This liquidity rally has fundamental legs!

Size: px

Start display at page:

Download "This liquidity rally has fundamental legs!"

Damian Byron May
5 years ago
Views:

1 MONDAY, 21 JULY 2014 This liquidity rally has fundamental legs! COLing the Shots is a monthly publication by COL which provides insights on investment opportunities based on global and local developments that could affect the market. COLing the Shots aims to provide timely and relevant information and analysis as well as a model portfolio for successful investing. Key Highlights After correcting to 6,700 last month, the PSEi has rallied to as high as 7,016 before settling to where it is right now. I think the main reason for the market s strength recently is developments implying that global interest rates will stay lower for longer. Last June, ECB chief Mario Draghi announced numerous liquidity measures meant to prevent Europe from falling into a deflationary trap. Meanwhile, US Fed Chairwoman Janet Yellen expressed a less optimistic LT view on the US economy explaining why Fed officials on the average reduced their long-run interest rate forecast. Locally, although interest rates have started to increase, the increase is not expected to be significant. With the said developments, liquidity conditions would remain favorable, benefiting the stock market. There are concerns that this liquidity led rally might not be sustainable. However, we believe that this rally has fundamental drivers as 2015 is expected to be a much stronger year compared to 2014, with the PSEi s EPS growth accelerating to 13% from only 6% this year. As a result, fundamentals will finally catch up with valuations, allowing the PSEi to trade at a more reasonable 2015E P/E of 16.8X. There is also room for positive surprises brought about by favorable readings on several leading indicators such as loan growth, investment spending, infrastructure spending and the awarding of PPPs. For the said reason, investors should have greater conviction to hold on to their stock investments. More than half a year later after it was listed, First Metro Exchange Traded Fund or FMETF has addressed two out of my three major issues, namely the expense ratio (now only 1.0%) and the tracking error (only 0.05%). Although FMETF s liquidity hasn t improved much, First Metro said that investors that want to buy a large volume of shares need only to get in touch with the asset management company for them to accommodate the order. The said improvements make FMETF a more attractive investment in my opinion. Our COLing the Shots stock picks rebounded this month, increasing by 2.8%, faster than the PSEi s 2.0% rise. Three stocks from our existing list remain investible MEG, ALI and SMPH. We are also adding AP to the list given the company s positive earnings growth outlook for 2015 and its solid LT fundamentals. Although there is a possibility that shares of AP could remain weak in the ST as the company is expected to announce lower earnings for 2014, we believe that this will provide investors with a longer time horizon to accumulate the stock at attractive levels. Even with a potential drop in cash dividends next year, investors can count on a dividend yield of 3.0% from AP making it easy to be patient. Head of Research April Lynn Tan, CFA Analysts George Ching Richard Lañeda, CFA Charles William Ang, CFA Kervin Sisayan, CFA Jed Frederick Pilarca Garie Ouano Meredith Hazel Cua

2 Making sense of this liquidity rally The performance of the stock market has been very confusing lately. When I last came out with my COLing the Shots report, the PSEi had corrected to 6,700. At that time, it was easy to be bearish as foreign investors, who had been responsible for the market s strong performance from February to April, had turned into net sellers. First quarter GDP growth and corporate earnings results had been disappointing, while inflation for the month of May surprised negatively. Finally, notwithstanding the correction, the market was not yet cheap as it was still trading at 18.6X 14EP/E. However, since that time, the PSEi had rallied by as much as 4.7% to 7,016 before correcting to where it is right now. Foreign investors had also turned back into net buyers the last three weeks. I think the main reason why the stock market rallied to as high as 7,000 recently is developments implying that global interest rates will stay lower for longer. This would mean that liquidity conditions would remain favorable, benefiting the stock market. Recall that on June 5, European Central Bank (ECB) chief Mario Draghi announced numerous liquidity measures meant to spur lending and prevent Europe from falling into a deflationary trap. Measures include the reduction of the ECB s base interest rate from 0.25% to 0.15%, the introduction of a negative deposit rate of 0.1%, and the opening of a 400 Bil liquidity channel tied to bank lending. Meanwhile, although US Fed Chairwoman Janet Yellen expressed optimism on US economic growth for 2015 and 2016, she also said that the Fed has a less optimistic view on the long-term growth outlook of the US economy. This explains why Fed officials on the average reduced their long-run interest rate forecast to 3.75% from 4.00% despite increasing their federal fund rate forecast to 1.2% from 1.125% by end 2015 and to 2.5% from 2.4% by end Locally, although interest rates have started to increase with the BSP raising its SDA rate by 25 basis points to 2.25% last June, we do not expect the increase to be significant enough to hurt economic growth. Note that the BSP is only increasing interest rates to pre-empt the risk of asset bubbles forming and not to quell run away asset prices. In fact, foreign investors welcome higher interest rates as this would mean less pressure for peso to weaken. Admittedly, it is difficult to participate in a liquidity led rally as it might not be sustainable. However, we believe that this rally also has fundamental drivers. By the fourth quarter of this year, analysts and fund managers will start looking at 2015 which we expect to be a much stronger year compared to In 2015, the PSEi s EPS growth is expected to accelerate to 13% from only 6% in As a result, fundamentals will finally catch up with valuations, allowing the PSEi to trade at a more reasonable 2015E P/E ratio of 16.8X. Moreover, we believe that there is room for positive surprises brought about by favorable readings on several leading indicators such as loan growth, investment spending, infrastructure spending and the awarding of PPPs. Consequently, although the market s rally might only be weak in the short term, we expect the rally to gather strength towards the fourth quarter and next year as investors turn their eyes towards the more favorable economic and earnings growth outlook for For the said reason, I believe that investors should continue to hold on to their stock investments. page 2

