Last opportunity to buy below 8,100

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1 Last opportunity to buy below 8,100 After two failed attempts in the past, we believe there is a strong likelihood that the PSEi will successfully break above the 8,100 resistance soon due to the improving global economic outlook, the approval of the much awaited tax reform bill, and the diminishing headwinds facing numerous sectors. To reflect the improving outlook of the economy and the various sectors, we have cut our risk premium assumption by 50 basis points to 5.0% after raising it last October Coupled with the adjustments in our FV estimates for SMPH and SM, our new end 2017 target for the PSEi is 8,700. Notwithstanding our bullish outlook, we recognize that the PSEi could go through a correction in the short term. A major factor which could trigger a correction is the inclusion of China-A shares in the MSCI Emerging Markets Index. To make room for the Chinese shares, the index weights of other emerging markets, including the Philippines, will be reduced, triggering a selloff. Historically, August is also a seasonally weak month for the Philippine stock market. A monthly publication by COL which provides insights on investments opportunities based on global and local developments that could affect the market. COLing the Shots aim to provide timely and relevant information and analysis as well as a model portfolio for successful investing. Nevertheless, the weakness brought about by the said factors is only expected to be temporary. The sell-off in emerging markets resulting from the inclusion of China-A shares in the MSCI Emerging Markets Index should stop once funds are already compliant with the new index weights. Although the month-on-month return of the PSEi is often negative in August, the average return six months later is already positive at 4.5%. That said, investors should take advantage of any correction in the short term to accumulate stocks as this could be the last time for the PSEi to trade below 8,100 before it breaks out to much higher levels. Since we last came out with our COLing the Shots report, two stocks registered declines MER and MBT. However, the weakness of the two stocks should only be temporary in our opinion. MER s share price fell significantly as its major shareholder, MPI, sold a 4.5% stake in the power distributor for only Php250/sh. Nevertheless, the shares were sold at only Php250/sh as MPI had an opportunity to buy more MER share (indirectly) at an even cheaper price of Php222/sh. Meanwhile, MBT is down 3.0% since we last wrote our COLing the Shots report. Nevertheless, MBT is only correcting after rising by as much as 25% since the start of the year. Nothing has changed as far as its fundamentals are concerned. APRIL LYNN TAN, CFA VP & HEAD OF RESEARCH april.tan@colfinancial.com Disclaimer: All content provided in COL Reports are meant to be read in the COL Financial website. Accuracy and completeness of content cannot be guaranteed if reports are viewed outside of the COL Financial website as these may be subject to tampering or unauthorized alterations.

2 Can we break above 8,100 soon? The PSEi is now back at the 8,000 resistance level. While the index failed to break above the 8,100 high twice in the past, we believe there is a strong likelihood that we will break above the said level this time around due to the following reasons: Improving global economic outlook The outlook of the global economy has improved significantly compared to the last few times that the PSEi hit 8,100. After slowing from 3.4% in 2014 to 3.2% in 2015 and 3.1% in 2016, the IMF now projects world output growth to accelerate to 3.5% in 2017 and 3.6% in Moreover, unlike in the past, the IMF did not reduce its 2017 and 2018 growth forecasts in its latest world economic output (WEO) report. In fact, it even increased its 2017 output growth forecast by 10 basis points. Growth of developed economies such as the U.S., Europe and Japan is picking up due to various factors including fiscal stimulus and cyclical rebound from economic recession. Coupled with the rebound in China s economic growth, the resulting increase in demand for commodities and other imports is in turn benefiting developing and emerging economies including the Philippines. Recall that during the first four months of 2017, exports increased by 15.2% while OFW remittances grew by 4.2%, exceeding expectations. Exhibit 1: World output growth forecast (based on IMF WEO reports) Date of Publication Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr source: IMF Aside from helping boost corporate earnings growth, we expect fund managers to increase their exposure to equities given the favorable global economic growth outlook. The significant amount of cash on the sidelines is also expected to slowly return to the market, boosting share prices. Finally, the strong global economic outlook is expected to lead to the rerating of equities globally. Note that during bull markets, stocks tend to trade at higher valuations due to the upside risk on profitability. COL Financial Group, Inc. 2

