EPHE - EPHE: A Far From Ideal Near-Term Setup For Philippine Equities

2023-04-23 04:26:37 ET

Summary

• The iShares MSCI Philippines ETF is down again this year, extending a multi-year streak of underperformance.
• While there is long-term growth potential in the Philippines, the economy is going through a rough patch amid elevated inflationary pressures.
• Continued monetary tightening and weaker corporate earnings will put pressure on equity valuations as well.

Navigating the Philippines market remains a challenging ordeal, not least because of the widening twin deficit and ‘stickier’ than expected core inflationary pressures (in contrast with the easing inflation figures for its Southeast Asian peers). The persistent foreign outflows in recent months reinforce the deteriorating investor sentiment; alongside a slower earnings growth outlook this year, Philippine equities could come under further pressure. As the Philippines is primarily a domestic-driven economy, the China reopening isn’t as much of a tailwind relative to its neighbors either. Nor is there much global FDI offset from the ‘reshoring’ of global supply chains, given the country’s lack of competitiveness (relative to Vietnam, for instance). With no strong growth catalysts on the horizon, the iShares MSCI Philippines ETF ( EPHE ) looks poised to lag behind its Southeast Asian peers this year.

Fund Overview – Gain Access to a Portfolio of Philippine Champions

The US-listed iShares MSCI Philippines ETF seeks to track, before fees and expenses, the performance of the MSCI Philippines IMI 25/50 Index, which comprises large, mid, and small-cap Philippine stocks (~99% of the free float-adjusted market cap). The ETF held ~$116m of net assets at the time of writing and charged a ~0.6% expense ratio, a reasonable price given the scarcity of US-listed vehicles for single-country Philippines exposure. A summary of key facts about the ETF is listed in the graphic below:

The fund is spread across 38 holdings, with the largest sector allocation going to Industrials at 29.0%, followed by Financials at 21.5% and Real Estate at 19.7%. No other sectors have a >10% allocation. The rest of the top-five list includes Consumer Staples (9.3%) and Consumer Discretionary (7.1%). On a cumulative basis, the top five sectors accounted for ~87% of the total portfolio; but given many of EPHE’s industrial holdings comprise conglomerates with a presence across sectors, EPHE isn’t as concentrated as many other emerging market or Southeast Asian ETFs. The fund’s outsized exposure to diversified conglomerates is reflected in a low equity beta of 0.7 (vs. the S&P 500 ( SPY )), highlighting the region’s defensive qualities.

The single-stock breakdown reflects the prominent role of Philippine multinationals within the country’s corporate sector landscape. The top holding is SM Investments’ property development company SM Prime ( SPHZF ) at 11.4%, followed by Philippine banking company BDO Unibank ( BDOUY ) at 9.1%. The third largest holding at 6.3% is SM Investments ( SVTMF ), a conglomerate with interests across real estate development and management, retail, banking, and tourism. The two other holdings with allocations >5% are Ayala Corporation’s real estate subsidiary Ayala Land ( AYAAF ) and Bank of the Philippine Islands ( BPHLY ) at 5.5% and 5.0%, respectively. In total, the top five holdings account for ~37% of the overall portfolio. At ~14x P/Earnings and 1.4x P/Book, the fund screens richly, particularly given the focus on conglomerates, banking, and property names, all of which tend to trade at the lower end of the valuation range.

Fund Performance – Sub-Par Returns for an Emerging Market

On a YTD basis, the ETF has declined by 2.3% and has compounded at an unimpressive 1.5% pace in market price and NAV terms since its inception in 2010. Digging deeper, much of the fund’s underperformance has occurred over the last decade (-3.2% annualized ten-year return), with the strong pre-2012 returns pulling up the overall performance figures. EPHE, like most other emerging market funds, has also been prone to bouts of volatility – the fund has suffered two double-digit % drawdowns in the last five years (2018 and 2022). With four of the last five years seeing negative returns, the one and five-year returns have underwhelmed at -12.9% and - 3.9%, respectively.

The semi-annual distribution yield stands at a disappointing 1.7% on a trailing twelve-month basis (<1% on a 30-day basis), despite EPHE’s outsized holdings in cash generative names. While the income-driven distribution has steadily increased in recent years, this isn’t a great choice for income-focused investors. Instead, EPHE should be viewed primarily as a vehicle to ride earnings growth in the Philippines, with the income portion serving as a supplement.

Stickier Than Expected Inflationary Pressures

Headline inflation may have eased in March , but at +7.6% YoY (down from 8.6% YoY last month), the inflation issue is far from over. Perhaps more importantly, core inflation has outpaced headline at +8% YoY on services-driven demand-pull pressures, as well as supply chain delays (e.g., the delay of food import arrivals). Externally, the production of key imports like sugar, which feeds through to food & beverages, will bear watching. And domestically, the hotter-than-expected weather over the last month is an issue; along with the swine fever outbreak last month, expect near-term price increases for the key proteins.

In contrast with the cooling inflation in the rest of Southeast Asia, the stickier inflationary pressures in the Philippines point to more rate hikes from the central bank. Recent comments from Governor Medalla citing the health of Philippine banks, which remain well-equipped to withstand further policy tightening, support the view that the country’s rate hike cycle isn’t over yet. Expect another 25bps of rate hikes at the policy meeting next month and, depending on inflation data, potentially even more hikes before year-end. The one-two punch of high inflation and monetary tightening point to a below-trend GDP growth outcome this year; in turn, corporate earnings could come under further pressure, presenting downside to EPHE.

A Far from Ideal Near-Term Setup for Philippine Equities

With the Philippines battling a twin deficit and persistently high core inflation numbers, the outlook for corporate margins isn’t great, as reflected by the sub-par YTD performance of Philippine equities. Exacerbating the fundamental headwinds is the prospect of more foreign outflows in the coming months, as the disappointing March inflation data signals another round of hikes (in contrast with the easing inflationary pressures in the rest of Southeast Asia). EPHE also remains levered to domestic drivers (in line with the nature of the Philippines economy), so any benefit from a rebound in Chinese tourism will likely be limited. Pending better visibility into a near-term growth turnaround or reforms to improve longer-term supply chain competitiveness, I would remain on the sidelines.

For further details see: