic par tner , K ir in Ho ld ingsJu l to De c 2009 - W on pub lic b idd ing f o r L imay , Sua l and San Roque pow er p lan tsSe p 2009 - A c qu ired 35% of Pr iv a te In f ras truc ture Dev e lopment Corpora tion ( "PIDC") w h ic h w ill dev e lop the Tar lac -Pangas inan-La Un ion Ex pres s w ay ( "TPLEX")De c 2009 - A c qu ired 65% of Cos pak, a pac kag ing trad ing f irm in A us tra lia

2010

2011

Jan an d M ay 10 - A c qu ired c oa l min ing c ompanies Daguma, Bonanz a, and Su ltan Energy - c oa l min ing c ompaniesA p r 10 - ( i) W on pub lic b idd ing f o r the IPPA c ontrac t f o r Ilijan pow er p lan t; ( ii) A c qu ired 93% of Trans A ire Dev e lopment Ho ld ings Corpora tion ( "TA DHC", f o rmer ly know n as Catic lan In ternationa l A irpor t Dev e lopment Corp) w h ic h ho lds c onc es s ion to dev e lop and opera te Catic lan A irpor tJu n , A u g an d Oct 10 - A c qu ired 37.8% of PetronJu l 09 , M ay an d Oct 10 - A c qu ired 41.5% of L iber ty Te lec om Hold ingsJu l to A u g 10 - A c qu ired 100% of Be ll Te lec ommunic a tions ( "Be llTe l")A u g 10 - A c qu ired Globa l 5000 and c ons o lida ted ow ners h ip in San Roque, Sua l, Ilijan and L Imay pow er p lan ts in G loba l 5000, now know n as SMC Globa l Pow er Ho ld ings Corp , w h ic h a ls o ow ns 6% in teres t in Mera lc oOct 10 - A c qu ired 10.1% of Indoph il Res ourc es , a go ld and c opper min ing c ompanyNo v to De c 10 - ac qu ired 51% of Un iv ers a l LRT (BV I) L imited , w h ic h w ill dev e lop the MRT-7 lineDe c 10 - ( i) ra is ed s take in Petron to 68% by ex erc is ing c a ll op tion , and ( ii) ac qu ired 40% of Eas tern Te lec ommunic a tions

Jan 11 - San Migue l Proper ties , Inc . ac qu ired a 7% s take in Bank o f Commerc e (pend ing regu la tory approv a l)Fe b 11 - Petron ac qu ired 35% of Manila Nor th Harbor Por t Inc .

Source: Company data, Credit Suisse

It is worth noting that SMC is the only top-five stock in terms of market cap in the Philippines that is not included in the Philippines MSCI index. The omission is due to lack of share liquidity on the part of SMC. This should change going forward, as the placement concluded on 5 May 2011 has improved SMC’s free float from 8% to 16%.

Figure 9: Top 10 Philippines stocks in terms of market cap (MSCI weighting)

-

2,000

4,000

6,000

8,000

10,000

12,000

TEL SM MER SMC AEV AP ALI BPI AC JGS

(US$ mn)

(9.39%)

(11.05%)

(7.40%)(0.00%)

(7.85%) (5.72%) (8.99%) (8.49%)(5.68%) (0.00%)

Source: Company data, Credit Suisse estimates as of 20 May 2011

SMC among the top-five stocks in Philippines in terms of market cap

01 June 2011


Diversification is strategic… Overall ROE for the power, energy, and utility sector has trended higher than that for the overall market (see Figure 10). In our view, this reflects the historical under-investment in the sector. As a result, the market, as well as the regulatory forces, is driving up the returns on power, energy, and utility assets. We believe that this is one important reason why market capitalisation for power and utility firms as a percentage of total listed market cap in the Philippines, has increased from 10% in 2006 to 36% in 2010 (see Figure 11).

Figure 10: Power, energy and utility ROEs vs market Figure 11: Market caps for utility and energy stocks

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Pow er/Utilities Rest

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10,000

2006 2007 2008 2009 2010

Rest Energy & Utilities

Energy & Utilities = 36%

(Pbn)


In our view, SMC’s expansion and diversification strategy is reflective of these trends. It should be pointed out that SMC’s ROE’s have steadily improved along with the company’s acquisition of Petron, Manila Electric Company and various power generation assets (Figure 12). The improvement in SMC’s ROEs is consistent with the superior ROEs enjoyed by Philippines infrastructure and power companies versus the market average.

Figure 12: SMC’s diversification plans resulting in improving ROEs

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2009A 2010A 2011E 2012E 2013E

(%)


01 June 2011


…while also opportunistic SMC’s decision to diversify and expand took place during a period (2007 to 2010) when the Philippines government was privatising much of its power, energy and infrastructure assets. Note that:

■ SMC’s acquisition of these assets has allowed the company to be a dominant player in key sectors of the Philippines economy. We view much of the assets purchased (e.g., Petron, Meralco and the power generation facilities) as difficult-to-replicate strategic entities operating in industries with significant barriers to entry.

■ SMC’s acquisition of these assets has allowed the company to be a dominant player in key sectors of the Philippines economy. We view much of the assets purchased (e.g., Petron, Meralco and the power generation facilities) as difficult-to-replicate strategic entities operating in industries with significant barriers to entry.

■ The bulk of government asset sales took place during the global financial crisis (2008 to 2009). Hence, competition for these assets was largely limited to Philippines players; thereby, keeping the sale valuations at reasonable levels. In fact, all of SMC’s power and energy acquisitions (for those that are publicly listed) are now trading well above their acquisition price, while the generation acquisitions were purchased at prices below our estimated current replacement cost.

■ SMC acquired companies and projects that for the most part have extensive operating track records and generate strong cash flows. These businesses (e.g., Petron, Meralco and the power generation facilities) immediately begin paying for themselves post-acquisition and are able to use their own cash flows and balance sheets to raise cash and fund expansion. This creates a new cycle of growth for SMC without burdening the parent firm with additional debt. As of end-2010, excluding the finance lease obligations related to the power generation assets but including SMC’s 970.5 mn outstanding ‘Series 1’ preferred shares, we estimate the company’s consolidated net debt-to-equity at 0.88x.

■ The new businesses open up new growth opportunities for SMC. The alternative growth strategy was to expand the traditional businesses beyond the Philippines. However, management believed that remaining within the Philippines borders but growing across sectors was a better strategy from a risk-reward point of view. Management arrived at this decision particularly in the context of the considerable investment opportunities available in the Philippines because of the government’s privatisation programmes from 2007 to 2010.

Figure 13: Revenue by geography (%) Figure 14: Revenue mix by business (%)

11.9 4.8

88.1 95.2

2009 9M2010

International Domestic

11% 4%

43%

13%

38%

21%

25%46%

2009 2010

Packaging Food Bev erage Pow er Oil Refining


These were not just ordinary assets that were up for sale

In our view, the burden of growth is manageable

SMC opted for opportunities at home rather than abroad

01 June 2011


Management to sustain initiatives SMC’s current management is committed to pursuing the company’s expansion into energy and infrastructure. At present, SMC has 2,554.5 mn total common shares and 970.5 mn preferred shares outstanding. Top Frontier represents the controlling shareholder in SMC with 57.1% ownership of all common shares in the company. Note that there have been significant changes to SMC’s shareholder structure over the past two years. These include: (1) Top Frontier (TF) acquiring a controlling stake in SMC, and SMC also acquiring a significant stake in TF and (2) the conversion of the Coconut Industry Investment Fund’s (CIIF) shares from common (voting) shares to non-preferred, non-voting shares. We believe these changes were meant to achieve greater management stability within SMC, and will help ensure that the current strategic thrusts continue.

Figure 15: San Miguel Corporation – key officers

Eduardo M. Cojuangco Jr.Chairman & ChiefExecutive Officer

Ramon S. AngVice Chairman & President &

Chief Operating Officer

Ferdinand K. ConstantinoChief Finance Officer

& Treasurer

Virgilio S. JacintoCorporate Secretary &

General Counsel

Aurora T. CalderonSenior Executive Assistant

to the President & COO

Roberto N. HuangPresident, San Miguel

Brewery Inc.

Carlos M. BerbaManaging Director,San Miguel Brewery International Limited

(BVI)

Francisco S. Alejo IIIPresident San Miguel

Pure Foods Company Inc.

Gerardo C. PayumoPresident, Ginebra

San Miguel Inc.

Ferdinand A. TumpalanPresident, San Miguel Yamamura Packaging

Corporation

Eric O. RectoPresident, Petron

Corporation

Dr. Allan T. OrtizPresident, SMC Global Power Holdings Corp.

Lorenzo G.Formoso III

Head, Infrastructure Projects

Andrew L. HuangHead,

Telecommunications Projects

Source: Company data

01 June 2011


SMC ownership structure At present, Top Frontier is the largest common shareholder in SMC with a 57.1% stake. TF also has the option to purchase the ECJ (Cojuangco) group’s remaining 19.3% stake in SMC. On the other hand, the Coconut Industry Investment Fund (CIIF) is the largest single shareholder of the non-voting preferred shares.

Figure 16: San Miguel Corporation – ownership structure as of 27 May 2011

San Miguel Corporation

Others

ECJ Group

Top Frontier57.1%

19.3%

16.2%

Preferred shareholdersCommon shareholders

49% of total common stock /

67% of total capital stock outstanding

EBUnderlying

shares 7.4%

Coconut Industry

Investment Fund77.7%

Others22.3%


Figure 17: SMC’s common shareholders Number of common Stake shares (mn) % Comments Top Frontier 1,457.7 57.1 Largest shareholder in SMC ECJ Group 493.9 19.3 Group affiliated with former Amb. Cojuangco Exchangeable bond underlying shares 189.1 7.4 Exchangeable into common shares by Nov-11 Others 413.7 16.2 Free float Total issued and outstanding common shares 2,554.5 100.0 Treasury shares 714.1 Total issued common shares 3,268.6


Figure 18: SMC preferred (non-voting, redeemable, with 8% coupon) shareholders Number of Pref. sh (mn) % Comments Coconut Industry Investment Fund 754.1 77.7 Converted from voting common shares in 2009 Others 216.4 22.3 Total issued and outstanding preferred shares 970.5 100.0


01 June 2011


Common shareholders After the share and exchangeable bond sale on 5 May 2011, total issued and common shares of SMC (including underlying shares associated with the Exchangeable Bond issue) stands at 2,554.5 mn.

Top Frontier

Holding Company Top Frontier (TF) currently owns 57% of the common shares of SMC. It should be pointed out that TF has call options to purchase San Miguel common shares held by the ECJ Group (Eduardo M. Cojuangco Jr.), representing 19.3% of SMC’s common shares at P75 per share. The call options expire 19 November 2012. Note that:

■ TF acquired its stake by buying 857,115,914 SMC common shares from SMC Retirement Fund at P75 per share n November 2009.

■ In March 2010, TF exercised a call option on 327,000,000 SMC common shares owned by Q-Tech at P66 per share and, at the same time, purchased 79,460,178 SMC common shares owned by the public at P75 per share through a tender offer. Following the tender offer, 1,943,906 SMC common shares were purchased in the market, at P75 per share.

■ In March 2011, TF acquired 301,666,675 SMC common shares owned by Q-Tech at P70 per share.

In early 2010, SMC acquired 49% of the common shares and 100% of the non-voting, redeemable, participating preferred shares of TF, resulting in the cross shareholding between SMC and TF. Such investment gives SMC interest over 67% of TF’s regular and special dividends. The investment consists of

■ 2,401,960 common shares of TF from its unissued stock; and

■ 2,598,040 non-voting, redeemable, cumulative, participating preferred shares with a preferential dividend rate of 3% per annum

Note that

■ Approximately 40% of the remaining common shares of TF are held by Mr Iñigo Zobel, who is also a member of the Board. A substantial portion of the remaining shares is owned by Master Year Limited and other nominal stockholders.

■ As of 31 December 2010, SMC’s total investment in TF amounted to P92.5 bn and is accounted for in SMC’s balance sheet as an investment.

■ In a statement to Bloomberg on 7 January 2010, SMC’s President and COO Ramon S. Ang said that: “An investment in Top Frontier is in the long-term interest of the shareholders of San Miguel. This investment will ensure the continuity of the ongoing business operations and strategic plan of San Miguel.” The same Bloomberg article mentioned that the SMC board approved the investment in TFHI based on TFHI agreeing to sell its San Miguel shares in an ’orderly manner’ to broaden the company’s shareholder base.

ECJ Group

The group of Eduardo "Danding" Cojuangco currently owns 19.3% of SMC common shares. Note that TF has call options due in November 2012 to acquire these shares. Ownership of the ECJ shares have been subject to a dispute between the Philippines Commission on Good Government (PCGG) and Mr Cojuangco since 1986, although the Supreme Court in a decision penned on 12 April 2011 declared that “the block of shares in San Miguel Corp. in the names of respondent Cojuangco et al... is the exclusive property of Cojuangco et al as registered owners." This affirmed a similar decision made by a lower court in 2007. However, in our view, the shares held by the ECJ group are unlikely to be sold to the market until legal ownership over the shares is resolved with finality.

Top Frontier is the single biggest shareholder in San Miguel

01 June 2011


Exchangeable Bond Holders

SMC issued US$600 mn of exchangeable bonds on 5 May, 2011. The bonds mature on 5 May 2014 and come with a 2% annual coupon payable on a semi-annual basis. Other key characteristics of the exchangeable bonds are as follows:

■ Reference share price is P110, equal to the offer price of the concurrent equity offering, while the initial exchange price is P137.50.

■ The bonds are denominated in US$200,000 and multiples thereof. The initial exchange ratio is 63,040 shares per bond. At a fixed exchange rate of P43.34/US$, the US$600 mn exchangeable bond issue translates to 189.1 mn shares, assuming the shares are exchanged in full. For purposes of computing shares outstanding and SMC valuations, we assume the entire US$600 mn EB issue is exchanged into shares.

■ The bond is exchangeable into common shares at the election of the bondholders at any time from 41 days after closing date to 7 days before maturity date.

■ If the arithmetic average of the volume weighted average price for one share for 20 consecutive trading days ending on and including each reset date (each a ’reset period’) is less than the exchange price as adjusted in effect on the relevant reset date, the exchange price shall be reset with effect from the relevant reset date to equal the reset price. Any such adjustment shall be limited so that the exchange price as adjusted shall not be less than the applicable reset price floor.

■ The rest price floor, at anytime, is 80% of the initial exchange price.

■ The reset dates are scheduled on the fifth day of February, May, August and November each year, starting on 5 November 2011 and ending with a final reset date of 5 February 2014.

Others

We estimate SMC’s free float at 16.2%. At this point, we do not classify the 189.1 mn underlying shares associated with the exchangeable bonds as part of the free float. However, SMC management has publicly said that it prefers to have free float of at least 20%.

Preferred shareholders In 2009, SMC issued “Series 1” preferred shares as part of its cash raising programme to raise funds needed for the company’s diversification plan and offer minority shareholders not keen on the diversification an opportunity to lock in the value of their shares and receive a healthy yield. The preferred shares with a dividend rate of 8% per annum are cumulative, non-participating, non-voting and redeemable in whole or in part at the sole option of SMC at the end of three years from the issuance of the preferred shares in 4Q 2009 at P75.00 per share, plus any accumulated and unpaid cash dividends.

Coconut Industry Investment Fund

The Philippines government accepted SMC’s offer to convert the 753.9 mn San Miguel Corporation common shares held by the Coconut Industry Investment Fund (CIIF) national government into “Series 1” preferred shares. The preferred shares held by CIIF account for 77% of all preferred shares outstanding.

Others

The balance of the preferred shares are held by pension funds and other investors.

2,554 mn shares issued and outstanding already include underlying shares from EB issue

Free float up from 8% to 16% and should increase further

01 June 2011


Brand built on iconic traditional businesses The first San Miguel beer was produced and bottled in 1890 in La Fabrica de Cerveza de San Miguel, the first brewery in Southeast Asia. From its original beer business at the turn of the twentieth century, SMC gradually expanded into food, packaging and other beverages. Today, SMC’s traditional businesses have grown to include a diverse range of consumer products. In our view, economies of scale resulting from SMC’s dominant market share in several of these consumer segments, coupled with extensive manufacturing, distribution and logistics facilities, provide significant competitive barriers.

