Stick to the plan - COL Financial

Stick to the plan - COL Financial

Stick to the plan - COL Financial

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. Stick to the plan ThePSEishowedsomesignsoflifethelasttwoweeks,triggeredbyseveralpositivedevel opments. While this could be an indicator that we have already seen the bottom, we don’t expect to see a rapid or“V”shaped recovery but rather a slow or“L”shaped recovery. One of the reasons for our subdued outlook is the disappointing first quarter earnings season.

Similar to the fourth quarter 2017 earnings season, the recently concluded first quarter 2018 earnings season was largely disappointing, with more than twice as many companies delivering weaker than expected results than those delivering better than expected results. Moreover, median earnings growth was very slow at 5.9%, with only the gaming, property and telco sectors delivered double digit earnings growth. Most consumer, power and media companies posted slower or negative earnings growth as profits were hurt by higher inflation. Meanwhile, banks suffered from trading losses brought about by higher rates.

Despite higher interest rates, inflation is expected to remain a problem for most of 2018 because of the continuous increase in the price of oil and other commodity products. It doesn’t help that the peso remains weak. Higher inflation will continue to hurt the profitability of companies, limiting the ability of their share prices to rally strongly in the short term. Since the stock market’s recovery is expected to be slow, we advise investors to stay disciplined and stick to the strategy of accumulating stocks only below certain levels using peso cost averaging strategy. Our recommendation is to buy only when the PSEi trades below 7,900.

There were two stocks in our COLing the Shots stock picks list of nine that performed poorly the past month – SCC and PIZZA. However, among the two, we are keeping SCC while we are removing PIZZA from our list of stock picks.

The main reason why SCC fell during the period in review was because of the news that the outage of Calaca unit 3 would be extended for another 90 days up to end July. However, we are not too concerned given the elevated prices of coal, which already allowed the profits of SCC’s coal mining business to more than offset the poor performance of its power generation business during the first quarter of the year. Valuations are also very attractive, with SCC trading at only 8X 2018E P/E, more than 1 standard deviation below its 10-year historical average P/E of 11.9X. Insiders are also buying the stock, with total insider buying reaching 67.5 million shares at an average price of Php37.80/sh during the past 12 months.

In contrast, PIZZA disclosed disappointing first quarter 2018 profits which grew by only 6.5% to Php184 Mil. Performance disappointed as margins were negatively affected by rising raw material costs and higher operating expenses. Going forward, margins could remain weak as raw material prices remain elevated. Valuations are also not yet attractive, with the stock still trading at 25.4X P/E and only slightly below our fair value estimate. 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.

TUE 22 MAY 2018 APRIL LYNN TAN, CFA VP & HEAD OF RESEARCH april.tan@colfinancial.com

COLING THE SHOTS I STICK TO THE PLAN TUE 22 MAY 2018 COL Financial Group, Inc. 2 Lump sum or peso cost averaging? After performing poorly for the most part of April, the PSEi showed some signs of life the last two weeks, triggered by several positive developments. On April 27, S&P raised the Philippines’ credit rating outlook to “positive” from “stable”. On May 10, the government announced that first quarter 2018 GDP grew by 6.8% and on the same day, the BSP raised interest rates by 25 basis points helping alleviate concerns that inflation would go out of control. Finally, on May 14, there was surprising news that the Philippines’ weighting in the MSCI Emerging Market index would not be reduced despite the addition of China in the index.

Consequently, the PSEi rallied by as much as 5.4% from its low of 7,499.26.

While the strength of the market recently could be an indicator that we have already seen the bottom, we don’t expect to see a rapid or a “V” shaped recovery. We think there is a stronger possibility that we will see a slow or an“L”shaped recovery in the stock market for the following reasons. Disappointing first quarter earnings season Similar to the fourth quarter 2017 earnings season, the recently concluded first quarter 2018 earnings season was largely disappointing, with more than twice as many companies delivering weaker than expected results than those delivering better than expected results.

