Local Equity ANALYSIS BANCOLOMBIA: EQUITY RESEARCH – Special Report Stock Universe I June 28, 2017 2H17 Investment Strategies: What’s Left for the Stock Market when almost Everything Seems Expensive? Near the end of the first half, the stock market accumulated an upside of 7.4%, partially reducing 2H17 Top Picks – Equity the gap maintained by other Latin American indices on Colombia. Such increase largely captures Target the positive but moderate recovery sense that the Colcap forecast updates made during 1Q17 Company Recommendation Upsie Weight Price and 2Q17 had brought. By the beginning of the second half the models are refreshed again, Grupo Éxito Buy 21,700 40.9% 100% seeking to incorporate new information and changes in the conditions of the economy, the market Source: Grupo Bancolombia and the perception of agents. With an upward revision of ~2%, up to 1,502 points, the local stock market index offers a 3.5% upside over the next six months, extending the dynamics observed since the beginning of 2016. Evolution Colcap vs. Top Picks 1H17 Despite the positive omens this forecast may bring, the absence of clear value catalysts highlights 125 the difficulties that the Colcap will have to face in order to cover the almost 52 points left to reach fair value. The main challenges facing the local equity market’s in 2H17 are: i) a less dynamic 115 economic recovery, ii) the downward bias in the oil market, iii) the delay in the execution of 4G 105 projects, and iv) the dependence on foreign flows. 95 By contrast the favorable conditions that could facilitate the capture of valuations, although may 85 already be partially discounted by prices, are: i) further reductions in interest rates and their effects 75 on economic activity and in the possible repricing of the market multiples, ii) an additional 65 improvement in the perception of country risk that brings with it additional buying flows (due to a Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 May-17 deterioration of the appetite for developed markets in favor of emerging ones), and iii) the Top Picks COLCAP execution of investment strategies towards indexation by institutional agents that favor the Source: Grupo Bancolombia, Bloomberg. creation of iColcap units. This risk balance, biased downward, is reflected in the result of the methods of 2H17 Top Picks, where only Grupo Exito stands out as the name with enough conditions to present a superior Performance recommended portfolio vs. COLCAP performance against the rest of the market. Although there are other groups of stocks worthy of Top Picks Colcap Alpha (bps) mention, such as Avianca, Celsia and Grupo Argos, at the top of the list, only Grupo Exito meets 1H15 -13.6% -8.5% -515 the minimum requirements of the methodology, details we analyze in this report. 2H15 -4.4% -13.7% 927 1H16 20.1% 15.8% 427 Grupo Exito: Dancing to the Rhythm of Samba 2H16 3.1% -2.5% 560 1H17 11.4% 13.1% -167 After applying our asset selection methodology we have chosen Grupo Exito as the only Top Pick Historical 15.17% 3.51% 1,166 for 2H17. Our main reason continues to be the company’s exposure to the Brazilian market and Source: Grupo Bancolombia. the potential recovery we expect it to have in the short and medium term. Since the 30th of November, when we published our previous Top Picks report, Grupo Exito’s stock has valued 7.7%. Despite this, we still believe that the asset is undervalued and the reasons may not differ much from those presented in the previous report. Analysts/Specialists Name: Jairo Julian Agudelo Restrepo It is important to emphasize that our methodology does not only take into account fundamental Phone: (574) 6047048 E-mail: [email protected] aspects but also those regarding market and risks in order to achieve an objective selection in line with our economic vision of 2017. Name: Juan Nicolas Pardo Ayala Phone: (574) 4029516 E-mail: [email protected] Name: Juan Pablo Espinosa Arango Phone: (571) 7463991 ext. 37313 E-mail: [email protected] 1 Colombian Equity | Colombian Universe Update June 28, 2017 Greater Convergence in Forecasting Models The quarterly update of the Colcap forecast for the end of 2017 shows a positive result, going from an expected level of 1,472 to 1,502 points. Beyond a 2% upward revision in the final estimate, the analysis of the components of the projection methodology reveals a unique behavioral pattern of the main levers of market value. On one hand we have corporate variables, those that are traditionally studied under bottom-up approaches and that denote the strength or financial