Figure 19: Consumer business: Sales (P mn) 2007A 2008A 2009A 2010A Beer 54,906 62,767 64,780 68,392 Ginebra San Miguel Inc 13,455 15,428 19,549 22,688 San Miguel Purefoods 63,806 73,412 77,144 80,422 San Miguel Yamamura Packaging 18,778 19,859 19,696 23,438 Total sales for consumer businesses 150,945 171,466 181,169 194,941


Figure 20: Consumer business: Operating income (P mn) 2007A 2008A 2009A 2010A Beer 11,337 14,831 14,970 17,895 Ginebra San Miguel Inc 509 217 1,086 1,519 San Miguel Purefoods 2,459 1,932 4,653 5,906 San Miguel Yamamura Packaging 425 1,371 1,624 2,028 Total Operating Income for Consumer 14,729 18,352 22,333 27,348


Figure 21: Consumer business: Operating margin (%) 2007A 2008A 2009A 2010A Domestic beer 27.8 32.0 31.4 33.7 International businesses & others -8.7 -5.8 -7.6 -7.3 Aggregate beer 20.6 23.6 23.1 26.2 Ginebra San Miguel Inc 3.8 1.4 5.6 6.7 San Miguel Purefoods 3.9 2.6 6.0 7.3 San Miguel Yamamura Packaging 2.3 6.9 8.2 8.7 Aggregate margins for consumer businesses 9.8 10.7 12.3 14.0


Beer revenue and operating income appear most predictable

GSMI (liquor) profits could be volatile

Among SMC consumer businesses, the domestic beer segment appears to provide the best margins

01 June 2011


Beverage Group

The Beverages Group of SMC is divided into alcoholic and non-alcoholic beverages. For the alcoholic beverages, the operations of the Beverages Group are further classified into beer and hard liquor. The beer and malt-based beverages operations of SMC in the Philippines are carried out by San Miguel Brewery Inc. (SMB), while the hard liquor operations are carried under Ginebra San Miguel Inc. (GSMI).

San Miguel Brewery Inc

Beer is the most popular alcoholic beverage in the Philippines and accounts for about 70% share of the alcoholic drinks market in terms of production. SMB is the largest beer producer in the Philippines with a domestic market share (as of end 2009) of 94%. SMC has a 51% stake in SMB, which is a publicly listed company. Kirin of Japan owns 43%, with the balance of shares (6%) considered as public float.

SMB owns five breweries in the Philippines and six breweries in Asia, with total capacity of 22.6 mn hectolitres per annum. All breweries are ISO 9001, ISO 14001 and cGMP certified. It is worth noting that the five Philippines breweries are strategically located near the intended end-markets in order to reduce transportation costs.

Figure 22: SMB breweries in the Philippines (as of December 2010) Capacity Brewery (hectolitres mn) Utilisation (%) Market Polo 3.2 81.6 Metro Manila and Southern Luzon San Fernando 5.9 80.9 Central and Northern Luzon Mandaue 3.2 85.4 Visayas and Mindanao Bacolod 1.0 83.9 Negros and Panay Davao 2.4 69.4 Mindanao Total 15.8 80.8


SMB has the most extensive distribution network in the Philippines beverage market with 49 sales offices and almost 500 dealers. Dealers generally provide their own warehouse facilities and trucks, thereby reducing SMB’s own investment requirements. Distribution rights, performance standards and sales procedures are developed by SMB and implemented in tandem with dealers to ensure high service quality.

SMB mostly sells its products in returnable glass bottles of varying sizes and shapes, as well as aluminium cans and kegs. In 2010, approximately 95% of the glass bottles used by SMB were returnable bottles. Returnable glass bottles are by far the most important and popular package for beer in the Philippines, accounting for 99% of total beer industry sales in 2010.

The company procures key raw materials for its beer operations through a procurement group that uses standardised procurement procedures. SMB enters into supply contracts with key raw material suppliers, with terms ranging from approximately one month to five years. This is intended to keep raw material costs stable and predictable. Nonetheless, depending on considerations such as price trends and supply availability, SMB also makes spot purchases in the open market.

San Miguel had a 94% share of the Philippines beer market in 2009; it produces a variety of products catering to different customer tastes and preferences

01 June 2011


Figure 23: San Miguel Brewery Inc (SMB) products Product Company’s Description

San Miguel Premium All-Malt Beer

Full-flavoured with a smooth balanced bitterness. San Miguel Premium All-Malt Beer has a malty flavour with pleasant hoppy notes. It is slightly sweetish in taste and has medium to full body. This beer targets the premium and upper premium consumer markets.

Super Dry

San Miguel Super Dry is more hoppy with slight citrusy notes. It has a moderate body and a crisp dry taste. Its bitterness is smooth and balanced. This beer targets the premium and upper premium consumer markets.

Cerveza Negra

Cerveza Negra is full-flavoured and full-bodied ’dark’ beer with roasted malty notes. Bitterness is moderate but still smooth. This beer product targets the premium and upper premium segment.

San Mig Strong Ice

A high-alcohol pale amber lager characterised by pleasant estery notes and mild balanced bitterness. A brilliant ice-filtered beer that gives exceptional smoothness and a refreshingly cool after-drink experience. This beer targets the premium and upper premium consumer markets.

San Miguel Pale Pilsen

Slight hoppy note with a distinct bitter hop character. San Miguel Pale Pilsen has a well-balanced medium body and is smooth on the palate with a pleasant clean finish. This beer product targets the upper popular segment of the market.

Red Horse

Red Horse Beer is a beer with a distinctive, full flavoured taste and extra satisfying strength of a world class premium strong beer. This beer targets the upper popular segment of the market.

San Mig Light

San Mig Light is the low-calorie beer that gives you the full beer flavour, the same beer alcohol, yet less filling. The perfect balance between right and light. This beer targets the upper popular segment of the market.

Gold Eagle Beer Gold Eagle Beer is moderately light bodied, yet with flavour, hopped just enough for a little bite on the finish bringing out an over-all ’easy drinking’ character. Gold Eagle Beer is SMC’s entry into the popular economy segment.

Cali Ice

A very pale greenish non-alcoholic, malt-based beverage characterised by a distinct green apple flavour and a crisp carbonation that makes for a refreshing, sparkling style. Variations to the product are Cali, Cali Ice and Cali Light.

Source: San Miguel Corporation

01 June 2011


Figure 24: SMB’s sources for major raw materials and packaging supplies Key materials Sources Contract period Malted barley Australia, Europe, USA, Canada 1 to 5 years Hops USA, Germany 5 years Adjuncts Corn grits Philippines 3 years Sugar Philippines Spot Food starch (from cassava) Thailand, Vietnam Spot Rice Philippines 1 year Packaging materials Bottles and crowns Philippines 1 year Aluminium cans Philippines 1 year Plastic cases Philippines 1 year Cartons Philippines 1 year Labels Philippines, Malaysia 1 year


The earnings predictability of SMC’s beer business is underpinned by the strong correlation between beer consumption and per capita GDP growth. Moreover, SMC’s extensive national distribution network is critical in protecting the company’s dominant market share.

Figure 25: Philippines’ beer market Figure 26: Brewers market share in the Philippines

14,430

15,107

15,798

14,781

14,144

15,446

13,000

13,500

14,000

14,500

15,000

15,500

16,000

2008 2009 2010E

Production Consumption

('000 hectoliter)

SMC94%

Others6%

Source: Canadean Beer Trends Report 2009, Credit Suisse Source: : Canadean Beer Trends Report 2009, Credit Suisse

Ginebra San Miguel Inc

SMC produces hard liquor through its majority-owned subsidiary, Ginebra San Miguel, Inc. (GSMI). GSMI is the world’s largest gin producer by volume with a production capacity in the Philippines of 72 mn cases per year. The company has three bottling plants, one distillery, one cassava starch plant, and five toll bottlers in the Philippines and one in Thailand. GSMI has a domestic liquor market share of 51% and benefits from operational synergies with San Miguel Packaging Yamamura Corp (SMPYC) for bottling and packaging services.

The majority of the domestic sales of spirits and liquor are made to the ’value conscious’ segment of the population. Hence, demand for these products is very price sensitive. Growth is also influenced by product innovations and diversification, as well as increased marketing activities. Consumer preferences in the Philippines market also vary by geographical region. Consumers in northern Philippines have a greater preference for gin and brandy, while consumers in the southern portion of the country prefer rum.

01 June 2011


Figure 27: Spirits volume sales in the Philippines

0

100

200

300

400

500

600

700

2004 2005 2006 2007 2008 2009

Brandy & Cognac White Spirits Rum Others

(million liters)

436 427 451509

549 575

Source: Euromonitor, Credit Suisse

Figure 28: Customer segmentation (%) as of end 2010

1 6 4

14 1118

2827

74

52 58

70

10

20

30

40

50

60

70

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100

Philippines Metro Manila Mega Manila

Upper class Upper middle class Lower midle class Lower class


Bulk of customers sensitive to pricing

01 June 2011


Figure 29: Ginebra San Miguel Inc (GSMI) products Product Company’s Description

Ginebra San Miguel

Ginebra San Miguel is the Philippines leading gin. First produced in 1834, it is now acknowledged as the world’s largest selling gin. It is an 80 proof Dutch type gin made from selected spirits and botanical extract. Its predominant flavour comes from juniper berries.

Ginebra San Miguel Premium Gin

This 70 proof, top of the class gin is made from Extra Neutral Alcohol. Distilled with the exquisite blends of botanical extracts and the finest juniper berries. It comes in a 750 ml long neck bottle with an individual box carton, with 35% alcohol strength.

G.S.M. BLUE G.S.M. BLUE is a 65 proof, sugar cane alcohol with essences of juniper berries and other botanicals. Its smooth, sweet taste gives drinkers a ’light-on-the-chest’ feeling without hangover.

Antonov Vodka Made from high-grade alcohol, Antonov is pure vodka that minimises hangover. Antonov undergoes double distillation and charcoal filtration. It has a neutral taste and aroma, making it appropriate for drinking and mixing. It is more affordable than imported vodka.

Gran Matador Brandy

Gran Matador Brandy is blended with high-quality alcohol, expertly mixed with real brandy concentrate from Spain. It is a 65 proof brandy, distilled in accordance with the Grand Spanish Solera tradition. Its rich and distinct aroma, smoothness and overall taste are as good as imported brands.

Añejo Rum

Añejo Rum Oro is the light-bodied rum of 72 proof produced from selected cane molasses spirits and aged in oak barrels. Individual characteristics come from specific blends and aging conditions. Añejo Rum Oro is available in a 375 ml flask bottle.

Tondeña Manila Rum Tondeña Manila Rum is Ginebra San Miguel Inc.'s leading export product. It comes in three variants: Tondeña Manila Rum Gold, Tondeña Manila Rum Silver and Tondeña Manila Rum Dark.

Vino Kulafu Vino Kulafu is Ginebra San Miguel Inc’s leading brand in the Chinese wine category. The brand has become a favourite in Visayas and Mindanao. Vino Kulafu is appreciated for its 50 proof, 25% alcohol, made from 14 authentic traditional Chinese botanical herbs, combined through a special distillation process to attain a well-blended herbal aroma.

Magnolia Fruit Juices

GSMI’s non-alcoholic product portfolio includes healthy ready-to drink teas, juices and bottled water under the Magnolia brand.

Source: San Miguel Corporation

01 June 2011


Figure 30: Market share of Philippines’ liquor companies (%) 2006 2007 2008 2009 2010 Ginebra 44.2 45.7 51.2 54.4 51.7 Tanduay Distillers Inc. 29.7 31.1 26.3 26.6 26.6 Emperador Distillers Inc. 22.4 19.7 19.2 16.0 17.9 Others 3.7% 3.5 3.3 3.0 3.8 Total 100.0 100.0 100.0 100.0 100.0


GSMI intends to build upon its market share lead by expanding in the southern part of the Philippines—where management believes market penetration remains low—as well as international markets. GSMI also plans to expand into new geographies overseas through the establishment of offshore production capabilities via tolling agreements. GSMI also believes there is scope to broaden the distribution of non-alcoholic beverages to the “at-work” markets.

GSMI intends to also control its costs via a further rationalisation of its sales and distribution network. The company has also embarked on initiatives to search for alternative raw materials to replace molasses, which is under threat from increasing prices and decreasing availability, as it is used as a raw material for the government’s clean fuel programme. Cassava has proven to be a reliable substitute for molasses, with other raw materials including sugarcane juice currently under research. GSMI also has options to import more crude alcohol if it is cost efficient.

Figure 31: GSMI’s revenues and operating margins

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(Pmn) (%)


01 June 2011


Food

San Miguel Pure Foods Company, Inc. (SMPFC) is a diversified food company and the leading player in poultry, feeds, processed meats, flour and bread spreads. SMPFC is a 99.9%-owned business of SMC and operates through the following subsidiaries and divisions:

■ San Miguel Foods, Inc. (SMFI) is a 100%-owned subsidiary of SMPFC and operates the integrated poultry and feeds businesses, the San Miguel Food Shop franchising operations and the San Miguel Integrated Sales selling and distribution activities.

■ San Miguel Mills Inc. is a 100%-owned subsidiary of SMPFC and engages in the manufacture and distribution of flour and premixes.

■ The Purefoods-Hormel Company, Inc. (PF-Hormel) is a 60:40 joint venture between SMPFC and Hormel Netherlands BVL, which produces and markets processed meat (hotdogs, hams, bacons, cold cuts and gourmet meat) and canned meat products (corned beef, luncheon meat, vienna sausage, pork and beans, liver spread and meat loaf).

■ Monterey is a 98%-owned subsidiary of SMPFC and is into livestock farming, processing and selling of meat products, mainly pork and cattle. Fresh produce from Monterey’s farms, as well as value-added meat products, are sold in Monterey meat shops located in major supermarkets/cities throughout the country.

■ Magnolia Inc. is a 100%-owned subsidiary of SMPFC and manufactures and markets butter, margarine, cheese, milk and ice-cream. The business also handles the sale and marketing of jellies and desserts.

■ SMPFC’s Great Food Solutions (GFS) is the food service division of the company that caters to hotels, restaurants and institutional accounts for their meat, poultry, dairy and flour-based requirements, as well as provides food solutions/recipes and menus. GFS also handles the Smokey’s hotdog bar, San Mig Café restaurant, and Outbox food-to-go stall/cart franchising operations.

■ San Miguel Super Coffeemix Co., Inc. (SMSCCI) is a 70:30 joint venture between the company and Super Coffeemix Manufacturing Ltd (SCML) of Singapore. SMSCCI’s product line includes a sugar-free line of coffee mixes, a premium line of coffee mixes, 100% premium instant coffee and 2-in-1 coffee mixes. The latest addition to SMSCCI’s list of products is its pro-health line of coffee mixes which was launched in the first half of 2009.

■ B-MEG Animal & Aquatic Feeds is the market leading SMPFC company which produces hog, poultry, and aquatic feeds.

SMPFC believes that a diverse range of products allows for a more resilient business model while also serving as a means for identifying growth opportunities both within and across the various product categories. In terms of cost control, the company believes that its vertically controlled ’farm-to-plate’ business model provides SMPFC with stable margins and operational flexibility. This model allows SMPFC control over the value chain from plantation, feed production and animal growing to meat processing.

A broad and diverse food product portfolio…

…underpinned by vertical integration strategy to control costs

01 June 2011


Figure 32: SMPFC products Product Description

Commercial Feeds: B-Meg

B-Meg Feeds produces hog, poultry, and aquatic feeds. B-Meg has a 39% market share in animal feeds and ranked No.1 in the commercial feeds segment as of 2009. SMPFC believes that the Philippines feeds industry is fast transitioning from a fragmented, backyard industry into a more concentrated and efficient industry with fewer big players, including foreign players.

Poultry: Magnolia chicken

SMPFC is the largest producer and marketer of poultry products in the Philippines, with a 40% market share in 2010. SMPFC’s involvement in the business includes the breeding, production and marketing of broilers (chicken raised specifically for human consumption). SMPFC’s poultry products include fresh, chilled and frozen chicken, chicken cut-ups, and even live chicken, and are sold under the Magnolia fresh chicken brand and through Magnolia chicken stations.

Fresh Meats: Monterey

SMPFC’s fresh meats business breeds, grows and slaughters hogs and cattle, and produces and trades beef and pork products under the Monterrey brand. SMPFC pioneered the use of the vertically controlled pork and beef production system in the Philippines, controlling the entire value chain from selection of genetic feedstock to its meat shop operations. Most of the production facilities are third-party owned and operated. Monterrey products are distributed through supermarkets, neighbourhood meat shops, live sales and to SMPFC’s value-added meats and food service business.

Value added meat cluster: Purefoods Tender Juicy Hotdog

SMPFC’s value-added meats business produces both refrigerated and canned meats. SMPFC’s value-added business has 57%, 23% and 15% market shares of the hotdog, corned beef, and luncheon meat markets, respectively. Raw materials are sourced through SMPFC’s business procurement group.

Milling cluster: Flour

SMPFC owns and operates the largest flour milling facilities in the Philippines, as well as the country’s first flour technology centre. The company also owns and operates two deep water ports with combined capacity of over 7,500 metric tons per day next to its two flour milling facilities in Mabini and Tabangao in Luzon. The principal raw material used for milling is wheat, which is sourced from the US and Canada. SMPFC’s marketing strategy focuses on making available the widest array of differentiated flour products in the Philippines. SMPFC also differentiates itself by focusing on higher-priced, better quality flour, thereby making it more difficult for local competitors to compete.

