PSEi Firms in a Panic Borrowing Spree! Borrowed Php 518 Billion in 1Q! PSEi 30 Generated Php 10.832 Billion or 7% in Net Income Growth in 1Q

In this issue

PSEi Firms in a Panic Borrowing Spree! Borrowed Php 518 Billion in 1Q! PSEi 30 Generated Php 10.832 Billion or 7% in Net Income Growth in 1Q

-PSEi 30 Generated Php 10.832 Billion or 7% in Net Income Growth in 1Q

-The Banking System’s Deteriorating Health Conditions Abetted by Record Fiscal Deficits

-The Variable Effects of Political Interventions on the Retail Sector

-Some Companies Explicitly Point to the Negative Effects of TRAIN!

-Non-Bank PSEi Firms Borrowed A Staggering Php 518 Billion in the 1Q Year on Year!

PSEi Firms in a Panic Borrowing Spree! Borrowed Php 518 Billion in 1Q! PSEi 30 Generated Php 10.832 Billion or 7% in Net Income Growth in 1Q

PSEi 30 Generated Php 10.832 Billion or 7% in Net Income Growth in 1Q

The 1Q GDP hasn’t been the only place where the footprints of the neo-socialist state have emerged. The symptoms have become apparent even in the earnings of the PSE listed companies.

While the reported real GDP grew by 6.8% in the 1Q, the PSEi registered a nominal net income growth of Php 10.832 billion or 6.89%.

 

If the GDP deflator (implicit price index) would be applied, then the real net income growth of the PSEi would tally 4.17% or about 61% of the 1Q GDP % expansion.

A back of the envelope analysis indicates that for the GDP to have hit its estimated growth rate either non-listed and ex-PSEi 30 firms grew more than the PSEi or the activities of the NG delivered the rest.

Clues suggest the latter.

The market economy hasn’t been the exclusive source of the PSEi’s net income.

Since Meralco, a listed government agency, and some firms have revenues derived from the government projects (e.g. San Miguel, Metro Pacific and others), the share of commerce from the market economy has been smaller.

And market economy’s share of the PSEi’s revenues will likely shrink some more.

Back to the PSEi 30’s 1Q report card.

In the 1Q, net income growth of the service sector soared +20.84%, spearheaded by telco companies partly bolstered by non-recurring income, which boosted the overall performance of the headline index. The service sector’s contribution was 27.07% share of the aggregate net income for the period.

The property sector was the second best sector which posted a dazzling 15.32% growth to account for a 24.17% share of aggregate net income.

The holding firms placed third with a modest 7.84% growth but contributed most to the aggregate net income performance with a 55.17% share

The sole representative for the mining sector, Semirara, posted a slim 3.43% growth.

Meanwhile, the banks and the industrial sectors posted slight contractions of -1.74% and -2.27% and deducted from the share of the net income pie.

The Banking System’s Deteriorating Health Conditions Abetted by Record Fiscal Deficits

Now, the effects of government’s action on earnings performance.

As previously explained, the rigid competition for access to savings and rising real economy prices has strained financial liquidity, which has contributed to the pressures on profits of the banking system, in particular, the big four (Security Bank, BPI, BDO and Metrobank).

See Philippine Banking System’s Underbelly Exposed: Cash Drains at Fastest Rate, Fixed Income Stampedes into HTM Accounts as Concentration Risk Mounts may 14, 2018

Nevertheless, the industry’s profits jumped 22.87%, according to the BSP, which means non-PSEi 30 banks offset the big four’s underperformance.

 

Banks have been issuing a RECORD number of loans to the real economy. At 75.23%, total loans-to-deposits have almost reached the record high of August 2012’s 75.55%. With substantial interest margins, however, such an enormous credit portfolio which supposedly delivered 22.87% profit in the 1Q hasn't translated to sufficient liquidity given that NPLs levels have been allegedly low.  That would be the supreme irony!

And that’s not all. The banking system has loaded up their investments in the Held-to-Maturity (HTM) accounts which also have soared to record levels, thereby aggravating their predicaments IF these are losses shielded by accounting acrobatics.

Aside from rising ROP yields across the curve, which have been mainly held by the banking and the financial sectors, the banking system’s most liquid assets, cash and due from banks, have turned south since the second semester of 2017. The decline even accelerated in the three months of the first quarter -5.09% in January, -1.84% in February and -9.32% in March.

