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 :)

Snippets of outlook on Malaysia

Thanks to this recent correction in the markets, this time will be a good buying opportunity again. I still believe markets are going to continue moving upwards and the recent concerns that caused this correction is more hyped-up than a real threat to the economic recovery. Time to buy again as markets might surge after CNY as investors are withdrawing money ahead of the CNY holidays where China markets will be closed for the whole next week and pump in again after CNY.

Anyway, I'll just share a gist of the Malaysian market outlook here, the things we can look out for in 2010.

Catalysts:

New Economic Policies:
This year, we will be seeing a clearer picture of the economic policies to be pursued by the Government over the next few years, to be unveiled in the new economic model by the National Economic Advisory Council (MPEN) in Mar 2010 (Delayed again) and the 10th Malaysia Plan in June 2010 . More favorable economic policies are expected, which is in line with Malaysian Prime Minister’s intention to navigate Malaysia from a middle income to a high income economy. Since Dato Seri Najib Tun Razak’s ascension to the Prime Minister’s office, the Government has laid down more investor-friendly policies, including liberalization of 27 services sector and financial sectors, review of minimum wage for selected industries to attract talents from overseas and improving ties with regional economies like Singapore, India and China via high level visits which could bring in more investments from these regions.

External Trade:
Exports which consist of 107% of total GDP, continue to remain bright in outlook driven by exports of E&E products and commodity related products. E&E products which is 43% of total exports continue to experience growth on the back of strong global demand, especially from Asia Pacific Countries. Global chip sales continue to surge to US$22.6 bil in Nov 09 since bottoming out in Feb 2009 which was near its high of US$22.9bil in Sept 2008. On top of that, manufacturers around the world cut its capacity and investments sharply in 2009 which could create a supply glut sometime in mid 2010. This will raise the prospects of higher selling prices and acceleration in semiconductor equipment investments. On the other hand, commodity exports which consist of 21% of total exports will be driven by global demand growth especially from developing economies and supported by increasing oil supply costs and resulted from declining supply of 'cheap oil'.
Electricity sector (Something to look out for if you doubt the economic recovery) continued to post strong gains in Dec 2009 at 14.1% y-o-y which was the seventh consecutive month of y-o-y increase. This would be one of the strong indicators of economic recovery as most if not all economic activities utilize electricity and it is almost impossible to function without it. I just ran some numbers of GDP and electricity output which showed Malaysia GDP growth has a strong correlation of 80% with electricity consumption.

Retail and Corporate Sector Growth:
Private expenditure, which consists of 54% of GDP, is expected to take the lead in driving Malaysian economy, backed by more pro-business policies, low interest rates and higher corporate earnings. Corporations emerge stronger from the recession enjoy greater efficiency and healthy balance sheets and cash flows.

Newsflow of major projects:
Construction industry expected to thrive this year. Major construction projects like Interstate Water Transfer Scheme (RM8.8 billion), LRT extension (RM7 billion), new LCCT terminal (RM2 billion) and Gemas-Johor Bahru Double Tracking Project (RM5 billion) are expected to roll out over 6-12 months (Please don't delay anymore!!). Construction industry is known to have high multiplier effects on the overall economy via construction output, income generation, employment and imports. It also generates extensive backward and forward linkages with different sectors such as manufacturing industries and service type sectors, of which both constitute a majority portion of total GDP.
Firmer commodity prices: Malaysian economy is very much intertwined with commodities. About 40% of Government’s revenue comes from oil related industries while about 22% of the FBM KLCI constituents consisting of commodity related companies. According to my computation, surprisingly KLCI has an 80% correlation with crude oil price over the past 10 years. Firmer commodity prices lead to improved fiscal position of the Government, enabling higher fiscal spending or lower fiscal deficit of which both are favorable to the economy. Higher corporate earnings among commodity-related companies could also lift up the local bourse.

Appreciation of RM over USD:
In view of the large fiscal deficit of the US resulted from its stimulus measures to curtail one of the worst financial crisis faced by US, US$ is expected to depreciate against RM. This is further backed by Malaysian Government’s efforts to rein in fiscal deficit via cuts in operating (hopefully they can implement that without having too much political pressure to do otherwise) and development expenditure, lowering of fuel subsidies coupled with broadening Government’s revenue base such as review of GST and disposal of government assets, all of which could strengthen the ringgit and enhance Malaysia’s attractiveness as an investment destination. Consequently, Malaysia’s fiscal deficit is expected to decrease to 5.6% of GDP (I'm following Government's guidance) in 2010 from 7.6% in 2009 .

Foreign Fund Flow:
Foreign fund shareholdings in Malaysia declined drastically since March 2008, triggered by the General Election in Mar 2008 which sparked a huge sell down by foreigners. As a result, foreign shareholding in Malaysia plunged to about 21% currently from 27% in Mar 2008. Nonetheless, we are seeing foreign funds slowly returning to the market albeit in a moderate way. Having said that, foreign investors still have reservations about the Malaysian market such as the willpower to execute Government’s planned reforms coupled with political and social security concerns. Nonetheless, with State Elections in Sarawak and the General Election approaching in 2011 and 2012 respectively, it will be crucial for the Government to ensure that its planned reforms be executed to regain the lost votes from the previous General Election. Foreign investors’ interest could revive again, backed by clearer picture of Malaysia’s economic growth plan over the next few years coupled with anticipated execution of Government reform policies and further liberalization of its economy, which could lend support to the uptrend of FBM KLCI. Intersesting to note that FBM KLCI has been resilient in its uptrend over the past year, despite the lack of foreign investors’ support, meaning the market is very much domestic-driven.
Concerns:
Doubts remain over the execution of economic reforms though the Government openly expressed intentions to navigate Malaysia from middle-income to a high-income economy. Investors still have reservations over Government’s willpower to undertake structural reforms as the Government has failed to implement them in the past.

Uncertainty in the political arena arises as Oppositions are making inroads, as seen in the General Election in Mar 2008 which denied BN two-thirds majority in the Parliament. The race in the coming Sarawak State Election and General Election in 2011 and 2012 respectively are expected to be fierce. The recent judgments on high profile cases, scandals and squabbling continue to undermine investor confidence. Further exacerbating the situation including the escalation of inter-race and inter-religious quarrels which led to the desecration and burning of places of worship.

Bye bye, FDI: Domestic and foreign investments in Malaysia are on a declining trend, dropping by about 55% y-o-y in 2009. About 45% of total investments are still being channeled to manufacturing sector which contribute about 30% to the economy while less than 30% find its way to the services sector which contribute about 55% to the economy. This is a hindrance to Malaysia’s intention to direct services sector to lead the economic growth and move up the economic ladder. Infrastructure, political risks, structural cracks and productivity remain key concerns among investors. Malaysia’s net outflow in investments to overseas are increasing significantly, raising concerns over lack of capital investments locally. If Government does not get its act together, we will be losing way behind emerging economies like Thailand, Indonesia and Vietnam.

Valuation:

Where are we now? KLCI still trading at forward PE of 14x, below its 10-year average of 16x. There is still upside in Malaysia equity market in the short term but will not be spectacular, probably about 15% upside. Nonetheless, without FDI support, economy is going to hurt in the long term while foreign funds will continue to ignore Malaysia if we keep on harping on race/religious dominance and undermine the independence of judiciary, police etc.

I think policies and politics are going to be one of the main determinants of the direction of the market this year.

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.