Philippines: The undiscovered country

June 2, 2022

Elevated view of Makati, the business district of Metro Manila.

Since 2010, the Philippines has been growing at a rate of 6%, with controlled inflation (except in 2018 due to rice inventories) and reasonable macro indicators. From 2010 to 2016, President Benigno Aquino implemented some pro-market reforms, increasing the space for growth and spending, reducing corruption, and implying an increase in investment and foreign flows. In the period of the Aquino presidency, the most pro-market policies caused FDI inflows in most years (which had only been seen in the period between 2003 and 2007). The Philippines received its investment-grade in 2012, after which the country continued growing nicely, and with good macro indicators, it was mostly market friendly.

In 2016, Rodrigo Duterte assumed the presidency of the country. Although the Build! Build! Build! infrastructure program was an interesting initiative, there was no significant progress, and the handling of the contracts led to doubts among investors. The Public-Private Partnerships (PPP) investment initiatives created by President Aquino were better accepted by the foreign investor community.

The Duterte government was faced with a strong fight against drugs, problems surrounding international relations (especially with the U.S. in its first half), and faced increasing internal protests. All of the above caused foreign investors to divest from local stocks almost every year. According to the CLSA report, BBM is it, more than USD$5 billion was divested from the Philippines market in 2016-2021, causing foreign ownership of the index to drop from around 30% in 2012 to nearly 20% currently.

Although the macro indicators continued to show good dynamism and controlled inflation, there was a certain crisis of confidence in the Duterte administration, along with a series of track records of policies missteps, troublesome relationships with some western countries, and better opportunities in other markets. The Philippines has essentially been forgotten by the foreign investment community for the last six years.

In the recent presidential election, Ferdinand “Bongbong” Marcos was elected. There is a logical execution risk for his new term. Nevertheless, its comparable base is very low. With foreign investments mostly out of the country, there is plenty of room to improve international relations. However, the huge infrastructure gap in relation to other countries remains. Bongbong Marcos wants to continue with the Build! Build! Build! Program, but may frame it differently.

Although it is too early to say, he doesn’t seem as conflictive as the former president was with some local groups. Duterte had some conflicts with leading economic groups, one example being the shutdown of ABS-CBN, the country’s leading broadcaster. In short, Bongbong Marcos has to avoid internal conflict and taking sides in international relations (as Duterte did with China). In that scenario, considering its vast growth potential (the Philippines should continue growing around by 6% in the coming years), foreign investors should regain some confidence in the country.

Of course, the transition is not easy. Investors will be keen to see some initiatives that will lower the deficit/GDP ratio from levels of -8.6% in 2021 to at least normal levels of -3% during his mandate. There are also ongoing discussions for a tax reform. Although there is no official proposal yet, the reform is not intended to harm a particular sector or corporations. It is more of a blended tax increase among different products (for example, liquor, cigarettes, removal of some exemptions in VAT). If done properly, the probable tax increases should be seen positively by investors and present organized measures to reduce the current deficit.

All in all, if the country is able to promote more FDI, it will benefit its deficit and debt ratios. Likewise, one of the best ways to grow the economy without compromising debt indicators is with more foreign and domestic investments. This could be a catalyst to regain a better sentiment towards the country. Investors need a clear roadmap. In 2017, we saw a rally in the stock market when the Duterte administration was elaborating a tax reform in order to reduce the deficit.

Together with a roadmap to reduce the deficit and create a sound monetary policy, investors are expecting Macros to appoint credible cabinet members. The President recently announced that Central Bank Governor Benjamin E. Diokno would serve as the new finance minister, which is good news for the market. Moreover, he is expected to make sound economic pronouncements and pursue pro-business policies. In his campaign, he mentioned several market-friendly initiatives, such as:

  • Continue the Build-Build-Build initiative of the former administration and increase digital infrastructure.
  • Increase attention on the agricultural sector (although many former politicians have mentioned the same thing and few improvements have been made).
  • Increase investments in healthcare (sound opportunity as consumption).
  • Increase funding for tourism (could be a relevant catalyst for the mid-term, as explained before).

