There are a lot of faces in the stock market today focusing on different things. Most are professionals who concentrate on different aspects of the industry. Some give investment advice while others interpret price movements through technical analysis. A few, sad to say, create or spread rumors that send newbies in the wrong direction...

By Raymond Nicky Franco

SAN Miguel Corp. (SMC) is one of the biggest conglomerates in the country by revenue and profits. However, we (at MyTrade/Abacus) don’t have active coverage on the company and, until quite recently, neither did anybody else. Maybe the breadth of its operations makes valuation such a daunting task or that concerns about high leverage have kept investors wary. This is unfortunate because back in the 1990s, analysts would delve into the firm’s quarterly results to get a read on the Philippine economy. In particular, there was a time when SMC’s domestic beer sales performed nearly lock step with gross domestic product (GDP). These days, most equity fund managers are underweight on the stock and, indeed, on the group as a whole.

A resurgence of interest, however, may be just around the corner. Last November, management announced the consolidation of its beer and liquor holdings into Pure Foods (PF) which will then be renamed San Miguel Food and Beverage (SMFB). The transaction was reported to be worth P336 billion which then implies that the merged entity has a valuation of P468 billion.

Using this figure, SMC Chairman Ramon S. Ang (RSA) said SMFB will conduct a follow on offering (FOO) as soon as next month for as much as 30% of the enlarged capital or up to $3.0 billion worth of shares. Investors appear to have taken the FOO news with a few grains of salt. The share price of soon to be renamed Pure Foods has been stuck near P500 which is far below the indicated valuation of nearly P800 per share.

Combining the country’s dominant beer company with the largest processed meat producer and the second-ranked liquor maker is like “going back to the future” for RSA. He is, in effect, reviving the San Miguel of old when it was purely a food company.

Although the new entity will be carved out from the present conglomerate, it would still be a behemoth. Most metrics (sales, operating income, profits, etc.) will show that SMFB will be bigger than Universal Robina Corp. (URC).

On attributable net income alone, we project that it will be around P18 billion for the former while consensus estimates are at P11 billion for the latter.

Another distinction for SMFB, especially since it makes for stark contrast with URC, is that it will not be impacted by the sugar sweetened beverage (SSB) tax included in RA 10963 (TRAIN). In fact, there may be a brief surge in sales for SMFB as those getting tax cuts may splurge on some discretionary items like beer, liquor and meats.

A small float and an even more negligible level of liquidity have kept Pure Foods out of most fund managers’ radars. A bulked up SMFB with a promised float of 30% is likely to command the attention and portfolio allocations that a company of its size should have. Moreover, SMFB would easily rank among the 20 biggest listed companies by market capitalization and would likely be added to the PSE index in due time (maybe as soon as March 2019).

By far, however, the biggest selling point for the stock and RSA’s planned FOO is this: Pure Foods is a better economic bellwether than some of the more popular listed firms. We recently updated our list of stocks that have revenues and profits that are highly correlated to GDP growth. To be included in this list, a company must have a market cap of at least P30 billion, revenue and profit correlation with GDP greater than 0.5 and at least 30 quarters of data available.

The results of our screen show that only nine companies are in the top 20 in terms of revenue and profit correlation to the country’s economic growth.

Based on this analysis, the four firms that appear to be most attuned to GDP should come as no surprise. These are Ayala Land (ALI), Jollibee (JFC), SM Investments (SM), and Ayala Corp. (AC). An equal-weighted portfolio consisting only of these four stocks would have had a cumulative return of 202% in the past 7 years, 105% in the last 5 years and 45% in the last 3 years. These returns compare quite favorably to the PSE Index’s performance during the same time frames (104%, 47%, and 18%) and would have given investors excess returns over the benchmark of 98%, 58%, and 26%, respectively.

Amazingly, the company that is next most correlated to the Philippine economy (still based only on revenues and income) is not SM Prime (the largest mall developer) or BDO Unibank (number one bank by most measures) or Meralco (biggest electricity distributor) or PLDT (most profitable telco). Rather, it is Pure Foods. The stock’s cumulative returns over the past 7, 5, and 3 years were spiked by news of the planned business combination but would have been less than stellar without it. This is probably due to the stock’s lack of liquidity which will be greatly enhanced by its upcoming FOO. And with beer and liquor being folded in, we believe the merged entity’s correlation with the economy will remain or become even higher.

Those who read my missives regularly would know that I’m not positive on the SMC group. I have actually been critical of how the parent and its subsidiaries present quarterly earnings press releases. This time, however, we have to give RSA props.

Reviving the San Miguel of old through the proposed Purefoods-San Miguel-Ginebra merger is what one would call a game changer. Investors looking for another way to play the Philippines’ growth story should seriously look at SMFB.

Views and opinions expressed in this piece are those of the writer’s and do not reflect the policy or position of BusinessWorld. This piece is for information purposes only and should not be construed as a recommendation, an offer, or solicitation for the subscription, purchase, or sale of any of the security(ies) mentioned.

Raymond “Nicky” Franco is a Certified Public Accountant and received his Chartered Financial Analyst (CFA) designation in 2000. He is the Head of Research of Abacus Securities and the head of its online trading arm, MyTrade (mytrade.com.ph).

By Raymond Franco

FROM the time I started elementary, until I was finally able to afford my own car, I rode jeepneys daily. I learned how to make sabit or hold on to anything at the end of one of these vehicles just to get home as quickly as possible.

At times it was fun (I let myself get soaked with rain a few times) but more often it was dangerous.

Once, I nearly fell onto moving traffic after the driver took a vicious swerve to avoid a collision. The constant exposure to dust, cigarette smoke, and vehicle exhaust also meant I often had respiratory ailments. Modernizing the jeepney, therefore, should definitely be a priority. The question, however, is whether we are going about it in the right way. From my point of view, there are at least three areas of concern.

First, the average price for a modern jeepney appears to be too steep at around P1.5 million per unit.