Dairy, Spreads, and Oils cluster: Dari Crème Classic

The dairy, spreads and oils (DSO) business manufactures and markets a variety of bread spreads, milk, ice cream, jelly-based snacks and cooing oils. The bread spreads include butter, refrigerated and non-refrigerated margarine and cheese sold primarily under its Magnolia, Dari Crème, Star and Cheezee brands. SMPFC’s dairy products include flavoured and non-flavoured milks under the Magnolia and Chocolait brands. SMPFC’s DSO brands have significant market shares in several segments: butter (42%), refrigerated margarine (85%), non-refrigerated margarine (97%), cheese (22%), ice cream (11%) and jelly-based snacks (33%).

Emerging business cluster: Coffee

San Miguel Super Coffeemix Co., Inc. product line includes a sugar-free line of coffee mixes, a premium line of coffee mixes, 100% premium instant coffee and two-in-one coffee mixes. The coffee business is a joint venture with a Singaporean partner, Super Coffee Corporation, Pte, Ltd. and is 70%-owned by SMPFC.

Source: San Miguel Corporation, Credit Suisse

01 June 2011


Figure 33: SMPFC’s revenue by product line (2010)

Milling9.6%

Value-added meats14.4%

Others10.5%

Agro-Industrial65.5%


SMPFC is looking to diversify geographic risk and tap into the fast-growing emerging markets in Asia. It will continue to pursue strategic opportunities in priority countries such as Vietnam and Indonesia.

In terms of cost control, SMPFC’s research and development team continues to explore the use of alternative raw materials to bring down costs without sacrificing quality. In order to achieve cost synergies, SMPFC has organised its businesses into clusters and expanded the outsourcing of labour-intensive and process-oriented operations. SMPFC intends to use outsourcing arrangements as its primary tool to achieve future capacity expansion and replacement. SMPFC expects that only projects of high strategic importance, or those that cannot otherwise be outsourced, will be considered for inclusion in SMPFC’s own capital expenditure budget.

Figure 34: San Miguel Pure Foods’ revenues and operating margins

68,000

70,000

72,000

74,000

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78,000

80,000

82,000

2008 2009 2010-

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Sales Operating margins (%)

(Pmn) (%)


01 June 2011


Packaging

The San Miguel Yamamura Packaging Group of Companies is a total packaging solutions business. It services SMC’s internal requirements, as well as those of external clients. San Miguel Yamamura Packaging is 65%-owned by SMC and 35%-owned by Nihon Yamamura Glass Co. Ltd of Japan. The packaging group has one of the largest packaging operations in the Philippines and also supplies packaging products to customers in the Asia-Pacific region, the US, Africa, Australia and the Middle East. Key clients include the Coca Cola Bottling Company, Nestle Philippines and Pepsi Cola Products Philippines.

Figure 35: The Packaging Group’s product line Product Description

Glass

Glass packaging is the largest business segment of the Packaging Group. The Group has three glass manufacturing facilities in the Philippines and one glass mould plant serving the requirements of the beverage, food, pharmaceutical, personal care and health care industries. The Packaging group’s glass businesses supplies about 75% of the demand for quality glass containers in the Philippines and accounted for 32% of the Packaging Group revenue in 2010.

Metal

The metal business manufactures metal caps, crowns, resaleable caps and two-piece aluminium beverage cans for a range of industries, including beer, soft drinks and food. The Packaging Group’s metal container plant is the second largest business in the packaging group and is the market leader in the metal caps, crowns and two-piece aluminium beverage can segments. The metal business accounted for 17% of the Packaging Group’s revenue in 2010

PET The polyethylene terephthalate (PET) business produces PET preforms and bottles, plastic caps and handles, and offers filling services for the beer, spirits, beverage, food, pharmaceutical, personal care and industrial applications industries. The Packaging Group’s PET business provides plastic crates and pallets, plastic poultry flooring, plastic trays and plastic pails and tubs to domestic markets, and caters to the requirements of SMC’s brewing operations in Vietnam and China.

Plastics

The Packaging Group’s plastics business produces bread and food trays, industrial containers, crates, pallets, poultry flooring, pails and tubs to companies in the beer and beverages industries, as well as chicken and agricultural industries.

Composites

The Packaging Group’s composites/flexible packaging business manufactures flexible packaging such as anti-static/ESD bags, plastic films, industrial laminates, trademarked Envirotuff radiant barrier and woven bags. Its customers include companies in the food, beverage, personal care, chemical and healthcare industries.

Paper The Packaging Group’s paper packaging business produces corrugated cartons and partition boxes. SMC also manufactures corrugated cartons and other paper-based packaging products through its wholly owned subsidiary, Mindanao Corrugated Fireboard Inc. The paper packaging business serves a broad range of beverage, food, and agricultural industries.


01 June 2011


The Packaging Group is a market leader in most of its product formats in the domestic packaging industry. This could be attributed to its modern manufacturing facilities, including the only food grade PET recycling facility in Asia and synergies from partnerships with key global packaging companies such as Nihon Yamamura Glass, Fuso, Kaito and United Resource Recovery Corporation.

The Packaging Group owns and operates four glass packaging plants, four metal packaging plants, one composite packaging plant, six plastics packaging plants and one paper packaging plant strategically located throughout the Philippines. It also owns and operates ten overseas packaging facilities. The plant facilities of the Packaging Group are shown in Figure 36.

Figure 36: Packaging facilities Type of plant International locations Philippines locations Composite Malaysia Canlubang Crown Vietnam Glass China, Vietnam Cavite, Cebu, Manila Metal Canlubang, Cavite, Cebu, San Fernando Paperboard / paper China Davao Plastic and plastic films Australia, China, Malaysia, New Zealand Canlubang, Cebu, Davao, Manila, San Fernando Research and testing centre Malaysia Woven bag and industrial laminates Malaysia


Figure 37: Packaging Group’s revenues and operating margins

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(Pmn) (%)


01 June 2011


New businesses provide future direction SMC’s diversification away from its traditional businesses was underpinned by three key transactions: SMC’s entry into a share purchase agreement for a 27% stake (eventually raised to 33%) in Manila Electric Company (Meralco), the acquisition of a 37.8% stake (eventually increased to 68%) in Petron Corporation and acquisitions of power generation facilities under the government’s power generation privatisation programme.

Power generation

SMC’s active participation in the government’s privatisation programme allowed the company to become a dominant player in the Philippines’ power generation sector within a relatively short period of time. Moreover, with power supply expected to remain tight for the medium term, there remains scope for both capacity and margin expansion in the sector.

Regulatory overview

Under the Electric Power Industry Reform Act (EPIRA) of 2001, power generation is not a public utility operation. Thus, generation companies are not required to secure franchises, and there are no restrictions on the ability of non-Filipinos to own and operate generation facilities. However, generation companies are subject to the Energy Regulatory Commission (ERC)’s rules and regulations on abuse of market power and anti-competitive behaviour. Under EPIRA, no generation company is allowed to own more than 30% of the installed generating capacity of the Luzon, Visayas or Mindanao grids and/or 25% of the national installed generating capacity. Also, no generation company associated with a distribution utility may supply more than 50% of the distribution utility’s total demand under bilateral contracts. The EPIRA intends the generation sector to be open and to compete with the private sector by taking the lead in introducing additional generation capacity. Generation companies will compete—largely based on pricing—either for bilateral contracts with various suppliers and private distribution utilities, or through spot sale transactions in the Wholesale Electricity Spot Market (WESM).

Supply-demand outlook

Data from the Philippines Department of Energy (DOE) indicate that only the Visayas grid is in a surplus. The Luzon and Mindanao grids face near-term power supply deficits. Based on DOE forecasts, CS estimates that incremental new capacity equivalent to 2,500 MW needs to be put in place between 2010 and 2015 in order to keep up with demand and preserve the necessary reserve margins. We note that:

■ While 2,500 MW is not significant in absolute terms, the long lead time required for project development and construction of a new power plant ensure that a deficit situation will likely exist in the medium term. It is again worth noting that only 1,413 MW of generation capacity has been committed by developers so far.

■ We believe there is a possibility that the supply shortfall may even be worse than expected. Hydro and oil-fired power plants make up 32% of the Philippines’ installed capacity. The former’s reliability is subject to weather and hydrology risk, while the latter is too expensive to run for base-load power.

■ There is also concern that the shortfall could be exacerbated by stronger-than-expected demand due to accelerating economic growth. It is worth pointing out that our forecasts assume 4% annual electricity demand growth (in line with recent DOE forecasts) from 2010 to 2015. Post-Asian crisis, there has been a correlation of 0.7x between GDP growth and electricity sales.

SMC’s attributable generation capacity of 3,165 MW already represents 90% of the Luzon grid cap and 84% of the nation-wide grid cap

With supply tight and no new capacity in the medium term, the risk to near-term power rates appears to be to the upside

01 June 2011


With no significant new capacity being built until 2014 and assuming that electricity demand continues to grow at an annual rate of 3-4%, the supply-demand outlook for the Luzon grid (which is where SMC’s power plants are located) looks tight for the medium term (see Figure 38). Hence, we believe there is scope to add capacity to SMC’s existing power plants provided that the expansion is within the regulatory guidelines set by EPIRA. The Visayas grid should be in surplus by next year as new coal-fired power plants become operational. The Mindanao grid, however, already needs additional capacity this year. Mindanao went through 8-hour a day power outages during the summer of 2010, as the dry weather exposed the Mindanao grid’s over-reliance on hydro-power (see Figures 39 and 40).

Figure 38: Luzon supply-demand situation (in MW)

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2008 2009 2010 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

Reserve margin Demand

Additional capacity needed

Existing dependable capacity

(MW)

Commited new capacity

Indicative new capacity

Source: Department of Energy (DoE)

Figure 39: Visayas supply-demand situation (in MW) Figure 40: Mindanao supply-demand situation (in MW)

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Source: DoE Source: DoE

In our view, the key implications of a supply shortfall in the Luzon grid would be: improved contract terms for power generators, the risk of higher for longer spot power rates (at least

01 June 2011


until the supply shortages are addressed), and expansion opportunities for firms involved in power generation. The power deficit in Luzon has already been reflected in terms of higher spot rates. We forecast spot rates (peak hours) will average P5.30/kWh from 2011-13. Since the wholesale electricity spot market (WESM) in Luzon began operations in July 2006, peak rates have averaged P5.11/kWh, while all-hour rates have averaged P3.66/kWh. Given the tight power situation in Luzon, we believe power plants that are costly to run (oil fired) and typically used for peak-load will still be dispatched. Barring a collapse in electricity demand, we expect the oil-fired plants to contribute anywhere between 6% and 8% of Luzon’s total energy output. With the expensive-to-run oil-fired plants selling to WESM at above P10/kWh, we expect spot prices to stay higher than their historical trend until new generation capacity comes on line.

Figure 41: Wholesale electricity spot market (WESM) rates in Luzon

0

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14

Sep 08 Dec 08 Mar 09 Jun 09 Sep 09 Dec 09 Mar 10 Jun 10 Sep 10 Dec 10 Mar 11

Peak hours monthly av erage All Hours monthly av erage

Historical av e. (peak) Historical av e. (all hours)

(P/kw h)

historical av erage peak hours =P5.07/kw h

historical av erage all hours =P3.63/kw h

Source: WESM, Credit Suisse estimates

Figure 42: Generation costs per fuel type Figure 43: Luzon generation mix (%)

Oil10.28

New coal5.77Old coal

4.5Natural Gas

4.3Geothermal3.61

Hy dro1.87

0

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13%

Hydro21%

Natural Gas26%

Coal29%

Geothermal4%

Diesel7%

Source: DoE, WESM Dec 2009, Credit Suisse Source: DoE, Credit Suisse

Unusually dry weather and unplanned plant shutdowns caused spikes in power rates in 1H 2010

01 June 2011


SMC Global Power Holdings San Miguel Corporation through SMC Global Power Holdings Corporation (SMCGP) and its subsidiaries, SMEC (Sual), SPPC (Ilijan) and SPDC (San Roque), administers a portfolio of three IPPA power plants with a combined capacity of 2,545 MW. In addition, SMCGP owns and operates through PEHI (Limay), a 620 MW oil-fired combined cycle power generation plant in Limay Bataan.

Figure 44: SMC power plants – Operating, contractual, and acquisition details Sual Ilijan San Roque LimayLocation Sual, Pangasinan Ilijan, Batangas San Roque, Pangasinan Limay, BataanInstalled capacity (MW) 2x647 2x600 CC 345 620 CCFuel Coal Natural Gas Hydro OilIPPA or direct ownership? IPPA IPPA IPPA Direct OwnershipOperator TeaM Energy KEPCO Marubeni-Kansai AlstomPlaced in service Oct-99 Jun-02 May-03 Apr-93Date SMC assumed operations Nov-09 Jun-10 Jan-10 Jan-10Date of ECA expiry Oct-24 Jun-22 Apr-28 N.A.Capacity utilisation (2010) 59% 80% 21% 26%Availability factor 85% 92% 100% 94%Net heat rate (Btu/kWh) (LHV) 9,743 6,451 N.A. 9,585 Acquisition date Aug-09 Apr-10 Dec-09 Aug-09Winning bid US$ mn 1,070.0 870.0 450.0 13.5 Winning bid US$ per MW 1.07 0.73 1.30 0.02


The four power plants service the Luzon grid but vary in terms of fuel type and role in the grid. Coal-fired Sual and gas-fired Ilijan are both base load power plants while hydro electric facility San Roque and oil-fired Limay serve as peaking plants. The mix in plant types provides SMC with a portfolio of generation assets that can take advantage of market opportunities while also mitigating competitive risks. It is also worth emphasising that these power plants were built by, and are maintained by private entities. In addition to its portfolio of power plants, SMCGP also owns various coal properties that are in the early-stage exploration phase. Note that:

■ SMCGP is the IPP Administrator for the Sual power plant, the largest coal-fired power plant in the Philippines.

■ The Ilijan power plant is one of two major offtakers for gas provided by the Malampaya gas-to-power project off the coast of Palawan. The Philippines government has a 10% stake in the Malampaya project via PNOC-Exploration Corporation.

Figure 45: Ilijan Plant is an offtaker of the Malampaya gas-to-power project

Source: Company, Credit Suisse

The Philippines government generates revenue from the gas sales to Ilijan

01 June 2011


■ The bulk of the power sales or off-take agreements for Sual and Pagbilao is expiring this year. Given that there is no significant new power generation capacity coming in 2011 (or within the next two years for that matter), we believe that the risk of the off-take agreements not being renewed is minimal.

Figure 46: Dates of expiration – Sual off-take agreements Figure 47: Dates of expiration – Ilijan off-take agreements

Year 20106%

Year 201162%

Year 201232%

Year 201188% Uncontracted

(Sold at Spot)12%


■ The 345 MW San Roque multi-purpose hydroelectric power plant provides relatively cheap power but is subject to hydrological risks resulting in a relatively low utilisation rate. Hence, San Roque is utilised as a peaking plant with all of its output sold to the WESM.

■ The Limay power plant is a combined cycle oil-fired power plant located in Bataan. Since it runs on fuel oil, Limay is relatively expensive to operate and is therefore also utilised as a peaking plant. Hence, all its output is traded on the WESM. It is worth pointing out that conversion of the Limay plant from an oil-fired ’peaker’ to an LNG fuelled baseload facility is being explored by SMCGP.

What is an IPPA?

The IPPA structure is intended to accelerate the government’s power asset privatisation programme while also providing a way for strategic investors to be involved in power generation without the expense and time consuming process of building a new power plant. Note that the power shortages of the early 1990s made it necessary for the Philippines government to find ways to encourage private sector investments in the power generation sector. Much of the private sector involvement came via Build-Operate-Transfer (BOT) contracts. BOT is a form of project financing, wherein a private entity receives a concession – typically from the public sector – to finance, design, construct, and operate a facility stated in the concession contract. The project proponent recovers its investment, operating and maintenance expenses in the project via concession payments. The government, in return, gets the facility built and maintained by experts without having to incur any upfront costs nor worry about operating issues. In the Philippines context, the BOT contractor is a private entity that would be paid to build and operate a power plant. The government would typically provide fuel for the plant as well as a guaranteed offtaker (who would also be responsible for sourcing the concession fees for the BOT contractor). At the end of the life of the BOT contract, the ownership of the power plant would be transferred to the Philippines government. Note that:

IPPA offshoot of BOT contracts

01 June 2011


■ The IPPA structure effectively allows the winning bidder (e.g., The IPP Administrator) to step into government’s role in the BOT contract. In return for paying a pre-determined schedule of monthly fees, IPPAs enjoy the benefits normally attributed to owners of power generation plants, including controlling the fuel and its dispatch, trading, and contracting of the power plant, without maintenance costs or capital upgrades, which remain with the IPPs. It is worth noting that for the Ilijan natural gas facility and the San Roque hydropower plants, fuel supply remains controlled by the government since the only sources of fuel for these two facilities are themselves partially or fully government owned or controlled (gas from the Malampaya reserves for Ilijan and water from the San Roque dam for San Roque).

