Market Outlook and Stock Picks for 1H2011

How high will the market go? Most of the analysts are expecting a good run in KLCI in the 1H2011 while 2H2011 performance remains uncertain. KLCI at current valuations does not appear cheap anymore as it is already trading slightly above historical average 1Y Forward PER of 15x but remains below PER’s historical peak of about 18x. Should the market breach historical levels, it should be able to touch above 1,800 points. However, I do not want to be too optimistic. Consensus is targeting KLCI to reach around 1,700 points which is at PER of about 17x (+1σ), about 10% upside from current level. Corporate earnings growth is going to be about 16% y-o-y this year based on consensus. The impetus for 1H2011 would be QE2 (Quantitative easing 2), roll-out of ETP projects, earnings growth and election play.

QE2 is going to flush the market with a lot of liquidity, at least in the early part of this year, causing money to flow into markets with higher returns including Malaysia. Foreign shareholding remains relatively low, though it has risen from a low of about 20% to current levels of close to 22%. Its 10-year peak was about 27.5% in mid-2007. Nonetheless, this could also contribute to greater volatility in the stock market. Investors should have the holding power to invest in stocks or risk losing out. One should take note of monetary tightening policies in major economies such as US in 2H2011 as QE2 ends in June 2011 which might adversely affect equities and bonds. Tightening measures could cause money outflow from Malaysian market, thus dipping the KLCI. Nonetheless, tightening measures will likely be gradual in the form of draining excess reserves via increasing fed funds rate-discount rate spread and interest rate hikes (or having the word ‘extended period’ erased from their announcements :p). Economic conditions in US such as lower unemployment, higher inflation and improving financial conditions should drive tightening measures. But for now, we are still seeing low inflation and high unemployment in US, thus tightening measures should be rather distant. Therefore, I think we could just enjoy the ride for now before unloading our chips off the table as KLCI approaches 1,700 points.

Elections should benefit sectors like construction, property and O&G sectors. Contract newsflow should be more intense ahead of the elections. Construction sector is going to benefit from rollout of LRT and MRT projects, Pahang-Selangor Water Transfer, LCCT 2 and SCORE projects. I still like Sunway Holdings (RM2.25; Target RM2.90) with news of merger with Suncity to form a newco. I’m seeing more than 30% upside from here. Naim Holdings (RM3.60; Target >RM5.00) looks attractive and could ride on Sarawak election play, another stock with possible >30% upside.

Property stocks that caught my attention: Plenitude (RM2.15; Target RM2.80) and Hunza Properties (RM1.73; Target RM2.60) appear undervalued. Plenitude has a huge cash pile of RM325mil or RM1.20 per share, about 55% of the current stock price (Wondering how they are going to utilize the cash. Acquisitions? Projects? Privatization? Bumper dividends? Plenty of financial flexibility for land purchases and projects), trading at P/BV of 0.7x and forward PER of 6x. At least the management is now taking interest in its share liquidity, as indicated by its recent 1-for-1 bonus issue in Nov 2010. On the other hand, Hunza Properties is trading at P/BV of 0.7x, relatively low gearing, forward PER of 5-6x.

O&G stocks: Generally I shun most O&G stocks, highly leveraged, high PER, earnings instability and therefore high risks in project execution. The one that I like is Coastal Contracts (RM2.46; Target RM4.00), a counter which has been highly recommended by most research houses for the longest time. At least it appears to be moving now. Having said that, it’s still trading at absurd forward PER of below 5x!!! Its ROE remains one of the highest in the industry. A Forbes’ Asia 200 Under A Billion company. Consensus target price is at around RM4.00. For my previous post on Coastal, click here. Another counter is EPIC (RM2.30; Target >RM3.00), trading at PER of 7x. Recently its shares were bought over by Terengganu Inc from AZRB for RM3.09. In view of its strong balance sheet, resilient earnings and beneficiaries of greater O&G activities in the east coast, it should be trading around 10x with fair value at around RM3.10. For EPIC posts, click here.