After the P80,000 government subsidy per unit and 5% equity required by Land Bank of the Philippines (LBP) and the Development Bank of the Philippines (DBP), the monthly amortization over 7 years at 6% interest will amount to a staggering P19,700.

Assuming five rest days per month, drivers would have to net almost P800 per day just to cover the monthly amortization. The Euro IV compliant engines and the reduced need for maintenance (at least for the first year or two) will help boost incomes but, still, P1.5 million per unit is expensive.

An operator, for example, may be better off buying two Mitsubishi Mirages or two Toyota Vioses and use them as Uber vehicles.

Second, LBP and DBP, the two institutions tasked to provide financing, apparently lack the financial muscle to support the program.

Both banks have so far allocated just P1 billion each which would be enough for a total of less than 1,500 modern jeepneys or only 0.6% of the required replacements.

And even if the modernization is phased in over 10 years, these government banks would need over P30 billion per year to accommodate the demand from jeepney operators and cooperatives. The government, therefore, may need to inject fresh equity into both LBP and DBP to make the program viable.

Third, the steep amortization is likely to result in high default rates.

If the default rate on private car loans is about 5%, it is certainly plausible to expect a figure two to three or even four times higher for public utility vehicle (PUV) loans.

And since these PUVs will tend to depreciate faster than private cars and have lower resale values, we can estimate that by the time a jeepney is repossessed, its intrinsic value will be lower than the loan balance.

With LBP and DBP footing the bill on these defaulted loans, it will again be taxpayers who will actually be burdened. Moreover, if default rates go high enough, the capital ratios of LBP and DBP will deteriorate and their financial standing may become compromised.

Hunter S. Thompson once said, “anything worth doing, is worth doing right.”

To address the concerns mentioned above, my suggestion would be to incorporate a special purpose vehicle (let’s call it JeepCo) to handle the modernization program.

JeepCo will be under the Department of Transportation (DoTr) and would be given funding through the national budget. The major functions of this SPV are to be as follows:

1. Bid out the design, manufacturing and purchase of the estimated 270,000 units of modern jeepneys needed to replace the existing stock of vehicles plying the streets today.

Having one entity to do all these will enhance economies of scale, increase bargaining power and ultimately lower the cost for jeepney drivers and operators. One specific task of JeepCo is to negotiate a “cost plus” pricing for the entire fleet of modern jeepneys.

“Cost plus” pricing is prevalent in construction and manufacturing and limits manufacturers’ mark up to 5%-10%. This is likely to be much lower than the estimated 20%-25% profit margins for the jeepney models recently presented to the public from manufacturers like Mitsubishi, Isuzu, Foton, Tata, and others.

Nevertheless, one or more of these companies may be willing to sacrifice margins in exchange for a guaranteed volume of sales.

2. JeepCo will design several financing schemes that take into account the wide range of financial capacities of drivers, operators, and cooperatives.

Given that JeepCo would be a nonprofit, it should be able to lend at rates even better than the 6% being offered by LBP and DBP. Combined with the lower sticker price from cost plus pricing, the monthly amortization per unit can be maintained at P15,000 to P16,000 per month.

3. To ensure collection efficiency and compliance, JeepCo will also be responsible for establishing collection arrangements with various financial institutions (public and private) and non-bank financial intermediaries (pawnshops or remittance companies with nationwide presence).

The agency will also look into partnering with LGUs to monitor the performance of various operators and cooperatives and come up with intervention efforts for those falling behind in their payments. Lastly, JeepCo should also be imbued with all other powers that will allow it to fulfill its mandate.

Understandably, the Department of Transportation and other government agencies spearheading the push for jeepney modernization may not want to go back to the drawing board. However, taking a step back and reevaluating should not be considered a setback.

Instead, it should be seen as an opportunity to ensure that the program does not encounter another form of sabit, the kind that can, instead, sabotage a worthy and much needed initiative.

Views and opinions expressed in this piece are those of the writer’s and do not reflect the policy or position of BusinessWorld. This piece is for information purposes only and should not be construed as a recommendation, an offer, or solicitation for the subscription, purchase, or sale of any of the security(ies) mentioned.

Raymond “Nicky” Franco is a Certified Public Accountant and received his Chartered Financial Analyst (CFA) designation in 2000. He is the Head of Research of Abacus Securities and the head of its online trading arm, MyTrade (mytrade.com.ph).

Raymond “Nicky” Franco is a Certified Public Accountant and received his Chartered Financial Analyst (CFA) designation in 2000. He is the Head of Research of Abacus Securities and the head of its online trading arm, MyTrade (mytrade.com.ph).

Views and opinions expressed in this piece are those of the writer’s and do not reflect the policy or position of BusinessWorld. This piece is for information purposes only and should not be construed as a recommendation, an offer, or solicitation for the subscription, purchase, or sale of any of the security(ies) mentioned.

Read his full op-ed piece: https://goo.gl/8eEPny

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EDC's wind farm in Burgos, Ilocos Norte. --www.energy.com.ph

AS EVERYONE probably knows by now, Energy Development Corporation (EDC) is being privatized. Philippine Renewable Energy Holdings Corporation (PREHC) is bidding for as much as 8.9 billion shares of EDC at P7.25 per share for a total of P64.5 billion.

After the initial confusion regarding the so-called scale down provision included in the tender offer, the price has settled at around P6.90. This provides thin upside of about 4% (after transaction costs) for the shares that will be accepted for tender but not bad given that the payment date is only about two weeks away. What we are concerned with in this article, however, is what happens next?

PREHC crafted its buyout offer in such a way that EDC’s float will still be at least 10% after the tender closes. The company cited the desire to keep disruptions for shareholders to a minimum. The longer-term goal, however, is clear – the stock will be delisted at a later date.

Management of both EDC and its parent, First Generation Holdings (FGEN), have been mum on the details but we believe that a second tender offer, conducted specifically with the intention of delisting, will be done by year end. There are varying opinions on what the new tender offer price will be but it is likely, in our view, to be at P7.25 as well. This is why we have not been concerned about the scale down provision and why we have actually been pushing to buy EDC especially at lower levels.