■ Also, since the IPPA does not directly control the power plant, many of the risks associated with actual ownership are explicitly managed through the contract. If there is an extended outage at the IPP, for example, there is up to a 50% discount on the monthly fees, and PSALM bears the force majeure risks to the power generation plants. The IPPA structure also permits an IPPA to assume NPC’s role as an IPP offtaker without affecting NPCs underlying agreements with the IPPs.

■ IPPA agreements typically provide for the optional transfer of ownership of the power plants or generation facilities from the IPPs to the respective IPPAs at the end of the term of the ECAs or the PPAs, as the case may be. It is worth emphasising that until such a transfer is made, the IPPA has no ownership claim on the power plant facility.

Pros and cons for SMC

New entrants to the power generation sector could opt to either: 1) build a “greenfield” facility, or 2) acquire an existing power plant outright from a private or public entity by paying cash upfront (which is what SMC did to acquire the 600 MW Limay plant). The IPPA framework, on the other hand, provides an alternative “rent to own” approach for acquiring a power plant. From SMC’s point of view, this offers several advantages:

■ The economic benefits associated with power plant ownership become immediately available to SMC in exchange for instalment payments with a back-ended schedule (see Fig 48). This arrangement reduces the potential near-term cash burden resulting from the acquisition. Moreover, the purchase should be self-liquidating, as cash generated by the plant helps defray the cost of acquisition.

■ In contrast to building greenfield power plants which entails taking on development risk and a long (and unpredictable) construction lead time, the IPPA set-up allows SMC to receive economic benefits from an already operational power plant. This is particularly important in the Philippines context as we expect the power supply situation – in the absence of any new capacity – to remain tight in the medium term and “first movers” into the generation sector probably stand to gain the most.

■ The IPPA set-up allows SMC option on the economic rewards associated with owning a power plant that is built and maintained by the private sector. Acquiring a government-owned power plant, on the other hand, might result in significant rehabilitation cost post acquisition depending on the condition of the plant.

■ The clear disadvantage of the IPPA set-up is that SMC has no ownership claim on the power plant until the BOT contract expires. Without any ownership claim, SMC has no operational control over the plant making the company dependent on the IPPA contract for redress in case problems at the power plant level adversely impact SMC’s investment returns. There are also potential mismatches between revenues and costs in the near term as SMC is taking over existing Transition Supply Contracts for Sual and Pagbilao which may or may not incorporate fluctuations in energy costs.

IPPA takes on government role in BOT contract

SMC can also assume ownership of the power plant upon expiration of the BOT arrangement

01 June 2011


Figure 48: IPPA framework

WESM

IPPNPC (IPP

Counterparty ) PSA LM IPPA Contrac t A dminis trator

Bilateral Sale

Fuel Supply A greements (1)

SalesContrac tECA

Ow nership transfer f rom IPP to IPPA at the end of IPPA contrac t

Monthly Payments + Energy/Generation Fee

Fuel suppliers

(Adminis trator respons ib le for fuel supply to IPP under

the IPPA Agreement) 2

Source: Company, Credit Suisse estimates

Figure 49: SMC’s liability payments to PSALM

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

2010 2013 2016 2019 2022 2025 2028

Sual Ilijan San Roque

(Pmn)


Figure 50: SMC’s liability payments to PSALM US$ mn 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028Sual 36.0 36.0 81.8 100.1 109.9 119.3 132.3 135.5 138.9 154.5 172.2 162.4 165.8 169.3 42.9 San Roque 22.8 22.8 40.1 40.1 40.1 40.1 40.1 40.1 40.1 40.1 40.1 40.1 40.1 40.1 40.1 40.1 59.1 59.1 19.7Ilijan 27.5 70.6 70.6 79.6 79.6 79.6 88.6 88.6 88.6 97.9 97.9 97.9 48.9 - - P bn Sual 1.7 1.7 3.9 4.8 5.3 5.7 6.3 6.5 6.7 7.4 8.3 7.8 7.9 8.1 2.1 - - - -San Roque 1.1 1.1 1.9 1.9 1.9 1.9 1.9 1.9 1.9 1.9 1.9 1.9 1.9 1.9 1.9 1.9 2.8 2.8 0.9Ilijan 1.3 3.4 3.4 3.8 3.8 3.8 4.2 4.2 4.2 4.7 4.7 4.7 2.3 - - - - - -Source: Company data, Credit Suisse estimates

01 June 2011


Petron Petron Corporation (PCOR PM) is the biggest player in the Philippines downstream oil industry with a 38% market share. PCOR is the owner of a 180 kbd refinery (by far the largest in the Philippines) and has maintained its dominant market share despite operating in a deregulated environment since 1998. While there are numerous competitors in the Philippines downstream oil industry, Petron is just one of two companies (Pilipinas Shell being the other one) to operate the Philippines-based refiners. Most other industry players market and distribute imported finished products.

Figure 51: PCOR market share since 2000 Figure 52: PCOR market share (1H2010)

30%

35%

40%

2001 2003 2005 2007 2009

Petron38%

Shell28%

Chevron13%

Others21%

Source: Petron, Credit Suisse Source: DoE, Credit Suisse

Market dynamics favour Petron

The Philippines is a net importer of finished petroleum products. Petron, with its extensive refining and marketing infrastructure, should be able to take advantage of the supply shortfall. It is worth emphasising that Petron operates in a fully deregulated environment wherein market forces determine pricing for petroleum products.

Figure 53: Petroleum product imports needed to meet domestic demand

-

50

100

150

200

250

300

350

400

450

500

2006 2007 2008 2009 1H2010-

5

10

15

20

25

30

35

40

45

50

Total demands Net imports Net imports as a % of total demand

Source: DoE, Credit Suisse

Market leader in a deregulated environment

Philippines market for petroleum products is under-served

01 June 2011


Private ownership is key

SMC’s recent assumption of a 68.2% equity stake in Petron last December 2010 is an important development. For the first time since deregulation, a fully privatised Petron has one entity – SMC – acting as majority owner. In this context, Petron gets to finally flex its muscles in an environment where pricing is determined by market forces. Given management’s view that Petron needs to build upon existing strengths to maintain its lead versus the competition, SMC is also pushing through with Petron’s long-delayed Refinery Master Plan 2 (RMP-2) upgrade.

RMP-2 builds on strengths and addresses weaknesses

RMP-2, which is to be implemented from 2011 to 2013 and estimated to cost US$1.7 bn, is meant to increase refinery complexity and enhance efficiencies. These, in turn, should result in improved profit margins. Note that:

■ Via RMP-2, Petron seeks to increase production of higher margin petroleum and petrochemical products and eliminate the production of low value fuel oil. At present, Petron operates as a simple refiner and, therefore, makes the bulk of its profit from marketing margins.

■ RMP-2 once completed allows Petron to have a level of complexity at par with most regional refiners. This, in turn, allows Petron wider refining margins at a time when average refining margins in the region appear to have already bottomed out (see Figure 54).

■ The upgrade also allows Petron’s refinery to produce petcoke which can fuel a 70 MW co-generation power plant that the company partly owns. Since the co-generation plant will be supplying all of Petron’s power requirements, the set-up makes Petron completely power supply independent while also significantly reducing the refiners’ operating costs.

■ RMP-2 also intends to double the size of PCOR’s already extensive marketing and retail network over the next five years. At present, Petron has over 1,700 service stations.

Figure 54: Average refining margins poised for a bounce

-10,000

-8,000

-6,000

-4,000

-2,000

0

2,000

4,000

6,000

8,000

1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q110

1

2

3

4

5

6

7

Gross margin Singapore GRM

(Pmn) (US$/bbl)

Source: Bloomberg, Credit Suisse estimates

RMP-2 should significantly boost margins

Petron finally flexing its muscles in a deregulated environment

Refining margins continue to rebound from 2009 lows

01 June 2011


Manila Electric Company Manila Electric Company is the largest electricity distribution utility in the Philippines. MER’s 9,337 sq km franchise area covers 31 cities and 80 municipalities including Metro Manila, the entire provinces of Bulacan, Rizal and Cavite; parts of the provinces of Laguna, Quezon, Batangas and Pampanga. The electrification level in the franchise is 98.7%. MER's service area, equivalent to only about 3% of the country's total land area, produces almost 46% of the gross domestic product (GDP), 33% from Metro Manila alone. The franchise area is home to 24.7 mn people, roughly a quarter of the entire Philippines population of 92 mn. SMC has a 33.2% equity stake in MER.

The implementation of the “forward looking” performance based regulation (PBR) in 2009 has introduced a predictable regulatory regime largely mitigating the risk of regulatory lags. These regulatory lags have depressed MER’s earnings and share price over the past ten years. Note that the transition to PBR was accepted by the public without significant opposition. In our view, while there remains pressure from regulators and consumer groups to keep power rates at affordable levels, we see very little risk of the regulatory regime regressing.

Figure 55: Performance based regulation (PBR) framework

Regulated Business

Guaranteed Return

Year to Year Enhancement on Guaranteed Return

Rate Rebasing

Return on Revalued Asset

base

WACC (for electric utilities)

ADR (for w ater utilities)

ManageOPEX

increasebelow CPIadjustment

Borrow fundsat a rate

low er thanindicatedby WACC

OutperformRate

Rebasingassumptions

on sales, leakages,

etc.

Rew ards foroutperforming

regulatorybenchmarks

Pow erGeneration (for electric utilities),

Real Estate, International Ventures,

etc

Non regulated

Non-core business

Source: Meralco, Credit Suisse

Regulatory changes have boosted income and strengthened the balance sheet

Under PBR, MERs profits are largely pre-determined by regulatory rebasings performed once every four years. The transition to PBR has improved the regulated levels of return and enhanced the predictability of Meralco’s profits. These developments, in turn, have resulted in an improvement in share price valuations. Note that SMC’s average cost for its 33.2% stake in MER purchased in 2009 from various Philippines Government Financial Institutions is P90 per share. As of (24 March, 2011), the stock is trading at P229.80 per share. The transition to PBR has also resulted in a significant improvement in MER’s balance sheet. The company’s gearing turned net cash in 2010 and we believe MER has scope to sustain dividend payout levels at 80% without compromising its ability to fund capex.

01 June 2011


Figure 56: PBR improves MER profits and valuations Figure 57: PBR strengthens MER’s balance sheet

-

1

2

3

4

5

6

Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11

-

4,000

8,000

12,000

16,000

20,000

P/B Net Income

(x ) (Pmn)

SMC begins buy ing MER shares

PBR approv ed!

-0.4-0.20.00.20.40.60.81.01.21.41.6

2006 2007 2008 2009 2010

Net debt/equity D/E ratio Net debt to EBITDA

Source: Meralco, Credit Suisse Source: Meralco, Credit Suisse

How does the Meralco tariff work?

The total average customer bill in 2010 was P8.95/kWh. It should be pointed out, however, that MER’s distribution charge only accounts for 16.1% of the P8.95/kwh tariff. Generation cost, transmission charges and systems losses (assuming that these are kept within regulator set limits) are all passed through to the end customer. This ’pass through’ tariff structure means that MER‘s earnings (once MER’s own distribution charge is approved by the regulator for the next four years) are relatively defensive and predictable.

Figure 58: Breakdown of MER customer bill Figure 59: MER 2010 power supplier mix

Generation58%

Distribution16%

Subsidies, Taxes, UC

10%

Transmission10%System Loss

Charge6%

WESM14%

IPP-QPPL10%

NPC41%

IPP-Sta. Rita23%

IPP-San Lorenzo

12%

IPP Others0%

Source: Meralco (average customer bill for 2010) Source: Meralco, Credit Suisse

01 June 2011


What happens next?

Meralco is entering the third Regulatory Period (July 2011 to June 2015) with the next tariff reset/rebasing scheduled for implementation in July 2011. The Energy Regulatory Commission (ERC) made public the Draft Determination for MER’s July 2011 to June 2015 regulatory period last December 2010. This document serves as the basis for our forecasts for MER as the ERC approved capex and tariff schedules are the key drivers of the company’s earnings. The final capex and tariff schedules, however, are to be contained in the Final Determination which is still scheduled to be released next month. In addition, there is no assurance the Final Determination will propose capex and tariff schedules similar to those contained in the Draft Determination. Nonetheless, our earnings forecasts are premised on tariff hikes associated with regulatory approval of the company’s pending PBR application for the June 2011 to June 2015 regulatory period.

Figure 60: Milestones for Meralco’s third regulatory period Date Event Status 18-Jun-10 Filing of the 3RP reset application Finished 11-Jan-11 Release of the draft determination Finished 28-Jan-11 Deadline for comments on the draft determination Finished 07-Feb-11 Public consultation on the Meralco draft determination Finished May-2011 Release of the final determination Pending May-2011 Submission of the rate translation filing Pending Jun-2011 Public hearings on the rate translation filing Pending Jul-2011 Implementation of RY2012 tariffs Pending

Source: Meralco, Credit Suisse

Figure 61: Meralco core profits and net margins

0

6,000

12,000

18,000

24,000

2005A 2006A 2007A 2008A 2009A 2010A 2011E 2012E 2013E-

1

2

3

4

5

6

7

8

Core Profits (Pmn) Net margins %

(Pmn) (%)

Source: Meralco, Credit Suisse estimates

Final determination was due in May

01 June 2011


Infrastructure SMC has ownership stakes in three companies with ongoing infrastructure projects. These are: TADHC, PIDC, and Universal LRT.

Trans-Aire Development Holding Corporation (TADHC). TADHC is a company that is 93%-owned by San Miguel Corporation. TADHC is tasked with the development, modernisation, expansion and operation of the Caticlan airport. Caticlan is the primary gateway to the Philippines tourist resort island of Boracay. In 2009, according to the Civil Aviation Authority of the Philippines, Caticlan airport registered 538,832 passenger traffic and 23,838 aircraft flights. The airport upgrade entails two stages: the construction of a new passenger terminal in the first stage, costing some P2.1 bn, and the extension of the existing runway to 2,100 meters as well as upgrading airport equipment and the existing apron, costing some P360 mn. The upgrading works would enable the airport not only to support jet aircraft (which it presently cannot) but also to directly service international destinations.

Private Infrastructure Development Corp (PIDC). SMC has a 35% stake in PIDC, the project company involved in undertaking the design, construction, operation, and maintenance of Phase 1 of the Tarlac-Pangasinan-La Union Toll Expressway (TPLEX). TPLEX is an 88.6-kilometer two-lane toll expressway currently under construction north of Manila, in the Philippines. The first phase will involve the construction of two lanes, while the second phase entails its expansion into four lanes to accommodate 25,000 vehicles. The first phase started construction in January 2009. The expressway is being built to boost trade, tourism, and facilitate access to the provinces of Tarlac, Eastern Pangasinan and La Union. The project is expected to be ready for full operation by 2014.

Universal LRT Corporation. San Miguel Corporation has a 51% stake in Universal LRT, a single-purpose corporation that also serves as concessionaire for the MRT-7 project. MRT-7 is a US$1.5 bn integrated rail and road project. The rail component consists of a 22 km mostly elevated railway from North Avenue to San Jose del Monte, Bulacan with 14 stations through the Quezon City Circle continuing along Commonwealth Avenue. The Manila Red Line or Mass Rapid Transit Line 7 (Red Line/MRT-7) will be the fourth rapid transit line to be built in Metro Manila. When completed, the Integrated Rail line will run in a northeast direction, traversing Quezon City and a part of Caloocan City in Metro Manila before ending at the City of San Jose del Monte in Bulacan province. The Integrated terminal in North Avenue beside SM City North Edsa will link MRT-7 with MRT-3 and LRT-1. The road component consists of a 22-km 6-lane highway from San Jose del Monte to Marilao/Bocaue, Bulacan North Luzon Expressway (NLEX) exit. There is also a real estate component to the project. A 194 hectare ’Transit Town’ will be located in San Jose del Monte, Bulacan. ’Transit Town’ will have a depot, intermodal transit facility, mall, office, and residential areas. The final alignment of the planned Circumferential Road Number 6 (C-6) is also planned to cut through ’transit town’ linking Bicutan, Taguig to NLEX.

01 June 2011


Figure 62: SMC infrastructure projects overview Project Overview Concession description Construction duration Estimated cost Caticlan Airport SMC equity stake = 93%

Development, modernization, expansion and operation of the Caticlan Airport, the closest gateway to Boracay resort island

25-year Build-Rehabilitate- Operate-Transfer ("BROT") concession

Construction commenced in 2H 2010, expected to take 66 months with completion in 1H 2016

P2.5 bn with a target debt-to-equity ratio of 75:25

Visitors and arrivals to Boracay island grew rapidly at a CAGR of 13.3% from 2001-2008

TPLEX SMC equity stake = 35%

High speed, controlled access 88.6 km two-lane expressway that connects Tarlac, Pangasinan and La Union

30-year Build-Transfer-Operate ("BTO") concession

About four years, with revenue generation commencing on the second year

P21.6 bn, funded by a combination of debt (45.8%), equity (40.8%), and government subsidy (13.4%)

SMC has invested P806 mn as of Dec 2010 to acquire a 35% stake

MRT-7 SMC equity stake = 51%

44 km rail road that will connect existing metro rail system and toll road

25-year Build- Gradual-Transfer-Operate-Maintain ("BGTOM") concession

About 42 months starting 3Q 2011

Estimated to cost US$1.5 bn with a target debt-to-equity ratio of 75:25

One of several rail extension projects which will service Metro Manila and a population of over 10 million people

Annual capacity fee payments totalling US$2.7 bn over 20 years


Figure 63: SMC infrastructure projects location


01 June 2011


Telecommunications SMC has invested a total of P10 bn in its venture into telecommunications. At this point, SMC is not a major player in the Philippines telecommunications industry. Moreover, SMC has publicly stated that unlike its ventures in power, energy, and infrastructure, it plans to keep equity in its telecom ventures to a minimum and would likely approach expansion only with the help of strategic partners.

