Shelter from India &Indonesia
Investors have turned jittery on emerging market exposure, with India and Indonesia being the key concerns. While Singapore is traditionally viewed as a safe harbour, the threat of rising interest rates means that the usual refuge of REITs and telcos is not that safe either.
To compound the difficulty of stock picking, 2Q13’s results showed weak earnings momentum. We begin with a process of elimination, crossing out stocks with large India or Indonesia exposures, and stocks that would lose out in a rising rate environment. Our top picks are CAPL, DBS, EZI, FR, KEP, M1, OEL, SUN, THBEV and UOL. Singapore is rated Neutral with an end-2013 FSSTI target (bottom-up) unchanged at 3,400.
Equity markets worldwide have been getting hammered as fears of an end to the low interest rates collide with relatively high oil prices, triggering current account deficit concerns for some emerging markets. India and Indonesia have borne the brunt of the sell-down. In Singapore, the earnings season that concluded last week has not lent any confidence to the corporate earnings outlook either. With markets having forgotten May and June’s fears and recovering from then, it has turned ripe for selling.
What We Think
Singapore has been viewed as a boring, no-growth market in the past, but the repeated concerns sprouting for emerging markets have given birth to the view that Singapore is a useful place to hide. We agree, but highlight that hiding places must be checked for danger signs before cosying up to them. Losers from a potential spike in interest rates do not make for safe hiding holes. The same applies to those that bank on demand drivers of emerging markets or have large portion of assets locked in to those markets. Obviously, not all emerging markets are the same also.
What You Should Do
Our top picks are CAPL, DBS, EZI, FR, KEP, M1, OEL, SUN, THBEV and UOL. Our top bank pick remains DBS; it has some Indian exposure, but its peers are not necessarily safer with their Indo exposure. For developers, we like UOL as a Singapore proxy with scope for NAV upside; and CAPL, more likely to do well now that China concerns are second to India and Indonesia. SUN replaces AREIT as the latter is well-owned and risky in terms of potential for sell-down. KEP has an earnings surprise potential in 2H. FR, M1 and OEL are new names. THBEV is still preferred as it does not have the high multiples to make it that vulnerable, even in an earnings soft patch.
Indiaand Indonesia weakness –stocksto be waryof
Markets have become very concerned with Indian and Indonesian exposures today. Both countries are struggling with widening current account deficits. Both are seeing their currencies plunge. Both bear the risks of having potential inflation spikes unravel domestic consumer spending. All these factors could throw a spanner into the works for corporate profitability, so there is certainly reason to be concerned. We leave out stocks with Thai exposure, as our regional strategists do not see Thailand’s current account deficit as being in the same vulnerable position; they view Thailand more as a valuation risk on the back of its lofty expectations. We list out Singapore-listed names with the most India or Indonesia exposures, in descending order of exposure.
STOCKS WITH INDIA CONCERNS
• Religare has 100% of its income and assets based in India, leaving it exposed to currency movements. However, management has hedged its cash flow for FY14 using forwards at an average contracted rate of Rs47.28 to the S$. Hence, the impact on P&L is mitigated. However, we note that RHT has a S$60 million loan facility denominated in SGD. RHT does not hedge its balance sheet. We estimate that at the current exchange rate, its gearing ratio will rise from 9% to 10%. This is still below industry average. We maintain our Outperform call with a target price of S$1.07, based on DDM valuation with discount rate of 12%.
• Sarin Tech derives 77% of its revenue from India and has 69% of its fixed assets deployed in India. Earnings are predominantly in US$, so there is no margin impact. However, the continued devaluation of the Rs and bank credit tightening do not bode well for the Indian consumers. Reduced purchasing power may crimp Sarin’s customers’ sales to end-users. Some of that drag may be mitigated with new products where Indian customers can afford smaller upfront costs with pay-per-use additional charges. Sarin’s monopolistic position will also enable the company to defend margins better, but cannot shield it indefinitely from a dramatic macroeconomic slowdown. We rate Sarin Outperform with a target price of S$1.98, based on 16x P/E.