Consumer sector: Beneficiaries of removal of subsidies such as Bernas (RM2.81; Target >RM4.20) and Tradewinds Malaysia – TWS (RM7.40; Target >RM13.00). For Bernas, please refer to here. TWS is a giant food conglomerate with three gigantic business segments, namely oil palm plantations, rice and sugar. Its rice and sugar businesses are monopolies in their respective fields and have the ability to set the prices of sugar and rice. Its expected profits will touch RM400 mil this year, or EPS of RM1.35. There have been worries over its high debt which is at RM2.2 bil. However, judging by its resilient earnings (Who does not need food?) of about RM400 mil, RM2.2bil is not a big issue at all. 5 to 6 years of earnings will be able to cover that. Besides, it holds more than 70% of Tradewinds Plantation which has 150k ha of plantation land, with matured plantation of 70K ha and immature plantations of 20K ha. Looks like it is going to be another Kulim in the making. Currently trading at PER of 5.5x, it is “super duper” grossly undervalued. Should it follow other F&B counters such as QSR, F&N, Mamee, QL etc, it should be trading at PER of above 10x, which is still conservative. Target price works out to be RM13.00 based on 10x PER!! Judging by its monopoly businesses, it should trade close to valuations of QSR and F&N which are trading at PER of 15-18x. Oh well, you could calculate the fair value. Just to be conservative, let’s just set it at RM13.00 first, which is already a 76% upside from current levels!!!

Conglomerates: Kumpulan Fima (RM1.70; Target RM2.20), DRB-Hicom (RM2.07; Target >RM3.00). Kumpulan Fima I’ve covered quite extensively in my previous posts. Refer here. I’m looking at another 25-30% upside for Kfima. DRB-Hicom is another giant, covered extensively by Dali here.

Automotive: MBM Resources (RM3.26: Target RM5.00) looks good fundamentally. But its share performance has been disappointing thus far as it has been stuck at this level for a very long time. Investors will just get fed up with it and sell the stock every time the stock price rises a little. Its PER is at 6x, net cash of RM120m or RM0.50 per share. Proton (RM4.54; Target RM6.00) remains attractive at PER of 7x supported by net cash of RM1.4b or RM2.55 per share.

Plantation: The sector very much depends on CPO prices. How long could CPO prices hold at this level? Will it be sustainable? I can’t really see where it is going. But this level is at historic high, I see limited upside from here. Plantation stocks might have a short run only during 1H2011 and likely cool down in 2H2011 in anticipation of higher production and potential bumper crops in 2012 especially from Indonesia (Assuming stock prices run ahead of fundamentals by half a year). The weak US dollar could be a drag to plantation stocks as well. TDM (RM3.04) had a really good run lately, as with other plantation counters as well. Hahaha. But I will be more careful at this level.

Other counters that look attractive at a glance: Pintaras Jaya, Protasco, RCE Capital, Mitrajaya, Century Logistics, Freight Management, Harrison Holdings, Poh Kong, MFlour, White Horse, Paramount (Might be rather quiet after its corporate exercises though attractive), Leader Universal, Leong Hup Holdings, Ajiya. – To be continued when I delve deeper into these counters. Please share with us as well if you find any good counters. Thanks :)

PS: I find it harder to pick undervalued stocks as many good ones have moved up :( Maybe after the rally in 1H2011, I will start unloading my investments from the stock market and put them into some bond funds. Btw, not a single research house covering TWS??!! Hopefully someone will get the ball rolling :)

"Why I Like Kumpulan Fima" by Dali: Malaysian research houses, please expand your horizon :p

Looks like the ballrolling has to start from the bloggers eh? There're still no research reports on Kumpulan Fima though probably everyone in the bloggersphere is recommending it (including Dali, Moolah and myself) and already investing in it!!!??? Maybe bloggers who are doing the hardwork of picking out these undervalued stocks should demand some payment eh..hehe..Ok, I'm just joking :p Some of the stocks which are not in the Bloomberg's analyst coverage list at all which have strong potential such as DRB Hicom, TDM, Kumpulan Fima, Cepatwawasan (though there's a write-up from CIMB with no recommendation).

Dali's article on Kumpulan Fima, click here.

PS: Another Forbes' Asia 200 Under A Billion award winner is Coastal Contracts which is trading at RIDICULOUSLY low PE of less than 5x!! Wakarimasen!!!

Stock Holdings & Stocks Under Watch

There have been some requests from friends to inform them of my investment holdings and investments decisions I make. So, here it is. Hope this could help in some ways in your investment decisions and do feel free to provide feedback to me so that it could help improve my trades as well. Thanks.

