Gearing up for growth: Following a steady year trade statistics look promising

The Philippine Stock Exchange (PSE) ended 2011 with modest gains despite uncertainties brought about by the debt crisis in Europe and the lingering concerns on the growth of the US economy. The PSE index (PSEi) was resilient, supported by more active trading in the market and increased capital raising activities by listed companies. Credit upgrades have also buoyed the PSE and authorities have been putting in place a number of reform efforts to bolster the exchange’s trading platform and corporate governance. The Philippines has seen a surge in liquidity, which has led to more investments. Meanwhile, the central bank has kept inflation in check, with the headline inflation rate at the national level averaging 4.8% by the end of the year.

However, due to outside events such as the threat of a Greek default and a sluggish US economy, the gains in 2011 have not been anywhere close to those in 2010. Nonetheless, by the end of 2011, the PSEi was the best-performing index in Asia and there are a number of encouraging factors for investors in 2012.

Turmoil in the eurozone, along with a sluggish US economy, has had some effect on investor sentiment. This has led to somewhat subdued trading throughout 2011, but there are still enough positive factors to encourage investors for 2012. The Philippines has seen a surge in liquidity, which has led to more investment. Meanwhile, the central bank has kept inflation in check, with the year-on-year (y-o-y) headline inflation rate at the national level slowing to 4.2% in December.

FOLLOWING A BANNER YEAR: Strong economic growth in 2010 saw the PSEi surge by 1148.5 points, or 37.6%, to end the year at 4201.1. Other factors behind the spike included higher corporate earnings by several listed firms, eased domestic inflation that allowed the central bank to keep its policy rates unchanged and rising confidence in the Aquino administration, which took office in June 2010.

However, trading throughout 2011 remained subdued as the market succumbed to external shocks and economic growth proved to be weaker than expected. The Philippine economy grew by 3.7% in 2011, which was slower than expected and far below the government’s full-year target of 4.5-5.5%. This is also well below the economic performance in 2010 when GDP grew by 7.6%, the highest rate in more than 30 years.

Nevertheless the market still managed to gain in 2011, unlike other markets in the region. Credit upgrades towards the end of the year for companies such as Philippine Long Distance Telephone Company (PLDT) helped rally the market to close the year stronger at 4371.96 points, 4.1% higher than in 2010. Besides the PLDT, some of the elite blue chip firms on the PSE include SM Investments, a holding company for the SM Group, which has interests in shopping malls, retail, real estate, banking and tourism; International Container Terminal Services, a port management company; and fast-food restaurant chain Jollibee Foods.

Meanwhile, average daily trading has continued to increase, standing at $131.93m by the end of 2011, a y-o-y increase of 21%, according to a PSE report. Average daily trading has seen an upward trajectory in recent years, increasing from $69.86m in 2008 to $86.22m in 2009 and $109.69m in 2010.

Net foreign transactions have fluctuated greatly in recent years. As the global financial crisis shook international markets in 2008, foreign fund managers unloaded stocks en masse. However, starting from the second quarter of 2009, the Philippine market’s performance improved as confidence began to perk up, with investors perceiving that the global recession had bottomed out and that the Philippines was generally resilient in weathering the equity shocks. For the full-year 2011, net foreign buying stood at $1.31bn, 44.7% higher than the $771.47m posted in the same period of 2010, according to data from the PSE.

NEW LISTINGS: Listed companies raised P107.50bn ($2.48bn) from the exchange in 2011, a 32% improvement compared to 2010. . The PSE also added Megawide Construction and Philex Petroleum to its roster of listed companies, bringing the total number of publicly listed firms to 253 at the end of 2011. The mining and oil counter was the only sector that posted gains, advancing by 47.2% during the third quarter of 2011. All other indices declined. Mining has been a major driver of investment growth, along with telecoms, power generation and business processing outsourcing. As firms working in these fields need increased capital to acquire fixed long-term assets, companies have increasingly been turning to capital markets with the aim of raising funds. In 2011 five firms went public and more initial public offerings are expected in 2012.

BOOSTING TRADE: Compared to other exchanges in the region, the PSE is still relatively small, but authorities have been intent on increasing its liquidity as well as raising its visibility. With a market capitalisation of $200.8bn in 2011, the PSE is the smallest of South-east Asia’s five major stock markets, behind Singapore, Malaysia, Indonesia and Thailand. Japan tops Asia’s markets with a value of $3.61trn.

“Financial sophistication is growing in the Philippines and should continue to increase as the country’s economy grows alongside a mass affluent class,” Manuel Tordesillas, the president and CEO of Maybank ATR KimEng Capital Partners, an investment house, told OBG. “This should lead to a rising demand for asset management services, but demand for ultra-exotic financial instruments is still a ways off.”

However, Cecilia Tan, the president of BPI Capital Corporation, the investment banking subsidiary of the Bank of the Philippine Islands, pointed out that while additional sophistication is anticipated, the Filipino investor has nonetheless traditionally been more conservative and interested in absolute returns and risk mitigation. According to Tan, derivatives could be used with greater frequency by the industry in the future.