Nevertheless, when the current tender offer expires on Monday, September 18, EDC is likely to decline while the market waits for PREHC’s next move. This may provide another opportunity for investors to profit from this privatization.

Once EDC exits the PSE Index (PSEi), two interrelated things will happen.

First, the PSE needs to determine which company will be added to its main benchmark. In the last periodic review, the Exchange decided to omit from its press release the names on its reserve list. However, based on our calculations, the choice will be amongst Vista Land (VLL), Robinsons Retail (RRHI), D&L Industries (DNL), Double Dragon (DD) and Bloomberry (BLOOM). Which of these will ultimately be added to the PSEi greatly depends on when EDC is actually delisted. Double Dragon, for example, has announced a follow-on offering before the end of the year. Meanwhile, a rumor went around last week saying that BLOOM was going to do a private placement (which management has denied). Things like these will keep investors guessing over the next few months.

Second, at least P52.9B of the P64.5B will be paid out to the public. Some of this will immediately be plowed back into the market by index tracker funds.

Whatever stock replaces EDC in the index, therefore, is likely to mount a strong rally especially if it does not have a strong institutional following yet. Some investors, on the other hand, may want to keep exposure in the energy sector by buying Semirara (SCC) which is significantly expanding its coal mining output, diversifying into cement production and recently gave a generous special cash dividend.

Of course the most obvious alternative is First Gen. Even after the tender offer, it would still have an economic interest of at least 40% in EDC and at least 60% of its voting rights.

Some may reflexively dismiss FGEN, however, because: 1) it is the worst performing index stock year-to-date, 2) weak H1 results are likely to carry over to the next 1-2 quarters because its new power plants, San Gabriel and Avion, remain significantly under-utilized, and 3) its falling market capitalization leaves it vulnerable to getting kicked out of the PSEi during the next review.

Nobody knows when First Gen will bottom out but it certainly looks very cheap at current levels. At the end of trading last week, the company had a market capitalization of P64.9B. This is smaller than the intrinsic value of its EDC stake (P68.7B = 9.48B shares x P7.25 PREHC offer price per share). In a very tangible sense, therefore, buying FGEN at the current price means one is buying EDC at less than fair value and getting the four power plants directly owned by the parent company with a combined capacity of 2,011 megawatts (MW) for free.

On the other hand, if we were to include debt in the equation and use enterprise value to see how much of a bargain FGEN is at current levels, we would find that the stock is trading at about $0.4m/MW. This is far lower compared to the replacement cost of the company’s entire 2,011MW natural gas portfolio which is between $1.6 to $1.8 million per MW.

Things can get uglier if, as we expect, FGEN gets booted out of the index in the next semiannual review. However, tying up with PREHC should pay big dividends in the long run and FGEN’s remaining stake in EDC should increase in value.

Moreover, exiting the index could be a blessing in disguise. It may, in fact, become a turning point for FGEN similar to what happened with BLOOM (it has rallied more than 100% since it was deleted from the PSEi last year). The time looks ripe for investors to take a good second look at FGEN.

Views and opinions expressed in this piece are those of the writer’s and do not reflect the policy or position of BusinessWorld. This piece is for information purposes only and should not be construed as a recommendation, an offer, or solicitation for the subscription, purchase, or sale of any of the security(ies) mentioned.

Raymond “Nicky” Franco is a Certified Public Accountant and received his Chartered Financial Analyst (CFA) designation in 2000. He is the Head of Research of Abacus Securities and the head of its online trading arm, MyTrade (mytrade.com.ph).

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By Raymond Franco

Oppositors to the tax reform bill being pushed in Congress, as embodied in House Bill (HB) 5636, are quite numerous. In addition, a good number of senators have voiced reservations with regard to one or more components of TRAIN (Tax Reform for Acceleration and Inclusion).

Very few, however, have expressed reservations about the government’s P8.14-trillion infrastructure push. Indeed, my not too optimistic view on “Build! Build! Build!” is probably unique within the investing community. My doubts have less to do with the possibility that TRAIN will not raise enough additional revenue and more with the question of whether or not the country has the absorptive capacity to roll out all the railways, airports, roads, and other infrastructure from 2018 to 2022.

There are several constraints.

First, the country’s notorious bureaucracy can stall even priority projects. Agencies often find themselves at odds with each other, losing bidders regularly go to courts seeking injunctions and, of course, corruption is rampant.

Second, right-of-way issues can cause significant delays, running up to a year or more, for road projects.

Third, the domestic construction industry does not have the capacity to handle P8.2 trillion worth of projects over five years. DMCI, the largest construction firm in the country, recently said that it can only handle P50 billion worth of projects at any given time but this already includes commercial and residential buildings. Overall, local contractors don’t have a lot of spare capacity that can help roll out the government’s massive infrastructure binge. This is where Chinese construction companies will come in but a slew of other potential problems may arise because of this.

The fourth and, by far, most important constraint is manpower.

Sec. Pernia said during one forum that P8.14 trillion worth of infrastructure spending will create about 6.3 million jobs until 2022. We learned later that this figure was based on dated (circa 2006) input-output tables.

Given improved technology, we (at Abacus/MyTrade) estimate that the number of workers needed over the next five years is closer to 3.4 million. In either case, we should be ecstatic because millions of additional jobs would generate trillions in salaries and put a fire under consumer spending, right?

Unfortunately, no.

In fact, we believe that even our own conservative estimate is impossible to reach.

First, construction companies have long complained that there is a dearth of middle managers and foremen in the industry because many of them seek greener pastures in foreign lands.

More recently, they have also been hurt by a shortage of skilled workers. These include welders, electricians, painters, machinists, heavy equipment operators and others. The shortage is forcing contractors to pay a premium for skilled workers and/or recruit and train farmers and fishermen from far-flung provinces. The government’s planned infrastructure binge, they acknowledge, will worsen the shortage and probably push labor costs higher.

