Buy Insas and Sell Parkson

It is a huge mistake by me as I am behind the curve in terms of retailing. The next wave of retailing seems to be is for companies like Alibaba and Amazon. I am currently reading the book on Amazon (The Everything Store) and I came out quite impressed on the level of technology investments as well as how much changes have been made by Jeff Bezos. Similarly, I have seen interviews made to Jack Ma and I must say that these two guys will be changing the face (or already are) of retailing or how people will be buying things in the future.

This of course does not mean companies like Parkson or Aeon or even Tesco will be dead but they definitely are affected. I must say I am behind like 5 years in this as sitting in Malaysia, we are definitely not seeing the full force of the changing face of retailing. This year alone, Walmart, Tesco are affected and they are not seeing growth. Their competition are not just Sainzbury, Target but the new wave of online commerce. Obviously, Parkson which have significant businesses in China is affected and they seem to change the way they do business as rental rates seems to be tougher for these companies.

Parkson has gone towards the AEON Malaysia model, where they have started to look at owning real estates, however it seems to me they are 10 years late. I hope for Parkson, it is a case of better late than never.

Anyway, I think this is time for me to reposition my holdings and I have decided to sell Parkson taking a huge loss (percentage wise) - do not want to calculate as it is a case of me taking too much time to realise my mistake. I am just glad I did not put too much money into this.

Buy Insas

I have written a piece on this company before - in fact two as the second one is more about its holdings on Inari. The thing I wrote is still very relevant but just that fundamentally Insas has improved over the 1+ years. Inari seems to me is getting more solid by the years and I have done a careful look at Insas past and it seems to me their concentration is more on the technology sector (largely Inari's contribution) nowadays. I had the opportunity to meet one of the directors before and I must say that these are very careful and thinking people - so much so that they are really strategizing every steps they make. While they do seem to plan a lot, you hardly can go wrong with this kind of management.

In the past Insas seems to me were more dependent on its other businesses such as M&A Securities which to me is not too interesting although they do manage the business well I must say. It also had made good money in several investments such as a London property, Gleneagles KL etc. These goes to show that they are very solid investors who know what they are doing. The most recent success as mentioned was definitely Inari.

Insas is trading well below its registered book value (RM1.80/share) and for me this kind of companies they should be trading close to their book value. An investment company especially with large holdings in a securities firm will see huge swings in their profits but to me it is allright as long as they are good assets. Its current price of around RM0.80 is significantly below its book or revised book value which I can easily see at beyond RM2.00 per share. This is because it does not recognize the full market value of Inari which in terms of the holding value for Insas should be more than RM500 million. Note that Insas is now trading at around RM560 million market value - i.e. almost similar to its holding in Inari alone. Only thing is why they do not do share repurchases really beats me...

I am buying this also due to I can see there is a level of confident on Inari's future with the company calling for Redeemable Preference Shares to subscribe for the rights call by Inari. I personally feel that it must be due to there is a good mid term prospect for Inari for it to continue to expand.

As such I am buying a good 10,000 units of Insas.

Note that Insas is issuing a Redeemable Preference Shares at 1 for 5 shares held and they are also providing free warrants at 2 for 5 shares.

Food for thought: A look at MWE

I know this is a hugely uninteresting stock, but there is a reason for me to look at it. It owns about 25% of Keuro where I already have a decent exposure. I would also like to know why it has sold a business where it has been earning between RM20-25 million a year and part of that proceeds have been used to buy Keuro. MWE spent around RM280-RM290 million to have a hold of 25% of Keuro. They purchased the substantial stake from Chan Ah Chye at RM1.34 per share and later picked up the rights at RM1.08 per share. There could be a reason it sold controlling stake of a business to own an associate stake of another business. Usually business people do not do that. And I am very sure they are many times smarter than me.

Accounting Treatment

The company has taken equity accounting method for its investment in Keuro. Basically MWE has taken the following treatment for its investments.

Latest financial report

Now we know that it has borrowed some money to buy the 25% stake including the rights. What does that mean? Its borrowings is in the form of revolving credit and the borrowing costs seems low - around 5%. The dividend income from Magnum alone (see below) can cover for the interest to be paid from the borrowings.

