Deep dive - Peru stocks: Neutral EPU ETF. Qualifies for World Cup, not (yet) for OW stance (vs MSCI

Peru's return to the World Cup after a 36-year hiatus was the main catalyst for this deep dive. Peru's qualification in the tournament (in Russia from mid-June 2018) may provide a material boost to consumer - and investor - sentiment. Whilst economic fundamentals and (monetary) policy flexibility have improved since 1H17, domestic politics remains challenging with Odebrecht-related allegations against Pres. Kuczynski ("PPK") still in flux. Recommendation: Neutral vs MSCI Latin America (3.2% weight).

Deep dive - Peru stocks: Neutral EPU ETF. Qualifies for World Cup, not (yet) for OW stance (vs MSCI LatAm)

Equity - Neutral EPU MSCI-Peru ETF. Raise to OW if/once Odebrecht cloud over PPK clears

  • Fundamentals (slight positive):

  • Economic (modest positive): Growth is expected to rise from a three-year trough of 2.6% (2017f) to 4% yoy (2018f). Economic activity is surprising to the upside (Itau Surprise Index), which is likely to translate to economist/strategist upward forecast revisions. Growth upside is mainly led by govt spending on public investment and record copper production/exports after years of mining investment. Odebrecht-related scandals that wracked the Kuczynski administration earlier in the year have produced a backlog of infrastructure projects that could be unlocked in the coming year. Exports are strong - with export revenues in Sep-17 rising +93% yoy to a record $1.49bn.

  • Besides public capex and exports, consumption could play a larger role in the near-term due to some sentiment gains related to Peru's World Cup entry ​for the first time in 36 years (19 Nov-17). Finance Minister Cooper said in Oct-17 that Peru's participation would lift consumer sentiment and boost demand. The "World Cup Effect" however should not be overplayed. While qualification in and of itself should provide a near-term boost (and this may be visible in the next economic activity indicators), even if long-shot Peru ultimately wins on July 2018, the impact could be fleeting. On average, the victor outperforms the global market by 3.5% in the first month, although the outperformance vs MSCI World fades significantly after three months (The World Cup and Economics 2014, GS May-14).

  • Policy (modest positive): Consensus forecasts expect CPI (Nov-17: 2% yoy) to decelerate to 1.8% (end-1Q18). Economist revisions for near-term CPI have been to the downside. Disinflation since 1Q17 (4% yoy) have allowed the BCRP to cut 100bp since May-17 to 3.25%. Although BCRP is not expected by consensus to cut further, previous frontloaded rate cuts could also stoke credit activity.​ Consensus sees BCRP hiking ~50bp in late 2H18 as domestic demand recovers.

  • Domestic politics (modest negative): President "PPK" Kuczynski's approval ratings are at their lowest (27%, 15 Nov-17 Ipsos via Reuters) amid criticism over Odebrecht-related allegations while he served as Finance Minister to Pres. Alejandro Toledo. Kuczynski denies that: 1/ He received bribes (allegedly $29m to various officials) and 2/ He had been hired by Odebrecht as a consultant a decade ago (as alleged by the firm's former president, Marcelo Odebrecht). PPK faces criticism from right-wing members of Congress led by Keiko Fujimor's Popular Force party, which successfully ousted his cabinet in Sep-17. It is unclear whether this marks a bottom for PPK's popularity. Gnews: [peru kuczynski approval rating]​ [odebrecht kuczynski]

  • Valuations (neutral): PE of 16.2x is modestly cheap vs MSCI Latin America (18.2), comparable to MSCI Emerging Markets (15.8). As of 22 Nov-17, Peru ETF EPU performance (+26%, mostly from Jul-17) has exceeded Mexico EWW (+16%), Brazil (+21%) and Latin America LTAM LN (+11%), while underperforming Argentina ARGT (+39%) and MSCI EM EEM (+36%).

  • Technicals (modest positive): Global investors are underweight and building positions (State Street, 23 Oct-17). Possible technical rotation from Chile and Mexico - where growth and MT political prospects are (possibly) dimmer - would benefit Peruvian equities.

  • Catalysts:

  • Negative: Extended copper strike (watch Southern Copper [Gnews]), Copper price collapse, domestic political frictions intensifies and affects governability of Kuczynski govt

  • Positive: Favourable economic data, BCRP reiterates room for further rate cuts, de-escalation of domestic political frictions

  • Near-term signposts (SG time):

  • ​1 Dec: CPI

  • 8-12 Dec: Trade balance

  • 15 Dec: BCRP MPC

  • 15 Dec: Economic Activity (prior 3.2% yoy)

Reference:

  • EPU MSCI-Peru characteristics: EPU is not well-diversified and rather concentrated. Top 10 holdings = 70% of portfolio. Top two sectors = 66% of portfolio.

  • SPX: Adjusted beta 1yr (0.75), Correlation (0.33)

  • Companies (22 Nov-17): Credicorp BAP (21%, PE 13.99 [Gnews]), Southern Copper SCCO (12%, PE 28.4 [Gnews]), Cia de Minas Buenaventura (9%), Alicorp (5%), Volcan Cia Minera (5%), Intercorp Financial (4.5%), Ferreycorp (4%), Trevali Mining (3%), Cia Minera Milpo (3%), Hochschild Mining (3%)

  • Sectors: Mining (44%), Banks ​(24%), Retail (6%), Building materials (5%), Food (5%), Diversified financial services (4.5%)

#peru #latam #epu

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