3 Although global markets fell recently following the delays in payments on short-term debt by Portuguese bank holding company Espirito Santo International, news that the US is imposing new sanctions against Russia and reports that a Malaysian plane crashed in Ukraine, I believe that these are isolated cases. Consequently, I don t expect these developments to have a significant and lasting impact on the performance of the stock market both here and around the world. ETFs revisited Last December, I wrote about exchange traded funds or ETFs after First Metro launched the country s first and only ETF First Metro Exchange Traded Fund or FMETF. To recap, an ETF is a security that tracks the performance of a portfolio of securities (such as stocks, commodities, etc.) but trades like a stock on an exchange. FMETF is an ETF that is supposed to track the performance of the PSEi. When I first wrote about FMETF last December, I highlighted the numerous benefits of ETFs including diversification and affordability. However, I had three main concerns regarding FMETF- the possibility that its expense ratio could hit the 2.0% cap due to its small size and absence of scale, its large tracking error, and its limited liquidity. More than half a year later, FMETF has addressed two out of my three major concerns, making it a more attractive investment in my opinion. Expense ratio: Based on the quarterly filing made by FMETF (for the first three months of 2014), the total expenses of the fund including management fee was kept at around 1.0%* of its average value. This is only half the 2.0% cap set by management and is much lower compared to the expense ratio of other mutual funds and unit investment trust funds (UITFs) in the country. This give FMETF a real cost advantage compared to other funds available in the market. Tracking error: FMETF s tracking error, which measures its ability to replicate the performance of the PSEi, has also diminished. Since its launch last December 2 up to this writing, FMETF s price has increased by 10.7%. During the same period, the PSEi has index increased by 10.1%. FMETF s net asset value or NAV per share, which more accurately reflects the underlying value of the fund, has also increased by a similar magnitude of 11.2%. Liquidity: Unfortunately, liquidity hasn t improved much. Average daily transactions for FMETF only reached around Php1.4 Mil during the first six months of the year. Last month, I had the opportunity to meet with Gus Cosio and Gonzalo Ordonez of First Metro to talk about my concern regarding the liquidity of FMETF. Cosio and Ordonez admitted that FMETF is illiquid. However, assuming that an investor wants to buy a large volume of shares, the investor only needs to get in touch with First Metro for the asset management company to accommodate the order. page 3

4 Cosio also said that FMETF is very transparent and investors can actually monitor the fund s performance, the underlying investments of the fund relative to the PSEi, tracking error and historical performance relative to its NAV through the First Metro ETF website Pieces of information that can be found in the website include the following: Underlying securities found in the portfolio Historical performance Premium or discount to NAV Tracking error And while the expense ratio had already fallen to around 1% during the first quarter, they said that it had gone down some more during the second quarter. They also shared with me the advantage of FMETF over ishares MSCI Philippines ETF (EPHE), an ETF listed in the US which also acts as a proxy to Philippine stocks. While it is true that EPHE has numerous advantages including a lower expense ratio (0.61%), the payment of cash dividends (0.84% dividend yield), larger market capitalization (US$322Mil or Php14.1Bil) and greater liquidity (average daily turnover of Php595Mil), since EPHE trades in the US, it is more vulnerable to price gaps as the ETF is not traded during the same trading hours as the Philippine market. Moreover, they highlighted the fact that EPHE tracks the MSCI Philippine index, not the PSEi. During the past three and a half years, the MSCI Philippines underperformed the PSEi. Although FMETF doesn t pay out cash dividends currently, there is nothing stopping the ETF from paying out cash dividends in the future. Exhibit 1: Comparison of FMETF and EPHE Source: Bloomberg, COL Estimates Exhibit 2: Comparative Performance of PSEi and MSCI Philippines Source: Bloomberg page 4