This all sounds counter intuitive given that so many Filipinos of working age are unemployed. But the fact is that the rate of labor force participation (LFPR) has actually been declining in recent years. This can be traced, in part, to the implementation of the K-12 program. Those who were supposed to graduate from high school two summers ago and who had no intention or capacity to go to college should already be in the labor force but are not.

With the recently signed law granting free education at SUCs, the dip in the LFPR may be prolonged. Meanwhile, one hypothesis (credit goes to an applicant I interviewed last year) is that many Pinoys are delaying their entry into the labor force because their finances are well taken care of by relatives who are OFWs. The attitude, it would seem, is why work when life is already comfortable with the dollars, rials, or euros that papa/mama/kuya/ate sends back home.

Whatever the reasons are, the fact is that LFPR is falling and the result is that an average of only 415,000 people have entered the labor force for the past five years. Given that half of these new laborers are women, only about a quarter million men are added to worker rolls every year. So where, again, will the government find the 3.4 million to 6.3 million (mostly male) workers?

A key problem is that the LFPR is inherently sticky and only moves a few tenths of a percent per year (most of the time).

It is practically impossible, therefore, for the country’s male LFPR to jump from 77.9% in October 2016 (latest available data) to more than 85.0% by 2022 if we use Pernia’s 6.3 million new jobs. This is especially true considering that of those who are of working age (15-65 years old) but are not in the labor force, only 30% are males and of these, many are students. The pool of potential recruits, therefore, is smaller than it appears.

Will OFWs return from places around the world to fill the gap? This is unlikely given that the monthly minimum in the Middle East is $500 (P25,500) per month or more than twice the monthly minimum here.

The final possibility is to import labor. Some, for example, have speculated that Chinese construction giants will bring their own workers here. China’s labor force, however, started shrinking a few years ago and wages there have been escalating by double digits annually as a result.

For construction jobs, in particular, there is a wide gap in wages between China and the Philippines. It may therefore be too costly to bring in Chinese laborers. For other reasons, we also believe that recruiting workers from other countries like Vietnam, Myanmar, Pakistan, or Bangladesh is also unlikely. Apart from the language barrier, assimilation would be unwieldy, at best, because of cultural differences. Housing hundreds of thousands of foreign workers, much less a million or more, would also be a logistical nightmare.

Bottom line, the government’s infrastructure program appears overly ambitious.

Even if P1.2 trillion in additional tax revenues can be raised, and even with promised support from China and Japan in the form of ODA, there may not be enough warm bodies to go around. It is also possible that the government will inadvertently crowd out the private sector in competing for a precious resource (labor) and stunt growth in other areas of the economy.

Our worst case scenario, however, is that the government will indeed be able to collect P1.2 trillion in incremental taxes over the next five years but that the money will be largely unspent because of all the constraints enumerated above. This will be a big, unexpected drag on growth.

Instead of pursuing all the projects encompassed in the P8.14 trillion spending program, it would probably be worth to consider which infrastructure need to be prioritized. Those with the most expansive impact to the economy should be greenlighted first.

For example, the number of foreign tourist arrivals has more than tripled since 2010. This has brought in foreign exchange and the private sector has responded by building tens of thousands of new hotel rooms. A weaker peso relative to the region should further enhance the Philippines’ attractiveness to tourists.

Our airports, however, are bursting at the seams and the tourism sector is likely to slow if gateways like NAIA are not expanded or even replaced. This is one area, therefore, where the government can get the biggest bang for taxpayers’ bucks. Not only would bigger and better airports make it more fun for foreigners to visit the Philippines, but Filipinos would benefit from a more robust economy.

Views and opinions expressed in this piece are those of the writer’s and do not reflect the policy or position of BusinessWorld. This piece is for information purposes only and should not be construed as a recommendation, an offer, or solicitation for the subscription, purchase, or sale of any of the security(ies) mentioned.

Raymond “Nicky” Franco is a Certified Public Accountant and received his Chartered Financial Analyst (CFA) designation in 2000. He is the Head of Research of Abacus Securities and the head of its online trading arm, MyTrade (mytrade.com.ph).

Most investors have seen or experienced a crowded trade -- a security or theme that has attracted an inordinately large number of followers or believers. The problem is that when it is “on”, such a trade often feels like a good bet until it falls apart. MSCI cites the risk of crowded trades thus: an “overlap of positions among managers may result in extreme levels of risk when those investors experience negative shocks in other parts of their portfolios, forcing them to liquidate their positions (selling what they can, rather than what they would necessarily like to.) These ‘fire sales’ may then cause losses for other investors following the same strategy and result in further liquidations, driving stock prices into a downward spiral.”

Crowded trades often go hand in hand with bubbles, and even recognized geniuses are not spared from being caught up in the ensuing craze.

From Business Insider, we learn that “in the spring of 1720, Sir Isaac Newton owned shares in the South Sea Company, the hottest stock in England. Sensing that the market was getting out of hand, the great physicist muttered that he ’could calculate the motions of the heavenly bodies, but not the madness of the people.’ Newton dumped his South Sea shares, pocketing a 100% profit totaling £7,000. But just months later, swept up in the wild enthusiasm of the market, Newton jumped back in at a much higher price -- and lost £20,000 (or more than $4 million in today’s money). For the rest of his life, he forbade anyone to speak the words ‘South Sea’ in his presence.” Not only did Newton get burnt but, by some accounts, he exited his South Sea position broke.

Is it me or is it just getting too crowded here?

The Philippines has its own colorful history of crowded trades. I’ve met a good number of senior people who refuse to touch stocks today because they lost money on mining and oil stocks in the 1970s.

More recently, the BW scandal of 1999 created great fortunes for a few but left most with nothing more than harsh lessons. One story has it that a group of BW investors had shares that were under lock up and their fortunes rose more than 30-fold into the tens of millions when the stock rose to its peak of Php102. Unfortunately, they could only watch as the bubble burst and BW eventually became a penny stock.

