Trading at a forward price-earnings ratio of 20 times, the Philippine Stock Exchange is one of the most expensive equity markets in the Asia-Pacific region.
Last year the PSE Index jumped 23%, placing it among the world’s 10 best-performing markets. Average daily trading volumes are running at P11 billion ($248 million), twice as much as they were four years ago.
Last year’s performance extends a six-year rally in which the country’s benchmark stock index has risen more than 280% since the end of 2008 – outpacing the MSCI Asia Pacific Index’s gain. So far this year the benchmark index is up another 8.8%.
But how long can this winning streak last and do Philippine stocks offer value for money?
“Investors recognise the market is highly priced,” said Eduardo Olbes, head of Security Bank’s wholesale banking segment in Manila. “Two years ago we were trading at the top of the historical trading band and everyone was expecting a correction, but it never came and we’re still touching the top of the band.”
With no end to the upswing in sight and the Manila exchange enjoying market-darling status there is growing pressure on it to implement reforms and transform itself into a world-class bourse.
Hans Sicat, who has been chief executive of the PSE since 2011, has a long list of projects underway including a merger with the bond exchange, the launch of new products such as real estate investment trusts and derivatives, and an overhaul of the securities regulation code.
Sicat believes current stock prices are supported by strong fundamentals: “The last time the market was trading at 19 to 20 times forward PE was in 1997, just before the crash of the Asian financial crisis, but back then companies weren’t performing as well in terms of earnings and revenue growth.”
Another contributor to the rising market is Asia’s growing pool of liquidity and the need for fund managers to find high-growth markets to invest in. Last year Philippine GDP grew by 6.1%, making it the second best-performing economy in Asia next to China. This year Standard & Poor’s expects GDP growth of 6.1%, compared with 5.6% in Indonesia, 4.6% in Malaysia and 3.9% in Thailand.
The simple truth is that the Philippines looks compelling against other Southeast Asian markets.
“True structural reform is underway in the Philippines,” said Ed Francisco, head of BDO Capital and co-chair of the Capital Markets Development Council representing private sector interests. “Much of last year’s 23% [stock market] rally was the result of investors scouring the region for somewhere to make a higher return. The continued flow of money into investment funds makes it necessary to find a place to put it to work.
Sicat wants to generate more listings on the PSE and took a trip to Japan in January where he spoke to executives from around 150 Japanese companies about the benefits of issuing stock in the Philippines. He has an overall capital raising target for 2015 of Ps200 billion ($4.5 billion) from preference shares, IPOs and follow ons, and expects much of the activity to come from financial institutions wanting to boost their core capital ratios, and from infrastructure and power companies looking to fund projects.
In January and February the market executed four, large top-up placements for Ayala ($350 million), JG Summit ($200 million), GT Capital ($222 million), and Metro Pacific ($200 million). The PSE had the same target of Ps200 billion in 2014 but fell slightly short of it, despite some hefty follow-on deals for Bank of the Philippine Islands, which raised $550 million, and Philippine National Bank, which raised $250 million.
According to one dealmaker at a local investment bank in Manila, the current equity capital market pipeline makes Sicat’s year-end target look ambitious. “There were some good deals in the first two months of the year but now the pipeline is thinning out,” the banker said. “The only deals on the horizon are a $700 million rights offering for Metrobank and a $180 million deal for East West Bank. The IPO pipeline is dominated by small- to mid-caps.”
As ever, the bourse’s biggest competitor in the capital-raising space is the country’s banking system, which is flush with cash and eager to lend to the corporate sector. Standard & Poor’s reports that banks expanded their lending activities by 19% in 2014 and expects loan books to grow by a further 15-18% this year, with most of the money going to local companies.
More products please
Some believe that the answer to a deeper Philippine stock market lies in new products. The PSE could reach its capital-raising target in a heartbeat if it could push ahead with the listing of real estate investment trusts.
Laws allowing the establishment of local Reits were passed in 2009 but so far property companies have been unwilling to issue, due to a government tax on asset transfers. “The tax was announced at the last minute, just as we had three transactions lined up, each worth about $1 billion,” Sicat said.
The tax obliterates the attractiveness of the Reit structure as a yield play, requiring another 190 basis points in effective yields to cover the additional costs. “We want the tax removed,” Sicat said. “We’re asking the tax authorities to look at models in operation in other Asean countries and Hong Kong, and we’ve prepared some analysis which shows that an active Reit market generates more tax revenue over time through increased property development, higher employment, and bigger transaction volumes.” So far, the pleas have fallen on deaf ears.
