Wednesday, January 4, 2012

Will the Bull return in the Dragon year? (DMG)

Small Cap Strategy:
Will the Bull return in the Dragon year?
Executive Summary
Turnaround is closer than you think… If history is anything to go by, the Singapore market may turn around as soon as the first quarter of 2012. A check into the down periods over the past 15 years reveals that the recovery always coincides with the trough in the economy. Debunking conventional wisdom, we have noticed that both large and small caps move up in tandem, rather than a lag in recovery for the latter. This may seem a little too soon to many investors, given that the Singapore market hasn’t fallen as deep or as long as previous crises. But I think that this is likely due to the fact that the economy is not as badly hit this time round. Our economics team still expects positive GDP growth for all four quarters of 2012.

... but not before a dip in Q1, possibly due to political wrangling in Europe, or weaker than expected economic data coming from the US or China. Domestically, a tepid earnings season may also have an adverse impact on the market. I wouldn't be surprised if the stock market dives another 10-15%. A sharp slump, like the one seen in Aug 2011, should be seen as an opportunity to snap up stocks on the cheap.

Themes to play: Offence is the best Defence. While there are still a lot of uncertainties out there, it may not be the best strategy to huddle in defensives. When the economy is at its worst, defensive stocks tend to underperform. In any case, small cap defensives are typically less resilient than the large cap ones. Instead, the first quarter of the year is the best time to search for stocks which are on the cusp of a turnaround (technology) or trading at deep value (construction). We are probably the only ones out there who are saying this, but don't completely write-off S-chips. There may be a few worth looking at once the dust settles (we figure it will most likely be in 2H12). Also look out for opportunities on the M&A and privatisation front.

Don’t take my word, if you believe in (i) the disintegration of the Eurozone, (ii) crash landing in China, (iii) tough times continuing in the US, (iv) geopolitical risks in the Middle East or North Korea, (v) unknown unknowns, or (vi) the end of the world in 2012. In the case of the latter, start working on your bucket list (but first, I think it is my responsibility to warn you that 21 Dec 2012 marks the end of the Mayan calendar, and not the end of the world).

Seeking market trough: Where & When
The second half of 2011 has been a brutal time for the market, with the benchmark STI falling 14.6% and the small cap FSTS slumping 23.4%. The month of August was particularly horrifying, as the STI and FSTS dived 9.5% and 13.7% MoM respectively. October saw a strong recovery, but that proved to be short-lived.

Valuation reasonable
The STI is currently trading at 1.27x P/B, more than 1 standard deviation below the historical average P/B of 1.65x. Over the past 15 years, there were four other periods when the STI traded below -1 standard deviation, namely (1) Asian Financial Crisis from 4Q97 to 1Q98; (2) Tech Bust from 2Q01 to 2Q02; (3) SARS period from 1Q03 to 2Q03; and (4) Global Financial Crisis from 4Q08 to 1Q09.

Our STI target stands at 3,022, based on sum-of the-parts valuation. This target works out to 1.31x P/B which is lower than the historical average. We believe this conservative level is justified given the global uncertainties (See ‘Market Strategy: Rain before the Rainbow’ by Leng Seng Choon).

On the earnings multiple front, the STI is trading at 12x FY12 P/E, which is at the lower end of the historical band. This is far more attractive compared to the Asian Financial Crisis or the Tech Bust, when the STI was trading at >60x and >20x respectively, and close to the trough valuation levels seen in 2009.

So where’s the bottom?
Looking back at the past three crises, the stock market slump lasted an average of 74 weeks, with the benchmark STI down 58.0% (no data for FSTS in 1997-98). This time round, the Singapore market has headed south for nine months, with the STI and FSTS declining by 19.0% and 34.6% respectively. I doubt the severity of the fall will be as bad as the one seen in 2008-09, given that the economy will unlikely be in a tailspin this time round (the STI chalked up its worst performance in history back in 2008, falling by almost 50%).

The inflection point for the STI in the past three crises coincided with the worst quarter in terms of GDP change YoY. It seems intuitive to assume that small caps will see some time lag in terms of recovery, vis-à-vis the large caps. But our study proves otherwise. The small caps actually move up almost in tandem with their big cap brethrens.