From MWE's 3Q14 financial report. The added on loans is after Keuro's rights

Balance sheet wise it is definitely sound. It has a Net Asset Value of around RM2.88 per share against its share price today of RM1.47. Generally, I do not think that its business is much of a significant although if one is to read its annual report, nothing tells that. (This is the reason why reading Chairman's statement is NOT telling much). The value of the company is in the investments, not subsidiaries. However, in the Annual Report's statement by the chairman, he was dwelling on subsidiaries business which I do not get excited from. Nothing much is mentioned on the investments.

The three largest shareholdings are investments (investments in associates and Other Investments - largely Keuro (around RM270 million in value including Keuro-WE), Magnum and MPHB Capital which can be read through below.

Magnum's substantial shareholding with MWE ownerships worth around RM181.5 million

MPHB Capital's substantial shareholding. MWE's shareholding value is around RM61.5 million

Other than that, it owns textiles business, the remains of the electronics business after selling to General Lighting Co. (Note that Carlyle has sold the business after 2 years holding it to Philips at a profit of course), some properties and a plantation in Kelantan (MWE tried to sell it but was rejected by the state government).

Anyhow, I can see it interesting from this findings...it is trading at 50% of its NAV. Would you buy it? There are many things to think through though like dividends, share buyback etc.

Happy holidays to all the fellow bloggers and readers.

Moving from Airport to Keuro

I am buying more Keuro as I think the lower oil price will cause the construction material costs to lower. Other material costs such as steel is also significantly lower recently. I think it will have positive impact to the construction of West Coast Expressway.

On the other hand, I was not too happy with the purchase of an airport in Turkey by Malaysia Airport. As a result, I have decided to switch by having a bigger exposure to Keuro.

The latest update is as attached.

Fully sold Jobst

This has been a very good stock, business and very humble management that takes care of its shareholders. However, as it is not very clear on its future business after selling a very good business, I have decided to clear all of Jobstreet's stocks.

Couldn't have found a better management.

A tale of two different plays

Ever wonder why the regional markets (especially China) are mostly doing well, while Malaysia's Bursa has been dropping? This is because a lot of the plays in the last 7 - 8 years or even more have been on oil and gas (O&G). The O&G play have been exacerbated by the proposed investments into marginal oil fields, huge plan for Pengerang pushing Malaysia into a country that is more and more dependent on O&G. The Malaysian stock market have been largely dependent on that sector. The first 3 SPACs are all O&G although many investors still do not know what that means. SPACs basically means taking your money and only decide (or search) where to invest in. Before they have your money, usually they have very little clue except borrowing their namesake. Also, it you do your search, there are more and more RTOs that are mainly by O&G related companies. Any companies that are into O&G are deemed to be good standing. Now comes the time for the famous saying, "When the tide's go down, only you discover who is swimming naked." as every Ali, Muthusamy and Ah Kau wants to be in the O&G business suddenly.

The O&G play, I believe are because of 2 main factors - price of oil since 2006 (except for dips in 2008) and PEMANDU. PEMANDU has been formed to look at large projects (especially) and O&G can be large projects, very. Imagine a name whom many would not have heard of before Dialog (joking, I know they are big among Malaysian O&G players) can declare that they are going to invest RM15 billion into Pengerang! The entire Pengerang is like RM100 billion investment altogether - more than the total investments for MRT1, MRT2 and MRT3!

With these investments, we are going to be one of the largest in the world in O&G trading!

Now! Brent crude at USD70/barrel. Now how? Ohh, btw, we are not selling Brent, we are selling Tapis. Even when Brent can be low, Tapis' price was priced at USD100. Betulkah? That was before. We are now talking about what happens in the future.

Will the USD100/barrel be back soon and all the projects will be at full steam again? What if it drops again? I know many projects will not be shelved by this factor but I am just wondering why is Malaysia pushing so hard into O&G.

O&G is a volatile play. It is a commodity and while many countries are pushing harder into alternative and renewable energy, we are pushing hard onto depleting energy source. We are trying to build expertise into an area where other countries are many years ahead while we are doing catching up. Diversification is key as O&G is too risky even as a trading hub. In addition, O&G is too small a job sector focus for Malaysia. There can be very few rich people (in this sector) but a lots more poorer people if we put our energy into this area. Yes, part of it is into logistics sector as a bunkering hub is good for Malaysia, but still O&G centric.