weakness of the listed companies. The upside contribution of these variables in the new forecast is minimal. As shown below, the variations in target prices of the fundamental Table 1 – Fundamental Model – Target Prices methodology and the growth in earnings per share of the relative value methodology have a lower incidence. Stock Var% 3Q 2Q Bancolombia PF -0.6% 29,488 29,659 On the other hand, economic and market variables related to the appetite of agents for risky G. Sura -0.9% 41,592 41,991 assets, commonly associated with top-down analysis approaches, are having a greater impact Ecopetrol 0.0% 1,420 1,420 on some of the forecast components. The sentiment methodology reveals this greater preference Nutresa 0.0% 27,920 27,920 G. Argos 0.0% 22,950 22,950 for risk, while opening the door to the debate about the repricing opportunity in the multiple at Bancolombia -1.8% 29,433 29,975 which the Colcap is valued. Cemargos -10.0% 11,650 12,940 G. Aval PF -1.0% 1,248 1,261 Fundamental Model G. Sura PF 1.6% 42,133 41,461 ISA 26.5% 13,050 10,320 For 2H17, the fundamental model increases only 1.1%, from 1,514 to 1,531 points. This is due to EEB 15.0% 2,070 1,800 the fact that 16 names, corresponding to 56% of the index, maintained relative stability in their G. Argos PF 0.0% 22,950 22,950 Corficol 15.2% 40,900 35,500 contributions to the Colcap due to small variations in their target prices (~2%). Of this group, Éxito 0.0% 21,700 21,700 Canacol stands out, whose valuation decreased 22.6% compared to 2Q17, but due to its low BanBOgotá 0.0% 64,000 64,000 weighting in the index the net effect is very small. Among those names that had the greatest Davivienda PF -0.8% 33,225 33,490 negative impact in the estimate, issuers from the financial sector stand out. Whether due to Cemargos PF -10.0% 11,650 12,940 reductions in target prices or a weaker weighting in the index, Bancolombia and Grupo Aval’s CLH -5.2% 13,550 14,300 Celsia 2.4% 5,220 5,100 shares contributed much less than they did in previous quarters. Finally, Cementos Argos, whose G. Aval n,a, n,a, 1,150 core value was revised downwards by ~10%, also joined the group of smaller contributions. Avianca PF 0.0% 4,440 4,440 Canacol -22.6% 10,340 13,360 On the other hand, the great contributors were Isa, EEB and Corficolombiana. In spite of their Conconcreto 0.0% 1,800 1,800 moderate weights within the index, the strong revision of target prices (~26%, 15% and 15%, ETB 0.0% 745 745 respectively) took them to lead the new estimate of the fundamental exercise. BVC 0.0% 23.7 23.7 COLCAP Fundamental 1,531 1,514 As of the closing date of this report, the fundamental methodology reveals a valuation potential of 5.5%, up to 1,531 points. It’s worth emphasizing that such a scenario is challenging, since low- Bloomberg Analysts Consensus weighted shares and even those with moderate liquidity should value more than 15% over the Bancolombia Equity Research next six months for this scenario to materialize, which is highly challenging. n.a. : Not available Source: Grupo Bancolombia. In short, except for isolated cases of material upward revisions, the fundamental methodology suggests that the fair value of the companies that make up the market index maintains relative stability. Relative Value Model The result of this methodology shows a target level of 1,491 points, presenting the smallest variation compared to the 2Q17 revision, which stood at 1,487. The theory behind this valuation Table 2 – Relative Value Model method assumes that the level of the index at the end of 2017 will be determined by i) the earnings per share (EPSs - 2018E) and ii) the expected Price to Earnings (FWD P/E). From a corporate Var% 3Q 2Q perspective it’s reasonable to anticipate that there will be no major changes in the forecasts of the short- and medium-term EPSs. On the contrary, the precision of the model will depend on the EPS 2018E (COP/share) -0.7% 127.6 128.5 fact that, between 2017 and 2018, local companies report a ~26% increase in net profits to 127.6 P/E Forward 1.0% 11.7x 11.6x index units, a situation that, although challenging, is plausible from a bottom-up perspective of COLCAP Relative 1,240 1,491 1,487 issuers. Source: Grupo Bancolombia 2 Colombian Equity | Colombian Universe Update June 28, 2017 Now, from a top-down perspective, is it possible to justify a repricing of the multiple used? Would Figure 1 – P/E Forward it be reasonable to price the stock market under a P/E ratio greater than 11.6x, corresponding to the multiple used in the last review of the valuation exercise? In short, no.