5 Investors can also execute a core-satellite investing strategy more easily by buying FMETF. In a core-satellite investing strategy, an investor creates a portfolio with a large allocation to passive investments that track the market such as ETFs or index funds (which is the core). The investor then uses the remaining funds to take position in stocks that he likes (which are the satellites). By adopting this strategy, the investor reduces the volatility of his portfolio and the costs associated with active management. However, he still has the opportunity to outperform the market through investments in high conviction stock picks. The portfolio below is an example of one that follows a core-satellite investing strategy. Exhibit 3: Sample Core-Satellite Portfolio Aside from cost, the advantage of purchasing FMETF as a core investment for a core-satellite investing strategy is that FMETF can easily be bought using a stock brokerage account (FMETF is available through COL Financial). To buy FMETF, there is no need to fill out additional forms and to call an agent or a banker, similar to what is required to purchase mutual funds and unit investment trust funds or UITFs. FMETF can also be viewed together with other satellite stock investments in a consolidated stock portfolio through a brokerage account. As such, it is easier for investors to determine the allocation of core and satellites investments in their portfolio and for them to adjust their asset allocation as needed. Although the core-satellite investing strategy is more advanced, beginning investors including those that follow COL s Easy Investment Program or EIP can also benefit from buying FMETF. Instead of buying individual issues, investors can buy FMETFs. In fact, buying FMETFs will automatically provide investors with diversification even if the size of their portfolio is only very small which is advantageous. Mining, gaming and property sectors There has been a lot of interest on mining, gaming and property stocks recently. During the past month, the mining sector has been one of the strongest performing sectors, with the PSEi Mining and Oil index rising by 9.5% from end May to the present. In contrast, gaming stock have been quite weak, underperforming the PSEi. Meanwhile, although the property sector continues to perform well, concerns remain regarding property bubbles. As far as the mining sector is concerned, the strongest performers have been NIKL and PX which together account for around 33% of the PSEi Mining and Oil index. page 5

6 For the year to date period, NIKL s share price has increased by 142%. For the month to date for July, it rallied by 11.7%. The main reason for NIKL s strong performance for the year to date period is the Indonesian ban on nickel ore exports. This has resulted to higher nickel prices which will benefit NIKL. In July, the share price of NIKL rose following news that the company is planning on developing a Ferronickel plant. There was also news that the DENR authorized the company to dispose of its low grade nickel stockpiles in Manicani Island in Eastern Samar. Shares continued to rally this week after the company disclosed strong first half 2014 revenues that beat our expectations. We are currently in the process of meeting with management to discuss the details of the potential Ferronickel plant, the disposal of the nickel stockpiles, and the reasons for the better than expected revenue performance during the first half of the year. The said information will help us determine whether or not an upgrade in our fair value estimate is warranted. At present, our FV estimate for NIKL is only Php25.30/sh, way below NIKL s share price of Php36.60/sh. Meanwhile, shares of PX have increased by 53% for the year to date period, with much of the increase happening in June after the company disclosed that the Pollution Adjudication Board of the Department of Environment and Natural Resources (DENR) lifted the order suspending the operations of PX s Padcal Mine. PX also benefited from the recent increase in gold prices. Note that gold price increased by 4.9% from its end May level to US$1311/oz currently as it is considered to be a hedge against possible inflation that would result from the prevailing low interest rate environment. We will soon come out with a more detailed report on PX. However, our analysts George Ching and Garie Ouano said that gold prices will be the major determinant of whether or not PX can sustain its strong performance. At this point, it remains to be seen whether concerns of inflation and geopolitical risk will triumph over weaker demand from China in determining the direction of gold prices going forward. As far as the gaming sector is concerned, gaming stocks have performed poorly due to negative sentiment brought about by numerous factors. In Macau, gaming stocks have been on a downtrend since the start of the year due to signs that gaming revenue growth of the VIP segment is slowing down. There are concerns that the slowdown in Macau would trickle down and hurt the operations of casinos in the Philippines. Aside from this, sentiment for local gaming companies is being negatively affected by uncertainty as to how the opening of Melco Crown Philippines (MCP) City of Dreams later this year would affect the earnings performance of existing casinos. The BIR s move to impose a 30% corporate income tax on local gaming companies instead of the 5% franchise tax on gross gaming revenues is also hurting investor sentiment. Finally, RWM s below expected gaming revenue performance during the first quarter of the year is negatively affecting sentiment for the stock. Admittedly, gaming stocks seem cheap relative to our fair value estimates. However, next year might be a better time to buy gaming stocks as there would be more certainty with respect to gaming companies earnings growth potential. Notwithstanding the expected increase in interest rates, we maintain our positive view on the property sector. As discussed earlier, we don t expect the increase in interest rates to be significant enough to hurt economic growth. The BSP is merely raising interest rates to pre-empt the risk of higher prices resulting from ample liquidity, and not to address asset bubbles. We would also like to reiterate that property companies continued to deliver healthy take up sales during the first quarter of this year. Based on our discussions with the management of property companies, they remain confident of reaching their full year targets. page 6

