28.02.2017 | 14:19

Henderson: The Philippines — a structural growth story

The Philippines has one of the fastest growing economies in Asia, thanks in part to its favourable demographics and its sound fiscal fundamentals. In this report, we explore why the country’s healthy macroeconomic environment makes for a compelling investment opportunity in its hard currency bonds.

The Philippines has one of the fastest growing economies in Asia, thanks in part to its favourable demographics and its sound fiscal fundamentals. In this report, we explore why the country’s healthy macroeconomic environment makes for a compelling investment opportunity in its hard currency bonds.

Demographics support growth

The Philippines is the fastest growing country in South East Asia, with a 6.6% real gross domestic product (GDP) growth in 2016 and an expected 6.7% growth in 2017, according to International Monetary Fund (IMF) projections. With 101 million inhabitants, the Philippines benefits from a supportive demographic dynamic — a young population with a median age of 23.4 years, combined with low and declining unemployment (less than 5% reported in December 2016). The country also benefits from a high savings rate (25.5% of GDP) and steady remittances from Filipinos working abroad, both of which create robust structural tailwinds to growth in domestic consumption and investment.

An economy on a solid footing…

The well controlled fiscal deficit is projected to widen to 3% of GDP, but the declining public debt to GDP ratio anchors debt servicing costs. This should give the government some extra leeway to continue productive infrastructure and social spending programmes. Meanwhile, inflation remains moderate; the Philippines core consumer price index (CPI) was at 2.5% (year-on-year) at the end of 2016, and well inside the central bank target range of 2-4%.

External debt remains low at around 22.7% of GDP projected for 2017. Additionally, the country has significant foreign exchange reserves (Figure 1) that can act as a solid buffer. They cover short-term liabilities by four times and represent 15 months of imports. The recent decline in the peso is thus an opportunity to gain competitiveness, especially in the service sector, rather than cause concern over higher liabilities.”

Figure 1: significant foreign exchange reserves (US$ billion) Source: Thomson Reuters Datastream, monthly data through January 2017Note: Philippines gross international reserves.

The economy is helped by strong domestic demand, as can be seen from the expenditure contributions to GDP growth in Figure 2 below.

Figure 2: expenditure contributions to GDP growth Source: Thomson Reuters Datastream, quarterly data through Q4 2016

Note: Philippines gross domestic product (GDP) at constant prices by expenditure component. The bars show the contributions to the % year-on-year change in GDP of household final consumption expenditure, government final consumption, gross fixed capital formation (GFCF) and net exports.
Despite a slowdown in exports due to subdued global demand, the current account has stayed in surplus (Figure 3); it is projected to contract further in 2017 as capital goods imports related to infrastructure investments pick up. However, infrastructure investment should result in stronger growth in the future, offsetting the temporary increase in imports.

Figure 3: current account balance remains in surplus (% of GDP)

Source: Thomson Reuters Datastream, monthly data through September 2016Note: Philippines balance of payment current account balance and components. The bars show 12-month moving averages of the balances for the current account, goods trade, services trade and remittance income, expressed as a percentage of gross domestic product (GDP) at current prices.

…but keep an eye on politics

On the political stage, Rodrigo Duterte won the presidential election in May 2016. Since he took office, he has committed to an active anti-drug war, using brute force to remove suspected users and pushers alike; there have been thousands of killings over the past year. As the international community denounced the rise in violent interventions, Duterte changed his stance vis-à-vis the UN member states and in particular with the United States, with whom it had historically maintained a close relationship. Instead he initiated an alignment with China, despite ongoing tensions over the ownership of some South East Asian Sea islands.

However, geopolitical tensions have eased recently, with the new US president Donald Trump having endorsed Duterte’s anti-drug policies. On the economic front, Duterte’s administration pledged to increase security and infrastructure spending, which should support growth in the medium term.

Capturing the structural growth theme

Most corporate bonds in the Philippines are unrated, leaving many investors unable to invest in these bonds. We view this as an opportunity for investors willing to perform credit analysis.

Within the corporates space, we like Petron, a flagship private sector business in the country. Petron is the largest oil refiner and retailer in the Philippines; it is one of only two integrated oil refining and marketing companies in the country. The Philippines is the largest and most profitable oil retail market in Asia, with expected growth supported by 15-30% annual car sales growth in the past three years (the fastest in the region). Petron stands to benefit from this structural growth. Indeed, EBITDA* has almost doubled in the past three years on the back of higher volumes.

The company levered up in 2014 to increase capacity (came on-line in 2016) and net leverage has since fallen from a peak of 11.4x (year end 2014) to 5.9x (JPM, full year 2016 estimate, at June 2016). With new capacity fully functioning and refining margins stable at recent highs, we believe the company will continue to deleverage.

An attractive investment

We prefer the Petron perpetual bonds. These are $750 million notional bonds, with a call in August 2018 and a step-up of 250 basis points if not called. Our projections are for net leverage to be under 4x by year-end 2017. If not called, the post-step-up yield would be too high for a company that is rapidly deleveraging. Furthermore, the company has shown a willingness to proactively address its balance sheet; it has been conducting liability management exercises and has pre-paid project financing related to expansion capex twice in the past year already.
Petron is just one example. With our strong focus on fundamental credit analysis, we believe it is possible to find investment opportunities among Philippine corporate bonds with more attractive risk/reward profiles than the broader EM sovereign debt and developed credit markets.

*EBITDA: earnings before taxes, interest, depreciation and amortisation