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Reasons to be more bullish on cyclical companies

/ 04:03 AM October 25, 2021

The PSEi index finally broke above the 7,000 resistance level this month as the number of daily new COVID-19 cases in the Philippines has started to go down, similar to the trend seen in other Asean countries. The market’s strong performance was led by cyclical companies such as property and banking stocks. For the month-to-date period, the PSE Property Sector Index and the PSE Financial Sector Index jumped by around 11 percent, more than double the 5-percent increase of the PSEi.

The most important reason for cyclical companies’ outperformance is the expectation that they will benefit the most from the reopening of the economy. Note that the pandemic hurt cyclical companies such as mall operators, hotels, restaurants and retailers of nonessential goods the most, as they were forced to shut down or operate at limited capacity to control the spread of the virus.

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Nonperforming loans

Meanwhile, banks suffered from higher nonperforming loans as many of their borrowers’ finances deteriorated, negatively affecting their ability to pay their debts. Demand for loans also weakened as companies put their expansion plans on hold, reducing the need to borrow funds.

Now that the economy is reopening and the likelihood of more hard lockdowns in the future is diminishing given the rising vaccination rate in the National Capital region and the country, and the availability of a medicine to treat the virus soon, cyclical companies will benefit the most in terms of earnings recovery.

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Aside from benefiting from the reopening of the economy, most cyclical companies are trading at depressed valuations.

For example, many property companies are trading below their book values. This implies that at their current prices, the stock market is valuing property companies’ land and buildings at a significant discount to their historical acquisition cost, which is unwarranted given that prices of properties have not gone down despite the pandemic.

Several banks are also trading below their book values, even though banks today are highly capitalized and very liquid. Provisions against bad debts are also very high, exceeding 100 percent for some banks, protecting them from losses on possible defaults.

Commodity prices

Admittedly, rising commodity prices will negatively affect the margins of some cyclical companies like consumer goods manufacturers and restaurants, which is the main reason why I am not too bullish about consumer stocks.

However, share prices of consumer companies also went up, most likely due to optimism that higher revenues resulting from the reopening of the economy will more than offset the impact of rising costs. Also, similar to property companies and banks, many consumer companies are trading at ridiculously cheap valuations.

Despite the strong performance of cyclical companies recently, there is still room for prices to go up because most are still trading below their historical average valuations. The most important indicator that will determine the sustainability of cyclical companies’ strong performance is the number of daily new COVID-19 cases.

If infections stay low, the government still has room to further relax quarantine restrictions, providing cyclical companies greater opportunity to recover profits that were lost because of the pandemic. INQ

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TAGS: Business, Intelligent Investing, PSEi
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