Manila Water (MWC) Investing Risk Reward

This past week, since December 16 up to December 20, I was making a move in the market. I sold some of my investments to free up some cash and bought boatloads of shares. I was making a big bet and hopefully it would pay off.

One of the most affected company in the “Water Issue” is Manila Water (MWC) owned by the Ayala Group. I wanted to write about the analysis on this blog before I made a move, but the market seems to tell me to act now. Because of the -40% decline on December 17, I just dropped everything, monitored the market and quietly bought my shares.

Source MWC Manila Water

This is not the first time that I made my move on the day of a 30% or more drop in price. My investment in FTDR and REZI are examples of such investments. And I was very clear that the job of a value investor is to catch falling knives. And it paid off handsomely for FTDR and not for REZI. Since I started buying MWC, my price range from 5 to 7.

Why I Might Be Wrong in MWC?

Before we proceed to the reasons why I think MWC is a great investment, lets first look at the downside. Remember margin of safety? What are the worst case scenarios that could happen?

During the week, there’s a lot of bad, scary news about the company. A military takeover, a complete shutdown of the company and the concession revoked by the government. All bad, and all scary news. These are the possible futures that can happen and that we should think about when investing.

These are real possibilities in the future that you must take into account. As most investors and traders might have sold because the future looks uncertain, there are ways a value investor can profit from this scenario.

Its not always about valuation

This is a peculiar investment scenario where evaluation of companies does not really have much effect on your decision making. The reason being is that, there’s an ongoing crisis that is reflected by the price. If you did a simple evaluation, you know that MWC is cheap in terms of its assets (0.22 price to book) and its earnings almost 2 P/E at its bottom. In terms of its competitive advantage, there are only 2 water companies that supplies one of the most populated regions in the country. So everything ticks the right boxes, yet the price is depressed.

And we all know why the price is depressed. There’s a lot of uncertainty going on right now with the company. But uncertainty does not mean it is risky. Those two are different.

Defining Uncertainty vs Risk

Uncertainty is where the future is unknown. Risk is the possibility of permanent loss of capital. MWC is such a scenario. We are uncertain. But are we at risk of potential loss of capital? Maybe. But is there a great risk of loss? I doubt.

What most people do, traders and investors alike think that uncertainty is synonymous to being risky.

There is a small amount of risk for MWC. Worst case scenario and the company shuts down by the government, all those pipes that MWC has invested all those years are not garbage that would be put away come the new water company. Most likely, those would be bought by the new water company and MWC would at least take back those investments. And it is a more rational approach than laying down new pipes all over Luzon. Those pipes have value. How much would that value be? I don’t exactly know how much. But given a discount to its book value, we might have a large margin of safety.

Will MWC go bankrupt? Is another worst case scenario. In my opinion, it won’t. Even if the concession halts to a full stop, MWC still has P2 billion in income coming from places not affected by the concession agreement. Its a big drop from its current income, but its still not zero.

Military takeover? This is another worst case where nobody would get compensated from owning any shares. It would be a forceful exit. It may happen but the probability is small.

Not so worse case

Since a re-negotiation is happening. It may spell some good news or bad news. The contract may not push through and the business of MWC may end in 2022. This is 2 years from now. But I bought at PE of 2. So in 2 years, if bad things happen, I break even. If MWC decides to shut down after 2 years and close its doors, I know I will be compensated after selling all the assets. P53 billion of equity for a market cap of P16 billion. Even if the assets are sold at firesale, I will still get my money back plus profit.

MWC Uncertain but not risky

An investment is only risky if you didn’t do any research into it. There is uncertainty because an investor does not know very much about the investment. And before I forget one more important aspect of investing, let me tell you this:

Anyone can evaluate companies. Anyone can form an opinion on something. Anyone can sound smart about an investment and speak fluently at how good an investment. But after all is said and done, what makes a great investor different from the rest, is the amount of money he puts in in his highest conviction bets.

Courage and Intelligence

Courage and intelligence goes hand in hand in value investing. Intelligence, through evaluation and research of companies is good. But it is only half the battle. Buying when everybody is selling. Catching falling knives, is what makes you a complete value investor.

Intelligence without courage is impotent. Courage without intelligence is reckless.

I may be wrong on MWC of course. And there might be things that I have missed. But judging by the risk and reward, even if this one fail and I lose money, I think the decision is a good one.

My average price on MWC is 6.5.

How about you? Have you placed your bets in this Water Issue?

9 comments

  1. I would be worried about its debt. Php 10 billion of which would be maturing within the next operating cycle. Also, given that it’s running a negative working capital operation, this appears to be alarming. A real business risk, don’t you think? Looking into is net tangible assets alone (after deducting goodwill, total liabilities, and preferred share capital), a sufficient cushion remains at current prices. Of course, this is assuming book value approximates liquidation value, which normally isn’t the case.

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