COLing the Shots 2016-02-16

Too soon for a turnaround

The PSEi has rallied by 7.8% since we conducted our first half 2016 market briefing presentation last January 23. The rally did not come as a surprise since the market was technically oversold as pointed out by COL’s chief market technician Juanis Barredo.

There were also some fundamental factors that acted as catalysts for the rally such as the statement from the ECB that it might increase in the size of its QE this March, the adoption of negative interest rates by the BoJ, and the Philippine government’s announcement of a better than expected fourth quarter 2015 GDP growth.

Nevertheless, the market’s longer term outlook has not changed. Commodity prices are still expected to remain weak as China’s economic growth led by industrial production continues to slow down. The outlook for the peso also remains negative as the Chinese yuan continues to devalue. Finally, there is a risk that the strong growth in government spending will not be sustained in the second half of 2016 as this usually slows down during the first six months of a new president’s term.

Given our cautious view of the market, investors who have a short term investment time horizon or who are too heavily invested should take advantage of the ongoing rally to sell or reduce their positions in the market.

EIP investors though should continue to buy stocks, even if they had bought at the peak. This is because sticking with a peso cost averaging strategy will allow investors to reduce the size of their drawdown and to recover faster when the market resumes its uptrend.

The main reason why the EIP strategy works is because investors can buy more shares as prices go down. Moreover, buying continuously as the market drops will allow investors to reduce average cost. Since average cost is lower, investors’ portfolio will turn profitable faster when the market recovers.

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Key Highlights

COLing the Shots is a monthly publication by COL which provides insights on investment opportuni-ties 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.

Head of ResearchApri l Lynn Tan, CFA

AnalystsGeorge Ching

Richard Lañeda, CFACharles Wi l l iam Ang, CFA

Jed Freder ick Pi larcaMeredi th Hazel Cua

Angelo LecarosMichel le Angel ine Yu

TUESDAY, 16 FEBRUARY 2016

FRIDAY, 29 JANUARY 2016 page 2COLING THE SHOTS

Just a rally

The PSEi has rallied by 7.8% since we conducted our first half 2016 market briefing presentation last January 23. It is not surprising then that some investors are wondering whether or not we had been too pessimistic given our cautious view of the market.

However, the market’s rally did not come as a surprise. During his presentation last January, our chief market technician Juanis Barredo already mentioned the possibility of a rally. At 6,084, the market was already oversold as it fell by a total of 13% in a span of only 16 trading days! Given the market’s oversold condition, Mr. Barredo mentioned that he expected a “B” wave rally to materialize soon with a target of 7,000 to 7,400. We are currently in the middle of the said rally.

There were also some fundamental factors that acted as catalysts for the rally. Last January, the European Central Bank hinted that it might increase in the size of quantitative easing in March (leading to even more liquidity and lower interest rates). Also in January, the Bank of Japan surprised investors by announcing that excess deposits with the central bank would no longer earn interest but instead be charged 0.1%.

In the Philippines, the government announced better than expected GDP growth of 6.3% for the fourth quarter of 2015.

Nevertheless, the market’s longer term outlook has not changed. Commodity prices are still expected to remain weak as China’s economic growth led by industrial production continues to slow down. Two weeks ago, China announced that January’s manufacturing purchasing manager’s index (PMI) came in at 49.4. This implies contraction in the manufacturing sector for the sixth straight month (any value below 50.0 implies contraction). Moreover, just this week, China disclosed that exports fell by 11.2% while imports dropped by 18.8% in January. The said numbers are significantly slower than the median forecast of -2.4% for exports and -4.6% for imports.

The outlook for the peso also remains negative as the Chinese yuan continues to devalue.

One of the main drivers of the Philippines’ stronger than expected GDP growth was government spending which jumped 17.4% during the fourth quarter. However, there is a risk that the strong growth in government spending will not be sustained, at least in 2016. Based on the track record of the past few administrations, government spending usually slows down during the first six months of a new president’s term. This could also happen once a new president is elected this May.

Exhibit 1: Government spending growth (first six months of term)

source: BSP, COL estimates

President 1st 6 Mos Term AveCory Aquino 2.00% 3.50%FVR -1.80% 2.80%Erap/GMA 0.60% -0.30%GMA 0.30% 6.40%Pnoy -6.50% 4.20%


Given our cautious view of the market, investors who have a short term investment time horizon or who are too heavily invested should take advantage of the ongoing rally to sell or reduce their positions in the market. On the other hand, those who are waiting to come back into the market should wait for prices to fall to more attractive levels before buying back stocks. We would like to reiterate what we said during our market briefing last January, that this is a buyer’s market, and that we should only be accumulating stocks when the PSEi falls below 6,400. Once the “B” wave rally is completed, the PSEi is expected to suffer from another wave down or a “C” wave. Based on what has taken place so far, there is still no reason to believe that the said scenario will not materialize.

What should I do if I bought at the peak?

“What should I do if I bought at the peak?” This was one of the questions asked during our market briefing in January.

As discussed earlier, assuming that you are too heavily invested in stocks, you should take advantage of the market’s ongoing rally to reduce your position.

Assuming though that you just started with your easy investment program (EIP) which involves peso cost averaging on a regular basis, sticking with the plan despite the market’s weakness will actually allow you to reduce the size of your drawdown and to recover faster when the market resumes its uptrend.