Hans Sicat, the president and CEO of the PSE, told OBG that there have been two basic fixes to encourage higher liquidity and more sophisticated trading. The first was the upgrade of the PSE’s trading engine, which has brought the technology up to the standards of other exchanges in the region. A second important improvement was the consolidation and integration of the trading locations. The Manila Stock Exchange, the first capital market in the Philippines, opened in 1927. The rival bourse, the Makati Stock Exchange, came on-line in 1963. These were eventually merged in 1994. Although they continued to maintain separate buildings, their operations were consolidated in 2010.

CHANGES: On the market side, the PSE has been taking steps to expand its product base. Sicat noted that one of the major challenges to increasing volumes has been that the PSE is officially a long-only market. To address this, the exchange has been working with the Securities and Exchange Commission (SEC) to approve securities borrowing and lending. This is expected to pave the way towards allowing shorting in the market. The PSE is also trying to list exchange-traded funds (ETFs), which are exchange-listed products that mirror indices, commodities, bonds and currencies and allow investors to buy and sell them like stocks. These are viewed as highly liquid and flexible, allowing investors to spread risk. The SEC has been working closely with underwriters in view of launching the new product.

According to SEC officials, the regulator is also expected to be better equipped in 2012, as it will receive a hefty budget of some P600m ($13.6m), which will allow it to implement a new market surveillance system and hire and train more people. The PSE has also announced that it will cede the regulatory function of overlooking brokers back to the SEC to avoid any potential conflicts of interest. The SEC has been operating according to full international accountancy standards since 2006, in line with a risk-based capital adequacy framework for securities brokers and dealers.

STRUCTURE: The companies on the PSE are listed on three trading boards based on market capitalisation: the first board; the second board; and the small and medium-sized enterprise (SME) board. Companies with a market capitalisation of more than P500m ($11.35m) in assets are listed on the first board, while the second board requires a market capitalisation of P250m ($5.7m). The SME board, meanwhile, is reserved for companies with at least P5m ($113,500) in tangible assets.

STRUCTURAL ALTERATIONS: Plans to boost trade include the extension of trading hours. To this end the board of the PSE has affirmed a plan to further extend trading hours until 3.30pm, which began on January 2, 2012. The move is set to further align the country’s exchange with its ASEAN neighbours, and could allow it to catch some of the European market openings.

This is also in sync with the bourse’s plan for an ASEAN trading link, which will provide a common electronic gateway to other ASEAN exchanges to promote cross-border trading. Four of the ASEAN exchanges – Bursa Malaysia, the PSE, the Singapore Exchange and the Stock Exchange of Thailand – will take part; and three other exchanges – the Indonesian Stock Exchange, the Ho Chi Minh Stock Exchange and the Hanoi Stock Exchange – have also voiced interest.

DOMESTIC INCENTIVES: Due to the lack of interest among individual investors to invest in the market in the Philippines compared to other countries in the region, there has been an increasing focus on the importance of strengthening domestic participation in the market in order to rely less on foreign funds.

The local bourse is primarily made up of institutional investors, Mark Visda, the head of the PSE’s corporate planning and research section, told OBG. Thus officials have been pushing for more products targeted at individuals, such as the Personal Equity Retirement Accounts (PERA), which went into effect in November 2011. According to the PSE, the accounts encourage individuals to begin long-term saving practices through investments in PERA products, which are designed to be locked until at least five years before the investor reaches retirement age. The PSE has indicated that such long-term savings accounts will aid in meeting the pension needs of overseas workers and will also lower the cost of government borrowings by creating increased demand for government securities.

Real estate investment trusts (REITs) are another capital market reform aimed to boost domestic investment. The REIT Act came into effect in 2011 and allows property developers to raise funds by selling assets with recurring revenues, specifically by transferring those assets in a special purpose vehicle to be listed on the PSE. However, concerns over minimum public ownership rules as well as tax rates deterred REITs throughout the second half of 2011.

Rules released in July 2011 require 40% public ownership of REITs for the first two years after the listing, and 67% by the third year. Critics of this rule point out that the requirement in other countries is much lower. For example, the minimum is only 10% in Singapore and 25% in Hong Kong and Malaysia.

Furthermore, because REITs are entitled to tax incentives, the Department of Finance expressed concern that their implementation could potentially reduce state revenues. As a result, the Bureau of Internal Revenue has set a 12% value-added tax on the initial transfer of property assets in REITs.

These rules are, however, curtailing the market. SM Prime, the country’s largest shopping mall developer, had hoped to raise up to $500m from a REIT issue. However, it dropped its offer due to the 40% minimum public ownership rule. Other large property companies such as Ayala Land and Megaworld have voiced interest in setting up REITs but have said they want the public ownership requirement to be cut to 33%.

ENERGY LISTINGS: The PSE also enhanced its listing rules for petroleum and renewable energy companies. Mindful of the petroleum and renewable energy companies’ contribution to the economy and their need to have greater access to capital, the PSE relaxed its operating history requirement for such companies listing in the second board to accommodate businesses that are just in the exploratory stages of their operations.

Under the new rules, petroleum and renewable energy companies that intend to list on the second board but lack the operating history requirement will need to comply with the general listing requirements in the Second Board Listing Rules. They must also comply with supplemental requirements, including technical reports and valid service contracts among others.

The PSE is also collaborating with the Department of Energy (DoE) and the SEC to further enhance the exchange’s main thrust to provide a fair, orderly and efficient market for the trading of securities and to determine the suitability of securities for listing for the protection of the public interest.

GOOD GOVERNANCE: In a bid to make the Philippines a more attractive market, the PSE is planning to set up a “Maharlika Board”, a separate trading board for local companies with high standards of corporate governance. To be listed on the board, companies must follow certain corporate governance practices beyond those already required by law. Initially planned for the fourth quarter of 2011, the board is now expected to arrive sometime in 2012. Sicat stated in late 2011 that the PSE was talking to around 25 companies that had expressed interest in joining the board.

Incentives for companies that join the board will include discounts on listing and maintenance fees paid to the PSE as well as other tax and financial benefits. “We want to rebrand our country to show the world that we are serious about focusing on good corporate governance,” said Argel Astudillo, the PSE’s head of corporate governance.

Maharlika companies will be required to have at least seven independent directors, three of which must be voted in by minority shareholders. The board is the first of its kind in Asia and will only include companies that will increase their public floats to at least 30%, compared to the 10% required on the rest of the exchange.

PUBLIC FLOAT: In 2010 the PSE reinstated a rule that was suspended in 2005 that enforces a minimum 10% float rate. Companies below this limit were given until the end of November 2011 to boost their float or face higher listing fees and a 2013 deadline to comply or be delisted, according to the PSE. In October Sicat said the PSE is considering whether to raise the minimum proportion to 12% to attract even more liquidity. Companies such as Chinatrust, the local arm of Chinatrust Commercial Bank of Taiwan, and Keppel Philippines Marine, a shipyard group, have decided to delist and buy back the shares held by the public as a result. Other companies such as San Miguel, the country’s largest food and beverage company, have sold shares to boost their float. As of the end of November 2011 about 41 of the 250 listed companies had not met the minimum.

BOND MARKET: Total outstanding local currency bonds equalled to P3.3trn ($74.9bn) as of the end of September 2011, up by 2.7% from the previous year, according to the central bank. Government securities continued to dominate the domestic bond market, accounting for around 85% of total bond issuances, while the private sector accounted for the remaining 15%. The bond market is still not deep enough for large corporate borrowings and most corporates go to the private placement market, which is quicker because they are not subject to SEC restrictions or credit rating requirements. There has, however, been some movement on the corporate borrowing side.

The Philippine Savings Bank has said it will sell up $117m in unsecured subordinated debt to shore up its capital, and that it was looking at a 10-year debt issue to help finance its expansion and pave the way for future acquisitions. Petron, the country’s biggest oil refiner and retailer, raised P3.6bn ($81.7m) from the sale of fixed-rate corporate notes during 2011. Other corporate issuances included the debt notes of real estate developer Filinvest Land and SM Investments.

On the public side, in early 2011 the government issued promissory notes amounting to $1.25bn in January and $1.5bn in March. The government’s plan to issue Samurai bonds in April was put on hold following the earthquake and tsunami that hit Japan in March.

Total foreign financing requirements in 2012 amounts to $4bn, of which $2.25bn will be sourced from commercial lenders, including international bond investors, according to the Department of Finance. The rest will come from official development assistance lenders such as the World Bank. In January 2012 the national government issued $1.5bn global bonds, raising part of the $2.25bn it hopes to secure from the international bond market in 2012. The country’s bonds have been rated speculative but the government hopes to secure an investment-grade rating in the medium term.

OUTLOOK: For 2012, the sentiment remains bullish on the PSE as a result of the country’s ratings upgrades, which were primarily earned by government efforts to contain the deficit and take concrete steps to boost economic growth and promote good governance. Moody’s Investors Service expects the Philippine economy to grow by a rate of 5% in 2012, following a rise in remittances and increase in investments in the business process outsourcing industry. This all bodes well for the stock market and will help cushion the bourse against potential external shocks in 2012.

Going forward, some local players have noted the market could grow by allowing at least some speculation, arguing that the PSE could offer multiple markets – both for established companies and for speculative companies – such as those found in the West, with large indices, small-cap indices, junk bonds and stocks. Overall, the market fundamentals are sound and the market is ready to offer a number of new opportunities.

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The Report: The Philippines 2012

Capital Markets chapter from The Report: The Philippines 2012

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