The OSK|DMG economics team is expecting the economy to expand by 4.5% in 2012, which is above consensus and government forecast of 1-3%. 1Q12 is expected to be the worst performing quarter, and judging from track record, the trough in the market may be seen in the next three months.

That said, the first quarter will likely still be volatile (and at times, hair raising). I wouldn't be surprised to see a 10-15% fall, due to a variety of reasons - Europe, US, geopolitics and/or weak results. But any sharp slump towards the end of the quarter should be seen as opportunities to pick up bargains.

Themes for 2012
Preemptive Strike! Play the potential turnaround in Technology
I think that it may soon be a good time to place our bets on the Technology sector, which has been hit with a confluence of negative factors – waning global demand, unfavourable forex and the Thai floods. Granted, we still have an UNDERWEIGHT on the sector, but the stocks under our coverage have fallen by 20% since August 2011 and are flirting with our revised target prices. Moreover, I hear that HDD major Western Digital, which was the most severely affected by the floods in Thailand, is recovering much faster than expected. The component suppliers will thus start ramping up their production in the current quarter. That is the inflection point I have been looking out for, and should result in interest returning to the tech sector. Many of the manufacturers affected by the floods will be collecting insurance money, and will see significant write-backs in 2012. Moreover, we will unlikely see violent swings in the USD, which should stabilise earnings for the manufacturers affected by forex losses in 2011.

Hi-P International (BUY, TP S$0.79)
Hi-P is an integrated contract manufacturing services provider specialising in precision plastic injection moulding, mould design and fabrication, assembly, ancillary value-added services and precision metal stamping. It is currently servicing OEMs such as Apple, Motorola, Nokia, Research In Motion (RIM) and Procter & Gamble (P&G) with products ranging from handsets, smartphones, electronic toothbrushes and shavers. It has been hit by slowing orders and worker strikes, but troubles are behind the company. It will likely achieve a record performance on the back of strong order flows in the coming quarters. BUY, with a TP of S$0.79 pegged to 9.9x FY12P/E (5-yr historical mean).

Head for the non-conventional defensives - Construction
During times of uncertainty, it is intuitive to snap up defensive stocks. But such counters have been heavily traded and will likely be the case as uncertainties continue. I would choose to look at somewhat defensive counters that have yet to see very much interest. One sector that comes to my mind - Construction. To most investors out there, the guys in hard hats and yellow boots can hardly be considered defensive. It is not, in the traditional sense. But given the strong pipeline of contracts, especially from the government sector, the construction players will not go hungry even if we head into a recession.

Taking into consideration all the construction activity that would be taking place within the next few years, order books of construction companies look set to grow. We believe that valuations are attractive at 5x FY12 earnings, below the sector's long term average of 7x.

Risks to industry growth include 1) rising raw material cost, 2) rising labour cost and government restriction on number of foreign workers entering Singapore and 3) foreign players (with deep pockets) entering the construction market and intensifying competition. However, we note that tender prices this year have been on an uptrend based on Building and Construction Authority’s (BCA) figures. We believe construction companies are able to pass on rising costs through higher tender prices.

Stocks to watch:
OKP (BUY, TP S$0.80)
As the only listed road specialist in Singapore, OKP looks set to ride on the nation’s building boom, benefiting from major public works like the S$6-7b North-South Expressway. OKP’s strategic tie up with China Sonangol, which owns 14.1% of OKP, is a gateway to more potential projects. With a cash hoard of S$95.8m (net cash of 31.1S¢ per share) and a financially strong partner like China Sonangol, OKP’s construction earnings may be given an added boost with property development. With a record gross order book of S$433.4m, FY11 looks set to be a banner year, with earnings likely to leap over 25% YoY. Maintain BUY and TP of S$0.80, based on a target P/E of 6.4x (ex cash).

Lian Beng (BUY, S$0.71)
Lian Beng Group (LBG), one of the largest contractors in Singapore, is set to ride on Singapore’s current building boom, benefiting from major public works like the S$60b MRT extension as well as a strong pipeline of private projects. Its partial stakes in private residential and industrial developments will also lend a meaningful kicker to the bottom line. Order books remain strong at S$761m and its net cash per share of 14.2S¢ as at Aug 11 would be used for its property/ industrial development business. At current price, it trades at 3.4x prospective P/E, which is way cheaper than its peers. Maintain BUY with a TP of S$0.71, based on 7x FY12 earnings.