3 Approval of the tax reform bill On May 31, the House of Representatives approved the comprehensive tax reform package, bringing it one step closer to being passed into law. As discussed in our previous reports, the passage of the tax reform program is crucial for the government to execute its aggressive infrastructure spending plan. Recall that the government plans to increase infrastructure spending from 5% of GDP in 2016 to 7% of GDP in The passage of the tax reform program is also necessary for the government to fulfill its plan of cutting personal income taxes from 32% to 25%. Based on our computations, the reduction in personal income taxes will lead to a 20% increase in disposable income for 93% of tax payers. The said factors in turn should enable the economy to sustain a faster growth of more than 7% going forward without hurting the country s finances. Faster economic growth should again help boost corporate earnings growth going forward, benefiting listed companies and the stock market. Diminishing headwinds and new tailwinds In the past, numerous threats facing various sectors prompted us to be cautious and more conservative in our earnings forecasts and fair value estimates. These include intensifying competition (retail, telcos), oversupply due to excessive expansion (retail, property), weaker than expected demand (retail, gaming), and rising costs (consumer). However, based on the information that we have gathered recently, these threats are diminishing either due to growing demand, and/or the implementation of mitigating measures. Moreover, the negatives facing some companies are in our opinion already priced in (based on a study of analyst earnings estimates and the share price performance of stocks). Some industries are also enjoying new tailwinds that never existed before, warranting a more positive outlook. Exhibit 2: Threats facing various sectors and mitigating factors Consumer Retail Threats Rising commodity prices, higher cost of labor Intense competition Mitigating Factors/Changes Price adjustments, cost cutting efforts Rationalization program, slower expansion Property (Residential) Property (Offices) Banking Telcos Gaming Automobile Oversupply Oversupply Trading losses Intense competition, falling revenues from legacy business Entry of fourth player, weaker than expected GGR from VIP players Higher excise taxes Less project launches, improving buyer confidence, pick-up in demand Growing demand from POGOs, possible revision of REIT law Faster than expected loan growth, slight recovery in NIM Less intense competition, growing share of data revenues Most players increase GGR despite Okada, rebound of GGR from VIP players Lower than expected increase in excise taxes COL Financial Group, Inc. 3