In any case, Malaysia is not like Russia or Saudi Arabia or Qatar where those countries are very dependent on oil. We should embrace that diversification. But yet we seemed to be pushing hard onto one sector currently.

For example, we used to have a strong technology sector - E&E and software - now that is dissipating although Malaysia is still a large exporter of semiconductor. These are good sectors to even out wealth and with that the local consumption economy will do better.

However, I believe economically Malaysia is fine with the price of oil drops. The drop in Bursa is largely to do with the O&G companies and along it pulls together the others as well. There are still more to drop for the O&G companies if the price of oil stays at current level for some time as these counters are still expensive.

Government's budget seems fine as it has eliminated subsidies in petrol and diesel altogether. Good move and right timing! I in fact feel that the government has more money for development next year although contributions from Petronas will drop.

But we got to do more.

With that, I still believe over time, by 2015 the other sectors may pick up back. Those that are not related to commodities. The construction sector should do well. Banks was on the rise and rise over the last 15 years or so. There is time to slow down. It seems to be now. I do not know of the banks exposure to the O&G sector, but looks like it is little as banks nowadays are happier lending to properties and automotive purchases. Retail should do better once the GST and other factors have put people on firmer footing. So are other industrial sectors that are export oriented now that our RM is getting smaller.

Hence, while the Malaysian market looks bad, it is more to do with one sector. The rest will be fine as commodity prices are now down and I am just hoping my Char Kway Teow seller will not increase price come 1 Jan 2015 in the name of high oil price! As it is not true.

Shifting portfolio

The past 2 trading days have seen huge drop especially to O&G companies. Not surprising, other stocks are getting some hit as well. With that, I am making some change to my portfolio. It is still a boring change though with the switch from Jobstreet to Keuro. (Yes, I am buying same same company.)

Jobstreet has already sold its main business to Seek and I do not see much upside anymore. The most it can go is probably to RM3.00.

Keuro, on the other hand I see huge potential. I have figured out that perhaps the holding of 40% in Bandar Rimbayu alone for Keuro could potentially be worth around RM0.9 billion at least. Yesterday, Gamuda had bought a piece of land adjacent at RM35 per sq ft and that is an agricultural land which will need some additional spending and work on (calculation below). Hence, if anyone is claiming that the purchase of Canal City land by Ecoworld at RM35/sq ft is expensive - it probably is not. Tropicana got it cheap.

Calculation of purchase price by Gamuda on an agri land near Kota Kemuning
Purchase price of - RM392,172,858.00
Total hectares - 104.1 hectares = 11,205,220 sq ft
Price per sq ft - RM35 per sq ft

Calculation on Rimbayu
Total acre - 1878 acre
Total sq ft - 1878 x 43,560 = 81,805,680 sq ft
Discount - 20% for an associate stake
Price per sq ft - RM35 per sq ft
Total Value - 81,805,680 x 80% x RM35 x 40% = RM916,223,616

At current price, Keuro is trading at around RM1.05 billion where the 40% ownership of Rimbayu is probably already worth that much. Additionally, I still think that the West Coast Expressway will be worth more than the Rimbayu stake. The drop in oil and other commodities may even help Keuro in having the construction costs lower as there is somewhere that I have encountered that in building of roads, around 70% are in the raw materials - cement, steel, bitumen (petroleum by products). Do check out where the prices of these items have been heading over the last year. I am not sure for Keuro's case, would raw materials comprise 70% of the costs. Any civil engineers here that can help to clarify? Do note that Malaysian government is taking up the costs on land acquisition in this project.

Hence, I have made some adjustments to the portfolio.

Strategies for 2015

What OPEC decided about 2 days ago is very significant to the market as well as the economy. It has decided to keep the production among OPEC members to 30 million barrels a day. Some say that the decision is to allow it to eliminate the weak players in the shale oil boom. Many players in the shale boom have been borrowing to put themselves at play for the boom. As much as 15% of the junk bonds are being issued to energy companies. Yes, to me that is true, but I also believe that there are economic reasons and as much as political reasons.

Imagine what a $60 per barrel would do to some of the net oil producing countries - Russia, Venezuela, Iran? US does not need to send troops to fight but this war itself would have a very strong impact to US in its international political policies. Putin would not be so bold and confident anymore.