Another symptom of the banking system’s liquidity strain has the barrage of Stock Rights Offerings and Long-Term Negotiable Certificate of Deposits issuances by most banks.

As I previously commented, since 2013 the banking system’s operations have been transformed which became evident through the massive changes in their balance sheet and income statement.

Changes in the BSP’s Special Deposits Accounts (SDA) policies could have incited to the alteration of bank operations. The BSP has limited access to such accounts in 2013. But that’s 5 years ago. Had banks been inherently healthy, they would have sailed through the adjustment period swimmingly. But that’s not what the banks have been showing today.

Liquidity strains don’t jibe with the popular notion that local banks have been operating under the cliché of “sound macroeconomic fundamentals”.

Of course, aside from financial strains surfacing as consequence to the BSP’s ill-conceived inflationary policies, another aspect compounding on the banking system’s dilemma has been the National Government’s record deficit.

Such record deficit not only means intensified competition with the NG for access to savings, it also translates to price pressures in the real economy, which should aggravate on the bank’s deteriorating health conditions. 

So policies of the past exacerbated with policies of the present have been affecting the banking system’s fundamentals.

The Variable Effects of Political Interventions on the Retail Sector

Next, the implementation of NG policies in the 1Q had material impacts on net income performance of many listed firms. 

Recently implemented policies produced diverse outcomes for the retail industry

For instance, Philippine Seven Corporation [PSE: SEVN] and Robinsons Retail Holdings [PSE: RRHI] attributed the jump in their 1Q revenue growth to RA 10963 or the TRAIN law.

An excerpt from SEVN: “The increase in net income can be attributed to the 12.9% growth in same store sales brought about by the favorable impact of the new Tax Reform for Acceleration and Inclusion (TRAIN) Act…”

From RRHI: “All retail formats registered positive SSSG, substantially benefitting from the positive impact of the TRAIN law on consumption…”

On the other hand, RA 10963 or the TRAIN law and ENDO or the ‘end of labor contractualization’ negatively affected food chain retailers as Max’s Group, Inc. [PSE: MAXS] and Shakey’s Pizza Asia Ventures [PSE: PIZZA]

From MAXS: “MGI was weighed down by escalating raw material prices and a larger manpower component as it realized the impact of its move towards professionalization which began in 2017. This initiative was undertaken to reinforce strategic capabilities at the management level to ensure sustainable growth. The Company likewise took into account recently enacted labor policies particularly on third-party service engagements. As a result, net income declined 30% to P123.7 million from P176.0 million year-on-year

From PIZZA: “Meanwhile, earnings grew by 6%, a tempered increase relative to sales due to increased cost pressures relative to the year before.”

The divergent effects of RA 10963 on consumer staples and consumer non-durable industries can be explained from two dimensions. 

First, the brunt of the price effects of higher excise taxes was felt most in food and in beverages or in the consumer staple industry

Next, the TRAIN have variable impacts on the shelf life of products for sale of these industries.

Food is considered perishable products. The projected consumption by its consumers determines the inventory of food retailers.  Since inventory turnover is fast, business costs tend to reflect on the immediate price pressures of the inputs. And since retailers may be hesitant to adjust prices to reflect such increases in costs, their margins suffer.

In this way, price increases of inputs get amplified by relatively faster inventory turnover. The heightened sensitivity to price changes thereby signifies a drag to the net income of food retailers/consumer staples.

In contrast, non-durable retail products have a longer shelf life. So sales or revenues generated in the 1Q 2018 were from inventories acquired mostly before the implementation of the TRAIN. Non-durable retail products were able to benefit from the changes in inflation brought about by Train in two ways.  One, TRAIN’s material income tax reduction provided an interim boost to the industry’s revenues. Second, the gap between the prices of inventories acquired from the pre-Train period and the selling prices in the TRAIN regime bolstered net incomes for non-durable retail firms.

Such price gap worked out as a momentary subsidized arbitrage in favor of the retailers  

However, the corrosive effects of inflation on business and consumers are intertemporal. Today’s benefit will be tomorrow’s cost.

Non-durable retail firms will have to bear with higher costs of restocking or the replenishing of stocks for sale which will likely be passed through to consumers.

 

And if such pass-through mechanism will be limited, price margins will eventually have to fall.

And if government’s data is to be believed, price imbalances may have reached a point where there will be a squeeze in profits

The Government’s measure of wholesale prices has spiked to 5.4% in March 2018 compared to general retail prices and the CPI which increased to 4.2% and 4.8% (4.3% 2012 base) over the same period. (upper window)

And higher consumer prices will gradually erode on the interim benefits to wages from TRAIN’s income tax reduction. 