7 Exhibit 4: 1Q14 Take up sales of property companies in Php Bil 1Q13 1Q14 % growth ALI % MEG % RLC* % FLI % VLL % SMPH % Total % Source: Company data * RLC figures are for 2QFY14 COLing the Shots stock picks I m happy to announce that our COLing the Shots stock picks rebounded this month. Compared to June 18, a portfolio with an equally weighted allocation of stocks in our COLing the Shots list would have increased by 2.8%, faster than the PSEi s 2.0% rise. Exhibit 5: COLing the Shots Stock Picks M/M Performance Price Stock 18-Jun Jul-14 M/M Change MEG % TEL 2, , % DNL % AC % BDO % MBT % ALI % SMPH % At present, only three stocks remain investible MEG, ALI and SMPH. We believe that all three remain fundamentally sound. Note that all three companies have what it takes to capitalize on the favorable long term outlook of the property sector cash, significant recurring cash flow, and huge landbank. We are confident that the three companies will be the undisputed giants in the property sector over the long term. Among the three, MEG has been the busiest lately. Just recently, the company acquired 49.2% of GERI which was held by AGI for Php10.4 Bil or 1.93/sh. Coupled with the shares bought from the public as a result of its tender offer, MEG now owns 80.4% of GERI. We have a favorable view on this development as MEG was able to acquire the shares of GERI at a steep discount from its estimated NAV of Php4.63/sh. At the same time, the acquisition should strengthen MEG s foray into the tourism sector given GERI s 3,000 hectare landbank found in attractive tourism locations. page 7

8 MEG also recently disclosed plans for numerous large scale projects including Mckinley West in the Fort Bonifacio area, Woodside City along C-5 Pasig, Mactan Newtown in Cebu, Iloilo Business Park in Iloilo and Davao Park District in Davao. The company also said that it is targeting to double its office leasing portfolio to 1 Mil sqm by The said initiatives should ensure continuous growth in MEG s profits going forward. Although shares of SMPH continued to underperform due to investors negative view towards the consolidation of SMDC and the residential property arm s poor earnings performance recently, we believe that this challenge is something that the company can overcome. As discussed previously, earnings of SMDC weakened as the company deliberately scaled back on product launches to address customer service issues, and not because demand was weak. And although the property company might have some excess inventory in terms of residential condominiums, this is not something that can be sold in a year or two. Recall also that SMPH recently disclosed its 5-year plan, saying that it aims to double revenues to Php119.6 Bil and net income to Php32.6 Bil by This implies a strong 5-year CAGR of 14.9%. SMPH also said that it is targeting to improve its ROE from 11% to mid-teens by In line with our earlier theme of looking forward to 2015, we would like to add AP to our COLing the Shots stock pick list. We like AP because it is one of the biggest power generation and power distribution companies in the country with strong cash flow generating capacity and a bright earnings growth outlook brought about by plans to boost its attributable power generation capacity by 46% from its end 2013 level to 1,000 MW by We are not discounting the possibility that shares of AP could remain weak during the next few months as the company is expected to announce lower earnings for 2014 due to the expiration of its tax holiday and the full year impact of higher cost of steam for its geothermal plant. However, we believe that this will provide investors with a longer time horizon to accumulate the stock at attractive levels. Even with an expected drop in cash dividends next year, investors can count on an attractive dividend yield of 3.0% from AP making it easy to be patient. Exhibit 6: COLing the Shots Stock Picks Price FV Buy Date Buy Price Current Return Buy Below Price MEG Jan % 4.77 TEL 3, , Jan-13 2, % 2, DNL Feb % 8.7 AC Aug % BDO Jan % MBT Jan % ALI Jan % SMPH Jan % AP Jul % page 8

9 Investment Rating Definitions BUY HOLD SELL 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 twelve months. 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 inline or underperform the market in the next six to twelve months. We dislike both the valuations and fundamentals of stocks with a SELL rating. We expect the share price to underperform in the next six to twelve months. Important Disclaimers 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 it 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 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 ans/or its employees not involved in the preparation of this report may have investments in securities or derivatives of securities of securities of the companies mentioned in this report, and may trade them in ways different from those discussed in this report B East Tower, Philippine Stock Exchange Centre, Exchange Road, Ortigas Center, Pasig City, 1605 Philippines Tel: Fax: Website: page 9

Riding the liquidity driven rally

Riding the liquidity driven rally The PSEi has rallied 4.2% since we last came out with our COLing the Shots repot. The strength of the market s rally surprised us given the absence of positive macro developments.