TUESDAY, 30 SEPTEMBER 2014

A steep or shallow correction?

COLing the Shots is a monthly publication by COL which provides insights on investment
opportunities based on global and local developments that could affect the market. COLing the Shots
aims to provide timely and relevant information and analysis as well as a model portfolio for
successful investing.

Key Highlights

• It looks like the much awaited correction of the stock market is finally taking place. Aside from
the PSEi’s “expensive” valuation, catalysts include the correction of the US stock market, the
weakness of the peso and rising US interest rates. Foreign investors have once again turned
into net sellers during the last few weeks after almost always being consistent buyers of the
Philippine stock market since February of this year.

• Despite similarities between today’s correction and that of May 2013, we believe that the
possible correction this time around will only be shallow due to several differences: a slower
than expected increase in developed market interest rates as deflation remains a threat in
some countries; higher interest rates domestically due to the BSP’s tighter monetary policy; and
negative investor sentiment. As a result, it might be best for investors to just stay invested and
ride out the volatility as we continue to have a positive long term view on the Philippine stock
market.

• Our COLing the Shots stock picks continued to perform well this September. A portfolio with an
equally weighted investment in our nine stock picks would have generated a return of 5.5%.

• MBT was the only stock in our list that saw its share price drop. This is most likely due to
concerns that it would be the most negatively affected by rising interest rates given that it has
the largest exposure to fixed income securities at 27.1% of its total asset base. While concerns
are valid in the short term, we believe that the bank’s long term outlook remains very attractive.
MBT’s capital adequacy ratio is comfortably above the minimum requirement and interest rates
would have to go up by as much as 150 basis points before MBT would encounter problems with
its capital adequacy. We don’t expect this scenario to happen in the short term.
Head of Research
April Lynn Tan, CFA

Analysts
George Ching
Richard Lañeda, CFA
Charles William Ang, CFA
Kervin Sisayan, CFA
Jed Frederick Pilarca
Garie Ouano
Meredith Hazel Cua
Stock market investors have been waiting for a correction in the PSEi since the month of May.
However, the market continued to rise, defying expectations. In fact, for the month to date of
September, the PSEi is up by another 3.0% to 7,261.30, even exceeding its all-time high of 7,403.65
last September 25! Even AC and ALI, which we expected to correct after the deadline of the MSCI
rebalancing, continued to rise. For the month to date of September, AC is up by 3.4% while ALI is up
by 3.6%.

Almost five months later, it looks like a correction is finally taking place. Aside from the PSEi’s
“expensive” valuation, catalysts include the correction of the US stock market, the weakness of
the peso and rising US interest rates. Note that historically, the depreciation of the peso has been
accompanied by the weakness of the stock market (see exhibit 1).

Foreign investors have once again turned into net sellers during the last few weeks after almost
always being consistent buyers of the Philippine stock market since February of this year.

TUESDAY, 30 SEPTEMBER 2014 COLING THE SHOTS page 2

Investors are understandably concerned given the similarities between today’s correction and that of
May 2013. Last year, the market fell by as much as 25% due to concerns that the US Fed would start
to taper its bond buyback program and as the peso weakened by as much as 11%. However, we
believe that the possible correction this time around will only be shallow due to several differences.
Recall that last year, foreign funds flowed back to developed economies given expectations of better
growth prospects and rising interest rates in developed economies vs. emerging market such as the
Philippines.

However, contrary to expectations, some central banks in developed economies adopted even
looser monetary policies as deflation remained a threat. For example, the European Central Bank
(ECB) reduced its base interest rate from 0.25% to 0.05%, while it cut its deposit rate to negative
0.20% meaning that depositors in Europe actually have to pay the ECB to keep money in their vaults.
Meanwhile, the Bank of Japan (BOJ) maintained its pledge to increase base money by 60 Tril to 70
Tril yen, and to buy 50 Tril yen of Japanese government bonds, 1 Tril yen of ETFs, and 30 Bil yen
of REITs annually as it continues to encounter challenges in reaching its 2% inflation target. There
is also speculation that monetary stimulus could increase further as the economy continues to face
numerous threats.

The US Fed is admittedly on track to “exit” from its highly accommodative monetary policy. In fact,
Federal Open Market Committee (FOMC) members this September said that they project the Fed
Fund Rate to be 1.375% at the end of 2015, slightly higher than their previous estimate of 1.125%.

However, the average long-term US GDP growth forecast of FOMC members also dropped to 2.0%
to 2.3% in September from 2.1% to 2.3% in June. The median forecast for a long-term neutral Fed
fund rate also remained at 3.75% after being adjusted down recently from 4.0% in March. The said
factors imply that although interest rates in the US are on the rise, they will probably stay lower than
historical levels.

Exhibit 3: Average Forecast of Fed Board Members and Bank Presidents

As of 13-Dec 14-Mar 14-Jun 14-Sep
Long-run GDP growth 2.2% to 2.4% 2.2% to 2.3% 2.1% to 2.3% 2.0% to 2.3%
Long-run Fed fund rate 4.00% 4.00% 3.75% 3.75%
Source: Federal Reserve

Aside from the slower than expected rise in developed market interest rates, the BSP is also currently
in a tightening mode. Recall that the BSP raised banks’ reserve requirements by 200 basis points
since the start of 2014, while it raised both RRP and SDA rates by 25 basis points. The market
expects rates to increase even further as the BSP takes steps to avoid any possible increases in
demand driven inflation. This should minimize the likelihood that the spread between the US and
Philippine 10-year bonds would narrow back to only 40 basis points, similar to what happened during
the second half of 2013. This we believe was one of the main reasons why the peso weakened
significantly last year.