The stock market, however, is not the only arena where crowded trades are born, mature and eventually fizzle. In business, there were the litson manok and Zagu crazes of the 80s and 90s. Eventually, many of these businesses folded simply because there were too many of them.

Meanwhile, some say that art has become a crowded trade with too much money chasing a limited number of actually great pieces. It is one thing to democratize art but some people are buying paintings or sculptures because they want to flip them as soon as possible or because an artist (especially a national artist) looks like he or she is likely to kick the bucket soon.

Going back to local equities, I suspect that we are in the midst of another crowded trade. This is based on several interconnected observations.

First, the first quarter earnings season has just concluded, and the results are not pretty.

Based on core or recurring profits, the weighted average year-on-year earnings per share (EPS) growth for the first quarter is a modest 6.6%. On reported or headline numbers, this figure becomes even more tepid at 5.5%. Meanwhile, the Philippine Stock Exchange index (PSEi) has thus far rallied 15% this year (through May 26), pushing the market’s price/earnings ratio close to a heady 19x on 2017 estimates.

Moreover, PSEi members’ earnings revisions have been mostly negative year-to-date. The notional EPS for the index is currently at P412, two percent lower since the start of the year. Two percent may seem trivial but it is not as it equates to about 160 index points. Finally, foreign investors remain net sellers of Philippine equities to the tune of $15 million year to date (also through May 26). This means the enthusiasm is largely coming from domestic investors. Despite all these, the PSEi has not only been resilient but is actually pushing into bull market territory.

NOT THE TAX REFORM WE NEED
So, what continues to stoke Filipino investors’ animal spirits? There are two factors, with the second (the promised “golden age” of infrastructure) being dependent on the first (comprehensive tax reform).

Everyone acknowledges the need for tax reform. When it is done right, it can indeed be a catalyst for economic growth. In the US, many economists agree that the posthumous passage of President Kennedy’s proposed tax cuts in 1964 helped the economy sustain growth of 5% for nearly a decade. In the same manner, Ronald Reagan’s 1980s tax cuts are also credited for boosting America’s growth to 4%. However, I believe that the current proposals in Congress, embodied in House Bill (HB) 5636 are not the specific tax reforms the Philippines needs.

First, it does not address the strict bank secrecy laws that enable many to avoid scrutiny from tax authorities.

Of course it would be a very contentious issue but no tax reform package would be complete without it. Studies show that bank secrecy results in billions of lost revenue for the government annually.

Second, the ultra-rich comprising the wealthiest 0.1% of families (approximately 23,000 households) may actually see a net tax benefit because estate and donor’s taxes will be slashed. Moreover, since ultra-rich families incorporate their business interests, they will gain immensely when corporate taxes are reduced as part of the Department of Finance’s (DoF) second tax reform package.

Third, the tax reform package does not address the issue of low tax compliance among the self-employed and professionals. Moreover, by raising the top tax rate to 35%, the incentive to evade taxes increases and could even lead to a drop in collection from these groups.

Fourth, as often pointed out by Rep. Romero Federico S. Quimbo, higher fuel and automobile excise taxes are likely to encourage even greater smuggling of these items (notwithstanding the implementation of fuel marking as one of the complementary tax measures). As a result, the projected revenues would be at risk.

Most importantly, the tax proposal from the DoF will result in a net tax increase for the average Filipino consumer. Despite infographics showing an increase in take home pay for teachers, policemen, call center agents and others, the truth is only a small fraction of people in the labor force (around 14%) will benefit from lower tax rates. This is because farmers, OFWs, construction workers, kasambahays, informal sector workers and more are either exempted from income/withholding taxes or are not captured as part of the tax base.

On the other hand, all Filipinos will feel the impact of higher fuel and car excise taxes, a new sugar tax, the lifting of VAT exemptions and more changes to the tax code.

To illustrate this, we begin by breaking down the impact of the major components of HB 5636 by economic class. The following calculations are based primarily on data from the Family Income and Expenditure Survey (2012 and 2015), Bureau of Internal Revenue and others. The table above gives rise to the following observations:

• Only 19% of the projected tax savings arising from lower tax rates will accrue to the bottom 50% of Filipino households. The middle 40% gets the lion’s portion of the tax savings but the top 10% will still get a big chunk.

• Including pass through effects from trucking (which feeds into the cost of manufactured or imported goods) and public transport, the bulk of higher fuel taxes will be borne by the middle 40%.

• The removal of VAT exemptions as well as the new tax on sweetened drinks will also impact the middle 40% the hardest.

• Higher excise taxes on automobiles, as expected, will mostly be shouldered by the top 10%.

Graphically (below), the net effect for each economic class becomes clear: EVERYONE loses.

However, the rich can afford to pay higher taxes while the bottom 50% will receive targeted subsidies. It is the middle class, therefore, that will bear the brunt of the government’s proposed hike in tax collections. And, given that these are permanent tax increases, the impact on consumption, especially discretionary spending, will be significant. This is why I disagree with most when they say that the tax reform pending in Congress will be a boon for consumer discretionary stocks.

GOLDEN AGE OF INFRASTRUCTURE?
Some can see through the smoke and mirrors and have spoken out against the potential negative effects of HB 5636.

As mentioned previously, Rep. Quimbo has warned that increasing fuel excise and automobile taxes may result in increased smuggling of these products. This seems likely given the resulting huge arbitrage.

On the other hand, Rep. Zarate and other left-leaning solons have said that the proposed tax reforms are anti-poor because they will significantly increase the cost of basic goods. Government calculations, indeed, show that consumer prices will rise by about 1.0%-1.5%. As a result, 2018 inflation is likely to breach the top end of the central bank’s target range. The DoF characterizes such increase as “minimal,” though not bothering to mention that those in lower economic classes are more vulnerable because most of their income is spent on food.

Various sectors have also expressed opposition to certain measures in the tax reform bill.

As expected, automobile manufacturers and importers are lobbying for a smaller increase in taxes. The beverage industry, meanwhile, warned that the P10.00 per liter tax on sweetened drinks is too big a burden and will drive up inflation.