• India accounts for 12% of SingTel’s PBT and 16% of our SOP-based target price. We reckon that there could be a small impact on revenue and opex from the depreciating currency, though the usage of mobile telephony has proven to be resilient in previous inflationary periods. Singtel is a Neutral with an SOP-based target price of S$3.80.
• Wilmar has 6% of its total trade receivables coming from India (end-12). The group has hedged most of the currency risks of its operations. Most of its revenues (palm oil exports) and feedstock costs (CPO) are US$-based, hence, there is a natural hedge in downstream operations. Overall, we see the currency risk exposure to be minimal to slightly positive for its plantations division, but this could be partially offset by currency translation risk from its net investments. Wilmar owns some India associates but that is only a minor 0.3% of assets. Wilmar is rated Outperform with an SOP-based target price of S$3.74.
• DBS had some NPLs coming from its India portfolio in 1H13. We estimate that India accounts for 4-5% of group assets and DBS said that the Indian SME book accounts for ~6% of its Indian loan book. This implies that the current problem area in DBS (Indian SME) is only 0.3% of assets. However, if India’s economic problems broaden out to the rest of the country’s economy, NPLs could rise further. DBS said that 40% of the Indian book is trade finance, 50% is Indian corporates, and 10% is Indian SMEs. Theoretically, current NPL problems could broaden out to the larger Indian corporates (~2.2% of assets), bring up its problematic loans in India to about 2.5% of assets; potential pushing up DBS’s NPLs higher than peers. We rate DBS as Outperform, with a DDM-based target of S$19.07.
• SCI has a power plant in India but that is not in operation yet.
STOCKS WITH INDONESIA CONCERNS
• Petra Foods: Indonesia accounts for 74% of sales. Impact so far has been limited to just translation losses, 1H13 saw +8.5% Indonesia sales growth (local currency terms) reduced to +2.7% because of currency loss. Despite raw materials denominated in US$, margins have not been affected because of the discontinuation of unprofitable agency brands and higher proportion of premium brand sales. This pushed up gross margins in 1H to 32.7 % from 30.4 % and could mitigate any further currency losses. Petra is rated Neutral, with a target price of S$4.41 based on 18x EV/EBITDA.
• SingTel: Indonesia accounts for 22% of its PBT, while 16% of our SOP-based target price is from Telkomsel in Indonesia. Again, we reckon that there could be a small impact on revenue and opex from the depreciating currency, though usage of mobile telephony has proven to be resilient in previous inflationary periods. Singtel is a Neutral with an SOP-based target price of S$3.80.
• Ezion: Ezion has two liftboats working in Indonesia and is set t0 deploy another one in early-2014. We estimate that Ezion has 15% of its assets deployed in Indonesia in terms of book value. Additionally, we estimate that Indonesia contributes to around 13% of the group’s earnings for 2013 and 9% for 2014. However, as Ezion’s revenue and costs are mainly in US$, and Ezion reports in US$, there is little impact from a weakening Rp. Ezion is our top-pick among the small-to-mid cap O&M stocks with a target price of S$2.68, still based on blended P/E & P/BV valuations (Implied 8x CY14 P/E and 2.3x CY13 P/BV).
• Dairy Farm: Indonesia contributed 11% of revenue and 10% of EBIT for FY12. Indonesia is the key growth market for the group. Dairy Farm is expanding rapidly in all formats in the country, achieving 10.7% yoy growth in earnings for FY12. However, the 7% weakness in Rp vs. US$ meant that Dairy Farm only reported a marginal 3.7% yoy growth in earnings in terms of US$. Dairy Farm is a Neutral with a residual income-based target price of US$12.23 (implied 28x CY14 P/E).
• IHH: Indonesian patients contribution is about 6% to the group's core PATMI. PPL Singapore forms 35% of group core PATMI. Within PPL Singapore, about half of Singapore’s profit comes from foreign patients. Indonesian patients make up roughly 1/3 of that. Theoretically, these are the more affluent segments of the Indonesian population base and would be able to withstand the ill-effects of a spike in inflation better. We rate IHH Outperform, with a target price of S$1.81.