Liberty Telecom. SMC has a 41.5% stake in Liberty Telecommunications Holdings Inc, a provider of nationwide and international voice and data connectivity services. Liberty Telecom’s congressional franchise is valid until 2014. Liberty is known for launching “wi-tribe”, wireless broadband products using 4G technology, in the Philippines.

Bell-Tel. SMC has a 100% stake in Bell-Tel, a full service telecommunications company offering converged voice, data, and video telecom solutions. Bell-Tel has rolled out fibre-to-the-curb in the Makati central business district and entered into strategic alliances with underutilised telecom infrastructures. The company also operates a domestic C-band satellite hub providing connectivity for customers in remote sites not yet covered by its wireless networks.

Eastern Telecom. SMC has a 40% stake in Eastern Communications, a provider of data and internet services and a pioneer in the development of Asia-wide submarine cable connections to the Philippines in the 1970’s. The company was involved in electronic mail, packet-switched data and high speed data services in the 1980’s and managed data, fax services, ISDN services and debt card payphones in the 1990s.

Other ventures SMC also has investments in property, banking, and mining. The mining (Indophil and the Coal mining companies) may possibly be able to contribute significant value to SMC in the future. At this point, however, the visibility on the potential of these ventures is limited.

Property and banking. San Miguel Properties, Inc. (SMPI) is 99.7%-owned by SMC and serves as SMC’s primary corporate real estate and development arm. SMPI is presently engaged in the development, sale and lease of real properties. As of end 2010, San Miguel Properties is estimated to have net tangible assets of P8.3 bn. SMPI also has a 39.9% in Bank of Commerce (“BOC”), which has been serving the Philippines banking community for over 15 years.

Indophil. SMC owns approximately 10.1% of Australian based resource company Indophil NL which is the beneficial owner of a 37.5% stake in Sagittarius Mines Inc (SMI). SMI, in turn, holds a 40% stake in a joint venture company to explore, develop and operate the Tampakan copper and gold project in Mindanao. Xstrata Plc is Indophil's partner in Tampakan. The project was scheduled to produce an average of 340,000 metric tonnes of copper and 350,000 ounces of gold a year for two decades, based on a pre-development study by Xstrata. Tampakan is estimated to be one of the largest under-developed copper-gold deposits in the world. SMC is still studying whether or not to increase its stake in Indophil (IND AU, Not Rated).

Coal mines. SMC has 100%-ownership of three coal mining companies with coal operating contracts in Mindanao – Daguma, Bonanza, and Sultan. Daguma has two coal blocks with a total area of 2,000 hectares. Bonanza has eight coal blocks with a total area of 8,000 hectares. Sultan has seven coal blocks with a total area of 7,000 hectares. The heating value of the coal, however, is relatively low at 5,000 kCal/kg. SMC has already spent P200 mn for pre-development and drilling costs. The ownership of the coal mining companies are held under SMCGP and are part of the company’s vertical integration strategy for power generation.

01 June 2011


Figure 64: Summary of Regional Coal Reserves (MT) as of December 2006 Resource Positive Probable In-situ Mineable Potential Reserves Reserves Reserves ReservesCagayan Valley 336,000,000 80,104,730 3,695,000 82,568,063 70,182,854Cebu Central 40,000,000 3,354,257 4,763,160 6,529,697 3,917,818 Northern 75,000,000 2,229,719 655,727 2,666,870 1,600,122 Southern 50,000,000 1,295,113 1,870,206 2,541,917 1,525,150Davao 100,000,000 208,000 208,000 124,800Masbate 2,500,000 74,994 74,994 44,996Mindoro 100,000,000 1,310,641 198,000 1,442,641 865,585Negros 4,500,000 1,204,952 1,213,387 2,013,877 1,208,326Polillo, Bataan & Catanduanes 17,000,000 5,122,494 1,604,675 6,192,531 3,715,518Quezon 2,000,000 93,000 93,000 55,800Samar 27,000,000 7,474,890 1,667,725 8,586,707 7,278,807Semirara 570,000,000 124,379,660 43,820,358 153,593,232 130,554,247Surigao 209,000,000 29,298,653 60,978,034 69,950,676 47,799,580Zamboanga 45,000,000 34,247,148 5,984,679 38,236,934 22,942,161Bukidnon 50,000,000 Maguindanao 108,000,000 Sarangani 120,000,000 South Cotabato 230,400,000 23,590,423 66,123,516 67,672,767 40,603,660Sultan Kudarat 300,300,000 Total 2,366,700,000 313,978,674 192,574,467 442,361,652 332,413,274

Source: Department of Energy

Figure 65:Location of SMC coal and mining projects

Source: Company

01 June 2011


Expansion paying off SMC’s entry into power, energy, and infrastructure has made a significant impact on SMC’s bottom line. Moreover, it appears that the price of expansion and diversification is not overly burdensome as the company’s debt levels appear manageable. Perhaps most importantly, SMC’s transition into new businesses positions it to take advantage of the possible growth sectors of the Philippines economy going forward.

New businesses drive growth A jump in 2010 revenues and EBITDA reflects the consolidation of Petron and SMCGP into SMC’s 2010 financial statements. We expect to see diversification result in organic growth in SMC’s EBITDA and core profits going forward as the new businesses – particularly power generation and oil refining – continue to contribute a larger proportion of the bottom line.

Figure 66: SMC Revenues and EBITDA (2007 to 2010) Figure 67: SMC 2011E EBITDA breakdown

050

100150200250300

2007A 2008A 2009A 2010A

Revenues from new businessesRevenues from traditional businessSMC EBITDA

(Pbn)

Food12%

Packaging5% Beverage

27%

Energy (Oil refining)

26%Power

Generation30%

Source: Company data, Credit Suisse Source: Company data, Credit Suisse estimates

Figure 68: SMC EBITDA and core profits

-

20,000

40,000

60,000

80,000

100,000

120,000

2010A 2011E 2012E 2013E

Core profits EBITDA

(Pmn)


We forecast SMC core profits and EBITDA CAGR of 34% and 23%, respectively, from 2010-13

01 June 2011


Debt and capex burden manageable The consolidation of Petron and power generation company SMCGP into the 2010 financial statements results in a significant increase in current and non-current liabilities. Stripping out finance lease liabilities (which represent the estimated present value of lease payments to PSALM under the IPPA contract), consolidated net debt-to-equity – already incorporating SMC’s 970.5 mn series 1 preferred shares – remains just 0.88x. In our view, these are manageable debt levels particularly in the context of the tenor of SMC’s liabilities and the strong and reliable cash flow generation associated with the company’s individual businesses. Moreover, our forecasts estimate that consolidated EBITDA for 2011 to 2013 is sufficient to cover maturing obligations as well as payables related to investments already made.

Increase in liabilities due to consolidation of Petron and SMC Global Power

Figures 69 and 70 show a significant YoY increase in SMC’s current and non-current liabilities going from 2009 to 2010. Note, however, that the increases are almost completely attributable to the consolidation of Petron (68.2% owned by SMC) and SMC Global Power Holdings (100% owned by SMC) into the SMC financial statements. Outside of the effects of the accounting consolidation of these two companies, debt levels at SMC barely increased on a YoY basis.

Figure 69: SMC’s current liabilities (2009 vs 2010) Figure 70: SMC’s non-current liabilities (2009 vs 2010)

020406080

100120140160180200

2009 2010

Rest of SMC Petron SMC Global Pow er

(Pbn)

90% YoY increase mostly due to accounting

consolidation of Petron

050

100150200250300350400450

2009 2010

Rest of SMC Petron SMC Global Pow er

271% YoY increase mostly due to accounting

consolidation of SMC Global Pow er

into SMC

(Pbn)

Source: Company data, Credit Suisse Source: Company data, Credit Suisse

It is worth pointing out that:

■ The increase in SMC’s short-term debt level is reflective of the nature of Petron’s oil refining business wherein short-term debt is used to fund crude oil imports. The cost of the short-term financing is incorporated in the product pricing.

■ The consolidation of SMCGP into SMC means that approximately P200 bn of SMCGP’s finance lease obligations are now reflected in SMC’s balance sheet. The finance lease obligations represent an estimate of the present value of the lease payments due PSALM in relation with SMCGP’s IPPA role with regard to the Sual, San Roque, and Ilijan power generation facilities (see Figure 70). The IPPA contracts are treated as finance lease obligations since the lessee – in this case SMC - will have economic use of the assets (power generation facilities) during the lease period and the option to accept ownership of the assets at the end of the lease term.

■ Based on SMC’s 2010 year-end financial statements and incorporating both the SMCGP finance lease obligations as well as the 970.5m outstanding Series “1” preferred shares, we compute a net D:E ratio of 1.80x for SMC.

YoY increase in gearing due to accounting consolidation of acquired companies

SMC Net D:E including PSALM lease payments = 1.80x

01 June 2011


■ The lease payments due PSALM are classified as finance or capital leases since the lessee (in this case San Miguel) will pay a series of rentals or instalments for the use of the power plants. Eventually (after the lease term) SMC has the option to acquire ownership of the power plants. Since a finance lease is capitalised, both assets and liabilities in the balance sheet increase, pushing the D:E ratio higher. Note that SMC’s balance sheet reflects the present value of entire stream of rental payments to PSALM even though SMC need only make the rental payments for a particular year in order to enjoy the economic benefits for that year. Based on 2010 year-end financial statements and excluding the finance lease obligations, we arrive at a net D:E ratio of 0.88x - comparable to those of other Philippines companies involved in the infrastructure, power, and utility space. In fact, net gearing for Philippines power and utility firms averaged 0.76x over the past four years peaking at 1.00x in 2009.

Figure 71: PV of PSALM lease payments account for half of non-current liabilities

Long-term debt41%

Deferred tax liabilities4%

Other non-current liabilities

4%

Finance lease liabilities51%

Present Value of lease pay ments to PSALM for Sual,

San Roque, and Ilijan IPPAs

Source: SMC 2010 Audited FS, Credit Suisse

Figure 72: Net gearing for selected Philippines companies Year 2007A 2008A 2009A 2010A AverageConglomerate AEV PM (21.6) 4.7 124.5 66.1 43.4AC PM 8.3 6.5 4.7 15.4 8.7SM PM 7.2 27.2 39.4 40.9 28.7JGS PM 55.1 96.4 83.1 39.7 68.6DMC PM 4.6 21.2 71.2 33.9 32.7MPI PM 141.1 111.7 59.9 41.4 88.5Sector average 32.4 44.6 63.8 39.6 45.1Power/Utilities AP PM (32.2) (8.9) 182.2 84.3 56.4EDC PM 62.6 113.8 117.1 107.1 100.1MER PM 40.3 37.0 7.8 (5.0) 20.0FGEN PM 144.9 187.6 111.4 69.8 128.4MWC PM 60.2 69.4 82.8 90.8 75.8Sector average 55.2 79.8 100.2 69.4 76.1Telcos GLO PM 38.5 69.5 87.1 95.0 72.5PLDT PM 15.4 29.9 57.2 53.7 39.1Sector average 27.0 49.7 72.1 74.3 55.8Average 40.3 58.9 79.1 56.4 58.7

Source: Bloomberg, Credit Suisse

SMC Net D:E without PSALM lease payments = 0.88x

Lease payments to PSALM distort SMC gearing levels

Net D:E of 0.88x comparable to gearing levels of the Philippines power and utility firms as well as infrastructure heavy conglomerates

01 June 2011


Spread out maturities, with cash flow generating subs shouldering most loans

Based on SMC’s 2010 financial statements, only 15% of the company’s borrowings are maturing within the next three years. Moreover, the bulk of the borrowings are payable by SMC’s subsidiaries and individual business groups, which, in our view, have already achieved a level of funding self-sufficiency. Note that:

■ As of end-December 2010, long-term debt at the parent level consists of P42.8 bn USD denominated floating rate debt maturing in 2015 and a P10 bn Philippines peso denominated floating rate debt with maturities up to 2012, 2014, and 2015. It appears that there is no urgent need to refinance maturing debt obligations at the parent level in the near or even medium term.

■ SMC has 970.5 mn Series “1” preferred shares outstanding at the parent level. The preferred shares have a dividend rate of 8% per annum, are cumulative, non-participating, non-voting, and are redeemable in whole or in part at the sole option of SMC at the end of three years from the issue date (July 2009) at P75.00 per share plus any accumulated and unpaid cash dividends. It is worth reiterating that the preferreds are redeemable at the sole option of SMC. This feature gives SMC significant flexibility with regards to the repayment schedule for the preferreds.

■ The rest of SMC’s borrowings are held by the company’s subsidiaries and individual businesses such as San Miguel Brewery, Ginebra San Miguel Inc., San Miguel Purefoods Corporation, San Miguel Yamamura Packaging, SMC Global Power Holdings, and Petron Corporation. We believe these individual companies should be able to tap the capital markets on their own for expansion or refinancing requirements if needed.

Figure 73: SMC debt maturities profile ex PSALM rentals Figure 74: Parent debt versus total debt ex PSALM rentals

010,00020,00030,00040,00050,00060,00070,00080,00090,000

2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E

Non-Peso Peso

(Pmn)

Debt at parent32%

Debt at company/project

level68%


EBITDA sufficient to cover medium-term maturities and payables

Figure 75 shows that SMC’s forecasted consolidated 2011-13 EBITDA is sufficient to cover maturing debt as well as payables associated with investments, purchase of power generation assets from the government, and dividends due on SMC preferred shares. Note that the company also has P126 bn in cash as of end 1Q 2011. Capex associated with Petron’s RMP-2 programme is also not included in the chart as this amount is to be funded by money raised at the Petron level. Figure 76 details our estimates regarding the payables SMC needs to meet from 2011 to 2013.

01 June 2011


Figure 75: EBITDA versus payables (2011E to 2013E) Figure 76: SMC payables estimates (P bn)

0

20,000

40,000

60,000

80,000

100,000

120,000

2011E 2012E 2013E

Principal payments Investment ActivitiesPSALM liability payments Preferred DividendsInterest payments Maintenance CapexEBITDA

(Pmn) Year 2011E 2012E 2013E

Investing Activities

Meralco shares - balance (14,000) (14,000) -

Infrastructure projects:

ULC (MRT7) - - -

TPLEX (1,250) (1,250) -

Caticlan (310) (310) (70)

Sub-total (1,560) (15,560) (70)

PSALM Liability Payments (11,335) (16,560) (18,207)

Dividends on SMC Preferreds (5,823) (5,823) (5,823)


Note that:

■ Payables associated with investments relate to payments still due from SMC as a result of the company’s purchase of Meralco shares as well as participation in the TPLEX, Caticlan, and MRT-7 infrastructure projects.

■ As of end-2010, SMC still has P28 bn payable in relation to its acquisition of a 33.2% stake in Manila Electric Company. Approximately half (P14 bn) is payable this year and the balance in 2012. Management stated that the payment related to the MER shares due in 2011 have already been paid.

■ We estimate the capital calls SMC needs to meet relative to the company’s pro-rata equity stakes in the TPLEX, Caticlan Airport, and MRT-7 projects. These capital calls are included in our estimate of SMC’s payables in the medium term. It should be pointed out that we exclude potential capital calls for MRT-7 in our computation given that the MRT-7 project has yet to achieve financial close (by the same logic, we also do not incorporate the value of SMC’s stake in MRT-7 in our valuations). Assuming MRT-7 does achieve financial close, we estimate that the capital call associated with SMC’s 51% stake in the project would be P8.4 bn over the length of the construction period.

■ The Power Sector Assets and Liabilities Management Corporation (PSALM) provides a schedule of liability payments due SMC Global Power Holdings Corporation (SGPHC) in relation to SGPHC’s acquisition of the Sual, Ilijan, and San Roque IPPAs. We incorporate this schedule in our 2011 to 2013 payables estimates.

■ We incorporate the dividend payments due SMC’s 970.5 mn Series “1” preferred shares in our payables estimates. We assume that SMC opts not to redeem the preferred shares in 2012 (SMC has sole option to redeem the preferreds), but rather continues making the dividend payments on the SMC preferreds which have an 8% annual dividend rate.