Supermax (RM5.50):

Going to hold this for rather long-term until I see signs of negative turnaround for the glove industry such as supply glut, rising costs of energy/latexx, weakening USD and whether these factors can be passed on to customers. Supply glut might happen probably in another 2 years or more according to Stanley Thai. PER remains reasonable at 9.8x and 8.7x for 2010 and 2011 respectively, a huge discount to Top Glove which is trading at PE of 14.7x and 13.5x for 2010 and 2011 respectively. Earnings growth for 2011 is OK at 12.5%. The recent bonus shares (1 bonus share for 4 existing shares held) could further boost liquidity of the shares (They are already very liquid) as shares are cheaper with more shares in the market. Still like glove industry which is resilient and recession proof. Click here for more info.

Sunway Holdings (RM1.49):

The stock remains very cheap at PE of 7.4x and 6.4x for 2010 and 2011 respectively, which is at a huge discount of 50% as compared to its peers like Mudajaya, IJM, WCT or Gamuda. The company is poised to post record earnings this year coupled with huge project tenders of RM16bil with expected success rate of 10-15%. It is even cheaper than HSL or Naim which only concentrate in Sarawak and depend more on government projects whereas Sunway's orderbook is more diversified from Malaysia and government projects (Fear of overseas ventures being riskier???). It is also supported by project development and quarry business segments. Earnings growth at 15% in 2011 with strong orderbook of RM2.8bil which could last them comfortably for the next two years. Click here for more info.

Notion (RM3.04):

This stock is about growth, high margins and strong shareholders. PE of 9.35x and 7.3x for 2010 and 2011 respectively. Earnings growth expected to be more than 25-30% over the next 5 years (If I can recall, this figure came from the CEO himself). Nikon is a substantial shareholder of about 9%. Global electronics/semiconductor sector is thriving, driven by greater usage of digital devices. With more usage of laptops, game consoles (X-box, PS3), IPAD (more tablets coming from HP and Blackberry?), demand for HDDs continues to be strong. Click here for more info.

Latexx (RM3.49):

Smaller glove manufacturer, PE of 9.4x and 7.4x for 2010 and 2011 respectively. Earnings growth expected to be strong at 27% for 2011. Stock price is cheaper which allows investors to hold more shares. Better than Adventa for now due to Adventa's hiccups in its latest quarterly results and delay in production expansion.

Stocks under watch

1. Coastal Contracts (RM2.35): Cheap valuation and high earnings growth but looks riskier for this current market (Dependent on contracts, too narrowed to O&G sector, share trading cold, costs dependent on steel prices, reliability of subcontractors). Might consider going in again when sentiments are better and shares are more liquid/volatile. Click here for more info.

2. Eng Teknologi (RM2.55): Cheap valuation, PE around 4x (unbelievably low, wonder why?). Expansion plans? Earnings growth expected to be little. Will research more.

3. APM (RM3.90): PE still below 10x. Potential to go higher. Tan Chong, MBM, Proton have moved up after the recent selldown except for this counter.

4. Dufu (RM0.54): Nobody's playing. Shares are too cold. PE exceedingly low at less than 4x. Customers too concentrated on 3 players i.e. Western Digital, Seagate and Hitachi Global Storage. Share performance is soft like tauhu :p Click here for more info.

5. Naim (RM3.00): Beneficiary of Sarawak projects. Click here for more info.

Disclaimer: The above article does not represent an investment advisory service as no subscription or management fees are charged. The contents of the article are provided as general information only and should not be taken as investment advice or as a recommendation to buy or sell any security or financial instrument. Any investment decisions carried out based on information, analysis, or commentary provided above is solely your responsibility. You should consult your investment adviser before making any investment decisions.

Coastal Contracts (Current Price: RM2.26; Target: RM3.76): Extermely low PE, High Earnings Growth, Declining Gearing and Strong Orderbook

Valuation:
Coastal Contracts Bhd performance is nothing short of spectacular, chartering a massive annualized growth of 48.2% and 65% for revenue and earnings respectively over the past 5 years. Owing to its huge earnings growth, the company was awarded the "Forbes Asia's 200 Best Under a Billion. Latest quarterly net profit in 1Q2010 was RM43.3 mil. Margins are rising as well owing to increasing sales of high-value vessels. Net profit is expected to touch RM170 mil or 47 sen per share in 2010, its highest ever earnings, making it extremely undervalued at PE of 4.9x. Net gearing has been declining tremendously from 53% in 2006 to a mere 6.2% currently. By attaching PE of 8x only, its fair value should be at RM3.76.