On the local front, low oil prices especially when it is traded below $70 per barrel, it seems would not be good for Malaysia. Petronas came out with all guns blazing saying that it cannot be the one who will be solely helping the government's coffers anymore. So we know that for this year Petronas contributed RM68 billion to the governments budget. That's huge. Oil price at $75 per barrel would drop Petronas payment to the government to RM43 billion i.e. a reduction of RM25 billion. Is it so?

In any case, in Malaysia we are seeing the reduction of subsidies on all front - from sugar to petrol. To me, that is a good thing and it seems that it will be the new normal for Malaysians. For 2015, we are seeing 2 significant things. GST while petrol will go free float. On the international front however, many commodities are dropping like there is no bottom. With that what are the strategies?

Oil and gas - obviously it is already seeing drop such as what happened to Bumi Armada and Sapura Kencana just over the last 1 week. Obviously, I do not foresee this sector to be able to see the light at the end of the tunnel soon. Perhaps few years down the road but not 2015. Imagine Petronas is even contemplating postponing or shelving the Pengerang project. That is significant as Pengerang is supposed to allow Malaysia being as a major player or at least a competitor in the bunkering business.

Consumption business i.e. retailing - unfortunately for Malaysia the drop in oil price is not good for Malaysians as we are actually paying more for petrol or diesel as opposed to many countries we read of. So, this sector will not be showing a rebound soon until we Malaysians are used to higher or floated oil prices. The GST will also do not good to this sector at least in the short term.

Palm oil - Malaysia is lesser of a significant player in this sector now that Indonesia is the largest palm producer and they are running away as the leader. With that, what we have been used to see may not reoccur again. Malaysia may not be the one who will be able to dictate the market. It will now be Indonesia. That has already happened several times as Indonesia has been the one taking the first shot. In chess it is like you have the white pieces and usually that is a slight advantage. In any case, Malaysian palm oil companies will continue to do well despite the prices not enjoying what they used to be. My only problem is that, their share prices are not attractive yet.

There are several sectors whom will benefit from the drop in commodity prices. The first will be the construction sector. Prices of raw material which comprise a large portion of costs to this sector will drop - or already and they will enjoy a better margin in the event these companies have secured the contracts in advance.

Also, probably surprising is that the margin for properties sector may not be that largely impacted as originally thought despite the GST effect. They are just complaining. The bigger factor however will be the Bank Negara's action - i.e. whether will it be loosening up the lending guidelines especially to first time house buyers. A week ago, China did the unexpected - reducing its benchmark lending rate by 40 basis points. That again is huge. It may impact the decisions of many other central bankers in the region - Malaysia included.

For me as compared to 2014, I may have to relook at the portfolio especially for the retail businesses as it seems that e-commerce is making an impact although many of these companies are yet to make profit - but they are definitely a disruptive factor. Jobstreet will be out of the way now as it has already completed its sale of the online business to Seek. With that, I am looking for new opportunities.

The above mention of cost reduction for construction sector may bring positive impact to Keuro. Definitely, Parkson and Padini may be impacted by the GST as it is already, due to stronger competition, this year.

The bad press on Malaysian Airport - I am just hoping that the single sector which benefited from the low oil prices alone - airline would bring positive impact to MAHB, with higher traffic.

All in all, I think 2015 will be better than 2014, despite the pessimism.

Will taxes on vehicles drop as well?

Now the burden on rakyat to claim that we are the ones that causes inefficiencies to government spending as the bulk of government's expenditure is on subsidies is soon over. Petrol is going to be on managed float from 1 December 2014 which means that there is very little and no subsidy from the government at all.

At last, I feel that this is one of the best decision to be made by the government as we have been doing all the wrong things in the automotive, transportation policies. We have subsidies on petrol and diesels, but high taxes on vehicles, lots of tolled roads.

It is time to reverse that, by eliminating subsidies, reducing taxes as it have been burdening the people. There is no doubt that the high car prices and many years of financing (up to 10 years) for cars is a burden and indirectly causes consumption borrowings to be high. By reducing taxes on cars, it also means reducing on borrowings for the people. Forget about those who will own more than 1 car per person. That's a small community. It is time to reduce burden on people with high borrowing costs on cars especially to the youth in which probably car is the first ever significant debt for them.

Hiccup for MOL Global

The number rule of thumb for newly listed companies are "To treat your CFO well".

This is because is he or she resigns just after the IPO, it usually spells trouble for the listed company. This is just what happened to MOL Global. Barely a month after its listing in NASDAQ, which is supposed to be a good thing as it was already valued at more than RM1 billion with that listing, has seen its shares dropped more than 50% yesterday.

The way investors community looks at it is that usually the burden of the reporting relies on the CFO and if he is not happy and resign, that is a bad sign towards the financial conduct of the company.

This is especially so for a company that has just listed, more so on the news that its CFO resigned after having joined for less than 3 months. To top off that it announced a postponement in announcing its results.

Well, I have made my review or opinion on the company previously before. Seems like it is a lesson learnt through the hard way for MOL in Nasdaq although it provides them with much higher valuation, but it can also discredit the company easily, unlike Malaysia's stock exchange. Well, it has that short selling tool, as well!

What happened to YFG?

I blame it on myself to even consider it as this stock is highly risky. Firstly, if you look at the below which was last year's annual report I thought that it is a cheap company with its new management having a view to make things right.

The front page of the Annual Report says, "Engineering Change". Two years before that, it did change most of its management, major shareholders and the way they do business. The past management and owner were parties that are connected to a political party. Hence, in usual cases contracts were signed through that means but with poor management.

With the takeover, I was thinking that it could have changed fast. It definitely has proven that is not easy to turnaround a company even with the change in management, change in name and changing the way business is done. In fact, they were so adamant to change that they changed to a Big 4 auditor (may not be a good thing). How many sub-RM100 million companies in Bursa has a Big 4 auditor?

With this, I thought since YFG is in a space where there are opportunities, it would have a good chance for growth. But the company's past probably still haunts the company. If you look at the accounts, its biggest challenge is the amount due from contract customers.

I am not so sure whether these were issues that were brought from the old management. If this is, then their due diligence were not done proper. They were probably too keen to rescue the company from collapsing. Just look below.

I am pretty sure that YFG cannot afford the hit totalling that amount of RM20.908 million, as if it does the company will go under PN17. Usually, if it potentially is a bad debt, many parties may opt to take the hit slowly - I think this could be the case for YFG. As YFG has substantial projects in hand, I would think that they would be able to absorb the impact especially where they have stronger major shareholders now.

But it will take a longer time to recovery. And not as fast as I would have envision.

Probably for the company, the fastest way for it to get back on track are just to do these 2 things:

- raise more capital - capital injection via private placements or another rights. It may also consider acquisitions of contracts (but at this traded price, probably not the best thing to do for now);
- write off whatever that is doubtful.

There is no point dragging over these issues as its business continuity is at stake.

And I think the reason for the health reasons for the CFO to retire is a bit coincidental judging from the amount mistakes on this case i.e. underestimating the amount to write off from one of the projects which ran into a change in management, non-ability to address the qualifying statement by KPMG early and the poor cashflow management as well as having to suspend the stock trading due to the company's quantum of impairment.

A look at the PRS Conservative funds

It is time for me to look at some of the PRS funds (due to taxes) and I thought that unlike last year, I want to do some research. Last year, I just went to a most convenient bank and picked an aggressive growth fund as I thought that with many years to reach 55 years old :), hence I might as well be slightly aggressive.

This year though, I wanted to take a back seat and be conservative (to also balance my investment in fund). This means that for this year I am for conservative funds perhaps. Taking a cue from AIA's Conservative funds (as below), a conservative fund basically invests 80% of the money into fixed income and money market instruments and remaining 20% into equity.

Fixed income as in the name is most of the time investment into bonds (usually high grade) while money markets are securities which are shorter time in nature and these are high grade securities. All in all, I expect to secure decent and above fixed deposit rates return. Add in the tax incentives, it should be good savings and return.

One way to look at which fund to choose is to look at its past performance (I know one should not measure performance on its past, but how else?). As PRS scheme is a new scheme for most of the funds, they have been in existence for slightly more than a year. These are what I have found - which is quite surprising. (Remember me saying I expect above FD type of return.)