4 Cutting risk premium, raising FV estimates To reflect the improving outlook of the economy and the various sectors, we have cut our risk premium assumption by 50 basis points to 5.0%. Recall that we raised our risk premium assumption last October 2015 to 5.5% to reflect the increasing number of threats facing the economy and the various sectors. The reduction in our risk premium assumption has led to a median increase of 7.3% in our fair value estimate. Based on our new FV estimates, our end 2017 target for the PSEi is now 8,700 (additional 700 points from adjustment in risk premium, additional 500 points from upward adjustment in FV of SMPH and SM last month). Last opportunity to accumulate stocks below 8,100 Notwithstanding our bullish outlook, we recognize that the PSEi could go through a correction in the short term. A major factor which could trigger a correction is the inclusion of China-A shares in the MSCI Emerging Markets Index. Note that the MSCI Emerging Markets index is tracked by an estimated US$1.6 Tril in assets as of the end June To make room for the Chinese shares, the index weights of other emerging markets, including the Philippines, will be reduced, triggering a sell-off. Historically, August is also a seasonally weak month for the Philippine stock market. During the past 15 years, the PSEi fell by an average of 1.6% in August. It also yielded negative month-onmonth returns more often (73% of the time in August) compared to other times of the year. Exhibit 3: PSEi month-on-month returns Monthly Return Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec % 3.3% -0.2% -4.1% -2.3% -12.1% -2.9% -1.8% 2.4% -7.2% -0.1% -2.8% % -3.5% 2.0% 2.7% 0.5% 13.9% 1.4% -3.8% 8.8% 7.8% -6.1% 9.8% % -1.7% -4.0% 9.2% -2.8% 4.5% 0.3% -0.3% 11.5% 3.3% 0.7% -0.4% % 3.0% -6.0% -5.1% 4.0% -0.3% 4.0% -3.2% 0.3% 0.9% 7.1% -0.2% % -1.0% 3.4% 3.4% 1.1% -5.1% 9.7% -3.3% 10.6% 5.9% 3.0% 7.0% % -5.3% 4.4% 2.1% 6.2% 5.4% -4.4% -3.9% 6.2% 5.2% -4.8% 1.2% % -4.2% -4.6% -7.9% 2.8% -13.0% 4.8% 4.3% -4.4% -24.1% 1.0% -5.0% % 2.6% 6.1% 5.9% 13.6% 2.0% 14.8% 3.1% -2.9% 3.8% 4.7% 0.3% % 3.1% 3.9% 4.1% -0.5% 3.1% 1.6% 4.1% 15.0% 4.1% -7.4% 6.3% % -3.0% 7.7% 6.5% -1.7% 1.1% 5.0% -3.4% -8.0% 8.4% -2.8% 3.8% % 4.6% 4.3% 1.9% -2.1% 3.0% 1.2% -2.1% 2.9% 1.5% 4.0% 3.1% % 7.7% 1.9% 3.3% -0.7% -7.9% 2.7% -8.5% 1.9% 6.4% -5.7% -5.1% % 6.4% 0.1% 4.3% -0.9% 3.0% 0.3% 2.7% 3.3% -0.9% 1.1% -0.9% % 0.5% 2.7% -2.8% -1.7% -0.2% -0.2% -6.0% -2.9% 3.5% -2.9% 0.4% % -0.2% 8.9% -1.4% 3.4% 5.3% 2.1% -2.2% -2.0% -2.9% -8.4% 0.9% % -2.0% 1.4% 4.8% 2.3% Average 3.0% 0.7% 2.0% 1.7% 1.3% 0.2% 2.7% -1.6% 2.8% 1.0% -1.1% 1.2% Median 4.2% 0.1% 2.4% 3.0% 0.0% 2.0% 1.6% -2.2% 2.4% 3.5% -0.1% 0.4% % Up 69.0% 50.0% 75.0% 69.0% 50.0% 60.0% 80.0% 27.0% 67.0% 73.0% 47.0% 60.0% % Down 31.0% 50.0% 25.0% 31.0% 50.0% 40.0% 20.0% 73.0% 33.0% 27.0% 53.0% 40.0% source: Bloomberg, COL estimates COL Financial Group, Inc. 4

5 The market s weakness in August is partly explainable by the timing of the ghost month, which happens during the seventh month of the lunar year (for 2017, the Ghost Month will last from August 28 to September 19). Some fund managers in Asia avoid making any major changes in their portfolios during this month for fear of bad luck. Several fund managers from the West are also on break in August being the tail end of their summer season. Nevertheless, the weakness brought about by the said factors is only expected to be temporary. The sell-off in emerging markets resulting from the inclusion of China-A shares in the MSCI Emerging Markets Index should stop once funds become compliant with the new index weights. In fact, active fund managers who are looking to enhance their returns are expected to take advantage of any excessive sell-off to buy more shares of companies with good fundamentals. Although the month-on-month return of the PSEi is often negative in August, the average return six months later is already positive at 4.5% (based on the PSEI s performance the past 15 years). That said, investors should take advantage of any correction in the short term to accumulate stocks as this could be the last time for the PSEi to trade below 8,100 before it breaks out to much higher levels. COLing the Shots stock picks - Weakness of MER, MBT only temporary Since we last came out with our COLing the Shots report, a portfolio with an equally weighted exposure to our stock pics would have generated a return of only 0.4%, underperforming the PSEi which increased by 1.1%. One of the main reasons for the underperformance was Meralco (MER). The power company s share price fell significantly as its major shareholder, MPI, sold a 4.5% stake in MER for only Php250/sh. However, investors should not be worried as the sale was not due to MPI s wavering confidence on MER. MPI sold the shares at only Php250/sh since it had an opportunity to buy MER share (indirectly) at an even cheaper price. Recall that MPI used the proceeds of the transaction to buy TEL s 25% stake in Beacon (Beacon owns 35% of MER). Based on our computation, the implied value of MER at MPI s purchase price of Beacon is only Php222/sh, 11% lower than MPI s selling price for its 4.5% stake. Once everything is complete, MPI s effective stake in MER would actually increase from 41.25% to 45.5%. COL Financial Group, Inc. 5