Company business:
The company has been in the marine business for four decades and was listed in KLSE in 2003. It is principally involved in three business segments, namely shipbuilding, ship repair/maintenance and shipping/chartering, therefore providing a one-stop center for shipping activities. Most of its earnings come from shipbuilding, supported by ship repair and chartering businesses.

Their main services include building barges (used to transport goods like palm oil, timber, coal, steel etc), landing crafts (Transport goods from ships to shores/beaches), tug boats (towing and pushing other ships) and OSV (Offshore Supply Vessels: Used for offshore oil and gas industry in areas like anchor handling and transportation). It has two shipyards of more than 90 acres with capacity to build 30 ships at any one time near Sandakan, Sabah. Current utilization rate is 80%, with the remaining area earmarked for upgrading purposes to accommodate future offshore structure fabrication (Due to the possible tie-up with Ramunia?).

It has a large customer base coming from different countries and sectors including oil and gas players, logistics provider, navy, shipping agents and commodities provider coming from Indonesia, Singapore, Australia, China and right up to the Mideast such as UAE, Iran and Egypt. This would help the company to be not overly dependent on a single customer.

There is a substantial portion of construction costs that comes from steel. Nonetheless, we continue to see its earnings grow in the midst of surging steel prices in 2007-08, implying its ability to mitigate rising construction costs. In addition, steel prices are expected to stay on a steady uptrend and will not experience a sudden surge in steel prices like what happened in 07-08, allowing the company to handle rising costs better.

"Build then sell" concept:
As opposed to most industry players, Coastal adopted a 'build then sell' strategy since 2006. The reason behind it is that this concept could eliminate the long and different lead-time in shipbuilding which will complicate shipbuilding schedules. Usually, shipbuilders have to wait to secure contracts from customers and then only determine the yard space and equipments required. With this method, the services provided are more attractive to customers owing to shorter lead-time in new deliveries.

Concern of increasing inventories which might explain the stock's low PER:
I don't understand why this stock has been so undervalued despite its strong earnings growth. Part of the reason could be its increasing inventories due to its build-then-sell model which can be risky if customers default, lack of secured orders and strain on its working capital. To mitigate this, the company requires 30% upfront fees from customers prior to building ships in addition to the choice of customers which are financially strong to mitigate defaults and the increasing demand for OSVs amidst increasing deepwater exploration. Even in the event of default, the company could always sell the ships to other prospective buyers at competitive prices owing to its shorter lead-time. Note that there have been no recorded defaults by its customers till now. This build-then-sell method actually helped the company to decrease its debt tremendously, as shown in its massive cut in debts from 2006 onwards as the upfront fees from customers were used instead of loans to start shipbuilding.


Key drivers:
Among the key drivers to its business are higher oil prices which will support deepwater explorations, fleet upgrades & expansion coupled with ageing fleet (about 48% of AHTS globally aged more than 25 years according to Mantrana Maritime) which could be phased out, thus driving new demand for OSVs. It has about RM1.2 bil worth of orderbook which could last it for the next two years. Its earnings are more or less secured over the next two years.

Diversify into fabrication business:
Coastal Contract had just signed an MOU with Ramunia to undertake tendering, bidding and fabrication of offshore structures for the oil and gas industry. Ramunia is one of the 7 licensed major fabricators for Petronas besides other fabricators such as Kencana, MMHE, Sime Darby and Boustead Heavy Industries Corporation. This will be beneficial for both companies as Coastal could provide the yard space while Ramunia has the license to undertake fabrication projects. This venture could signal a new chapter for Coastal Contracts as it could diversify from shipbuilding business and start bidding for fabrication contracts from Petronas and its PSC contractors, which could potentially chart another spectacular earnings growth going forward.

Market Data:
Earnings for 2010 & 2011: RM170mil and RM200mil
Shares Issued: 362 mil
Market Cap: RM830mil
EPS for 2010 & 2011: 47 sen and 55 sen
PER for 2010 & 2011: 4.9x and 4.2x
Net Gearing: 6.2%
P/BV: 1.7x

Shareholders:
Ivory Asia S/B: 31.3%
Pang Fong Thau: 21.4%
Lembaga Tabung Haji: 6.8%


Disclaimer: The above article does not represent an investment advisory service as no subscription or management fees are charged. The contents of the article are provided as general information only and should not be taken as investment advice or as a recommendation to buy or sell any security or financial instrument. Any investment decisions carried out based on information, analysis, or commentary provided above is solely your responsibility. You should consult your investment adviser before making any investment decisions.