The crux, have fun while it lasts!

Some Companies Explicitly Point to the Negative Effects of TRAIN!

Another, in anticipation of the baneful effects of TRAIN, firms like GTCAP reduced overhead costs substantially by cutting down on production.

GT Capital’s 1Q’s action seems representative to the industry’s reaction to a new tax regime. According to the Philippine Statistics Authority’s data, transport manufacturing contracted by about 7% in the 1Q. Auto sales were down by 8.5% over the same period and were lower by 11.9% in April 2018. GT Cap also relied upon real estate sales to offset its deficit from auto sales.

Finally, while listed companies had been challenged by TRAIN, mostly on the manufacturing side, some were explicit about it.

From Philex Mining: “The results were attributed to lower metal production, caused by low ore grades, higher non-cash charges, and increased taxes arising from the doubling of excise tax rates under the Tax Reform Acceleration and Inclusion (TRAIN) Law.”

Pryce Corporation: “The anticipation of an increased LPG price due to the January 1, 2018 effectivity of the TRAIN Law, which would slap a P1 per kilo excise tax on LPG, probably took away 2 to 3 days worth of sales from January 2018 and instead added these to December 2017 sales. Thus, volume sales in January 2018 came out lower than they would have been otherwise.

MacroAsia: “The net results were impacted heavily though by a 22% rise in direct costs, from Php480 million in 2017 to Php587 million, largely attributable to the increase in staff numbers to cope with new clients and the temporary spiraling cost of raw materials, utilities and supplies that could be linked to the pervasive effect of the TRAIN that became effective early this year.

As noted at the start, the government’s influence on the PSEi 30’s net income through various channels (TRAIN, ENDO, record fiscal deficits, BSP’s QE and more) have become pronounced.

The government’s actions have been taking over the market economy

For now, the immediate benefits from interventions have partly offset the negatives.

But since the commercial and economic effects from the myriad of political actions are asymmetric and intertemporal, present noises will most likely morph or converge into signals.

In the 2Q, the impact of the closure of Boracay will make its initial appearance on the economy and in the performance of listed firms.  The establishment has downplayed largely the ramifications of the war on Boracay (and tourism).  Supply and demand chain linkages, as well as credit flows, have been ignored.

And Boracay will piggyback on the vortex of a mishmash of political interventions which should have unintended consequences

If the PSEi 30’s net income has been gasping for air, more interventions will likely drown them

Non-Bank PSEi Firms Borrowed A Staggering Php 518 Billion in the 1Q Year on Year!

And that’s not all.

Don’t you know that PSEi companies went into a panic borrowing spree??!!

The non-bank 26 PSEi 30 issues posted a nominal net income growth of Php 11.2 billion or an 8.24% growth in the 1Q (yoy). Annualized net income translates to Php 44 billion

And the zinger.

Yet the same companies borrowed a STAGGERING Php 518 billion (yoy) or Php 257 billion quarter on quarter!

That’s Php 44 pesos of borrowing for every peso of net income generated. Annualized that’s Php 12 of borrowing for every peso of earnings.

And San Miguel wasn’t the sole borrower but was the largest.

[see San Miguel’s 1Q Debt Rocketed to the Moon with Php 172 Billion Growth! In 2017, PSE 30 Borrowed Php 10 for every Peso of Income Growth! May 14, 2018]

The real estate sector generated Php 2.7 billion of net income in the 1Q 2018 or an increase of 15.32%

But the same property firms borrowed a WHOPPING Php 46 billion! That’s 17 pesos of borrowings for every peso earned.

Strikingly, Robinsons Land used its stock rights to wipe off most of its debt. It astutely chopped Php 6.7 billion in its credit year-on-year and Php 15.4 billion from the close of Php 2017.

So RLC camouflaged or suppressed the debt figures of the aggregate.

Panic borrowing while interest rates zoom means two things. One, the banking sector’s cash crunch has spilled over to the real economy. Second, borrowers have come to think that interest rates will rise further prompting them to frontload borrowings.

Panic borrowing as the government takes control of the economy should be a toxic mix!

 

As a final note, Tuesday’s massive 87.9 or 1.1% end session pump was probably the largest or second largest tactical operations launched to boost the Phisix.

Desperate times calls for desperate measures.