CIMB Plus Islamic Conservative - 1 year return 2.8%

AMPRS - CONSERVATIVE FUND - CLASS D - 1 year return 1.6%

Affin Hwang Conservative - 1 year return 3.6%

AIA PAM - CONSERVATIVE - 1 year return 2.7%

Manulife Conservative PRS - 3.4%

RHB Conservative - 1 year return 3.2%

Manulife Shariah PRS - Conservative - 1 Year return 0.6%

Based on the above, among the conservative funds, it can be said that over a short 1 year period, the best performing one at 3.6% return is Affin Hwang while worst performing one is Manulife Shariah at 0.6% return. On average, these 7 funds I looked at provided 2.557%. If I were to compare against most of the fixed deposits, they provide return of between 3.2% to 3.4% over the last 1 year. Could I claim that these conservative funds underperformed?

In fact, if I were to eliminate the best and worst performing from the average, it is still giving average return of 2.74%.

The worrying thing is that these funds does not create much value, except for the government's incentive of tax deduction up to RM3000 invested. One can argue that we should not look at these funds over the short term. I agree as I myself pitch long term. But these are funds that largely invested into fixed income securities. Fixed income provide in most cases fixed return. Yes, they are tradeable in the secondary market, hence the fluctuation in prices, but aren't one been paid and taught how to look at the interest and bond market movement? In any case, these are conservative funds.

They are not creating value! To me. And without the incentives from government, these will not stick!

P.s. I did not include some of the funds e.g. Public Bank's which registered 3.41% return over the last 1 year.

Also the fund management guys will not like me, but these are FACTS!

Another place to look at the performance is through Morningstar i.e. here.

Market fluctuation

When there is market fluctuations or consolidation as experienced in recent times, it is time to revisit some of the best advice out there. This is from Berkshire Hathaway's Annual Report in 1997 at a time when there were some market challenges. Remember our "Tom Yam effect"?

How We Think About Market Fluctuations 

A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.

     
But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the "hamburgers" they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.

      
For shareholders of Berkshire who do not expect to sell, the choice is even clearer. To begin with, our owners are automatically saving even if they spend every dime they personally earn: Berkshire "saves" for them by retaining all earnings, thereafter using these savings to purchase businesses and securities. Clearly, the more cheaply we make these buys, the more profitable our owners' indirect savings program will be.

      
Furthermore, through Berkshire you own major positions in companies that consistently repurchase their shares. The benefits that these programs supply us grow as prices fall: When stock prices are low, the funds that an investee spends on repurchases increase our ownership of that company by a greater amount than is the case when prices are higher. For example, the repurchases that Coca-Cola, The Washington Post and Wells Fargo made in past years at very low prices benefitted Berkshire far more than do today's repurchases, made at loftier prices.

      
At the end of every year, about 97% of Berkshire's shares are held by the same investors who owned them at the start of the year. That makes them savers. They should therefore rejoice when markets decline and allow both us and our investees to deploy funds more advantageously.

      
So smile when you read a headline that says "Investors lose as market falls." Edit it in your mind to "Disinvestors lose as market falls -- but investors gain." Though writers often forget this truism, there is a buyer for every seller and what hurts one necessarily helps the other. (As they say in golf matches: "Every putt makes someone happy.")

      
We gained enormously from the low prices placed on many equities and businesses in the 1970s and 1980s. Markets that then were hostile to investment transients were friendly to those taking up permanent residence. In recent years, the actions we took in those decades have been validated, but we have found few new opportunities. In its role as a corporate "saver," Berkshire continually looks for ways to sensibly deploy capital, but it may be some time before we find opportunities that get us truly excited. 

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The recent consolidation is hardly a time to think about opportunities yet, but would be good if it is to deteriorate further taking a cue from the above.

Quite interesting times

Should one catch a falling knife? I would not especially when we have seen that the knife is already been held high up. In recent times, useless stocks have reached all time high. The usual lesson is that if one is to hold on to those stocks, be afraid as we would never be comfortable with those companies. It may be a one time wonder. Good stocks would however pick itself up. I have seen that in old old stocks like Genting, BAT, Nestle etc. and they would reach all time high again and again.

Not for those useless ones as chances are some of these companies financials are tweaked to accommodate the good times. When it is bad times, no point for these companies to show good results right?