For its part, the Cooperative Development Authority (CDA), which has 26,000 registered coops with 14 million members (mostly farmers, teachers, drivers, rank and file employees), has said that removing their tax exemptions would pose a huge challenge. The group notes that cooperatives are people-based enterprises that are not driven by profit and HB 5636 would threaten the viability of small and micro coops that make up more than 90% of their membership.

In short, there are many, but disjointed, voices against one or more provisions of the bill advancing in Congress. Most, though, have been sanguine, believing, for the most part, that the short term pain will be worth it and pay dividends in the long run. More and better infrastructure, they say, will eventually lift the tide for everyone.

According to Sec. Bello and other government officials, the P8.2 trillion infrastructure spending program will create 12 million jobs until the end of the President’s term (an average of 2.4 million over the next 5 years). Both ambitious and impressive but these numbers should not be taken at face value.

While tax reform should pass the House with ease, there will be greater opposition in the Senate and thus the threat of dilution. Even administration senators have expressed apprehension with one or more of the controversial revenue generating proposals and Sen. Drilon has been quoted as saying that passage may slide to 2018.

SKILLED LABOR SHORTAGE
And even if most of the DoF’s first tax package gets approved, the economy’s absorptive capacity will be an issue. The slack in the construction sector is practically non-existent. Where, for instance, is the government going to find 2.4 million additional workers per year? The country’s population does not even grow by 2.0 million a year and the labor force has expanded by approximately 1.1 million annually over the past decade. It would help if the labor force participation rate goes up several percentage points but it is sticky, ticking up only slightly (if at all) in any given year and is probably being held down by other factors.

Meanwhile, property companies have confirmed there is a skilled labor shortage that is causing delays, mainly for residential condominium projects. The same issue has forced construction firms to be more selective or to reject some projects outright. The problem has gotten so bad that major contractors are paying 50%-70% above minimum wage for skilled labor, up from 20%-30% in the past. They have also had to recruit farmers and fishermen plus invest heavily in training and housing them.

Industry stakeholders agree, therefore, that the government’s infrastructure program will significantly worsen the Philippines’ shortage of skilled workers.

Bringing in advanced technology and equipment (from China, perhaps) can bridge some of the labor gap but this will not change the equation. Neither will banning or reducing the deployment of skilled laborers to Middle East. Filipinos will continue to prefer working far from home because of the huge wage differential. Could we, perhaps, import labor from neighboring countries? This is going to be a stretch. Myanmar has a skills shortage of its own, Vietnam’s unemployment rate is much lower than the Philippines’ and Indonesia’s economy is booming as well.

Meanwhile, issues that plagued previous administrations are expected to crop up.

Right of ways, legal challenges from losing bidders and the snail-like pace of the court system can cause significant delays. New problems can arise as well. Potentially the most serious would be the lack of qualified contractors. DMCI, for example, has said that it has a capacity of P50 billion worth of projects at any single time. Out of this figure, only a fraction is infrastructure related so for the industry as a whole, there may be serious limits as to how many simultaneous projects can go on at once. Foreign (read: Chinese) engineering and construction firms will certainly be invited to participate but again they will be competing for limited human resources.

Most recently, several private companies have begun to air concerns regarding the government’s plan for hybrid PPPs. That is, project construction will be undertaken by responsible government agencies using ODA funding or through budget appropriations and, after completion, management and operation will be bid out to interested parties.

The concern is that ODA funded projects usually take longer to finish. A case in point is the Iloilo airport which took 9 years from start to finish. Another example is SCTEX which was delayed by two years and incurred cost overruns of more than 50%. SMC chairman Ramon Ang, for his part, has said that going the hybrid PPP route risks damaging the government’s balance sheet and warned that the conditions tied to ODA funding are “scary.” Not only this, if the government will take it upon itself to plan and execute major infrastructure projects, the projected benefits for various listed companies are not likely to materialize in the near to medium term.

The worst case scenario, therefore, is that real consumer spending growth slows down due to the impact of a net tax hike and higher inflation while, at the same time, the hundreds of billions in additional tax collection becomes stranded and unproductive because the government’s infrastructure roll out is bogged down by major constraints. This is a key risk that is not being priced in by the market that seems to be “all in” on this crowded trade.

Views and opinions expressed in this piece are those of the writer’s and do not reflect the policy or position of BusinessWorld. This piece is for information purposes only and should not be construed as a recommendation, an offer, or solicitation for the subscription, purchase, or sale of any of the security(ies) mentioned.

Raymond “Nicky” Franco is a Certified Public Accountant and received his Chartered Financial Analyst (CFA) designation in 2000. He is the Head of Research of Abacus Securities and the head of its online trading arm, MyTrade (mytrade.com.ph).

FINANCIAL MARKETS are full of quirks or anomalies.

In the US, for example, they have what is called the January effect. It is so named because many of the best performing stocks during the said month usually had the worst returns in the prior month. The theory is that fund managers sell (realize losses on) their losers in December to be able to claim losses for tax purposes. The selling causes weak stocks to fall even more which then sets them up nicely for a recovery in January of each year. This is not applicable in the Philippines but there are local anomalies worth noting.

For example, the chart below shows that there appears to be more than a grain of truth in the adage “sell in May and go away.” From 1995-2016, the average return for the six-month period ending May 31 is 8.9%. In contrast the average return from June to November is negative 1.0%.

Theoretically, therefore, one can take vacations for six months at a stretch and not miss a beat. Of course, trading or investing is never that simple. Friction costs would be substantial, there would be no assurance that you can buy (or sell) the stocks you want at prices that you would consider fair and past experience is not always a great predictor of the future.

Anomalies can also occur due to foreign investment flows. Sometimes, we observe that a conglomerate’s stock price will diverge widely from its subsidiaries.