01 June 2011


ROEs rising, gearing levels declining Our forecasts indicate improvement in SMC’s ROEs from 3.5% in 2009 to 12.2% in 2013 as the company’s expansion and diversification programs begin to impact on the bottom line. Note that the consolidation of Petron and the power generation assets under SMC in 2010 meant that the company’s consolidated financial statements would incorporate debt held by these entities (even though debt at SMC parent level would be largely unchanged). Nonetheless, given the P125 bn in cash the company has on its balance sheet and EBITDA versus total debt coverage ratios for 2011, 2012, and 2013 of 1.9x, 1.3x, and 1.8x respectively, we expect leverage ratios to fall even as ROEs are rising.

Figure 77: ROEs rising, gearing falling

0.00.20.40.60.81.01.21.41.61.82.0

2010A 2011E 2012E 2013E-

2

4

6

8

10

12

Net D:E (w/o PV of PSALM lease) Net D:E (w/ PV of PSALM lease) ROE (%)

Net gearing x (%)

ROE

0.00.20.40.60.81.01.21.41.61.82.0

2010A 2011E 2012E 2013E-

2

4

6

8

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12

Net D:E (w/o PV of PSALM lease) Net D:E (w/ PV of PSALM lease) ROE (%)

Net gearing x (%)

ROE


At this point, SMC's infrastructure, telco, and mining businesses have limited visibility and are not incorporated in our forecasts. Some of these businesses, however, assuming they develop and mature, have the potential to have a significant impact on SMC’s earnings. Nonetheless, SMC’s management driven M&A activity should result in an EPS CAGR of 30% during 2010-13. This rate of growth is superior to that of other sectors in the Philippines market.

Figure 78: M&A activity driving SMC’s EPS CAGR

30%

0

5

10

15

20

25

30

35

SMC Real Estate Banks Conglos Power, Energy, &Utilities

Telcos

2010 to 2013E EPS CAGR%(%)

30%

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30

35

SMC Real Estate Banks Conglos Power, Energy, &Utilities

Telcos

2010 to 2013E EPS CAGR%(%)


01 June 2011


Proxy for an evolving economy The Philippines economy grew by 7.3% in 2010. This represents the highest rate of growth in 34 years. We believe that SMC, given its dominant and diversified businesses, serves as a good proxy for the Philippines’ economic activity as it is today. Moreover, it appears that SMC’s focus on new ventures into energy and infrastructure mirrors the likely changes that will occur in the Philippines economy going forward.

Consumption drives GDP for now

The continued growth in the Philippines economy took place notwithstanding the headwinds brought about by the global financial crisis. Prior to the 7.3% growth in 2010, the economy managed real GDP growth of 1.1% in 2009 versus a global economy that actually contracted by 0.7% that same year (see CS Global Economy Monthly review, 10 March 2011).

Figure 79: Philippines macro-economic data 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012EReal GDP growth (% YoY) 4.9 6.4 5.0 5.4 7.1 3.7 1.1 7.3 4.6 5.0Real fixed investments (% YoY) 3.8 1.3 -6.6 3.9 10.9 2.7 -0.4 17.1 3.0 4.0CPI inflation (avg % YoY) 3.9 8.6 6.7 4.3 3.9 8.0 4.3 3.0 5.4 5.4Key policy rate (end-year) 6.8 6.8 7.5 7.5 5.3 5.5 4.0 4.0 5.0 5.3Exchange rate (P/US$, end-year) 55.6 56.3 53.1 49.1 41.4 47.5 46.2 43.8 41.5 40.0Govt budget deficit (% GDP) -4.6 -3.9 -2.8 -1.2 -1.6 -1.3 -3.9 -3.7 -3.4 -3.3Current account balance (% GDP) 0.4 1.9 2 4.5 4.9 2.2 5.5 5.0 4.9 4.7Source: CEIC, Credit Suisse estimates

We believe that the resilience of the Philippines economy can be attributed to its sizeable domestic consumer market which, in turn, is fuelled by remittances from Overseas Filipino Workers (OFWs). Except for a brief reversal during the Asian crisis, OFW remittances have registered steady growth during the past two decades regardless of prevailing global economic conditions. In our view, OFW remittances growth is a function of continued worker deployment. This, we believe, is dependent on several factors but none probably more important than demographic trends, as migrant workers are hired to perform jobs in countries with increasingly ageing populations.

Figure 80: Remittances key to resilient domestic economy

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000

1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

Remittances grew ev en during the global financial crisis

(US$ mn)

Source: Bangko Sentral ng Pilipinas, Credit Suisse estimates

We believe demographic rather than economic trends drive OFW deployment and therefore remittances

01 June 2011


OFW remittances are sent back home and serve to fuel domestic consumption. In 2010, OFW remittances totalled US$18.8 bn—10% of real GDP. It is worth pointing out that from 1990 to 2009, Personal Consumption Expenditures (PCE) as a percentage of GDP have averaged 78%. With the total Philippines population now at 92 mn, the Philippines has a significantly sized market for consumer goods.

Figure 81: Consumption % of GDP Figure 82: Population (in millions)

68

70

72

74

76

78

80

82

84

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

(%)

-

50

100

150

200

250

Indo

nesia

Philip

pines

Viet

nam

Thail

and

Mya

nmar

Mala

ysia

Cam

bodia La

o

Sing

apor

e

Brun

ei

Source: National Statistics Coordination Board, Credit Suisse research

Source: CEIC, Credit Suisse research

SMC looking at “uncrowded” segments of the economy

National Statistics Office (NSO) data indicate that food and beverage expenditure accounts for 49% of the Philippines CPI basket. We believe that the historic growth in SMC’s beverage and food businesses tracked the growth in the domestic consumer market. It appears, however, that SMC has made a strategic bet that the best medium-term domestic investment opportunities for the private sector now lie in the need to upgrade the country’s poorly designed and ill-maintained infrastructure (see Figure 83).

Figure 83: Overall quality of infrastructure rating (highest rating is 7)

0

1

2

3

4

5

6

7

Malay sia Korea Thailand China Indonesia Vietnam India Philippines

Source: The Global Competitiveness Report 2010-2011

SMC’s focus now turns to infrastructure

01 June 2011


Private players likely to dominate infrastructure space

For much of the period post the Asian crisis, fixed capital formation as a % of Philippines GDP has declined (see Figure 84). While there has been an uptick in real fixed investments in the past two years, we believe this can largely be attributed to government “pump priming” during the final years of the Arroyo administration. Large-scale government spending may prove difficult to sustain, however, given the focus of President Benigno S. Aquino III’s government is on controlling the deficit and keeping the 2011 deficit below the targeted level of 3.2% of GDP. With public expenditure being held in check, the government will likely turn to the private sector to help bear the financial burden of building infrastructure projects. The Public Private Partnership (PPP) programme launched by the government in a well-publicised conference on 19 November 2010 provides the private sector with an opportunity to help address the “dearth” of infrastructure projects. On the sidelines of the conference, SMC President and COO Ramon Ang said they are keen on participating in the different projects in the pipeline. “We will participate in all the projects: power projects, infrastructure projects and tourism.” Mr. Ang said that SMC’s priority would be projects in infrastructure and energy.

Figure 84: Fixed capital formation as a % of GDP

15

17

19

21

23

25

27

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: CEIC, Credit Suisse estimates

Figure 85: Real fixed investments Figure 86: Fiscal deficit as a % of GDP

40

45

50

55

60

65

70

75

80

Mar 04 Mar 05 Mar 06 Mar 07 Mar 08 Mar 09 Mar 10-10

-5

0

5

10

15

Real fixed investments, % qoq (RHS) Real fixed investments, Pbn

-3.4-3.7

-3.9

-1.3

-6

-5

-4

-3

-2

-1

02002 2003 2004 2005 2006 2007 2008 2009 2010 2011F

Source: CEIC, Credit Suisse research Source: CEIC, Credit Suisse estimates

Government PPP policy provides opportunities for SMC

01 June 2011


Financial statements Figure 87: San Miguel income statement (P mn) Year to December 2009A 2010A 2011E 2012E 2013ESales 174,213 246,109 561,606 593,115 642,016 Cost of sales (124,295) (173,906) (447,148) (463,434) (500,719)Gross profit 49,918 72,203 114,458 129,680 141,297 S&A expenses (30,249) (37,426) (51,888) (57,219) (60,613)EBITDA 30,013 52,534 76,992 89,350 98,682 Operating profit 19,669 34,777 62,570 72,462 80,684 Interest expense & other financing charges (7,926) (16,578) (25,253) (24,918) (24,647) Interest income 5,989 3,023 2,150 1,800 1,900 Equity in net earnings (losses) of associates 2,816 6,817 5,898 5,321 5,396 Gain on sale of investments and property & equipment 50,630 529 0 0 0 Other income (charges) (6,843) 6,926 366 312 1,249 Income before tax 64,335 35,494 45,730 54,977 64,582 Income tax expense (3,706) (11,438) (9,821) (10,814) (13,000)Income after tax 60,629 24,056 35,910 44,163 51,582 Net Income (ex-extraordinaries) 9,999 23,527 35,910 44,163 51,582 Non-controlling interests 2,830 3,965 8,632 9,200 10,055 Profits attributable to equity holders of parent 7,169 19,562 27,278 34,963 41,527 Less: dividends on preferred shares for the period 1,281 5,823 8,139 8,139 8,139 Core net income attributable to common shareholders 5,888 13,739 19,139 26,824 33,388


Figure 88: Net income breakdown by business group (P mn) Year to December 2010F 2010F (pro-forma)* 2011E 2012E 2013E Beverages 12,083 12,083 10,814 11,541 13,481 Food 4,134 4,134 3,275 4,062 5,136 Packaging 1,400 1,400 1,425 1,853 2,101 Power Generation 2,550 7,866 7,801 13,657 16,655 Energy (oil refining) 753 6,955 7,809 7,971 8,312 Parent (7,180) (14,106) (11,985) (12,260) (12,297) Totals 13,739 18,331 19,139 26,824 33,388

* Assumes San Miguel acquired 100% equity interests in both SMC Global and Petron on 1 January 2010 Source: Company data, Credit Suisse estimates

Figure 89: EBITDA breakdown by business group (P mn) Year to December 2010F 2010F (pro-forma)* 2011E 2012E 2013E Beverages 22,264 22,264 20,715 21,846 23,385 Food 7,605 7,605 8,933 10,759 12,425 Packaging 3,599 3,599 4,036 4,848 5,302 Power Generation 11,916 20,870 23,404 29,231 32,869 Energy (Oil Refining) 904 16,051 19,905 22,666 24,701 Others 6,545 1,766 0 0 0 Totals 52,834 72,155 76,992 89,350 98,682

* Assumes San Miguel acquired 100% equity interests in both SMC Global and Petron on 1 January 2010 Source: Company data, Credit Suisse estimates

01 June 2011


Figure 90: San Miguel cash flow statement (P mn) Year to December 2009A 2010A 2011E 2012E 2013ECash flows from operating activities Income before income tax from continuing operations 64,335 35,494 45,730 54,977 64,582 Income (loss) before income tax from discontinued operations 0 0 0 0 0 Gain (loss) from disposal of discontinued operations 0 0 0 0 0 Income before income tax 64,335 35,494 45,730 54,977 64,582 Adjustments for: Depreciation, amortisation and others - net 14,724 9,457 14,422 16,888 17,999 Interest expense and financing charges 7,926 16,578 25,253 24,918 24,647 Interest income (5,989) (3,023) (2,150) (1,800) (1,900) Equity in net losses (earnings) of associates (2,816) (6,817) (5,898) (5,321) (5,396) Loss (gain) from disposal of discontinued operations 0 0 0 0 0 Gain on sale of investments and PPE (50,630) (5,020) 0 0 0 Operating income before working capital changes 27,550 46,669 77,357 89,662 99,932 Changes in non-cash current assets, certain current liabilities, & others (1,183) 13112 (1,323) (17,728) (4,310)Cash from operations 26,367 59,781 76,034 71,934 95,622 Interest paid (6,348) (5,155) (25,253) (24,918) (24,647)Income taxes paid (6,651) (9,312) (9,821) (10,814) (13,000)Net cash flows provided by operating activities 13,368 45,314 40,961 36,203 57,975 Cash flows from investing activities Acquisitions of subsidiaries, net of cash (1,494) (18,978) 0 0 0 Additions to investments and advances (5,771) -99762 0 0 0Additions to PPE (6,249) (8,518) (34,853) (29,109) (22,319)Increase in non-current assets and others (950) 1424 4,029 (1,126) (1,342)Payments by (advances to) related parties 3,243 (6,070) 0 0 0 Proceeds from sale of investments and PPE 55,127 1,175 2,614 0 0 Proceeds from disposal of discontinued operations, net of cash 0 0 0 0 0 Interest received 5,249 3,798 2,150 1,800 1,900 Dividends received 0 0 2,090 3,043 2,748 Net cash flows provided by investing activities 49,155 (126,931) (23,969) (25,392) (19,013) Cash flows from financing activities Proceeds from: Short-term borrowings 691,093 685,768 7,195 1,718 0 Long-term borrowings 67,786 72,937 1,281 0 0 Payments of: Short-term borrowings (683,569) (703,376) 0 0 (8,289) Long-term borrowings (44,657) (29,196) 0 (20,495) (4,708) Payment of finance lease liabilities (12) (4,798) (10,946) (17,007) (19,418)Cash dividends (3,301) (21,118) (8,948) (8,948) (8,948)Proceeds from issuance of capital stock 7,087 2,314 0 0 0 Dividends paid to non-controlling shareholders (2,192) (4,883) (5,157) (4,845) (5,127)Increase in non-controlling interests 315 126 0 0 0 Net cash flows provided by (used in) financing activities 32,550 (2,226) (16,575) (49,577) (46,490)Effect of exchange rate changes on cash and cash equivalents (2,601) (380) 0 0 0 Net increase in cash and cash equivalents 92,472 (84,223) 417 (38,766) (7,528) Cash and cash equivalents at the beginning of the year 116,939 209,411 125,188 125,605 86,839Cash and cash equivalents associated to assets held for sale 0 0 0 0 0 Cash and cash equivalents at end of year 209,411 125,188 125,605 86,839 79,311


01 June 2011


Figure 91: San Miguel balance sheet (P mn) As at 31 December 2009A 2010A 2011E 2012E 2013ECurrent assets Cash and cash equivalents 209,411 125,188 125,605 86,839 79,311Trade and other receivables - net 49,082 75,904 72,185 77,579 82,989 Inventories 25,458 57,442 55,875 55,778 60,738 Current portion of biological assets - net 2,525 3,267 3,398 3,534 3,675 Pre-paid expenses and other current assets 8,891 16,914 22,223 23,156 24,378 Assets held for sale 2,746 823 823 823 823 Total current assets 298,113 279,538 280,109 247,709 251,915Non-current assets Investments and advances - net 39,005 152,814 156,622 158,900 161,548Available-for-sale financial assets 351 3,597 983 983 983Property, plant and equipment - net 65,919 308,073 328,504 340,725 345,045 Investment properties - net 1,867 2,133 2,133 2,133 2,133 Biological assets - net of current portion 1,847 1,479 1,546 1,615 1,688Goodwill - net 6,408 30,251 30,251 30,251 30,251Other intangible assets - net 3,630 10,980 10,980 10,980 10,980Deferred tax assets 8,883 7,134 7,435 7,695 8,046Other non-current assets - net 12,468 33,801 31,800 32,636 33,604Total non-current assets 140,378 550,262 570,252 585,918 594,278Total assets 438,491 829,800 850,361 833,627 846,193 Current liabilities Drafts and loans payable 56,789 74,128 81,323 83,041 74,752 Accounts payable and accrued expenses 31,391 69,774 60,730 49,691 55,487 Finance lease liabilities- current portion 13 10,946 17,007 19,418 20,289 Income and other taxes payable 4,186 10,001 16,428 16,105 17,733 Dividends payable 573 826 2,275 2,275 2,275 Current maturities of long-term debt - net of debt issue costs 1,077 12,549 20,495 4,708 32,991 Total current liabilities 94,029 178,224 198,257 175,237 203,526Non-current liabilities Long-term debt - net of current maturities and debt issue costs 71,885 156,378 149,713 145,005 112,014 Finance lease liabilities- net of current portion 0 197,461 180,454 161,036 140,747 Deferred tax liabilities 12,037 13,752 14,900 14,927 14,959 Other non-current liabilities 19,602 17,160 18,407 18,421 18,439 Total non-current liabilities 103,524 384,751 363,474 339,389 286,159 Equity Equity attributable to equity holders of the parent Capital stock - common 16,150 16,343 16,343 16,343 16,343 Capital stock - preferred 4,852 4,852 4,852 4,852 4,852 Additional paid-in capital 99,085 101,406 101,406 101,406 101,406 Revaluation increment 18 1,391 1,391 1,391 1,391 Cumulative translation adjustments 5,845 5,365 5,365 5,365 5,365 Retained earnings: Appropriated 5,497 5,671 5,671 5,671 5,671 Unappropriated 151,911 150,544 168,874 194,889 227,469 Treasury stock (69,541) (69,541) (69,541) (69,541) (69,541) 213,817 216,031 234,795 261,252 294,293Non-controlling Interests 27,121 50,794 54,269 58,624 63,552 Total equity 240,938 266,825 288,630 319,000 356,507Total liabilities plus equity 438,491 829,800 850,361 833,627 846,193


01 June 2011


TP of P135 represents 22% upside Our target price of P135 represents 22% potential upside. Our NAV determined target price incorporates base-case valuations for SMC’s businesses, a 20% conglomerate discount, and full share dilution resulting from the US$970 mn combined equity and exchangeable bond issue concluded 5 May 2011. In terms of P/E multiples, SMC is currently trading at 14.3x 2011E EPS, at par with market valuations, notwithstanding superior EPS growth of 31% for 2011 and 36% for 2012. Note that SMC is among the top-five Philippine stocks by market cap but currently has zero weighting in the Philippine MSCI index. This should change going forward as both free float and share liquidity have significantly improved after the 5 May fund raising.