Good companies however would not need to tweak their accounts. They will perform and pick themselves up usually (not always). Anyway, the market has only been down for few days. I am not sure whether how far more it will deteriorate.

Globally, stocks are not performing as well with some fear that China and Europe will be slowing down again. As mentioned, commodities are taking a hit and that may impact our country as well being one country that is quite dependant on petroleum related and other types of agri products. Things are not well it seems now.

It should be interesting to see what Bank Negara and government will do if the fall is continuing... 

Financing: Why government and banks may have gotten it all wrong

We are pretty good at encouraging Malaysians to borrow more for homes, cars, other consumption purposes but probably not in the areas where it is probably more beneficial to the nation.

How much is my flexible rate loan from a bank if I am to borrow RM1 million? I can get as low as BLR - 2.5%. At the current BLR rate of 6.85%, my effective interest rate is 4.35%. That is historically very low although BLR is not at its lowest. It was as low as 5.5% back in 2009. Bank Negara is trying very hard to regulate interest rates and that in itself is only helpful towards owning a home or a car, which is why consumption loan is at its highest ever, EVER.

Now turn this around? If I am a business owner, and I need a term loan from a bank. What is the interest rate I am paying? I would still be charged something like BLR + 1.5% or even more. That translates to around 8.35% - a whopping 4% higher than if I am to get a housing loan. Would this be friendly towards business? Or would this action be friendly towards the property sector only?

With the differences in rate, if I own a property, I would probably be refinancing my home by taking opportunity of the lower rate (by 4%) to fund my business.

Banks would act upon where it stands to make from the most and it is not surprising that they have been focusing on home loan or other consumption loans such as automotive, credit cards and personal loans recently. Lending for these purposes however is less productive as compared to lending for businesses, which is also why Malaysia has not been very successful in churning out entrepreneurs.

If I am an young entrepreneur, one whom most probably would not be owning many assets, I would be probably be turning towards business loans with little collateral. That is expensive comparatively against buying a home where the collateral is the house. Where as a young person should I be looking at? That young person would probably be less inclined to startup his own business, but ended up investing in a home.

This to me is a move towards wrong direction where as a country, we should be more friendlier towards business entrepreneurship. Is there a reason why we are not entrepreneur friendly, but the type of corporations we have been attracting are only large ones who are able to get loans (non BLR) at much lower rates unlike the smaller corporations.

Price-to-earnings ratio and its use as an investment strategy

by KC Chong

“The key to successful investing is to relate value to price today.”

PE ratio is the most widely used metric as a measure of how expensive or cheap a stock is. Analysts and investment bankers use this valuation metric in their valuation reports all the time.

Price-earnings ratios vary across sectors with stocks in some sectors consistently trading at lower P/E ratio than stocks in other sectors. It is generally acknowledge that stocks that trade at low P/E ratios relative to their peer group must be mispriced.

P/E = Market price / Earnings per share (EPS)

The widely used of P/E ratio to gauge the attractiveness of a stock is often justifiable as given below:

• ·       it is an intuitively appealing statistic that relates the price paid to current earnings.
• ·       it is simple to compute for most stocks, and is widely available, making comparisons across stocks simple.
• ·       it is a proxy for a number of other characteristics of the firm including risk and growth.

One big problem with P/E ratio is which “EPS” is used.

• ·       Is it the EPS of the most recent financial year?
• ·       Is it an undated measure of EPS by adding up the latest four quarters results?
• ·       Is it the expected EPS for the next financial year?
• ·       Is it before or after the extra-ordinary items?
• ·       Is it based on the outstanding number of shares or all shares that will be outstanding when all warrants or ESOS are converted (fully diluted)?

Consider this case of internet stocks at the end of the 20^th Century. All telecom and internet stocks were trading at P/E multiples of high tenths or even more than hundred. If a particular internet stock is trading at a P/E ratio of say 50, was it considered cheap? I don’t.

Besides that, all companies, even those in the same industries, contain unique variables - such as growth, risk and cash flow patterns. Surely a company which has poor operating efficiencies, no potential growth, a poor balance sheet should not be accorded a similar P/E ratio with one which has superior earnings and cash flow growth, and a healthy balance sheet. A company with strong market position in general generates more stable earnings should be accorded with higher P/E ratio.