Moreover, median earnings growth was very slow at only 5.9%. Out of the various sectors that are part of the Philippine stock market, only the gaming, property and telco sectors delivered double digit earnings growth. Most consumer and power companies posted slower or negative earnings growth as profits were negatively affected by higher costs due to the weak peso and rising commodity prices or simply put, these companies were negatively affected by higher inflation. Media companies were indirectly affected too as ad revenues weakened due to the numerous companies’ decision to reduce ad spending as a means to cut costs.

Meanwhile, banks suffered from trading losses brought about by higher rates.

Exhibit 1: Median Earnings Growth of Different Sectors in the PSE Source: Listed Cos, COL Estimates Sector Median Gaming 53.40% Properties 12.40% Consumers 4.50% Conglomerates 9.10% Banks 1.90% Power -2.40% Telcos 31.80% Cement -17.20% Media -21.30% Total 5.90%

COLING THE SHOTS I STICK TO THE PLAN TUE 22 MAY 2018 COL Financial Group, Inc. 3 Inflation will most likely remain a problem for most of 2018 Despite higher interest rates, inflation is expected to remain a problem.This is not because of the impact of the tax reform program, but because of the continuous increase in the price of oil and other commodity products.

For example, the price of oil has increased from only US$60.37/barrel during the start of the year to around US$71.63/barrel currently, higher by 18.7% for the year to date period. It doesn’t help that the peso remains weak. Higher inflation will continue to hurt the profitability of companies, limiting the ability of their share prices to rally strongly in the short term.

Exhibit 2: Oil Price (US$/Barrel, Year to Date) Source: Bloomberg In our opinion, the main reason why the market rallied strongly during the past two weeks was because investor sentiment was just too negative. This was reflected in the depressed valuations of numerous stocks. In fact, at 7,500, most stocks in the PSEi were already trading at par or below their 10-year historical average P/Es. As a result, when economic indicators proved that things were not as bad as they seemed, and when the BSP finally raised interest rates to control inflation, the market rallied to more normalized levels.

COLING THE SHOTS I STICK TO THE PLAN TUE 22 MAY 2018 COL Financial Group, Inc.

4 Exhibit 3: PSEi Members’Current P/E Relative to their 10-Year Historical Average vs. Market Capitalization Source: Bloomberg, COL Estimates However, as discussed earlier, we don’t think that the challenges facing corporate earnings will go away anytime soon. As such, it is pre-mature to expect stocks to rally on a sustainable basis, explaining why we think we will see a slow“L”shaped and not a rapid“V”shaped recovery. For the said reason, we advise investors to stay disciplined and stick to the strategy of accumulating stocks only below certain levels using peso cost averaging strategy. Our recommendation is to buy only when the PSEi is trading below 7,900.

COLing the Shots – Removing PIZZA Stocks in our COLing the Shots list performed relatively better during the past month. Although an equal weighted portfolio comprised of our stock picks would have suffered from a loss of 1.2%, this is better than the 3.3% drop registered by the PSEi during the same period.

COLING THE SHOTS I STICK TO THE PLAN TUE 22 MAY 2018 COL Financial Group, Inc. 5 Exhibit 4: Period Return of COLing the Shots Stock Picks There were two major drags among our nine stock picks – SCC and PIZZA. The share price of both stocks fell by 8.5% for the period in review. However, among the two, we are keeping SCC while we are removing PIZZA from our list of stock picks. The main reason why SCC fell was because of the news that the outage of Calaca unit 3 would be extended for another 90 days up to end July. This would result to foregone revenues of around Php1.7 Bil or 3.2% of 2018 revenues.

However, during the recently concluded first quarter earnings season, the strong performance of SCC’s coal mining business more than offset the poor performance of the power generation business. SCC’s profits during the first quarter of 2018 managed to grow by 3.3% to Php4.6 Bil, beating our forecast. Consolidated revenues grew by 7.6% as the 17.1% jump in coal mining revenues more than offset the 13.9% drop in power generation revenues. Revenues from the coal mining business increased strongly due to the 24% increase in the average selling price of coal, thanks to rising coal prices.This trend should continue, at least during the second quarter, as coal prices remain elevated.