Earnings outlook We are forecasting a 31% EPS CAGR for SMC from 2010 to 2013. The bulk of the profit growth is driven by the company’s new businesses, particularly Petron, and the power generation assets. These new businesses, which were not under SMC ownership control in 2009, are expected to account for 56% of EBITDA in 2011. Note that:

■ The pick-up in Petron profits would be due to an improvement in refining margins while the growth in power generation profit comes about as the off-take agreements are repriced over the medium term during what we believe remains a tight power supply environment.

■ Our EPS numbers already incorporate the underlying shares associated with the issuance of US$970 mn combined equity and exchangeable bond offering on 5 May 2011.

■ At current share price levels, SMC is trading at 14.2x EPS, nearly at par with the Philippines market average, notwithstanding showing stronger EPS above-trend estimated EPS growth for both 2011 (31% versus 11% by the market) and 2012 (36% versus 13% by the market).

Figure 92: Earnings summary Year 2009A 2010A 2011E 2012E 2013E Sales (P mn) 174,213 246,109 561,606 593,115 642,016 EBITDA (P mn) 30,013 52,534 76,992 89,350 98,682 Net income (P mn) 60,629 24,056 35,910 44,163 51,582 Net income attributable to equity holders (P mn) 7,169 19,562 27,278 34,963 41,527 Core profit (net of preferred dividends) (P mn) 5,888 13,739 19,139 26,824 33,388 Core profit % change YoY -5.3% 133.3% 39.3% 40.2% 24.5%Number of shares issued and outstanding (mn) 2,329.9 2,329.9 2,479.6 2,554.5 2,554.5 EPS (assumes full dilution from Exchangeable Bonds) 2.5 5.9 7.7 10.5 13.1 EPS % change YoY -5.3% 133.3% 30.9% 36.0% 24.5%ROA 1.8% 3.1% 3.2% 4.0% 4.8%ROE 3.5% 7.7% 9.8% 11.4% 12.2% Valuation ratios PER (x) 43.5 18.7 14.3 10.5 8.4P/CF (x) 19.2 5.7 6.6 7.7 4.8EV/EBITDA (x) 15.3 10.0 7.1 5.8 5.1


01 June 2011


Balance sheet analysis In our view, notwithstanding SMC’s significant diversification and expansion programme, the company’s debt situation is manageable. The substantial increase in balance sheet gearing levels from 2009 to 2010 is due to the accounting consolidation of Petron and the power generation assets – entities that SMC purchased in 2010. Parent level debt as well as debt held by SMC’s traditional F&B businesses have not increased by a meaningful amount since 2009. Note that:

■ For purposes of computing gearing and debt coverage levels, SMC preferred shares (redeemable at the sole option of SMC) with face value of P72.8 bn are classified as debt.

■ From an accounting point of view, the “rent-to-own” payments SMC makes to the Philippines government for the Sual, San Roque, and Ilijan power plants are classified as finance leases. This means that these payments are capitalized, inflating SMC’s D:E ratios. Incorporating the PSALM finance leases, SMC 2010 year-end net D:E is at 1.80x. Excluding finance leases, SMC net D:E is at 0.88x. SMC’s net gearing ex-finance leases of 0.88x is comparable to the Power and Utility sector net gearing average of 0.76x.

■ The company’s key subsidiaries are able to raise money and fund capex on their own. We believe the major capex going forward consists of Petron’s US$1.7 bn refinery upgrade. The money for the refinery upgrade would be raised at the Petron – not SMC - level.

■ We forecast SMC’s gearing, debt cover, and leverage ratios will all be improving over the medium term.

Figure 93: Balance sheet summary and gearing ratios (P mn) 2009A 2010A 2011E 2012E 2013ECash and cash equivalents 209,411 125,188 154,741 115,975 108,447 Short-term loans 56,789 74,128 81,323 83,041 74,752 Current maturities of long-term debt - net of debt issue costs 1,077 12,549 20,495 4,708 32,991 Total current liabilities 94,029 178,224 198,257 175,237 203,526 Estimated present value of PSALM leases 0 197,461 180,454 161,036 140,747 Other noncurrent liabilities 19,602 17,160 18,407 18,421 18,439 Long-term debt - net of current maturities and debt issue costs 71,885 156,378 175,813 171,105 138,114 Total noncurrent liabilities 103,524 384,751 389,574 365,489 312,259 Face value of preferred shares 72,800 72,800 72,800 72,800 72,800 Equity 213,817 216,031 237,397 263,412 295,992 Scheduled payments per annum Interest expense and financing charges 7,926 16,578 25,253 24,918 24,647 Payment of finance lease liabilities 12 4,798 10,946 17,007 19,418 Long-term borrowings (principal) 44,657 29,196 0 20,495 4,708 Dividends paid to non-controlling shareholders 2,192 4,883 5,157 4,845 5,127 Gearing ratios (x) Net debt/equity (w/ PV of PSALM lease payments) -0.03 1.80 1.59 1.43 1.19Net debt/equity (w/o PV of PSALM lease payments) -0.03 0.88 0.83 0.82 0.71Debt cover ratios (x) EBITDA/interest payments (including preferred dividends and lease payments) 3.0 2.0 1.9 1.9 2.0EBITDA/total debt payments (including principal payments) 0.5 0.9 1.9 1.3 1.8Leverage ratios (x) Net debt (w/ PV of PSALM lease payments) vs EBITDA -2.5 6.4 4.4 3.8 3.2Net debt (w/o PV of PSALM lease payments) vs EBITDA -2.5 2.7 2.1 2.0 1.8


01 June 2011


NAV determined target price of P135 We broke down SMC into its individual businesses and subsidiaries and then proceeded to value each of these components of the conglomerate independently. We then sum up the value of these individual components to arrive at an equity value (post-conglomerate and holding company debt adjustments) of P345 bn. This translates to a target price of P135. Our valuation methodologies for SMC’s individual components are described in the following pages. Comparable firms used in the valuation process are listed in Figure 91.

San Miguel Brewery. We value SMC’s 51% stake in San Miguel Brewery at P99.8 bn. We arrive at this range by applying the regional peer brewery average P/E multiple of 15.8x, plus a 20% premium, versus estimated 2011 earnings for San Miguel Brewery. We believe that the premium is deserved in view of San Miguel Brewery’s iconic brand name and dominant position in the Philippines market.

Ginebra San Miguel Inc. We value SMC’s 78% stake in GSMI at P5.4 bn. We arrive at this figure by applying the regional peer average distiller multiple of 19.3x less a 20% discount. We believe a valuation discount is warranted given the volatility in GSMI profits.

San Miguel Purefoods Company Inc. We value SMC’s 99.9% stake in San Miguel Purefoods Company Inc. at P29.2 bn. We arrive at this figure by applying the regional branded food company average P/E multiple of 16.7x to estimated 2011 earnings of San Miguel Purefoods.

San Miguel Yamamura Packaging Corp. We value SMC’s 65% stake in the Packaging Group at P7 bn. We arrive at this figure by applying the regional peer packaging company average P/E multiple of 8.3x to estimated 2011 earnings for the Packaging Group.

Manila Electric Company. We value SMC’s 33.2% stake in Meralco at P73.6 bn. This is based on a DCF methodology using a WACC of 9.7%. Our key assumptions under the DCF methodology are:

■ We assume no significant differences between the draft determination made public by the Energy Regulatory Commission (ERC) last December 2010 and the final determination due out in April 2011. Our cash flow forecasts for Meralco assume that the next rate rebasing (distribution tariff adjustment) as outlined by the Final Determination for the July 2011 to June 2015 regulatory period will be implemented on July 2011.

■ Our estimates incorporate the estimated value contribution from the company’s planned 150 MW peaking plant scheduled to become operational on 1H 2012.

Petron Corporation. We value SMC’s 68.3% stake in Petron Corporation at P112.7 bn. This is premised on a 7.9x EV/EBITDA multiple – in line with regional refiners in Asia – applied to estimated 12-month rolling EBITDA. Our key assumptions are:

■ Regional refining margins are very strong in 2011 – YTD Singapore Refining margins are at US$11.5/bbl, and is now above 2004-07 average. Global demand momentum is strong in 3Q-4Q10 on the back of robust non-OECD demand and recovery in the OECD. While we are seeing signs of slowing momentum heading out of winter, 1Q11 demand is boosted by the tragic earthquake in Japan and a strong diesel demand in China. China imposed power curbs in 4Q10 to meet energy efficiency targets, and industrials turned to diesel generators to meet power shortfall. Power shortages still persists in China this year – some expects the coming summer to have the worst shortage situation since 2004, where diesel demand grew 24% YoY. CS forecasts global oil demand to grow 1.8% in 2011 and 2.5% in 2012, while global refining capacity growth is expected to grow at 1.3% in 2011 and 1.1% in 2012.

■ We forecast Petron's EBIT will grow at a 12.3% CAGR through to 2013. This is due to organic growth driven primarily by service station expansion as well as cost savings as

01 June 2011


the company sources its power requirements from its own power plant. We expect Petron to maintain its dominant position in the Philippines downstream market – Petron's revenue is forecasted to grow at a 7% CAGR between 2011 and 2013, mainly driven by the 4% p.a. growth in retail sales. We expect Petron's refining margins to be largely flat in 2012-13, in line with regional margins. Note that our forecasts and valuations have yet to incorporate Petron's RMP-2 refinery upgrade which raises refinery utilisation from the current 70% to above 90%, but would impact earnings only in a significant way beginning 2014.

SMC Global Power Holdings Corporation (SMCGP). We value the Sual, San Roque, and Ilijan IPPA contracts together with SMC’s direct ownership of the Limay power plant – in aggregate at P130.3 bn using DCF methodology. Our key assumptions are:

■ We assume that SMC's three IPPA’s and the Limay plant enjoy Income Tax Holidays (ITHs) from August 2010 until August 2014.

■ We value SMC's power plants based on the net present value of its forecasted free cash flows using a WACC of 8.8% and terminal growth rate of 3% less SMCGP’s net debt. Note that our free cash flow forecasts are net of SMC's cash payments to PSALM. Hence, we do not treat the PSALM liability as part of debt but rather as an operating expense.

■ We assume that SMC's coal and natural gas plants combined sell power at an average of P5.1-5.4/kwh over 2011-13. This is based on the average selling price for power currently produced by new coal plants in the Luzon grid. We also forecast 5-6% annual hikes in tariff rates over the medium-term.

■ We assume that capacity factors for SMC's plants peak from 2012-13 given the absence of new baseload capacity in Luzon.

Universal LRT. We apply zero value to this business as the commercial viability of MRT-7 is difficult to ascertain until the project achieves financial close. Financial closure is expected by 2H 2011.

Private Infrastructure Development Corp (PIDC) and Trans-Aire Development Holding Corporation (TADHC). We estimate the DCF determined fair value of PIDC and TADC to be at P112 mn to P120 mn and P182 mn to P200 mn, respectively. The valuation range is the result WACC ranging from 11.5% to 12.5%. For the purpose of our NAV computations, we use 11.5% WACC for these two projects. Our valuations do not incorporate benefits from the real estate components of these projects as such benefits are difficult to quantify at this point.

Telecoms (Liberty Telecom, Bell-Tel and Eastern Telecom). We value SMC’s 41.5% stake in Liberty Telecom (LIB PM, NR) based on the market value of the Liberty Telecom shares as of 27 May 2011. SMC’s investments in Bell Tel and Eastern Telecom are valued at cost.

Indophil. We value SMC’s 10.1% stake in Indophil at P1.5 bn based on the market value of the Indophil shares (IND AU, Not Rated) as of 27 May 2011 converted to Philippines pesos at prevailing exchange rates.

Coal mining assets (Daguma, Bonanza, Sultan). We value SMC’s coal assets at US$100 per MT of positive reserves less extraction cost equal to US$70 per MT of reserves.

Others:

01 June 2011


■ Our P14 bn net debt figure is based on the SMC parent level 1Q 2011 cash level of P30.5 bn plus cash raised during the exchangeable bond and share sale transaction of 5 May 2011 less straight debt amount of P74 bn.

■ SMC has 970.5 mn cumulative, non-voting, non-participating, preferred shares with an 8% dividend yield, redeemable at SMC’s option at P75 per share. For valuation purposes, we assume these preferreds are redeemed immediately. The value of the preferreds are subtracted from our NAV computation for SMC.

■ We estimate that SMC will have payables over the next three years due to commitments (approximately P30 bn over the next two years) related to its purchase of Meralco shares in 2009 and likely equity calls for the Caticlan and TPLEX projects.

■ A conglomerate discount of 20% has been applied to arrive at the final NAV figure. This discount is our estimate of the average historical NAV discount, adjusted for M&As, applied by the market to Philippines conglomerates (see our 15 December 2010 report: Philippines conglomerates: Unlocking value).

■ We use 2,554.4 mn number of common shares to compute for our NAV per share and target price per share estimates. The 2,554.4 mn number of common shares incorporates the 189.1 mn underlying shares and 35.5 mn reissued treasury shares which were part of the US$970 mn exchangeable bond and share sale transaction 5 May 2011.

■ In early 2010, SMC acquired 49% of the common shares and 100% of the non-voting, redeemable, participating preferred shares of TF, resulting in the cross shareholding between SMC and TF. Such investment gives SMC interest over 67% of TF’s regular and special dividends. The investment consists of 2,401,960 common shares of TF from its unissued stock; and 2,598,040 non-voting, redeemable, cumulative, participating preferred shares with a preferential dividend rate of 3% per annum Approximately 40% of the remaining common shares of TF are held by Mr. Iñigo Zobel, who is also a member of the SMC Board. The substantial portion of the remaining shares is owned by Master Year Limited and other nominal stockholders. As of 31 December 2010, SMC’s total investment in TF amounted to PHP92.5 billion and is accounted for in SMC’s balance sheet as an investment. Nonetheless, in our NAV methodology, we do not attribute any value to SMC’s investment in TF. Note that TF’s only substantial assets are its ownership of SMC common shares currently equivalent to 57.1% of all SMC common shares outstanding. For SMC to realize value from its TF investment, therefore, TF in turn needs to monetise its SMC shareholdings or somehow unwind the cross holding structure. At this point, however, it is unclear if and when these events will occur. Hence, we do not incorporate SMC’s 67% interest in TF in our NAV estimates.