To cite, JG Summit (PSE:JGS) has rallied 28% year-to-date (through May 8) on the back of large net foreign buying. In contrast, its major subsidiaries and affiliates, accounting for more than 80% of its net asset value (NAV), have only risen by an average of 8%. The disparity is so wide such that investors may be rewarded by rotating out of JGS and into its units; more so considering that the stock is already more than 10% above its consensus target price. In other cases, foreign interest is concentrated in only a few issues within a particular sector.

In the property sector, for example, the majority of foreign buying and selling is focused on just SM Prime (PSE:SMPH) and Ayala Land (PSE:ALI). Partly as a result of this, these two companies trade at more than twice the valuation of its domestic peers.

And then there are stocks that seem to defy gravity. Valuations are so steep such that traditional metrics or models appear pointless. Remember when the number of page views was used to justify share price targets during the dot com boom?

Locally, there are a few counters with valuations that appear exceedingly stretched.

Among them, Philippine Seven (PSE:SEVN) once traded as high as 100x trailing earnings and has averaged approximately 70x in the past five years. Growth has picked up recently but this valuation is still about 4x the market average during the same period and twice that of its convenience store peers in the region. In part, SEVN’s lack of liquidity appears to be protecting it from de-rating to more reasonable levels. However, this does not explain why other stocks with similar growth profiles do not enjoy the same lofty ratios.

Another example is a very popular stock which is currently trading at nearly 200x trailing earnings (that is not a typo). The concerned company’s reported net income has been growing but if we exclude non-cash revaluation gains (to make it comparable with its peers), it would actually have no profit to speak of. Apparently, investors are looking forward to the time when management’s vision of several billions in profits becomes reality which would bring down valuations. However, the said target is still more than 3 years away. Moreover, the oft-quoted profit target, as confirmed in a meeting with top officials, is gross of minority interests and distributions to preferred shareholders.

Therefore, even if this company can catch up with its roll out (slightly delayed based on earlier presentations), its stock would still be trading at well over 30x on 2020 earnings. On the other hand, fair value is relative and is often defined as the price a willing buyer and seller agree on. In this case, maybe it is not an anomaly at all.

Views and opinions expressed in this piece are those of the writer’s and do not reflect the policy or position of BusinessWorld. This piece is for information purposes only and should not be construed as a recommendation, an offer, or solicitation for the subscription, purchase, or sale of any of the security(ies) mentioned.

Raymond “Nicky” Franco is a Certified Public Accountant and received his Chartered Financial Analyst (CFA) designation in 2000. He is the Head of Research of Abacus Securities and the head of its online trading arm, MyTrade (mytrade.com.ph).

AS A STUDENT taking up accounting, I hated auditing theory.

More than boring, the subject often seemed pointless. If it were not a major component of the board exam, most students would have probably ignored it. There was one thing, however, that one of my board exam reviewers was able to drill into my brain. That is, CPAs need a very healthy dose of professional skepticism which is defined as “an attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence.” Simply put, this means that numbers should not be taken at face value.

In this regard, the Philippine Stock Exchange (PSE) has done a great job with the Bell Awards which seeks to promote greater transparency and improved corporate governance among publicly listed companies. Among others, the Bell Awards have encouraged many firms to disclose financial data and other material information in a more timely and exhaustive manner. China Bank holds the distinction of being the only five-time winner of this award while the Aboitiz Group, Manila Water, and Philex Mining are among those that have won it more than once.

Despite the success, a lot of work still needs to be done. The level of compliance and zeal among PSE-listed companies in improving corporate governance is very uneven. One major corporation, for example, has not updated its investor relations page since 2013. Another kept reducing details from its quarterly briefings until the last broker covering it suspended its reportage more than three years ago.

Professional skepticism, however, is not just for auditors and accountants. As an investment professional, and especially as an analyst, it has served me in good stead for the past 20 years. Early in my career, for example, I encountered a high-flying property company and its top and bottom lines were growing rapidly. However, unlike its peers in the industry at the time, its debts were piling up and free cash flow was negative. Despite its popularity, my call was to switch to another property company with a less risky profile.

A few years later, the firm collapsed as the peso imploded due to the impact of the Asian financial crisis. The other company I told clients to switch into also lost a lot of value but at least it never needed corporate rehabilitation.

In another case, despite the hype surrounding the new government’s infrastructure program and the positive outlook touted by management, we declined to put a subscribe rating on an initial public offering (IPO) last year. Although some investors did profit from this IPO, the stock is now down more than 30% from its initial offer price as the industry’s competitive environment has deteriorated.

Until now, we have not turned overweight on infrastructure stocks. There are significant doubts that the first tax package submitted by the DoF will be passed into law largely intact or on time. And even if it is, implementation is unsure given that property and construction firms themselves have been complaining about a shortage in skilled labor since early 2016.

So, whenever asked for advice by retail clients, I tell them, among other things, to develop a healthy dose of curiosity and skepticism. For investors, this can be demonstrated in several ways.

First, always take rumors and tips with more than just a grain of salt. Remember, those that spread such rumors and tips are often the ones that have the most to gain. To this end, the PSE recently circulated an advisory warning the investing public about an investment portal that is selling investment tips for P120,000 to P180,000 a year.

Second, investors should realize that companies will often highlight only the positives in their press releases and quarterly reports. The negatives, on the other hand, are usually buried deep in the details. Whether it is done on purpose or not, what can happen is that the true picture does not become evident until much later. Recently, a conglomerate issued a press release touting that its net income last year grew by 80%. Unfortunately, management did not clarify that the amount disclosed was still gross of minority interests, distributions to preferred shareholders, and profits from discontinued operations. Excluding all these, the profit that actually accrued to common shareholders was just a fifth of what was proclaimed in the press release. Unsuspecting investors took the press release at face value and thus arrived at an earnings per share (EPS) figure that was quite overstated. Even Bloomberg used the wrong EPS until we pointed it out to them.

At the other end of the spectrum, the Aboitiz, Lopez and MVP groups of companies (among others) always break down quarterly performances in detail and present core earnings which gives a better picture of a firm’s true profitability.

Lastly, investors should take the time to do their own research. It will not eliminate risk.

