Deutsche Bank Markets Research Asia Strategy Date Philippines 24 June 2016 Philippine Strategy Strategy Update Rafael Garchitorena Deutsche Regis Partners, Inc. The straight path turns to the left Research Analyst (+63) 2 894 6644 [email protected] Duterte administration to take office on 30 June As the world digests the implications of Brexit, the Philippines focuses on a Gio Dela-Rosa, CFA much more local regime change. On 30 June, Mr Rodrigo Duterte will be Deutsche Regis Partners, Inc. sworn in as the 16th President of the Republic of the Philippines. Mr Duterte Research Analyst has quickly consolidated his base with a coalition that claims a "super- (+63) 2 894 6642 majority" of over two-thirds of Congress. His incoming Cabinet has unveiled a [email protected] "10-point socio-economic agenda" that strongly signals his business-friendly, expansionary, if left-leaning, policies. Related recent research Date Taking a left(ist) turn, towards a more “inclusive” kind of growth Philippine Market - Economic 17 Jun 2016 The incoming government inherits a robust domestic economy – much more priorities of the new government resilient to global shocks like Brexit – thanks to the “straight path” of good Gio dela Rosa governance under President Aquino. However, Mr Duterte has vowed to make Consumer Sector - Incoming 17 Jun 2016 growth more "inclusive". Social reforms include enhanced welfare (CCT), administration to propose pension and healthcare benefits. A tax reform package seeks to lower personal additional consumption taxes and corporate income tax rates, while improving collection and Carissa Mangubat Philippine infrastructure - 17 Jun 2016 introducing/hiking taxes on "junk food", real estate, and petroleum. To attract Infrastructure a priority for investments, Mr Duterte wants to raise foreign ownership limits for certain incoming administration industries (eg. telecom, power), cut red tape, and revisit the REIT law. Klyne Resullar Infrastructure spend is targeted to rise to 5% of GDP, a goal that eluded the Economics Update - Philippines: 16 Jun 2016 Aquino administration. He also espouses a shift to Federalism. Central to Mr Gunning for inclusive growth Duterte's campaign was his strong anti-crime and anti-corruption drive. Diana del Rosario Source: Deutsche Bank PSEi up 11.2% since early May, now the best performing in the region The markets seem to like what they see and hear. The PSEi Index is up 11.2% since just before the election, and is up 10.6% YTD, now the best performing market in Emerging Asia. The Peso, too, is up c.2% since early May. Foreign net buying has surged, reversing months of outflow. Policies favor consumers/retailers, infra plays Mr Duterte's policies to promote broader, more inclusive GDP growth will support consumption, with retailers as likely winners. Increased infrastructure spending would benefit project proponents, construction, building materials, and even support banks’ loan growth. A review of the REIT rules could be positive for property companies with strong rental portfolios. Neutral on the market – at 20x PE on 2016F; earnings disappoint again However, the market's jump has meant that the PSEi Index is again trading at 20x our 2016F profit estimates, near the top of its historic trading range. Meanwhile, earnings in 1Q16 disappointed again, up just 6% YoY and posing downside risk to our 12% index earnings forecasts. Change is here; short-term disruptions likely; fiscal slippage is a risk Mr Duterte ran and won on a platform of change, some of it radical. Change can often be a (very) good thing, but it is hardly ever easy. Much needed long- term reforms will likely come with short-term disruptions, whether politically, economically or both. The fiscal side, for example, bears close monitoring as the incoming administration juggles tax reform, social and infra spending, and a crackdown on corruption in the revenue collection agencies. ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong This research has been prepared in association with Deutsche Regis Partners, Inc. The opinions contained in this report are those of Deutsche Regis Partners, Inc. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 057/04/2016. 