The main reason why the EIP strategy works is because you can buy more shares as prices go down. For example, at MEG’s peak price of Php5.88/sh, you could only buy 850 shares with Php5,000. However, now that MEG is only Php3.40/sh, you can already own 1,470 shares with Php5,000. This is 73% more shares with the same capital!

Buying continuously as the market drops will also allow you to reduce your average cost. Going back to our previous example, assuming that you were able to buy 1,470 shares of MEG at Php3.40/sh, your average cost would drop to Php4.30/sh from Php5.88/sh initially.

Since your average cost is lower, your portfolio will turn profitable faster when the market recovers. Referring again to our example, you would already be breaking even assuming that MEG starts to trade above Php4.30/sh. You would no longer have to wait for prices to recover all the way back to Php5.88/sh which would obviously take longer to materialize.

We did a study assuming that an investor was unfortunate enough to have bought the PSEi during the peaks before the Asian Financial crisis (February 1997) and the Global Financial crisis (October 2007). We then compared the results of two portfolios using different strategies– one portfolio that just “bought and held” and another portfolio that adopted the “EIP” strategy.

During the time of the Asian Financial crisis, the investor who adopted a buy and hold strategy would have suffered a maximum drawdown of 71.6% and would have taken 127 months or more than 10 and a half years to break even!

On the other hand, the investor who adopted an EIP strategy would have suffered a maximum drawdown which is much less at 46.3%. It would have also taken the investor only 88 months to breakeven, or three years and three months faster.


During the time of the Global Financial crisis, the investor who adopted a buy and hold strategy would have suffered a maximum drawdown of 56.0% and would have taken 35 months or almost three years to break even.

On the other hand, the investor who adopted an EIP strategy would have suffered a maximum drawdown of only 34.9%. It would have also taken the investor only 21 months to breakeven, which is a year and two months faster.

Exhibit 2: Scenario analysis of “Buy & Hold” vs. “EIP” during bear markets

source: Bloomberg, COL estimates

A small caveat though is that adopting the EIP strategy will mean larger absolute losses in the short term while markets are falling. This is something that we already warned about during our market briefing. Nevertheless, you need to have a longer term perspective. Although you will suffer from bigger absolute losses in the short term, you will turn profitable faster once markets recover. The absolute value of your profits will also be much larger over the longer term than that of an investor who stopped investing after buying at the peak.

No changes in our COLing the Shots stock picks

There will be no changes in our COLing the Shots stock picks this month.

Among the stocks in our recommended stock list, we recognize that FGEN is one of the most controversial picks as its share price remains flat despite the 7.8% rally of the PSEi. Nevertheless, we see no reason why we should remove FGEN from our recommended stock list.

A possible reason why FGEN is not performing well is that profits of its 49% owned subsidiary EDC (which also accounts for 38% of its NAV) are under threat. In an environment of falling coal and oil prices, costs of non-renewable power generation companies are on the way down, giving them the room to cut power prices. This in turn could hurt the profitability of renewable energy producers such as EDC which don’t have the same flexibility in terms of cost.

Nevertheless, EDC’s vulnerability to such a threat should be mitigated by the fact that around 88% of its capacity is already secured by long term contracts, with 69% of the said contracts lasting for more than six years. Hopefully, coal and oil prices will be higher once EDC is set to renew its contracts.

FGEN’s depressed valuations are also unwarranted. Even if we assumed that EDC’s current market price of Php5.30/sh is its fair value (vs. our FV estimate of Php8.22/sh), and that FGEN’s existing gas plants would be worthless once their contracts finish by 2023, FGEN’s fair value would still be Php20.20/sh, a premium relative to its market price of Php18.00/sh.

Buy & Hold EIP Buy & Hold EIPAsian Fin’l Crisis 71.60% 46.30% 127 88Global Fin’l Crisis 56.00% 34.90% 35 21

Maximum Drawdown Months to Breakeven


Hopefully, the share price of FGEN will recover once its two new plants – the San Gabriel and Avion plants– start contributing to profits this year. The first time contribution of the two plans will allow FGEN’s profits to jump by 22.3% this year. The said increase is faster than the PSEi’s 2016E EPS growth of 10%.

Listed companies have started releasing fourth quarter earnings results and we are keeping our fingers crossed that the fourth quarter earnings season will be much better compared to the past three quarters. Recall that poor earnings results were one of the catalysts for the PSEi’s decline from the peak in April last year.

Among the stocks in our list, only RLC has released earnings so far and results have been better than expected because of revenues.

Exhibit 3: COLing the Shots stock picks

Exhibit 4: Index funds

Sector Stock Price FV Buy Below High Conviction Buy Level

Power FGEN 18.00 32.70 28.40 16.50SMPH 21.35 21.70 18.90 12.22

ALI 31.15 41.67 36.20 24.00MEG 3.33 5.58 4.70 3.05RLC 25.50 29.60 25.70 19.50DNL 8.57 8.30 7.20 6.60

CNPF 17.00 21.50 17.20 14.28

Properties

Consumer

Ticker Current Level

Buy Below Price

High Conviction Buy Level

6,692.58 6,400.00 5,600.00Equity Fund

The Philequity PSE Index Fund

XPEIF 4.4125 4.2617 3.729

PSEi


Investment Rating Definitions

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.

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.

Important Disclaimers

2401-B East Tower, Philippine Stock Exchange Centre, Exchange Road, Ortigas Center, Pasig City, 1605 PhilippinesTel: +632 636-5411 Fax: +632 635-4632 Website: http://www.colfinancial.com

BUY HOLD SELL

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COLing the Shots 2016-02-16