It appears that having trained his considerable direct executive powers, supportive legislature and indirect political influence on dissenting elements within the judiciary, the drugs mafia, and the media, President Duterte is now targeting commercial contracts between private sector companies (many of which are publicly listed or have publicly listed shareholders) and government entities, to redress perceived excessive benefits for those private sector companies.
Examples of publicly listed companies that have contracts with the government to manage utility, land, and transport assets, and have been caught in the cross-hairs so far include: Ayala Corp, Ayala Land, DMCI, Metro Pacific, Manila Water, and San Miguel. The share prices of these companies are down between 10% and 50% since the start of December 2019. A foreign company subsidiary, oil marketer Chevron Philippines, has also been mentioned in connection with a land rental agreement.
The full extent of damage to equity valuation remains to be seen and any final contract revisions may pale compared to the initial rhetoric when they are launched. But emerging and frontier market investors bearing scars in recent years from government efforts to re-set commercial and regulatory rules in, for example, Argentina, Bangladesh, Mexico, Nigeria, Romania, Sri Lanka, and Tanzania, may not wait around to see. We have to admit that the political power used by President Duterte to implement much needed structural reform (tax, infrastructure, China engagement), which deserves a handsome reward in equity valuation (and underpins our positive view on the Philippines), is at risk of turning into a spoiler for the investment thesis.
Philippine equities, measured by the local PSEi index, are down 3% in the past year compared to MSCI FEM up 8% and MSCI Asia ex-Japan up 17%. Trailing price/book and price/earnings are both at c20% discounts to the 5-year median (which puts the Philippines towards the cheaper end of the range on these measures in the Asia peer group). Banks and Consumer (excluding San Miguel) sectors provide more defensive exposure in an environment of contract revision compared to Conglomerates and Real Estate..
For now, cheap equity valuation, low FX rate valuation, healthy macroeconomic indicators and a presumption that the bark on contract revisions will be worse than the ultimate bite keeps us positive. Ultimately, the Philippines needs private sector capital and, to the degree that President Duterte is motivated to establish a political dynasty – with his daughter, Sara Duterte, a potential candidate in the 2022 election when he reaches his single term limit – he is likely also minded not to jeopardise economic growth by ripping up the rules of commerce.
Duterte's mandate enables structural reform but risks ad hoc contract revision
Healthy macroeconomic metrics and low FX rate risk (all global factors equal)
Equity valuation attractive
Philippine equities, measured by the local PSEi index, are down 3% in the past year compared to MSCI FEM up 8% and MSCI Asia ex-Japan up 17%. Trailing price/book and price/earnings are both at c20% discounts to the 5-year median (which puts the Philippines towards the cheaper end of the range on these measures in the Asia peer group). Banks and Consumer (excluding San Miguel) sectors provide more defensive exposure in an environment of contract revision compared to Conglomerates and Real Estate.