Riding the liquidity driven rally

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Steven Flynn
5 years ago
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Note that after being net sellers since the middle of January, foreigners have turned into net buyers the last few trading days.

1 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. The main reason for the market s recovery is the return of foreign funds. Note that after being net sellers since the middle of January, foreigners have turned into net buyers the last few trading days. One possible reason for the return of foreign funds to the Philippines is the PSEi s poor performance relative to other emerging markets during the year to date period. As of end March, the MSCI Emerging Market index was up by 12.4% while the PSEi was up by only 7.2%. Fund managers might also be increasing their portfolio allocation to stocks in general as they are heavily underweight in terms of their exposure in the stock market globally. This would benefit all markets including the Philippines as rising tides lift all boats. However, we do not know how long this liquidity driven rally will last. The year to date outperformance of emerging markets has already narrowed from 5.2 percentage points as of end March to only 0.6 percentage points right now. Valuation also remains a concern. At present, the PSEi seems expensive relative to other emerging markets, especially since our earnings growth is slower and we are not positioned to benefit from rising commodity prices. COLing the Shots is 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. Some risk management tips for those who would like to participate in the ongoing rally: Stick to value. Focus on those that are still trading at attractive valuations as there is a stronger likelihood that these stocks would be bought up. Some stocks with a fundamental buy rating that are still trading at reasonable valuations include EW, MBT, SCC, BLOOM, PGOLD, EDC, FGEN, MER, ALI, MEG, and VLL. Take profits. Given the absence of fundamental drivers, the ongoing rally might not be sustainable. As such, it might be a good opportunity to lock in gains on stocks that become fairly valued because of the rally and just buy them back when they return to more attractive levels. Diversify. Even though the rally might be short lived, diversification remains important. Our COLing the Shots stock picks continued to do well last month. Although two of our seven stock picks ended the month lower MER and RRHI we are keeping them in the stock picks list as we believe that their drop is only temporary. We are also removing MCP from our list since its share price has gone up quite significantly, even exceeding our FV estimate. It is a good idea to take profits at this point. April Lynn Tan, CFA VP & Head of Research april.tan@colfinancial.com of the COL Financial website as these may be subject to tampering or unauthorized alterations.

2 The PSEi has rallied significantly since we last issued our last COLing the Shots report in March, increasing by 4.2% to 7, Admittedly, we were surprised by the strength of the market s rally given that recent local macro developments were more negative than positive. Note that the passage of the much anticipated tax reform program in congress did not materialize despite reports saying that the House committee aims to pass the comprehensive tax reform package before it goes on break in March 17. Moreover, we have yet to see the full roll out of any public-private partnership (PPP) projects despite earlier pronouncements by the new administration that it would roll out all stalled PPP projects of the Aquino administration by The main reason for the market s recovery is the return of foreign funds. Note that after being net sellers since the middle of January, foreigners have turned into net buyers the last few trading days. Exhibit 1: PSEi 2017 net foreign buying and selling Source: PSE, Bloomberg One possible reason for the return of foreign funds to the Philippines is the PSEi s poor performance relative to other emerging markets during the year to date period. Recall that last March 15, the U.S. Fed raised the Fed Fund Rate by 25 basis points to 0.75% to 1.00%. Despite the increase, the US 10-year T-bond rate fell while the US dollar weakened as investors were already anticipating the Fed s move. Commodity prices also increased in response to the weaker dollar, acting as a catalyst for emerging markets (which are heavily exposed to commodity exports) to rally. 2

3 Exhibit 2: US 10-year bond rate Exhibit 3: US dollar Although it can be observed that the MSCI emerging market index rose quite significantly in March, the PSEi was a laggard as it merely moved sideways. It would not be surprising then for foreign investors to buy the Philippine market as a laggard play, anticipating that it would catch up with other emerging market that have done much better for the year to date period. 3

4 Exhibit 4: MSCI Emerging Market Index vs PSEi Fund managers might also be increasing their portfolio allocation to stocks. As highlighted by Valens Research s Joel Litman during COL s market briefing earlier this year, fund managers are heavily underweight in terms of their exposure in the stock market globally. This fact was also highlighted by Mark Matthews of Julius Bar during his presentation in the recently concluded Asia Pacific Real Estate Investment Summit. As such, an increase in fund managers exposure to the stock market would benefit all markets including the Philippines as rising tides lift all boats. Exhibit 5: Fund flows 4