24 June 2016 Philippine Strategy Change is here Market cheers Duterte win Philippine financial markets seem to be cheering the election of former Davao City mayor Rodrigo Duterte, who takes his oath as the 16th President of the Republic of the Philippines on 30 June. Since the elections on 9 May, the main PSEi Index has risen 11.2% to a new 52-week high, roundly outperforming the region. Year-to-date, the PSEi is up 10.6%, the best performing market in Emerging Asia. After a year of near-constant net foreign selling, foreigners turned aggressive buyers in May. The local stock market saw net inflows of $285mn. The Peso also strengthened since the elections. After appreciating as much as 2.7%, the currency has settled down, but is still up 1.7% from 6 May. Figure 1: PSEi Index surges post May 2016 election 8,500 PSEi Index all-time high 8,127 Apr'14 +11.2% since elections 8,000 7,756 +10.6% year-to-date 7,500 end-2015 +27% from January low 6,952 7,000 6,991 6,500 06May'16 6,000 6,084 Jan'16 5,500 15 15 16 16 14 14 15 15 14 14 15 15 15 16 14 14 15 15 15 16 16 14 15 15 16 - - - - - - - - - - - - - - - - - - - - - - - - - Jul Jul Jan Jan Jun Jun Jun Oct Oct Apr Apr Sep Feb Sep Feb Dec Dec Aug Aug Nov Nov Mar Mar May May Source: Deutsche Bank, Philippine Stock Exchange Figure 2: PSEi – best performing in Emerging Asia Figure 3: Net foreign buy/(sell), monthly in USDmn 15% 800 May'16 11.6%10.6% 600 $285mn 10% 6.6% 4.5% 400 5% 3.2% 1.6% 200 0% 0 -5% -3.2% -3.4% -200 -5.1% -10% -400 -600 -15% -800 -20% -17.9% -1,000 Source: Deutsche Bank estimates, Bloomberg Finance LP Source: Deutsche Bank estimates, Philippine Stock Exchange Page 2 Deutsche Bank AG/Hong Kong 24 June 2016 Philippine Strategy Duterte's team hits the ground running We must admit that the market’s positive reaction somewhat surprised us. While we did downplay the pre-election worries over Mr Duterte’s headline- grabbing comments (see "Testing its resilience, Pt2 - Do the elections matter?"), we expected the market to take a more wait-and-see attitude towards the controversial candidate. In that report and in another directly after the election ("A missive from Manila - The road less travelled", 10 May), we reckoned that Mr Duterte's appointments to his Cabinet would be crucial for calming markets' nerves. Individually, the proposed Department Secretaries have so far received mixed reviews (see Figure 8, on page 9). Cabinet bares “10-point socio-economic agenda” However, those in the "economic cluster" have come out strong. Within days of the election (on 12 May), the transition team – led by incoming Finance Secretary Carlos G Dominguez – revealed the new administration’s 8-point socio-economic agenda, which was later expanded to a 10-point agenda: 1) Maintain the key macroeconomic policies — including fiscal, monetary and trade — of the previous administrations. 2) Reform the tax system to make it more progressive, improve collection effectivity, and index tax rates to inflation. 3) Attract more investment (both foreign and local) by improving competitiveness and ease of doing business. Relax Constitutional foreign ownership limits for partially protected industries (exception for land ownership). 4) Accelerate infrastructure spending to 5% of GDP (from less than 3% in 2015). This will be done both through direct government spending and through public private partnership (PPP). 5) Promote rural development, improve agricultural productivity, and promote rural tourism. 6) Ensure security of land tenure, and streamline land titling agencies and processes. 7) Invest in human capital development by improving access to healthcare and making the education system better responsive to the demands of businesses. 8) Enhance innovation by promoting science, technology and the creative arts. 9) Stronger and broader social safety nets for the poor, including an expansion of the existing Conditional Cash Transfer (CCT) program. 10) Fully implement the Responsible Parenthood and Reproductive Health Law. Since then, the Cabinet has been proactively promoting the 10-point agenda. Earlier this week (20-21 June), Duterte and his Cabinet hosted "Sulong Pilipinas" (or "Onward Philippines") in Davao City, a two-day consultative forum in which the country's business leaders were asked to give their recommendations — a "wish list" — for the incoming officials. Deutsche Bank AG/Hong Kong Page 3 24 June 2016 Philippine Strategy Consolidates hold on Congress – from fringe party to a super-majority There were also concerns over how quickly Mr Duterte could form a coalition in Congress. Many of the proposed reforms need Congressional support. This is especially true for the ones that require a change in the Constitution such as the shift to a Federal form of government and the relaxation of foreign ownership restrictions. His political party, the Partido Demokratiko Pilipino-Lakas ng Bayan (or PDP- Laban), is quite small. Immediately after the May election, the party only held three seats in the 292-member Lower House, and only one of the 24 seats in the Senate. Just two weeks after the election though, his party had formed coalition agreements that claim at least 260 members, much more than the two-thirds super-majority needed to begin the process of Constitutional change.