Lessons From The Elections

Voting in the elections and investing in the stockmarket are similar in a lot of ways. The recent elections gives us some valuable investment lessons that we can adopt.

First, it's not about popularity. Manny "Pacman" Pacquiao - a 130 lbs world boxing champion was floored by a 90 lbs incumbent congresswomen - Darlene Antonino Custodio. People might see this as an upset considering that the Pacman is a national icon. In reality, the odds are stacked against the Pacman from the very start. First, his fans don't want him to run and instead wanted Pacman to focus on boxing. Second, Pacman is popular nationwide but opted to run for a local post. However, in General Santos City, the Antoninos are as popular as the boxing champ. So it evens out the popularity factor. Third, its the machinery that counts. The Antoninos have dominated local politics for the past 40 years. Its machinery is entrenched whilst Pacquaio has none. This is the same predicament faced by losing celebrity candidates like Richard Gomez and Ceasar Montano.

In the stock market, the odds of choosing the winners or "outperformers" are driven by the following: fundamentals of the company which is dictated by earnings and earnings growth and valuation.

Since January 2006, the PSEi has risen by 74%. While 95% of the stock has appreciated, the biggest winners are stocks that have shown significant improvement in their fundamentals and not necessarily the popular stocks. Amongst the big winners are:

1.) Geo Grace (GEO: P.0675 - P2.20) - from a losing holding company called Global Equities, the company was transformed into a major player in the local mining industry.

2.) Republic Cement (RCM: P0.84 - P5.80) - price of cement continue to surge on the back of resurgent property sector. At P0.84, RCM was trading at 2x PER compared to 10x PER of market peer Holcim (HLCM - P9.10). The discount was too good to ignore.

3.) Philipine Stock Exchange (PSE: P145.0 - P600.0) - surging local equities market and comparative valuation of other exchanges makes PSE a "steal" despite the never ending politicking amongst the board members. PSE trades at 17x PER compared to the average 35x PER of regional exchanges.


Second, (always) do your homework. Team Unity (TU) won the elections despite losing the senate battle. Obviously, TU did their homework by ensuring victory in the local elections and conceding the senatorial race where they have little chance of winning. How did TU achieve this? They fielded 2 allies in areas where they are weak. In the end, 90% of the the TU candidates in the local elections won. In the the congressional race, estimates show that opposition lawmakers are now down to 20 from around 50 during the last congress. This will ensure that the President will not be impeached. This is a classic case of winning the war and losing the battle.

A lot of times, investors would ask for "tips". Instead, investors should try to do their own research. You only need some common sense to interpret what the disclosures are saying. Don't be afraid. Just go ahead and read the fillings. In fact, the Philippines has one of the most stringent disclosure requirements amongst the Asian markets. The SEC fillings and the PSE disclosures offer a lot of insights on where the companies are heading.

I stumbled upon PCI Leasing (PCIL - P2.38) at the start of the year when the stock was trading at P1.34. What attracted me to the stock aside from its valuation - 0.80x P/BV vs. 1.8x average P/BV of non-bank financial stocks; is that the company has been paying out dividends and has an existing stock buy back program. In 2005, the company paid out P0.20 cash dividend, declared 120% stock dividend and bought back around P90m worth of shares. So, with 2006 earnings growing by 12% to P441.0m, PCIL should be able to sustain its dividend and buyback program. Besides with Equitable PCI Bank owning 85% of the shares, there is very limited free float in the market. So with share price appreciating 74% this year, i guess doing some research will yield good returns in the long run.

Hope these lessons will make us better investors.

Quote for the day: "The world awaits. This is what you have been waiting for. Let's get ready to rumbbbleeee ..."

Michael Buffer, Voice of Champions, de la Hoya vs. Mayweather; May 5, 2007

Power Play

As I mentioned at the start of the year, the key theme for 2007 is to overweight power/utility sector. Let me share with you some excerpts from the power sector report of Citiseconline.com. Both analysts - George Ching and Paul Lu got it all right. There is a clear paradigm shift in the industry that merits a second look.

Here are some highlights of the report.

1.) Power sector reform in place. In 2006, the government launched the Wholesale Electricity Spot Market (WESM) to create a competitive market for trading of electricity for the power sector. This will spur new investments, as the economics of the sector will move from regulatory bias to market driven parameters. Next step in the reform agenda is to move the pricing mechanism to Performance Based Regulation (PBR) scheme from the current Return or Rate Base (RORB). In simple terms, PBR will allow utility companies to charge rates based on their efficiency versus the current framework of charging based on a fixed return.

2.) Privatization play. Last year, Power Sector Asset Liability Management (PSLAM) was able to sell 472 MW of government owned power generation assets. In the next 3 years, the PSALM is looking to sell 5,580 MW of power assets. On top of this, is the pending privatization of TransCo.

3.) Electricity shortage. In the next 10 years, government estimates that additional 4,074 MW of installed power is needed to meet the country’s power demand.

Against this backdrop, I guess it’s a matter of time before power stocks become in vogue again. As I always say, buy when the writings are on the wall. So let me give you my take on how these factors can boost the sector.

1.) Go where the money is. As always – “show me the money”. Based on my estimate, proceeds from privatization and investments in new capacity will reach US$10.0bn in the next 5 years. The privatization of TransCo is expected to fetch US$3.0bn while the construction of 4,072 MW in new capacity will have an implied investment value of US$4.2bn based on US$1.2m per installed MW.

The power sector is in the same situation as the telco industry in the late 90’s. During that period, we saw a dramatic shift in sector fundamentals as the industry moved from landline to mobile and - from analog to digital/internet - thereby generating new wave of money. Note that shares of PLDT and Globe during that period were trading at 1/5th of their current value.

2.) Demand driven dynamics. Clearly, there is a looming power shortage. This means that power companies have the pricing advantage. As power generation is an incremental business, any increase in capacity utilization will go straight to bottom-line. Most power companies are still operating at slightly above 80% utilization. This means there is still upside for earnings expansion based on current utilization.

3.) Room for re-rating. Obviously, 2 stocks that come into play are First Generation Holdings (FGEN – P58.50) and EDC Energy (EDC – P5.90). FGEN is currently trading at 8.7x PER whilst EDC is valued at 10.0x PER. These valuations have not reflected the paradigm shift in the sector. So, I guess a re-rating to around 12.0x – 14.0x PER for both companies should generate at least 30-40% upside from current levels.

Even if we exclude the sector upside, FGEN and EDC are cheap since both companies are currently generating above market return on equity (ROE) of 17.1% and 54.7% respectively. So, in itself, both companies deserve to trade at a much higher valuation.

So, looks like another win-win scenario to boot.