5 However, we do not know how long this liquidity driven rally will last. Valuation remains our major concern. At present, we believe that the PSEi is already fairly valued. The PSEi also seems expensive relative to other emerging markets, especially since our earnings growth is slower as we are not positioned to benefit from rising commodity prices. Exhibit 6: MSCI EM & PSEi relative valuation E 2018E MSCI EM EPS (%) -6.00% 14.70% 11.10% P/E PSEi EPS (%) 16.00% 6.90% 9.10% P/E The year to date outperformance of emerging markets has likewise narrowed from 5.2 percentage points as of end March to only 0.6 percentage points right now. Nevertheless, for those who would like to participate in the ongoing rally, here are some tips on how to manage risk: Stick to value. When buying stocks, focus on those that are still trading at attractive valuations as there is a stronger likelihood that these stocks would be bought up. Some stocks with a fundamental buy rating that are still trading at reasonable valuations include EW, MBT, SCC, BLOOM, PGOLD, EDC, FGEN, MER, ALI, MEG, and VLL. Take profits on stocks that become fairly valued. Given the absence of fundamental drivers, the ongoing rally might not be sustainable. This is especially true for industries that are facing threats such as the auto industry (rising excise taxes), some food companies (rising raw material costs, possible excise taxes on sugary drinks) and property companies (rising interest rates, slowing demand for residential properties and slower granting of PEZA benefits to new office buildings). As such, it might be a good opportunity to lock in gains on stocks that become fairly valued because of the rally and just buy them back when they return to more attractive levels. Diversify. Even though the rally might be short lived, diversification remains important. It still makes sense to buy stocks that belong to different sectors. COLing the Shots stock picks continue to do well Our COLing the Shots stock picks continued to do well last month. In fact, an equally weighted portfolio comprised of our stock picks would have generated a return of 5.2%, outperforming the PSEi which generated a return of 4.2% during the same period. 5

6 Performance of COLing the Shots stock picks Stock Price (3/6) Price (4/10) Return FGEN % MER % SCC % MEG % MBT % RRHI % MCP % Average 5.20% PSEi 4.20% One of our best performing stock picks for the month is MEG. From March 6 to April 10, MEG s share price rallied by 7.4% to Php4.04/sh. Earlier this year, we removed property companies ALI and RLC from our COLing the Shots stock picks. However, we decided to keep MEG since valuations were very attractive. Although we recognize that there were risks facing the property sector (slower demand for residential condominiums, talks that the government would no longer accredit new office buildings in Manila as PEZA special economic zones), we felt that the risks were already priced in as far as MEG was concerned as it was trading at only 9.3X 17E P/E and a steep 50% discount to its NAV. The good news is, MEG recently disclosed that recurring profits in 2016 increased by 11.3% to Php12.4 Bil, exceeding both COL and consensus estimates. More importantly, the company expressed optimism on its residential segment as reservation sales are showing signs of picking up. From a low of Php11.1 Bil in 4Q15, reservation sales increased by an average of 22% per quarter to reach Php24.2 Bil by 4Q16. This brought reservation sales for the whole of 2016 to Php87.15 Bil. For 2017, MEG is targeting residential sales to grow further by 3.3% to Php90 Bil. Moreover, after cutting back the value of project launches to only Php18.7 Bil in 2016 from Php35.3 Bil in 2015, MEG now plans to increase launches back to Php30.0 Bil in On the other hand, two of our stock picks performed poorly MER (-5.2%) and RRHI (-2.7%). Despite their poor performance, we are maintaining the two stocks in our stock pick list. MER was sold down following the ex-date of its cash dividend, which is expected. However, MER s share price fell by around Php15.00/sh, which is larger than the size of its cash dividend of Php9.30/sh. We believe that the exaggerated drop in MER s share price is an opportunity for long term investors to buy the stock cheaper. RRHI was also sold down after it said that the adjustment of its labor practices (in response to the prohibition of hiring contractual workers) would lead to a 10 to 20 basis point reduction in its operating margin. However, we believe that the sell-off was overblown as operating profits would drop by only 3% even after factoring in a 20 basis point reduction in operating margin. Moreover, in our forecast, we already factored in higher expenses related to the adjustment in labor practices. This explains why our earnings forecast for 2017 is more conservative than that of consensus. Even with our more conservative forecast, there is still a reasonable upside to our fair 6

7 value estimate of Php86.00/sh. Finally, we still forecast profits to grow by 9% to Php5.3Bil this year as the continuous expansion in RRHI s store count would allow it to more than offset the added costs related to the adjustment in its labor practices. We are removing MCP from our COLing the Shots stock picks. Since we recommended MCP earlier this year, the stock has gone up substantially and is currently trading at Php6.70/sh, significantly higher than our FV estimate of Php5.06/sh. COLing the Shots stock picks Sector Stock Price FV Buy Below Buy Date Buy Price Power FGEN /20/ MER /30/ Power/Mining SCC /30/ Properties MEG /9/ Banks MBT /21/ Consumer RRHI /29/

8 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 Velasco Research Analyst kyle.velasco@colfinancial.com John Martin Luciano Research Analyst john.luciano@colfinancial.com Contact COL Financial Group, Inc D East Tower, Philippine Stock Exchange Centre, Exchange Road, Ortigas Center, Pasig City 1605 Philippines Tel No Fax No Website: 8

Lock in gains on MER; switch from RRHI to DNL

Lock in gains on MER; switch from RRHI to DNL Since we last wrote our COLing the Shots report, the market rallied to as high as 8,605.15, but eventually corrected to its current level of 8,343.23. We think