Stocks are Back

With prices returning to five-year highs, issuers are encouraged to go public this year

By Jojo Gonzales

The Philippine Composite Index (Phisix) rose 26% in 2004, adding on to a 41% gain in 2003. These stellar gains over the last two years have nudged the Philippine stock market back onto the fringe of many an investor's radar screen. Once again, the man on the street is wondering whether his hard-earned savings should be plunked into the next initial public offering (IPO) or into the hottest tip from the friendly neighborhood punter.

To be fair, the gains over the last two years were not without basis. I believe the primary driver was profit growth. Earnings among publicly-listed companies grew sharply in 2003 and 2004. The profit growth was initially confined to telecommunication companies though later on broadened onto consumer companies and utilities. Of late, profits seem to be accelerating among banks and property companies, as well.

Apart from corporate profit growth, the macroeconomic and political environment has also been favorable – a rarity considering that the Philippines has had a habit of shooting itself in the foot every now and then.

On the macroeconomic side, the Bangko Sentral brought domestic interest rates down to record lows in 2004, and more importantly, has stuck to them in the face of criticism that rates should have begun to rise in step with rate hikes by the US Fed. It has also helped that the government managed to keep well within its fiscal deficit target in 2004 and appears committed to raising added revenues that may significantly reduce the deficit in 2005.

As for politics, this is hardly a satisfactory area at any point in recent memory but I think the Philippines dodged a bullet in the May 2004 Presidential elections by handing President Arroyo a fresh six-year mandate. Going forward, if politics only remained neutral, it should be one less drag on what could otherwise be a buoyant stock market once more in 2005.

Favoring Equities

In my opinion, earnings and interest rates are the two key drivers to watch out for in 2005.

On the earnings front, we estimate that profit growth would slow to about 12-15% in 2005, from a growth rate of roughly 37% in 2004. Though seemingly modest, it should be pointed out that 2005 would mark the fifth straight year of earnings growth, following four consecutive years of profit decline from 1997-2000.

If we are correct on profits, then it indicates that the market is trading around 12 times the 2005 P/E ratio, which is still not expensive in the context of historical market valuations and regional comparables.

As for domestic interest rates, the risk of a sharp increase (that is, 200 basis points within 2005) is greatly diminished by forecasts of a reduced fiscal deficit and increased foreign financing for it; inflation topping out in the second quarter of 2005; and a stable if not stronger peso. For as long as most of these three conditions persist, interest rates will favor increasing exposure to equities.

New Names Needed

Sadly, there have been very few new names added to the stock market in the last decade. The lack of new listings has caused the Philippines to shrink in relative importance to other markets where many new companies were added especially during the telecom-media-technology boom three to four years ago.

Having seen stock prices return to five-year highs, issuers now appear encouraged to seek public listings, thinking perhaps that they could now get fair value for their companies, which could not have been the case through most of the last four or five years.

So far, the share placements done in late-2004 were successful and the pipeline for 2005 is gradually filling up. If evenly spaced, these IPOs or rights issues need not drain much liquidity from the rest of the market and would add greatly to its depth.

For instance, SM Investments Corporation could potentially be the largest IPO since Petron went public nearly a decade ago. If SMIC is offered in mid-March at the top-end of the indicative price, SMIC could become the sixth largest publicly-listed company in market capitalization terms and would be one of only eight companies with a market value in excess of US$1 billion (a critical benchmark for large foreign institutional investors). By market value, SMIC would be behind only PLDT, San Miguel Corporation, Ayala Corp., BPI, and Globe but larger than Ayala Land and SM Prime in that elite US$1 billion-plus club.

Jojo Gonzales is Head of Research of Philippine Equity Partners, a top-tier broker and among the largest in turnover among independent and locally-owned brokerage houses