As the Philippine equity market has appreciated more than 20% in the first half of 2014, our team has continually analyzed valuations and the degree to which we include Philippine equities within our portfolios. While the recent appreciation in equity prices makes valuations less compelling than last year, we are still finding attractive opportunities.
In fact, we are optimistic that the Philippine growth story has several long chapters ahead, a view supported by the country’s progress in infrastructure investments and reform initiatives. While maintaining exposures to the Philippine consumer via opportunities in the retail, banking and gaming industries, we have also identified new opportunities in property development as we believe infrastructure investments are creating significant value for the premium operators in this market.
Within the Philippines, the banking industry is one which we have favored historically, due both to the consolidated nature of competition (three dominant competitors hold 40% market share and lead consolidation within the industry) and positive economic tailwinds. Over the previous 10 years, individual wealth within the Philippines has grown by 12% per annum, but 80% of Filipinos are “unbanked.” Overall credit penetration remains below 40% of GDP, one of the lowest levels in the world, and credit card penetration is still below 10%.
Following a slow recovery from the Asian Financial Crisis, the Philippine financial sector is in a much better economic position for sustainable growth than many other emerging markets. We’re identifying companies with strong capital positions, ample liquidity (loan-to-deposit ratios of less than 70%), and strong asset quality and coverage ratios. Foreign competition has been held in check by regulations that limit foreign ownership of local institutions to 40% and cap foreign banks’ branch networks at 20 banks. As a result, foreign banks are essentially unable to compete with larger local institutions that operate 800+ branches each. In our view, the high growth in branch networks from local players over recent years should provide future margin upside as these locations become more fully utilized and operational efficiencies are realized.
Additionally, the Philippine bank regulator has been proactive, implementing the voluntary global banking standards of Basel III at the beginning of this year, at a far more rapid pace than many other emerging markets. We have been closely monitoring recent developments by the regulator, including recent discussions pointing to a new law being enacted in late July that will likely further liberalize the banking sector and permit additional foreign investment. Although this may create near-term competition for the largest local banks, we believe these developments can have positive longer-term implications for the banking industry and the Philippine economy as a whole, as we expect more foreign capital investment and an acceleration of consolidation within the banking industry.
Finally, the overall economic backdrop in the Philippines remains favorable. As we have discussed in past posts (see "Perspectives on the Philippines"), we believe that as economic freedoms continue to increase so too will the flow of foreign capital, fuelling for the economic investments necessary to further develop this economy.