Bankers like Francisco and Olbes would also like to see the introduction of derivatives as there is currently no real way to short or hedge Philippine stocks. Sicat is hopeful he can offer new derivatives products when the exchange switches its trading engine over to Nasdaq OMX X-stream in May.
“We chose this platform because of the ability to bolt-on modular products and the first one we will trial is securities borrowing and lending,” he said. “Then we’ll practice with warrants.”
The exchange has been experimenting with index futures since 2013 when it cut a deal with the Singapore Exchange to offer access to contracts based on the MSCI Philippines index. Sicat had hoped to make index futures available locally but says the Securities and Exchange Commission wasn’t able to sanction the product in a timely manner.
The SEC is often blamed for taking a sluggish attitude to both general market reforms and the approval of individual deals.
“The regulatory registration process causes a lot of heartburn for issuers trying to tap the capital markets,” said the Manila-based investment banker, who wants to see a more streamlined process. “Working with the SEC is like operating in a black box and it can take months or longer to get approval. All too often documents land on the desk of an examiner who is ill-equipped to assess the deal and the lawyers burn a lot of time trying to get these people up the curve.”
Another item on the reform agenda is a fairer book-building process for IPOs. Under current rules, underwriters are required to set aside 20% of every deal for PSE trading participants (a pool of 133 brokers, many of them very small) and 10% for retail investors. Both groups are offered shares at a set price. Brokers have three days to decide whether they want to take up their allocation or return it to the underwriters – essentially giving them a free option on the shares. And, on the 10% retail tranche, take-up rates can be as low as 2%.
“Underwriters are being asked to take a contingent risk on 30% of the entire IPO, resulting in distribution and allocation complications with respect to our institutional and retail clients,” said Marcelito Ordonez, managing director at investment house Maybank ATR Kim Eng Capital Partners.
Things get more complicated on deals where there is a foreign bank handling the offshore book. “We need to negotiate an equitable sharing of the 30% contingent risk to make sure our investors will be provided appropriate IPO allocations,” he said, indicating local brokers aren’t playing on a level field.
While conscious of protecting the interests of his trading participants, Sicat said he is in favour of a shift to a single book. “The reason the separate sequential marketing system exists is because the SEC requires us to go out with the set price. We need to revise the Securities Regulation Code (SRC) to allow us to book-build using a price range, as is done in other markets,” he said.
In order to make it happen the SEC has to agree to rewrite the country’s somewhat antiquated securities code.
“We have a committee working on a final draft of suggested changes to the SRC and we hope to present it soon,” Sicat said. “We realise these changes are long overdue, and we also want to see better enforcement mechanisms to deal with non-compliance.”
Asean exchanges linkup in the balance
Reforms such as an overhaul of the SRC will be required if the PSE is to achieve its goal of joining the Asean Trading Link that connects the stock markets of six Asean countries. The link went live in 2012 but so far only three bourses are involved: the Stock Exchange of Thailand, Bursa Malaysia, and the Singapore Exchange.
Market participants support the link and see it as an opportunity to put the PSE on a par with its peers. “The continuing adoption of international best practices will further encourage international and domestic investor participation in the market,” Kim Eng’s Ordonez said.
But the process is being hindered by the SEC, which has yet to join the International Organisation of Securities Commissions, the Paris-based body made up of the world’s securities regulators. The SEC says it needs more time to implement reforms and comply with IOSCO’s rules but some blame the delay on the regulator’s reluctance to budge on certain issues.
“The sticking point appears to be the SEC’s anti-money laundering laws,” said Francisco at BDO. “There are certain [individuals who] do not want the laws to be tightened as it would reveal their true wealth.”
He added that other policymakers didn’t want to flick the switch on the Asean link because they feared it might encourage capital to exit the country.
Much of what happens in the Philippines is still dictated by vested interests and the power of political influence.
With a national election to select a replacement for President Benigno “Noynoy” Aquino due in May 2016, Francisco is concerned necessary market reforms will be suspended.
“There are several bills we are pushing as part of an updated capital markets blueprint but some congressmen may resign as they prepare to run for their local seats,” Francisco said. “Those bills that aren’t passed by the third-quarter of this year will be put on the backburner.”