One of the themes that we often take into account in emerging markets is the consumption of the emerging middle class. We feel that in a mid-long term scenario, opportunities are massively driven by the increasing purchasing power of the emerging middle class, as well as people climbing the corporate ladder, therefore accessing better opportunities and quality of life.

While it will take time, the transformation of the Philippines is possible; take Chile for example. In the 2000s, the country had a GDP/capita of close to 11,000 USD, and in 2019, it was close to 25,000 USD. Indonesia is another example, with a population of nearly 250 million, the country enjoys great opportunities to increase the purchasing power of the emerging middle class, fostering its current 4,500 GDP/Capita. In order to be able to upgrade and increase consumption patterns, a stable and open macroeconomic scenario, certainty and foreign investments are required. Indonesia has undergone several transformations aimed at achieving better investor confidence.

As for the Philippines, hopefully this new government will be able to boost investors’ confidence. We feel the country should follow a similar pattern as Indonesia, with some lag. The mining sector is very relevant in Indonesia, but has been quiet in the Philippines. Although the country has one of the highest worldwide resources in gold and copper, a lack of investments and politics have clouded its development. Last year, the Duterte administration lifted a nine-year ban on new mines, which is likely to slightly improve the scenario, but foreign capital is needed. The country can enjoy relevant opportunities in the mining sector if things are managed correctly, following a similar path that Indonesia is currently developing.

In terms of drivers of growth, the Philippines is one of the world’s biggest suppliers of labour. Remittances are around USD$35 billion per year, accounting for close to 8% of the GDP, as per the CLSA report, Back on the Road. Revenues have been growing at a rate of 4-5% per year, and they are expected to continue doing so. Moreover, the country enjoys the world’s second position in business process outsourcing (after India), accounting for USD$25-30 billion per year, around 7% of the GDP, growing at similar levels to remittances.

Tourism is another source of revenue the country must increase. Rich in natural beauty, tourism in the Philippines represents only 2-3% of GDP, a far cry from what tourism represents for nearby Thailand and Malaysia. If things are done well, the country could be another reopening player. In the first quarter of 2022 GDP increased by 8.3%, and the banking sector loan growth continues to pick up according to Bloomberg data. In February and March 2022, they were up 8.9% and 8.8% year-over-year, respectively. There are many catalysts for the Philippines to perform well. In the last six years, the country hasn’t driven foreign investor attention, remaining an undiscovered country with plenty of potential to unlock value.

We are currently overweight in the Philippines. Our investment in the country is in Puregold Price Club Inc. (Puregold)

Puregold Price Club Inc. (PGOLD PM)

Puregold is a multi-format consumer retailer in the Philippines. The company operates under the two phimain brands: Puregold and S&R. Puregold includes hypermarkets and supermarket discounters, mainly serving lower income classes, with the average ticket size of PHP 0.9k. S&R operates 20 warehouse stores based on annual membership fees and primarily targets customers in the middle to upper income classes, with an average ticket size of PHP 4.1k.

The top three formal grocery retailers account for 40-45% of the market. S&M Retail (owned by the country’s richest family, Sy) holds 20% of the market share and is also the leading mall operator. Puregold is the second=largest grocery retailer, with a 15% market share. Robinsons Retail accounts for 5-10% of the grocery market and is also engaged in department and specialty stores, hardware stores, and malls. Puregold is the only pure grocery operator among the largest players. The grocery industry is expected to grow in line with the nominal GDP, at 9-11% annually.

The company enjoys many strengths. Their multi-format strategy provides more flexibility and optionality. Covering all income segments makes Puregold a more defensive retail player and enables the company to benefit from improvements in the spending power of all income groups. Puregold has a strong balance sheet, generating plenty of free cash flow with almost no debt. Their stores have strong unit economics. Additionally, Puregold is a well-recognized brand with a perception of the best value among consumers, coupled with a large loyalty program that enhances customer loyalty.

In terms of opportunities, the company is well-positioned for the Philippines’ growth due to its lower-priced merchandise. The consolidation of mom-and-pop stores and small chains is also a driver for growth considering its strong track record of integrating acquired grocery chains. Moreover, a rise in the private label mix has an ongoing positive contribution to margin expansion (from <1% currently to at least 10-20% in the medium term).

Global Alpha Capital Management Ltd.
June 2nd, 2022