Equity Strategy: Santos Re-Election Best-Case Scenario For Markets

We remain neutral towards Colombia's IGBC benchmark equity index amid a high likelihood of market turbulence in the run-up to and immediate aftermath of the May 25 presidential election. We believe the re-election of President Juan Manuel Santos is the most likely scenario and the most positive for investor sentiment towards Colombian assets, as it ensures policy continuity, especially regarding the ongoing peace negotiations between the government and the left-wing insurgent group Fuerzas Armadas Revolucionarias de Colombia (Farc) ( see 'Domestic Politics Crib Sheet', May 5).

However, a first-round victory, which requires more than 50% of the vote, is highly unlikely, and we expect a tight second round between Santos and the candidate from the Centro Democrático coalition, former finance minister Óscar Iván Zuluaga. The second-round vote would take place on June 15, and speculation over a potential win by Zuluaga, who opposes negotiations with Farc, implies Colombian equities will see high levels of volatility, at least until the election process is over. A victory by Zuluaga would likely trigger a deterioration in sentiment towards energy companies Ecopetrol and Pacific Rubiales (which together account for 25.2% of the IGBC index) given the potential for greater attacks on energy infrastructure by Farc if peace negotiations are abandoned. That said, other sectors that we like, such as materials and consumer sectors, will remain relatively unaffected by the result of the election, and we maintain a positive multi-month outlook towards those areas of the economy owing to their strong fundamentals.

Election And July Licensing Round Key For Energy Sector Equities

Tight Election Race To See Significant Market Turbulence
Colombia - IGBC Benchmark Equity Index

We remain neutral towards Colombia's IGBC benchmark equity index amid a high likelihood of market turbulence in the run-up to and immediate aftermath of the May 25 presidential election. We believe the re-election of President Juan Manuel Santos is the most likely scenario and the most positive for investor sentiment towards Colombian assets, as it ensures policy continuity, especially regarding the ongoing peace negotiations between the government and the left-wing insurgent group Fuerzas Armadas Revolucionarias de Colombia (Farc) ( see 'Domestic Politics Crib Sheet', May 5).

However, a first-round victory, which requires more than 50% of the vote, is highly unlikely, and we expect a tight second round between Santos and the candidate from the Centro Democrático coalition, former finance minister Óscar Iván Zuluaga. The second-round vote would take place on June 15, and speculation over a potential win by Zuluaga, who opposes negotiations with Farc, implies Colombian equities will see high levels of volatility, at least until the election process is over. A victory by Zuluaga would likely trigger a deterioration in sentiment towards energy companies Ecopetrol and Pacific Rubiales (which together account for 25.2% of the IGBC index) given the potential for greater attacks on energy infrastructure by Farc if peace negotiations are abandoned. That said, other sectors that we like, such as materials and consumer sectors, will remain relatively unaffected by the result of the election, and we maintain a positive multi-month outlook towards those areas of the economy owing to their strong fundamentals.

Tight Election Race To See Significant Market Turbulence
Colombia - IGBC Benchmark Equity Index

Election And July Licensing Round Key For Energy Sector Equities

Our Oil & Gas team sees significant upside potential for crude production in Colombia; however, key events in the next few months will determine the magnitude of the fundamental improvements to the sector. First, as mentioned previously, the result of the election will be important in determining the operational costs for energy firms in Colombia. State-run Ecopetrol has failed to reach oil and gas production targets due to ongoing attacks on pipelines ( see 'Attack Highlights Operating Environment Costs', April 7), and a victory by Zuluaga could increase the risk of more attacks on energy infrastructure. Canadian-based energy firm Pacific Rubiales, the second largest oil and gas operator in the country, while not targeted directly by insurgents, would also be negatively impacted owing to its joint projects with Ecopetrol. While Farc and the second largest insurgent group, the Ejército de Liberación Nacional, declared a unilateral ceasefire between May 20 and May 28 in observance of the election, there is no guarantee the ceasefire will extend to a likely second round in mid-June.

Second, the level of investment interest by energy majors during Colombia's international oil and gas licensing round in July will be important in determining future production growth in the country. According to the national hydrocarbons agency, 47 companies have bought information packages to participate in the bidding process for 101 blocks. A strong licensing round would likely bolster sentiment towards Ecopetrol and Pacific Rubiales in light of potential for greater investment in exploration and production, which would benefit earnings for both companies.

Significant Upside Potential If Factors Align
Colombia - Ecopetrol's Share Price, COP

Were Santos to win the election and the licensing round to receive large investor interest, we see strong upside for the share price of Ecopetrol given its attractive technical picture. After declining by more than 36.0% since January 2013, Ecopetrol's share price has strong multi-year support around COP3,450, about 4.2% below its current level. On the upside, Ecopetrol is approaching resistance around COP3,700, and a break of that level could see the share price head back to its October 2013 high of COP4,500, which implies a 20.0% move from its current level. We are relatively less constructive towards Pacific Rubiales given high levels of uncertainty over the renewal of its license in the Rubiales field, one of its largest revenue-generating operations, as well as due to a relatively unattractive technical picture. Pacific Rubiales' share price has remained in a downtrend since March 2012, declining by nearly 75.0% since then. Unless there is confirmation that the company will continue to operate the Rubiales field, an inflection point for its share price looks unlikely.

Still A Ways To Go Before Breaking Downtrend
Colombia - Pacific Rubiales' Share Price, COP

Infrastructure Will Remain A Bright Spot

We continue to see robust upside in construction sector equities and see no major election-related disruptions for infrastructure projects. Even if Zuluaga were to win, the government's infrastructure investment plan, known as 4G, is well under way, and a change in administration is unlikely to significantly slow the process. Growth in the construction sector in recent years has been increasingly driven by infrastructure activity, bolstered by the government's strong push to reduce the country's infrastructure deficit, especially in transport ( see 'Road Infrastructure To Bridge Competitiveness Gap', March 17). This focus made construction the fastest growing sector in the Colombian economy last year, expanding by 9.8% in real terms. Strong infrastructure activity, combined with still-expanding residential sector construction, will continue to benefit materials companies such as Cementos Argos (Cemargos), which supplies much of the cement needs for both public and private projects. Cemargos' share price reached an all-time high of COP11,380 on May 12 and has since consolidated around the COP11,000 level. With strong support around COP10,800 and sentiment towards Colombian construction likely to remain positive in the coming months, we believe the share price is likely to reach another all-time high this year.

Infrastructure Sector Will Be Relatively Unaffected By Election
Colombia - Cemargos' Share Price, COP

Consumer Fundamentals Remain Strong, But Rising Competition Limits Upside

Another sector we expect to remain attractive regardless of the outcome of the election is the consumer. We expect stronger private consumption growth in the coming years, driven by the end of a two-year household deleveraging cycle and improving labour market dynamics ( see 'Consumer To Strengthen As Labour Dynamics Continue To Improve', February 19). However, increasing competition, with the recent entry of retailers such as Chile-based Cencosud or Portugal's Jeronimo Martins ( see 'Colombia A Growing Focus For Food & Drink Companies', March 13), could weigh on the share prices of established retailers that are listed on the Colombian bourse, such as Almacenes Éxito. Éxito's share price has declined by more than 18.0% since early 2013 despite relatively robust household spending levels throughout that period, as its market share is being challenged by new entrants. While Éxito has bounced by over 19.0% since hitting support around COP25,000 in early March, it is facing significant resistance around COP30,000, which is less than 1.0% from current levels.

Facing Stiff Resistance Around COP30,000
Colombia - Almacenes Éxito's Share Price, COP

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Geography: Colombia
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