In this briefing:
- Brazilian Political Turmoil Adds to Market Volatility, and Concerns on Pension Reform
- Is There Still a Bright Future for FutureBright?
- Security Bank: Something Makes Me Feel Insecure
- Philippines: El Niño’s Comeback – How Bad?
- China Blood Products: Deals Highlight Values
1. Brazilian Political Turmoil Adds to Market Volatility, and Concerns on Pension Reform
- Brazil’s Ex-President Michel Temer has been arrested as part of the on-going CarWash (Lava Jato) criminal investigation, on bribery and corruption charges
- We believe that this increases the near-term downside risk to the BOVESPA index and blue chips, including the large cap banks
- This will also, we believe, heighten the negative “noise” around pension reform, potentially increasing the complexity of the reform process; even if this development alone should not serve to derail it, in our view
- Large cap Brazilian banks’ share prices have come under pressure recently, and we would expect the market correction to continue in the short term
- Nonetheless, we still see potential for Banco Do Brasil Sa (BBAS3 BZ) to re-rate over the medium term, and narrow the PBV gap with its core peers, Itau Unibanco Holding Sa (ITUB4 BZ) and Banco Bradesco Sa (BBDC4 BZ), as Banco do Brasil’s own internal restructuring takes effect
2. Is There Still a Bright Future for FutureBright?
Almost 12 months after posting our initial thesis on Future Bright Holdings (703 HK)Gambling on a Bright Future, we review FutureBright’s most recent results, raising questions on whether stalling improvement in the core restaurant business performance warrants taking chips off the table while waiting for key catalysts to materialise.
3. Security Bank: Something Makes Me Feel Insecure
Security Bank (SECB PM) trades at a premium to Asian banks on a P/Book, franchise valuation, earnings yield, and total return ratio basis.
The PH Score™ of 5.3 is neither good nor bad. (Asia median is 5.7).
In terms of fundamental traction, efficiency has eroded and interconnected profitability has narrowed. “Jaws” are negative. Funding cost growth is sharply in excess of interest income growth. On the other hand, liquidity and capital adequacy are moving in the right direction or are stable.
Asset quality seems to have dramatically improved. Headline non-performing loans are now very low due to adoption of PFRS9. These are calculated now as loans aligned to a default criteria. The bank seems to have reclassified part of “stage 3” impaired loans back into “stage 2”. “Stage 2” is comprised of assets which have experienced a SICR (significant increase in credit risk) since initial recognition, such as substandard, past-dues, and SMLs, and are not classified as NPLs. “Stage 2” represents almost 4% of the loan book versus a headline impaired or problem loan ratio of just 0.64%. In addition, unimpaired past-due loans (73% of headline NPLs) climbed 57% YoY. Charge-offs soared 47% YoY. Perhaps the asset quality is not as pristine as the NPL ratio intimates.
When we look back from 2004, we see an explosive increase in loans (+10x since 2004) coinciding with lower profitability over this period. This is not a good sign. As the bank shifts to consumer lending for growth, up 10x since 2012, we wonder whether a similar pattern will emerge.
In short, the bank resides in the bottom decile of our global VFM (Valuation, Fundamentals, Momentum) rankings.
4. Philippines: El Niño’s Comeback – How Bad?
- With SST (sea surface temperature) in the Pacific past 26oC, El Niño’s comeback is highly likely. Past occurrences of severe El Niño was isolated in the farm sector with upside risks to food prices. While another round of contraction in farm output and employment would be expected, the liberal rice import policy would entice imports to plug the gap between demand-supply in 1H19 and ease potential rice/food price upticks.
- The El Niño supply shock would coincide with the global macro slowdown and fiscal spending delays that spawn downside risks to growth. With a legally handicapped fiscal budget, monetary policy may have to step up to ease likelihood of severe, near-term constraints to growth. We believe monetary adjustments would be the appropriate responses to the macro challenges as inflation winds down. Sequencing and appropriate timing of monetary reaction remains key to credible policy responses starting with the bank reserve ratio cut in 2Q19 (staggered cuts for a maximum of 3% this year) followed by policy rate cuts commencing in 3Q19 (cumulative -50bp in 2H19) when inflation hits rock bottom of less than 2%.
- Buy bonds with preference for the curve’s belly to short-duration.
5. China Blood Products: Deals Highlight Values
Grifols SA (GRF SM) and Shanghai RAAS Blood Products Co Ltd (002252.SZ) recently announced an asset exchange that effectively combines the companies’ blood products operations in China. This transaction marks the third investment (two are cross-border) into the industry in the last two years. Despite some challenges arising from recent healthcare reforms, the industry has favorable supply/demand dynamics and high barriers to entry. US-listed China Biologic Products (CBPO US) trades at a significant discount to the implied private market values, but requires patience as management adjusts to the new operating environment.
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