Instead, research will arm investors with knowledge that will help reduce or manage risk. Research also gives insight into a company or an entire industry. Once a buy or sell decision is made after doing research, the profit or loss from a trade becomes truly one’s own. This will help foster discipline and responsibility and will ultimately help investors become more successful.

Views and opinions expressed in this piece are those of the writer’s and do not reflect the policy or position of BusinessWorld. This piece is for information purposes only and should not be construed as a recommendation, an offer, or solicitation for the subscription, purchase, or sale of any of the security(ies) mentioned.

Raymond “Nicky” Franco is a Certified Public Accountant and received his Chartered Financial Analyst (CFA) designation in 2000. He is the Head of Research of Abacus Securities and the head of its online trading arm, MyTrade (mytrade.com.ph).

I HAVE GLOSSOPHOBIA, the fear or anxiety of public speaking. As a result, my speaking style (or lack thereof) will often put people to sleep.

Therefore, when making presentations to clients, I sometimes try to engage with them by asking trivia questions. For example: In Japan, which personal consumer product is now bought/used by more adults than babies? The answer, in case you don’t already know, is diapers. Yes, due to its relatively old population, adult diapers outsell baby diapers in Japan. Some would be amused at this fact but, really, we shouldn’t because the underlying cause affects many countries in Asia: demographics.

Due to steep declines in fertility rates after World War II, and especially in the ’60s and ’70s, the populations of Japan, China, South Korea, Taiwan, Hong Kong, and Singapore have aged dramatically. These states have fertility rates ranging from 1.1 to 1.6, well below the 2.1 needed for a stable population (excluding immigration).

Consequently, Japan’s population is projected to fall by a staggering 39 million people -- nearly a third of its current population -- by the year 2065.

In Singapore, the government has tried various inducements for couples to have more children to no avail. The influx of foreign skilled and professional labor has staved off a shortage of talent but there has been a backlash from ethnic Singaporeans who complain that the country is losing its identity.

This begs the question: should the Philippines hitch its rising star to a powerful yet clearly vulnerable patron?

China’s labor force began shrinking in 2012 and its population is likewise expected to start falling within a decade.

In a few major Chinese cities, the fertility rate is below 1 and thousands of kindergartens all over the country have closed. Without straining the imagination, it is quite possible that China will experience a “lost decade” similar to what Japan went through in the 1990s. The common denominator is the aging of the population which causes demand for products and services to change over time and, eventually, to slow dramatically as people exit the labor force in droves. The fundamental difference between the two, on the other hand, is that Japan was already a rich nation in the ’90s whereas economists doubt whether China can escape the so-called middle income trap before its population begins to shrink. Moreover, Japan has a very robust social safety net while China has a looming public pension system crisis which could make the effects of an aging population even worse for the latter. Nevertheless, only time will tell if the Philippines will be a net beneficiary of its pivot to China.

The good news is that we are just entering our demographic window of opportunity; that period in a nation’s history when the percentage of its population in the labor force is at its most prominent. As a nation progresses through this time frame, expected to last over 20 years, the number of dependents (children plus elderly) per worker declines significantly. Therefore, not only will GDP per capita grow but Filipinos will have more money to spend on wants rather than needs. This is already beginning to happen.

Breaking down last year’s GDP report, for example, shows that the fastest growing components of personal consumption expenditure (PCE) were spending for restaurants, entertainment, and recreation.

Second, data from Japan’s tourism agency shows that the number of Filipino visitors jumped by over 200% between 2013 to 2016. Third, one of the biggest growth drivers for hospitals today are elective procedures, particularly those for aesthetic purposes. This list can go on but the trend is clear: discretionary spending is on an uptrend. This will continue to rise in the long term and benefit consumer companies.

Still, investors should diversify and be discerning; not all of the listed consumer stocks are currently doing well. Recently, two of the biggest names in the sector posted lower recurring net income in the fourth quarter.

Meanwhile, competition is intense in certain industries resulting in soft same store sales and/or falling margins. Inflation, on the other hand, accelerated to 3.4% last month from 1.1% a year ago and the proposed increase on fuel excise taxes and removal of VAT exemptions on many items will push this even higher.

Most importantly, the fundamentals and prospects of each listed consumer company vary widely.

For example, the labor department’s DO 174 will have a material impact on personnel costs for restaurants but should be negligible for retailers. Another point is that while many firms’ same store sales tend to grow in line with population growth plus inflation (e.g. department stores and supermarkets), a few have higher growth potential because of the Philippines’ changing demographics.

One specific example is Wilcon Depot (PSE: WLCON).

It recently went public but the reception has been lukewarm thus far. To some extent, the concerns are valid. As someone pointed out, people go to the mall every day but only a few times a year to a home improvement store. The pricing of its IPO was also perceived to be on the high side. The company, however, is benefiting from a major trend. The average household in 2015 was estimated to have 4.4 members, down 17% since 1990.

Not only are women having fewer children but, because of higher disposable incomes and cheaper financing, more families are building or buying homes of their own. Household formation, therefore, has been growing much faster than population growth. Philippine Statistics Authority (PSA) data for the period 2010 to 2015 shows a 5-year CAGR of +1.77% for the latter and +2.64% for the former -- a differential of nearly 50%! This is why same store sales comparables have all been healthy at Wilcon, SM’s Ace Hardware, and Robinsons’ Handyman in the past year. With pure home improvement stocks in the region trading at ~28x earnings, WLCON should give shareholders solid returns over a long investment horizon.

Views and opinions expressed in this piece are those of the writer’s and do not reflect the policy or position of BusinessWorld. This piece is for information purposes only and should not be construed as a recommendation, an offer, or solicitation for the subscription, purchase, or sale of any of the security(ies) mentioned.

Raymond “Nicky” Franco is a Certified Public Accountant and received his Chartered Financial Analyst (CFA) designation in 2000. He is the Head of Research of Abacus Securities and the head of its online trading arm, MyTrade (mytrade.com.ph).