01 June 2011

San Miguel C

orporation (SM

C.PS / SM

C PM

) 56

Figure 94: Sum-of-the-parts NAV computation for SMC (pricing comparables as of 27 May 2011) SMC effective Bloomberg Total# Valuation of SMC share NAV Ownership (%) Listed? Ticker shs (m) Pbn P/share Valuation Methodology Traditional businesses Beverage San Miguel Brewery (includes SMB Int'l) 51 Y SMB.PM 15,411 99.8 39.1 20 percent premium vs regional comps of 15.8 x PER Ginebra San Miguel Inc 78 Y GSMI.PM 281 6.0 2.3 20 percent discount vs regional comp of 19.3 x PER San Miguel Purefoods Company Inc 100 Y PF.PM 167 74.7 29.2 Regional Comps = 16.7x PER San Miguel Yamamura Packaging Corp 65 N None 7.7 3.0 Regional Comps = 8.3x PER Power and Energy Petron Corporation 68 Y PCOR.PM 9,375 112.7 44.1 Regional Comps (7.9x EV/EBITDA) Power Generation in Aggregate 100 N None 130.3 51.0 Net DCF value of 3 IPPAs + Limay SMC Global Energy Sual DCF San Roque DCF Ilijan DCF Limay DCF Manila Electric Company 33 Y MER.PM 1,127 73.6 28.8 DCF based on ERC Draft Determination Businesses under Development Infrastructure Universal LRT (MRT-7) 51 N None - - Zero value until financial close is achieved PIDC (TPLEX) 35 N None 0.1 0.1 DCF on project returns/no real estate TADHC (Caticlan) 93 N None 0.2 0.1 DCF on project returns/no real estate Telecoms Liberty 42 Y LIB PM 1,294 2.1 0.8 Market value of shares BellTel 4.5 1.8 Carrying cost Eastern Telecom 3.5 1.4 Carrying cost Others San Miguel Properties Inc 100 Y SMP PM 122 8.3 3.3 Book value Indophil 10 Y IRN AU 471 1.5 0.6 Market value of shares Coal Assets in aggregate 100 9.1 3.6 Net value (less estimated extraction cost) of positive reserves Daguma " N None Still in pre-development Bonanza " N None Still in pre-development Sultan " N None Still in pre-development Sub-Total (Traditional + New + Others) 534.1 209.1 Plus Parent Net Cash/(Debt) (14.4) (5.6) Cash (Debt) position as of May 2011 Less BV of SMC Prefs (72.8) (28.5) 970m prefs assume redeemed Less NPV of Estimated Payables (16.0) (6.3) Mostly payables re MER purchase SMC aggregate NAV 430.9 168.7 Less 20% conglomerate discount (84.1) (33.7) Avg discount to NAV of listed PH conglos (20%) Target price, net of discount 344.8 135.0


01 June 2011


Comp tables and charts Figure 95: Regional comparables PE EV/EBITDA Company Ticker Country Region Currency 2011E 2012E 2011E 2012EBeer Foster's Group FGL.AX Australia Asia Pacific AUD 17.7 16.4 11.7 11.1Hite Brewery Co Ltd 103150.KS South Korea Asia Pacific KRW 13.9 11.8 8.7 8.1Average 15.8 14.1 10.2 9.6 Distillers Jinro 000080.KS South Korea Asia Pacific KRW 14.3 12.3 10.7 8.9United Spirits Ltd. UNSP.BO India Asia Pacific INR 24.3 18.1 13.3 11.1Average 19.3 15.2 12.0 10.0 Foods Balrampur Chini Mills Ltd BACH.BO India Asia Pacific INR 7.2 7.9 5.3 5.8CJ Cheiljedang 097950.KS South Korea Asia Pacific KRW 11.2 9.8 11.2 9.8China Mengniu Dairy 2319.HK China Asia Pacific HKD 22.7 17.5 10.0 8.1Goodman Fielder GFF.AX Australia Asia Pacific AUD 10.2 12.1 6.8 7.5Indofood Agri Resources Ltd IFAR.SI Singapore Asia Pacific SGD 12.0 13.8 5.3 6.0Indofood Sukses Makmur INDF.JK Indonesia Asia Pacific IDR 14.3 13.2 6.2 5.8Nong Shim 004370.KS South Korea Asia Pacific KRW 13.3 11.1 8.3 7.1Tingyi 0322.HK China Asia Pacific HKD 31.9 25.3 14.8 10.7Uni-President Enterprises 1216.TW Taiwan Asia Pacific TWD 16.6 16.3 68.9 68.4Want Want China Holdings Ltd. 0151.HK China Asia Pacific HKD 27.8 22.8 18.9 15.2Average 16.7 15.0 15.6 14.5 Packaging FP 7947 Japan Asia Pacific JPY 13.1 11.7 5.7 5.4AMVIG Holdings 2300.HK China Asia Pacific HKD 7.9 6.9 5.2 4.6Amcor AMC.AX Australia Asia Pacific AUD 15.7 12.1 7.6 6.5Lee & Man Paper 2314.HK Hong Kong Asia Pacific HKD 11.7 10.5 10.3 8.9Nine Dragons Paper Holdings Ltd 2689.HK Hong Kong Asia Pacific HKD 10.4 8.5 8.9 7.2PaperlinX PPX.AX Australia Asia Pacific AUD (9.5) (28.0) 10.3 8.1Sateri 1768.HK China Asia Pacific HKD 8.7 7.3 6.4 5.5Average 8.3 4.1 7.8 6.6 Refiners Thai Oil TOP.BK Thailand Asia Pacific THB 9.3 11.0 5.7 6.4PTTAR PTTAR.BK Thailand Asia Pacific THB 11.3 10.3 6.8 6.5Esso Thai ESSO.BK Thailand Asia Pacific THB 8.6 8.2 7.1 6.5Bangchak Petroleum BCP.BK Thailand Asia Pacific THB 7.6 7.9 6.0 6.2IRPC IRPC.BK Thailand Asia Pacific THB 13.2 12.2 10.4 9.2Shell Refining Malaysia SLRS.KL Malaysia Asia Pacific MYR 21.1 14.0 11.4 8.6S-Oil 010950.KS Korea Asia Pacific KRW 8.7 8.5 7.5 6.7GS Holdings 078930.KS Korea Asia Pacific KRW 7.7 7.3 8.0 7.6Average 10.9 9.9 7.9 7.2

Source: Bloomberg, Company data, Credit Suisse estimates

01 June 2011


Key risks General risks related to the Philippines Nearly all of SMC’s revenues are generated by businesses located in the Philippines. Hence, adverse political and economic events in the Philippines may have negative implications for SMC. Examples of such adverse events include political instability, changes or reversals in government policy, or deceleration in the country’s economic growth. These events can result in reduced economic activity which in turn could adversely impact SMC’s profitability. Such events can also trigger adverse reactions from the financial markets resulting in foreign exchange rate and interest rate volatility. As of end-December 2010, 68% of SMC’s debt is floating rate while 43% is denominated in US$.

Risks related to SMC’s diversification policy SMC’s diversification strategy is associated with inherent risks. Over the past three years, SMC has utilised cash flows from its traditional beverage, food, and packaging businesses to expand into oil refining, power generation, electric utilities, infrastructure, telecommunications, mining, and other ventures. While the strategy has so far been able to boost earnings growth for SMC, there are no guarantees that the company can continue to successfully implement this strategy.

■ Lack of technical expertise. Continually executing major acquisitions (especially of businesses that are new to SMC) requires technical expertise that may not be readily available.

■ Difficulty in accessing capital. Continually executing major acquisitions, especially of non-core businesses, requires access to capital that may not be readily available. Access to capital is dependent on conditions in the financial markets which are beyond the company’s control.

■ Problems with execution. Even if acquisitions are successfully implemented, there is no assurance that SMC will be able to generate the expected economic returns and synergies from these. Integrating the acquired business(es) into SMC may prove problematic or may involve additional costs beyond those originally projected.

Risks related to SMC’s traditional businesses We believe that SMC’s traditional beverage, food, and packaging businesses face the following risks:

■ Competition. To a varying extent, SMC faces competition in all of its businesses. The competition is probably most extreme in the beverage, food, and packaging businesses. Failure to innovate or match pricing of competitors may result in reduced market share and shrinking profit margins for SMC.

■ Fluctuations in commodity and raw material prices. Fluctuations in commodity prices impact profit margins for SMC’s food and beverage businesses. In a period of rising commodity prices, strategies such as input substitution, hedging and vertical integration may help mitigate the effects of rising commodity prices, but there is no guarantee that these strategies will be effective.

■ Shortages of raw material supply. SMC’s beverage and food businesses are dependent on raw materials procured from third parties. Unless the company is able to identify alternative inputs, shortages of these materials could adversely impact production, pricing, and profitability.

01 June 2011


■ Change in customer preferences. SMC’s ability to maintain dominant market share in its beverage and food businesses is dependent on the company’s ability to create products that satisfy consumer tastes. Changes in consumer preferences due to demographic, economic, or social trends may adversely impact SMC’s ability to maintain market share and grow revenues.

■ Outbreak of diseases. The occurrence of such events, such as incidences of avian influenza or bird flu, can disrupt production and distribution activities of SMC’s food business. These events may also reduce demand for SMC’s food products.

■ Problems between SMC and its joint ventures partners. The businesses of some of SMC’s subsidiaries are conducted through joint ventures with other partners, including Kirin Holdings Company, Limited (“Kirin Holdings”) for beverages, Hormel Foods Corporation for processed meats, Nihon Yamamura Glass Co., Ltd. (“Nihon Yamamura Glass”) for glass bottles. Cooperation among the joint venture partners on business decisions is crucial to the sound operation and financial success of these joint venture companies. Such problems may result in disruptions to these businesses.

Risks related to San Miguel’s new businesses We believe that SMC’s new businesses in Energy and Infrastructure face the following risks:

■ Regulatory. It is difficult to quantify the impact of adverse changes in the regulatory environment on SMC. Nonetheless, all of SMC’s companies to some extent or the other are exposed to regulatory risk. The adverse effects of regulatory changes could range from heightened competition to an increased cost of doing business. Regulatory risk is probably the most relevant for Manila Electric Company (since the electricity distribution utility’s profit margins are determined by regulators) and regulated infrastructure projects such as MRT-7, TPLEX, and the Caticlan Airport project.

■ Competition. To a varying extent, SMC faces competition in all of its businesses except for the regulated utilities such as Manila Electric Company. Among the new businesses, oil refiner Petron and the power generation company San Miguel Global Power Holdings Corporation both operate in deregulated environments where price competitiveness is important.

■ Commodity and raw material prices. Fluctuations in commodity prices impact profit margins for SMC’s oil refining and power generation business. There are no assurances that Petron could maintain profit margins and pass on cost of imported crude.

■ IPPA framework. Potential mismatches between TSC and fuel cost could result in margins being squeezed. Moreover, SMC does not control the asset as IPPA. While a power generation facility is maintained by qualified private contractors and the IPPA arrangement is meant to compensate the IPPA for operational problems with the facilities, there is no assurance that problems at the power plant facility will not adversely impact the economics of the IPPA.

■ Foreign exchange and interest rate risk. Fluctuations in the exchange rate between the Peso and other currencies, such as the U.S. dollar, could have a material adverse effect on the financial condition of SMC’s businesses that are involved in importation such as Petron or have significant dollar liabilities such as San Miguel Global Power Holdings Corporation.

Companies Mentioned (Price as of 31 May 11) Amcor (AMC.AX, A$7.30, OUTPERFORM, TP A$8.00) AMVIG Holdings (2300.HK, HK$5.50, OUTPERFORM, TP HK$7.85) Balrampur Chini Mills Ltd (BACH.BO, Rs61.95, UNDERPERFORM [V], TP Rs70.00) Bangchak Petroleum Public Co (BCP.BK, Bt21.30)

01 June 2011


China Mengniu Dairy (2319.HK, HK$24.90, OUTPERFORM, TP HK$28.00) CJ Cheiljedang (097950.KS, W241,000, NEUTRAL, TP W260,000) Esso Thai (ESSO.BK, Bt12.60) Foster's Group (FGL.AX, A$4.32, UNDERPERFORM, TP A$5.90) FP (7947, ¥4,740, OUTPERFORM, TP ¥5,400) Ginebra San Miguel (GSMI.PS, P29.00) Goodman Fielder (GFF.AX, A$1.06, UNDERPERFORM, TP A$0.93) GS Holdings (078930.KS, W93,000, OUTPERFORM, TP W88,000) Hite Brewery Co Ltd (103150.KS, W118,000, NEUTRAL, TP W110,000) Indofood Agri Resources Ltd (IFAR.SI, S$1.63, NEUTRAL, TP S$2.50) Indofood Sukses Makmur (INDF.JK, Rp5,400.00, OUTPERFORM, TP Rp6,400.00) Indophil (IRN.AU, A$0.565) IRPC Public Company Ltd (IRPC.BK, Bt5.85) Jinro (000080.KS, W36,000, OUTPERFORM, TP W38,000) Lee & Man Paper (2314.HK, HK$4.72, NEUTRAL [V], TP HK$5.15) Liberty Telecom (LIB.PS, P3.95) Manila Electric (Meralco) (MER.PS, P240.20, UNDERPERFORM [V], TP P194.00) Nine Dragons Paper Holdings Ltd (2689.HK, HK$7.37, UNDERPERFORM [V], TP HK$10.80) Nong Shim (004370.KS, W251,500, NEUTRAL, TP W230,000) PaperlinX (PPX.AX, A$0.17, UNDERPERFORM [V], TP A$0.40) Petron Corporation (PCOR.PS, P13.40) PTT Aromatics and Refining (PTTAR.BK, Bt38.25, UNDERPERFORM, TP Bt40.00) San Miguel Brewery (SMB.PS, P31.00) San Miguel Corporation (SMC.PS, P110.80, OUTPERFORM, TP P135.00) San Miguel Properties (SMP.PS, P610.00) San Miguel Purefoods (PF.PS, P999.50) Sateri (1768.HK, HK$6.62, OUTPERFORM [V], TP HK$10.55) Shell Refining Co, Fom Bhd (SLRS.KL, RM10.80) S-Oil Corp (010950.KS, W153,000, OUTPERFORM, TP W130,000) Thai Oil (TOP.BK, Bt80.75, OUTPERFORM, TP Bt99.00) Tingyi (0322.HK, HK$23.75, NEUTRAL, TP HK$19.40) Uni-President Enterprises (1216.TW, NT$41.25, NEUTRAL, TP NT$37.20) United Spirits Ltd. (UNSP.BO, Rs1,062.35) Want Want China Holdings Ltd. (0151.HK, HK$7.45, NEUTRAL, TP HK$6.60)

Disclosure Appendix Important Global Disclosures I, Dante Tinga, Jr., certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. See the Companies Mentioned section for full company names. 3-Year Price, Target Price and Rating Change History Chart for SMC.PS SMC.PS Closing

Price Target

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Initiation/ Date (P) (P) Rating Assumption 05-Aug-08 43.5 NC 13-Dec-10 127 153.92 O X 19-Jan-11 169.9 R 10-Feb-11 180 R

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Closing Price Target Price Initiation/Assumption Rating

P

O=Outperform; N=Neutral; U=Underperform; R=Restricted; NR=Not Rated; NC=Not Covered

The analyst(s) responsible for preparing this research report received compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities.

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Analysts’ stock ratings are defined as follows: Outperform (O): The stock’s total return is expected to outperform the relevant benchmark* by at least 10-15% (or more, depending on perceived risk) over the next 12 months. Neutral (N): The stock’s total return is expected to be in line with the relevant benchmark* (range of ±10-15%) over the next 12 months. Underperform (U): The stock’s total return is expected to underperform the relevant benchmark* by 10-15% or more over the next 12 months. *Relevant benchmark by region: As of 29th May 2009, Australia, New Zealand, U.S. and Canadian ratings are based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe**, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. Some U.S. and Canadian ratings may fall outside the absolute total return ranges defined above, depending on market conditions and industry factors. For Latin American, Japanese, and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; for European stocks, ratings are based on a stock’s total return relative to the analyst's coverage universe**. For Australian and New Zealand stocks a 22% and a 12% threshold replace the 10-15% level in the Outperform and Underperform stock rating definitions, respectively, subject to analysts’ perceived risk. The 22% and 12% thresholds replace the +10-15% and -10-15% levels in the Neutral stock rating definition, respectively, subject to analysts’ perceived risk. **An analyst's coverage universe consists of all companies covered by the analyst within the relevant sector. Restricted (R): In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Volatility Indicator [V]: A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.

Analysts’ coverage universe weightings are distinct from analysts’ stock ratings and are based on the expected performance of an analyst’s coverage universe* versus the relevant broad market benchmark**: Overweight: Industry expected to outperform the relevant broad market benchmark over the next 12 months. Market Weight: Industry expected to perform in-line with the relevant broad market benchmark over the next 12 months. Underweight: Industry expected to underperform the relevant broad market benchmark over the next 12 months. *An analyst’s coverage universe consists of all companies covered by the analyst within the relevant sector. **The broad market benchmark is based on the expected return of the local market index (e.g., the S&P 500 in the U.S.) over the next 12 months. Credit Suisse’s distribution of stock ratings (and banking clients) is:

Global Ratings Distribution Outperform/Buy* 48% (63% banking clients) Neutral/Hold* 40% (56% banking clients) Underperform/Sell* 10% (50% banking clients) Restricted 2%

*For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors.

Credit Suisse’s policy is to update research reports as it deems appropriate, based on developments with the subject company, the sector or the market that may have a material impact on the research views or opinions stated herein. Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: http://www.csfb.com/research-and-analytics/disclaimer/managing_conflicts_disclaimer.html Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purposes of avoiding any penalties. See the Companies Mentioned section for full company names. Price Target: (12 months) for (SMC.PS) Method: Our target price of P135.00 is based on NAV methodology using average PER and/or EV/EBITDA of comparable regional firms to value SMC's individual subsidiaries. For those subsidaries with no comparables, we use either a DCF or Book value approach. We also apply a 20% conglomerate discount and adjust valuations to take into account the company's net debt position before we arrive at the target price. Risks: Risks to our target price of P135.00 are 1) volatility in macro environment for traditional businesses, 2) regulatory risk for new businesses, and 3) overdiversification. Please refer to the firm's disclosure website at www.credit-suisse.com/researchdisclosures for the definitions of abbreviations typically used in the target price method and risk sections.

See the Companies Mentioned section for full company names. The subject company (SMC.PS) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. Credit Suisse provided investment banking services to the subject company (SMC.PS) within the past 12 months. Credit Suisse has managed or co-managed a public offering of securities for the subject company (SMC.PS) within the past 12 months. Credit Suisse has received investment banking related compensation from the subject company (SMC.PS) within the past 12 months.

01 June 2011


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01 June 2011Asia Pacific/Philippines

Equity Research

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