Moreover, SCC said that it has an insurance policy against unplanned outages, which should allow it to reduce potential losses from the outage of Calaca 3. Finally, valuations are very attractive. At SCC’s current price, the stock is trading at only 8X 2018E P/E, more than 1 standard deviation below its 10-year historical average P/E of 11.9X. Insiders are also buying the stock, with total insider buying reaching 67.5 Million shares at an average price of Php37.80/sh during the past 12 months. Stock Price (4/10) Price (5/18) Return SCC 31.70 29.00 -8.50% AP 37.55 38.85 3.50% MEG 4.50 4.53 0.70% ALI 41.25 42.00 1.80% MBT 82.80 82.75 -0.10% DNL 10.70 11.10 3.70% PIZZA 14.38 13.22 -8.10% BLOOM 13.10 12.78 -2.40% AC 938.50 929.00 -1.00% Average -1.20% PSEi 7934.68 7672.28 -3.30%

COLING THE SHOTS I STICK TO THE PLAN TUE 22 MAY 2018 COL Financial Group, Inc. 6 In contrast, PIZZA disclosed disappointing first quarter 2018 profits which grew by only 6.5% to Php184 Mil. Performance disappointed as margins were negatively affected by rising raw material costs and higher operating expenses. Going forward, margins could remain weak for PIZZA as raw material prices remain elevated. Valuations are also not yet attractive, with the stock still trading at 25.4X P/E and only slightly below our fair value estimate. As such, we are removing PIZZA from our COLing the Shots list. AP also disclosed disappointing first quarter earnings results, with core profits growing by 4.4% to Php5.2 Bil, accounting for only 20.3% of COL’s full year forecast.

Results were below expected as AP’s coal and geothermal plants suffered from lower than expected output and higher than expected costs. Moreover, several of its new power generation projects have yet to start commercial operations.

Despite AP’s below expected first quarter 2018 earnings results, we are keeping the stock in our COLing the Shots list as we believe that the bad news is already reflected in AP’s depressed share price. Exhibit 5: COLing the Shots Stock Picks Sector Stock Price FV Buy Below Buy Date Buy Price SCC 29.00 45.70 39.70 30/01/2017 34.65 AP 38.85 49.90 43.40 19/01/2018 41.15 MEG 4.53 6.15 5.30 9/9/2015 4.18 ALI 42.00 53.12 46.20 24/05/2017 38.95 Banks MBT 82.75 103.00 89.60 21/07/2016 92.50 Consumer DNL 11.10 11.60 10.10 23/11/2017 10.68 Gaming BLOOM 12.78 14.10 12.30 24/05/2017 9.54 Conglomerates AC 929.00 1,090.00 947.80 1/12/2017 1,007.00 Power/Mining Properties

COLING THE SHOTS I STICK TO THE PLAN TUE 22 MAY 2018 COL Financial Group, Inc. 7 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 ANDY DELA CRUZ
JOHN MARTIN LUCIANO FRANCES ROLFA NICOLAS SENIOR RESEARCH ANALYST
SENIOR RESEARCH ANALYST
RESEARCH ANALYST andy.delacruz@colfinancial.com
john.luciano@colfinancial.com
rolfa.nicolas@colfinancial.com JUSTIN RICHMOND CHENG ADRIAN ALEXANDER YU RESEARCH ANALYST
RESEARCH ANALYST justin.cheng@colfinancial.com
adrian.yu@colfinancial.com COL FINANCIAL GROUP, INC.

2402-D EAST TOWER, PHILIPPINE STOCK EXCHANGE CENTRE, EXCHANGE ROAD, ORTIGAS CENTER, PASIG CITY PHILIPPINES 1605 TEL NO. +632 636-5411 FAX NO. +632 635-4632 WEBSITE: www.colfinancial.com IMPORTANT RATING DEFINITIONS IMPORTANT DISCLAIMER 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. 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

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