Philippine Markets Newsletter

MONDAY MACRO: Uniform Accounting shows that there is little to fear about how long the Philippines’ first recession in over 2 decades will last.

June 1, 2020

The COVID-19 pandemic caught most businesses unawares, prompting the widespread closure of businesses considered non-essential during the community quarantine periods.

More than two months since the start of the quarantine in the Philippines, businesses have slowly started to reopen. However, most economic models would point to this period as the start of the first recession since the late 1990s.

The model we’ll discuss today will provide some insight on the Philippines’ ability to recover from the impending recession.

Philippine Markets Daily:
The Monday Macro Report
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The Philippines has just recorded its first ever economic contraction in 22 years. Philippine GDP shrank by 0.2% in Q1 2020, which is concerning since widespread shutdowns began in the second half of March 2020.

This generally means it’s likely that we’ll see even worse results for Q2 2020, which took the brunt of the temporary closures. It appears a recession is all but inevitable.

As we’ve noted in one of our Investor Essentials Daily, modern recessions are normally preceded by a negative credit event — or a credit crunch.

This was the case for the Great Recession of 2008 and the 1997 Asian Financial Crisis. Economic recovery for those recessions took long because of how complicated a debt-driven economic downturn is. Banks did not want to lend, and corporations could not push back their debt payments.

However, we don’t see distressed credit as the main reason for the current impending recession.

The main problem is that many businesses were unable to generate sales in over two months to pay any of their operating obligations or debts.

Even with grace periods for rent or debt repayment, those obligations eventually have to be paid. Not all businesses would immediately have the financial capacity to do so.

Fortunately, this may not be as big of a concern as you would expect, particularly if the larger Philippine companies managed to keep healthy balance sheets before this pandemic.

While there is an opportunity cost in holding on to cash rather than using the liquid asset for investment purposes, there is value in holding the right amount of cash. This makes management’s ability to optimally allocate capital even more crucial. They must be able to incorporate a worst-case scenario into their capital allocation strategy.

As companies filed their 2019 financial results, analysts adjusted their expectations to incorporate the coronavirus impact. This gives us an updated aggregate picture of how healthy businesses’ balance sheets are in weathering this unexpected business headwind.

As a refresher from our previous Monday Macro report, the aggregate Credit Cash Flow Prime uses Uniform Accounting numbers where the bars represent the financial obligations that Philippine companies need to service. This “stack” bar includes items like debt maturities, dividends, required reinvestment levels into the business, and rent.

The most flexible obligations would be at the top (blue stripes). These obligations can be delayed until further notice since they are of least priority. The company may easily push back these payments and continue operating.

The least flexible at the bottom (red stripes) are of utmost priority. If the company does not pay these, there could be serious financial repercussions in the company’s ability to operate going forward.

The blue line represents the aggregation of corporate cash flows available for paying their financial obligations. The blue circles above represent the liquidity available to the company, which includes excess cash on hand.

Even when debt and capital requirements exceed the firm’s cash flows, as long as they still have enough cash on hand, there should be nothing to worry about for the year.

Our CCFP chart on the entire PSE All Shares Index (excluding Financials) shows that there is enough cash available to cover the high-priority obligations such as debt and interest payments. Philippine companies can opt to postpone any spending on maintenance capex (yellow bar) or seek debt refinancing to continue to operate.

However, as long the community quarantine exists in one form or the other, revenue generation will be further challenged.

35% of the total 232 listed non-financial companies in the Philippine Stock Exchange have 2-year debt maturities greater than their cash on hand. These companies may face difficulty in the coming year if earnings generation continues to deteriorate.

Fortunately, we are not in the worst-case scenario yet.

Our Philippine Aggregate earning power chart shows that a 6% profitability is still possible for Philippine corporations as a whole if businesses adapt to the “new normal” way of doing business. Analysts are not as optimistic, as the current economic trajectory implies a decline to 2% aggregate growth in 2020, according to the Asian Development Bank (ADB).

Management teams will need to modify their business strategies to adapt to the new environment. There is too much uncertainty on whether or not it is possible to return to some semblance of our pre-COVID-19 economic environment.

With liquidity not an issue in the near future for the largest Philippine companies, and the fact that this recession is not debt-driven, an economic rebound is expected to occur at a much faster pace than previous recessions.

About the Philippine Market Daily
“The Monday Macro Report”

When just about anyone can post just about anything online, it gets increasingly difficult for an individual investor to sift through the plethora of information available.

Investors need a tool that will help them cut through any biased or misleading information and dive straight into reliable and useful data.

Every Monday, we publish an interesting chart on the Philippine economy and stock market. We highlight data that investors would normally look at, but through the lens of Uniform Accounting, a powerful tool that gets investors closer to understanding the economic reality of firms.

Understanding what kind of market we are in, what leading indicators we should be looking at, and what market expectations are, will make investing a less monumental task than finding a needle in a haystack.

Hope you’ve found this week’s macro chart interesting and insightful.

Stay tuned for next week’s Monday Macro report!


Angelica Lim
Research Director
Philippine Markets Daily
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