P/E ratio is hence more likely to reflect market moods and perceptions but this can be viewed as a weakness, especially when markets make systematic errors in valuing entire sectors.

Figure 2 above shows the PE ratio distribution of S&P500 stocks on 31^st December 2013.

As you can see above, most stocks are now trading above a PE of 16. Hence a PE ratio of less than 16 may be good, below 8 will be fantastic, but above 20 may be too expensive.

Estimating fair PE ratios from fundamentals

One way for the practitioner to do to solve this problem is to use the Katsenelson’s absolute P/E method to find a fair value of P/E ratio for a specific firm which we will discuss further later.  

Here we will look into a theoretical view of how P/E ratio is related to metrics such as return on equity (ROE), dividend payout, growth, cost of capitals etc.

P/E ratio: Theoretical background

The financial theory postulated by John Burr Williams in his “The theory of investment value” says the value of a stock is worth all of the future cash flows expected to be generated by the firm, discounted by an appropriate risk-adjusted rate. The simplest model for this purpose would be the Gordon constant dividend growth model for a stable firm.

P₀ = DPS₁ / (r-g)                     Equation 1

P₀ = Value of equity

DPS₁ = Expected dividends per share next year
r = Required rate of return on equity

g = Expected growth rate in dividends (forever)

Divide both sides of Equation 1 by expected earnings per share next year, EPS₁

P₀ / EPS₁ = Forward PE = (DPS₁ / EPS₁) / (r – g ) = Expected payout ratio / ( r – g )                           

Equation 2

Equation 2 shows that:

·       A higher growth firm should  have higher P/E.

·       A higher risk firm having a higher cost of equity, r, will have a lower P/E ratio

·       P/E should increase when the payout ratio increases.

·       Firms that are more efficient about generating growth by earning a higher return on equity will trade at higher multiple.

Note that the above equation 2 is the fair PE ratio for a stable growth phase. For a high growth company, you would have to estimate the payout ratio, cost of equity and the expected growth rate in the separate phase of high growth and the stable growth period, and summing up the value in these two phases taking the time value of money into consideration. This approach is general enough to be applied to any firm, even one that is not paying dividend right now.

Investing using the low P/E ratio strategy

Tons of research has shown that investing in low P/E ratio stocks have yield extra-ordinary returns when compared to the broad market. However just basing on P/E ratio alone is not a desirable way as P/E ratio theoretically depends on a number of factors. It is possible that these low PE stocks are riskier than average and that the extra return is just a fair compensation for the additional risk, low future growth rates and poor quality earnings. One can improve the strategy tremendously with some screening works based on the discussion above as below.

• Low P/E ratio with respect to the prevailing market, say not more than 12
• Low idiosyncratic risk as measured by debt/capital ratio, of less than 0.6, current ratio of more than unity, and interest coverage ratio of more than 3.
• Reasonable expected growth in earnings of more than 5%
• Historic growth rate in past 5 years of more than 5%
• Good quality of earnings with reasonable cash flows

Quite predictable

What does the below graph tells you...

Our net exports for petroleum is narrowing. At the same time oil prices if dropping to a new low recently in comparison to the last few years. If you have followed our own Malaysian story, we have been rather active on re-opening our marginal oil fields as when oil prices increases, the price of oil would have surpass costs of those older oil fields which were deemed to be too expensive to extract from.

Now that oil prices have started to take a hit, that profit margin is thinning. Malaysia have been largely dependent on oil produces, palm produces as the main revenue for the government. Hence, if oil is to have drop in price, it is actually not so good for us as government's income would be affected as taxes from petroleum could have been lower. That is quite similar for the crude and refined palm where we have scrapped taxes on those produces temporarily.

With that, what does one expect the government to do?

Buy TA Enterprise

This is not a massive purchase, but I like the stock particularly its strong asset backing. TA as a stockbroker is no longer dominant - quite the right thing to do as the business is not as profitable as what it used to be before. Commissions is now reduced.

However, TA is still a careful and diligent investor. TA has nowadays been more interested into buying assets overseas - hence if you want some exposure overseas, this is one company. It has been buying hotels - good long term asset hold in very established markets.

I have written about TA some time ago, and during then was cheaper. I think it is not too late though.