6 We don t expect the ongoing sell-off to be sustained. In fact, it is an opportunity to buy more shares of MER at a cheaper price. Another underperformer is MBT. The stock is down 3.0% since we last wrote our COLing the Shots report. Nevertheless, MBT is only correcting after rising by as much as 25% since the start of the year. Nothing has changed as far as fundamentals are concerned. Exhibit 4: COLing the Shots stock picks Sector Stock Price FV Buy Below Buy Date Buy Price Power MER /30/ Power/Mining SCC /30/ Properties MEG /9/ ALI /24/ Banks MBT /21/ Consumer RRHI /29/ Gaming BLOOM /24/ COL Financial Group, Inc. 6

7 IMPORTANT RATING DEFINITIONS BUY Stocks that have a BUY rating have attractive fundamentals and valuations based on our analysis. We expect the share price to outperform the market in the next six to 12 months. HOLD Stocks that have a HOLD rating have either 1) attractive fundamentals but expensive valuations 2) attractive valuations but near-term earnings outlook might be poor or vulnerable to numerous risks. Given the said factors, the share price of the stock may perform merely in line or underperform in the market in the next six to twelve months. SELL We dislike both the valuations and fundamentals of stocks with a SELL rating. We expect the share price to underperform in the next six to12 months. IMPORTANT DISCLAIMER Securities recommended, offered or sold by COL Financial Group, Inc. are subject to investment risks, including the possible loss of the principal amount invested. Although information has been obtained from and is based upon sources we believe to be reliable, we do not guarantee its accuracy and said information may be incomplete or condensed. All opinions and estimates constitute the judgment of COL s Equity Research Department as of the date of the report and are subject to change without prior notice. This report is for informational purposes only and is not intended as an offer or solicitation for the purchase or sale of a security. COL Financial and/ or its employees not involved in the preparation of this report may have investments in securities of derivatives of the companies mentioned in this report and may trade them in ways different from those discussed in this report. COL RESEARCH TEAM APRIL LYNN TAN, CFA VP & HEAD OF RESEARCH april.tan@colfinancial.com CHARLES WILLIAM ANG, CFA GEORGE CHING RICHARD LAÑEDA, CFA DEPUTY HEAD OF RESEARCH SENIOR RESEARCH MANAGER SENIOR RESEARCH MANAGER charles.ang@colfinancial.com george.ching@colfinancial.com richard.laneda@colfinancial.com FRANCES ROLFA NICOLAS ANDY DELA CRUZ JUSTIN RICHMOND CHENG RESEARCH ANALYST RESEARCH ANALYST RESEARCH ANALYST rolfa.nicolas@colfinancial.com andy.delacruz@colfinancial.com justin.cheng@colfinancial.com KYLE JEMMRIC VELASCO RESEARCH ANALYST kyle.velasco@colfinancial.com JOHN MARTIN LUCIANO RESEARCH ANALYST john.luciano@colfinancial.com COL FINANCIAL GROUP, INC D EAST TOWER, PHILIPPINE STOCK EXCHANGE CENTRE, EXCHANGE ROAD, ORTIGAS CENTER, PASIG CITY PHILIPPINES 1605 TEL NO FAX NO WEBSITE: COL Financial Group, Inc. 7