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Finally, unlike last year, investors are currently very cautious. This is reflected in the 90% drop in net
sales of the mutual fund industry during the first half of this year. In contrast, net sales of the mutual
fund industry were very strong during the first five month of 2013 as investor sentiment was very
positive. This was partly responsible for the significant 47% increase in the net asset value of the
mutual fund industry from Php146 Bil as of end December 2012 to Php215 Bil as of end May 2013.
Given our expectation that the correction would only be shallow, it might be best for investors to
just stay invested and ride out the volatility as we continue to have a positive long term view on the
Philippine stock market.

“COLing the Shots” stock picks continue to perform well

Our COLing the Shots stock picks continued to perform well this September. A portfolio with an
equally weighted investment in our nine stock picks would have generated a return of 5.5%.

Exhibit 4: COLing the Shots Stock Picks M/M Performance

8/26/2014 9/26/2014 M/M Change
MEG 4.24 4.97 17.20%
DNL 11.34 13.22 16.60%
AC 722.5 724 0.20%
BDO 90.8 97 6.80%
MBT 87.5 86 -1.70%
ALI 33.6 34.2 1.80%
SMPH 16.66 17.8 6.80%
AP 38.85 39.5 1.70%
EEI 11.28 11.3 0.20%
source: COL estimates

Compared to the last time we wrote our report, the best performing stocks in our list are MEG
(+17.2%), DNL (+16.6%), BDO (+6.8%), and SMPH (+6.8%).

MEG rose sharply following news that GSIS was able to auction a piece of property in Fort Bonifacio
for 500,000/sh. MEG is expected to be one of the major beneficiaries of the said development given
that is has approximately 40 hectares of raw land in Mckinley West and Uptown Bonifacio, two areas
which are really close to Fort Bonifacio.

DNL rose significantly after the company said it would buy remaining shares in affiliate Chemrez
(COAT) which it doesn’t own at Php6.00/sh. We believe that the acquisition will be both earnings and
value accretive for DNL. This is based on the company’s guidance that COAT’s profits would grow
by 20% in 2015 and that it was buying COAT at only 13X 2015E P/E, a discount relative to its own
2015E P/E of 23X.

SMPH recovered sharply after it disclosed first half 2014 earnings results which showed that take up
sales of its residential property arm SMDC picked up. This alleviated concerns that SMDC is suffering
from a glut and that it is encountering difficulties in selling its condominium units.

TUESDAY, 30 SEPTEMBER 2014 COLING THE SHOTS page 4

Meanwhile, MBT was the only stock in our list that saw its share price drop. This is most likely due to
concerns that the bank would be the most negatively affected by rising interest rates given that it has
the largest exposure to fixed income securities at 27.1% of its total asset base. While concerns are
valid in the short term, we believe that the bank’s long term outlook remains very attractive. MBT’s
capital adequacy ratio is comfortably above the minimum requirement and interest rates would have
to go up by as much as 150 basis points before MBT would encounter problems with its capital
adequacy. We don’t expect this scenario to happen in the short term.

Exhibit 5: “COLing the Shots” Stock Picks

Price 15 FV Buy Date Buy Price Current Return Buy Below Price
MEG 4.97 5.48 1/11/2013 3.11 59.80% 4.38
DNL 13.22 11.5 2/14/2013 6 120.30% 10
AC 724 816 8/5/2013 600 20.70% 709.57
BDO 97 107 1/23/2014 80 21.30% 93.04
MBT 86 111 1/23/2014 79.8 7.80% 96.52
ALI 34.2 37.5 1/23/2014 27.55 24.10% 30
SMPH 17.8 20.3 1/23/2014 14.48 22.90% 16.24
AP 39.5 44.9 7/15/2014 36 9.70% 39.04
EEI 11.3 13.7 7/30/2014 11.26 0.40% 11.91
source: COL estimates

Unfortunately, the strong performance of the stock market has reduced the number of investible
stocks in our list to only two –MBT and EEI. In some ways, we welcome a possible correction as
this would open up opportunities for investors to buy more stocks at a cheaper valuation. Despite
the strong performance of the market, we don’t think it is the right time to be aggressive and chase
prices. Investors should stay disciplined and wait for values before buying stocks.

TUESDAY, 30 SEPTEMBER 2014 COLING THE SHOTS page 5

Investment Rating Definitions

BUY HOLD SELL

Stocks that have a BUY rating have attractive
fundamentals and valuations, based on
our analysis. We expect the share price
to outperform the market in the next six to
twelve months.
Stocks that have a HOLD rating have either We dislike both the valuations and
1.) attractive fundamentals but expensive fundamentals of stocks with a SELL rating.
valuations; 2.) attractive valuations but We expect the share price to underperform in
near term earnings outlook might be poor the next six to twelve months.
or vulnerable to numerous risks. Given the
said factors, the share price of the stock may
perform merely inline or underperform the
market in the next six to twelve months.

Important Disclaimers

Securities recommended, offered or sold by COL Financial Group, Inc.are subject to investment risks, including the possible loss of the principal amount
invested. Although information has been obtained from and is based upon sources we believe to be reliable, we do not guarantee its accuracy and it may
be incomplete or condensed. All opinions and estimates constitute the judgment of COL’s Equity Research Department as of the date of the report and are
subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation for the purchase or sale of a
security. COL Financial ans/or its employees not involved in the preparation of this report may have investments in securities or derivatives of securities of
securities of the companies mentioned in this report, and may trade them in ways different from those discussed in this report.

2401-B East Tower, Philippine Stock Exchange Centre, Exchange Road, Ortigas Center, Pasig City, 1605 Philippines
Tel: +632 636-5411 Fax: +632 635-4632 Website: http://www.colfinancial.com

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