S-chips: Still untouchables?
S-chips are still very much a bad word, particularly with all the corporate governance issues swirling. The latest saga involving a public spat between China Sky and Singapore Exchange (SGX) doesn’t help matters.

S-Chips’ share price fell over 40% in 2011, more than STI’s 17% decline. Major headwinds during the year included slower external demand and tighter credit in China, and their impact on companies’ financials were clearly shown in 3QCY11. Out of the 13 S-Chips that we cover, 62% of 3QCY11 results (1Q-2Q: 40%-42%) came in below expectations compared to 15% (1Q-2Q: 20%- 25%) that outperformed. We believe share price weakness may stretch into 1H12, having seen China’s Nov 11 industrial production and urban fixed asset investment being weaker than expected. There is, however, a likelihood that the S-chips play could return in 2H12, as favourable policies begin to flow through.

Stock to watch:
China Minzhong (BUY, TP S$1.38)
China Minzhong (MINZ) is an integrated vegetable processor that engages in modern upstream farming, and has 59,400 mu of farmlands in China as of Sep 11. Its net profit is projected to grow by 36%-39% to RMB768m-RMB1,068m in FYJun12-FYJun13, driven by farmland expansion and an improving margin mix. We like MINZ for its exposure to upstream food production and management’s strong execution post-listing in Apr10 but note that headwinds remain strong from uncertainty over the US and Europe demands, and its private equity investors' share overhang concerns. Current valuations are undemanding at FY12F 2.9x P/E and 0.6x P/B. Maintain BUY at TP of S$1.38, pegged to 5x FY12F P/E.

Leader Environmental Technology (BUY, TP S$0.30)
Leader Environmental Technologies (LET) is an Integrated IWT equipment maker with key focus in dust removal equipment and desulphurisation systems. It belongs to one of the “seven strategic emerging industries” in China which will continue to receive strong support from the government. With the established track record, LET is well-placed to tap on trends like the shift in desulphurisation demand and the upcoming denitrification market in the rapidly growing environmental protection industry. Though the recent credit tightening measures in China had cause LET to miss our expectation for FY2011, we remain upbeat over the group’s long-term prospects as there are already signs that the government will loosen its credit as inflation problem eases. It is currently trading at 2.0x F12F P/E which we opine to be steeply undervalued given that the Chinese government will still have to meet its aggressive 2015 emission cut target. We have a TP of S$0.30 based on 8.2x FY12 P/E (-1.5 SD industry P/E).

In the current uncertain climate where macro concerns seemed to over-ride bottom-up company analysis, focusing on privatisation plays can be a low-risk strategy to eke out positive returns. In the past year, we have already seen at least 15 stocks get taken private. The companies involved cover a whole gamut of industries, from healthcare (Qualitas) to stockbroking (Kim Eng), from port operator (Portek) to confectionery manufacturer (Hsu Fu Chi). This privatisation theme is a continuation of the trend seen in 2009 and 2010, which saw 33 companies with an aggregate market capitalisation of S$15b being privatised/delisted from SGX. Momentum will continue into 2012, given that many are attractively priced but yet thinly traded.

Major shareholders typically have to offer a decent premium to entice minority shareholders to part with their shares. Of the 38 companies privatised in the past three years that we tracked, the offer premium averaged 35% over the last transacted price, and 36% and 39% over the prior 1- month and 3-month period, respectively. The challenge is to pick a basket of privatization candidates with reasonably high probability of being bought out. Given the randomness of this process, we use several measures to screen out potential candidates. Companies that seek to delist share some common DNA: 1) stocks trading at steep discount to NAV/RNAV or low P/E multiples relative to the sector, 2) stocks with small free float, 3) major shareholders controlling more than 60% of the outstanding stock, 4) lightly-geared companies or companies in net cash, 5) regular insider purchases.

We will be releasing a report on this theme soon. Look out for it.

Source/转贴/Extract/Excerpts:DMG & Partners Research
Publish date: 03/01/12

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There’s no such thing as defensive stocks.Every stock can be defensive depending on what price you pay for it and what value you get,
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