• OCBC and UOB: OCBC has 5.6% of 1H13 profits from Indonesia and 3.3% of assets locked in Indonesia. UOB has 4.5% of 1H13 profits coming from Indonesia and 2.9% of assets locked in Indonesia. If NPLs in Indonesia crank up, these would be the size of their potential problems. UOB stands potentially more sheltered as it has been wary of going after booming segments like motorcycle loans in the earlier boom years; hence, UOB could be more sheltered if consumer loans go bad.
• Tat Hong: Indonesia contributes 2-3% of Tat Hong’s group profits. On the topline, Indonesia distribution contributes ~8% of group revenue and Indonesia crane rental, ~2%. Profit contribution of distribution is lower, as it is low-margin. Gross margin for Indonesia is around 12-15% blended. Going forward in the next 2-3 quarters, management is easing off in Indonesia as it does not see immediate recovery in business there.
• Plantations sector: First Resources, Indofood Agri and Golden Agri have the bulk of their revenue generated from Indonesian operations (Golden Agri lower at 80% of total revenue). Assets in Indonesia (FR 100%, IFAR ~100%, GGR 93%) are also high. CPO prices are traded in US$ while about 50% of their total cost components are linked to US$. As such, operations wise, they are net beneficiary of the weaker rupiah as labour costs (denominated in Rp) will be lower. All have US$ debt exposure though these are hedged by US$ receipts for their palm oil exports.
Seeking refuge –dividend yields and earnings resilience
Stocks that have large exposures to India or Indonesia eliminate themselves as stock picks in this environment. These new concerns add to our previous concerns on stocks with high gearing, especially in a rising interest rate environment. As highlighted before, stocks with high gearing are mostly in the second-tier capital goods space or the commodity sector. The exception we like, among the highly-geared companies, is Ezion. We think that its earnings growth can overwhelm concerns on gearing levels.
Whenever emerging markets turn jittery, Singapore typically acts as a safe harbour. Unfortunately, blindly choosing yield stocks this time around is not necessarily the best defensive strategy either. The world is tumbling headlong into a rising interest rate environment, and dividend yields that are artificially leveled up will not hold up when financing costs rise. We sieve for high dividend yields, trying to avoid those where yields are propped up by high gearing. We also sieve for earnings resilience, using 2008-2009 earnings growth as a proxy while appreciating the difference in earnings drivers now and then. Unfortunately, the highest dividend yield stocks today are mostly REITs and business trusts, with the two highest yield stocks justifiably so because of their high gearing (APTT) and Indian exposure (RHT). AREIT has been one of our top picks for some time, the last of those among the REITs; however, it is rather well-owned and we are also getting concerned from the ownership angle. Among the stocks that showed earnings resilience in the 2008-09 crisis, we think EZI, PETRA, CCT, CD, RFMD are among those that still have the environment and business model to prove their mettle in 2013-14.
Earnings momentum -2Q13 earnings season highlights
That brings us to the issue of immediate earnings momentum – the recently concluded 2Q13 results season. The 2Q13 earnings season that ended last week saw earnings fall short of analysts’ expectations yet again. Three companies missed expectations for every five that beat expectations. Singapore’s corporate earnings were trimmed by another 3% over the season. The biggest EPS cuts came from transport, commodities and property. Our FSSTI core EPS growth expectations for CY13 have now gone negative (-4%). With two of the three banks beating expectations and Singapore banks being fairly defensive, we think banks are the new shelters for 2H13.
As the twin threats of fragile emerging markets’ growth and rising interest rates hammer at global equity markets, the mitigation for Singapore is that 1) market valuations are hardly demanding; 2) corporates’ balance sheets have little gearing, 3) the bulk of the local consumers are hardly over-stretched; while 4) banks have large capital buffers. We think there are stock picks in Singapore to help investors hide from the storm. Safety and resilience are fast emerging as the main attractions rather than absolute dividend yields or exposure to overseas growth.
Publish date: 20/08/13