Monday, June 8, 2020

Why is the stock market doing fairly well, while we expect economy to go into recession

There is no doubt the economy globally is getting into a recession. Technically, recession is when an economy faces a decline in two consecutive quarters. Most economies are facing lockdowns situation between the end of first quarter and second quarter of 2020. That by itself would have caused a technical recession for the 2 quarters. For some economies that are dependent on foreign purchases of our services, goods (such as Malaysia, Singapore, Thailand), even if we do well for our local economy, lower demand from overseas would cause a recession nevertheless. What is in most economists and government would be not to allow prolonged recession which is what we termed as depression. In short today, the argument is to whether we are moving into a depression or not and how to prevent it.

This time around people have been shocked by the so-called disconnect between the general economy (which we called Main Street) and stock market. In US, while technical unemployment is registering close to 20%, its Wall Street (stock market) is actually registering record numbers (Nasday which is mainly for technology stocks). Many stock markets although have not been registering as good numbers as Wall Streets, it nevertheless has rebounded and seemed to be doing well. KLCI which is the main blue chips stocks in Malaysia, is not at 1,556 points after touching a low of 1,219 on 19 March 2020, days after the Movement Control was announced. Our peak was about 1,878 points, the period when oil price was still registering above USD100. Hence, I would call it that the market is now at midpoint. However, the economy is seemingly going to suffer beyond the mid-point level for the stock market as we suffered a what I would call a double whammy - COVID-19 pandemic and low oil price (our economy is dependent to a large extent on oil).

Now the question is why is the stock market holding up? Here are a few explanations.

Emergence of retail investors

I have been investing in the market for a while. The last time I have seen the huge participation from retail was 1997 - prior to the last major Asian financial crisis. During then, we were trading at what we called T+7, which was we only pay 7 days after we made our trade. Today it is T+2. Hence, during then a lot of people were playing contra - where we do not have to pay for the trade until many days later. Hence, during the trade, if the stock rises, we do not need to pay any money for the purchase. Since the crisis, with EPF (a very large fund) started to come into the stock market, retail players started to dwindle. The market has been largely determined by how EPF and several smaller others wanted the market to be (together with smallish foreign institutional funds).

The emergence of the retail investors seemingly is appearing from the lockdowns. I have started to hear doctors, lawyers, young professionals, executives started exploring the market. I call this healthy as it is obviously a financial lesson for many of them whether they made money or not. (I am not worried of rich doctors losing money in the market and started learning about fundamentals - they can learn fast)

One of the stockbroking license holder which focuses on retail (Rakuten) for the first time experience profits. Now, whether post COVID-19 these retail investors remain. I hope so, as the market is starved of new groups of investors. Imagine, how eager for us to hope for this group while these new investors whom have been looking at other asset classes such as bitcoins, forex are now putting some attentions on stocks. The focus now is for them to make money over the long term rather than losing and leave.

Stocks as alternatives for other investment assets

As mentioned above, while the younger generations have gone into other kinds of investments, this time around those alternatives are not doing well. Those includes commodities mainly and to a smaller extent bonds.

It helps when in US, the largest of the stocks such as Amazon, Microsoft, Netflix are expected to report record numbers. In Malaysia, those are the rubber gloves companies. It does help to spur the stock market economy as there are no substitutes for investing into rubber gloves companies if not investing into the stock market. Similarly, there is no other way to invest into Amazon.

Flush with liquidities

The Federal Reserve of US is throwing $4 trillion or more into the economy. We are far, but we will get some as well. In Malaysia, we are getting hundreds of billions of stimulus cash or other forms. Imagine if the banks tell us we do not have to pay our loans for 6 months, we suddenly have extra cash. That is probably where money will flow into the stock market. At the same time, when we cannot spend outside of our homes, we may buy some goods online, the remaining some would probably go into the stock market. Profits feed more liquidity into the market and this time around the liquidity is into the hands of the small guys rather than the institutionals - which is good.

In addition, when the system is flush with liquidity with the Feds printing money, it also means the cash we hold has come down in value. This encourages even with the complex investment thoughts not to hold cash in the long term as the money they hold would lose value.

I have been chasing where the money has flowed to - however I have missed out that it actually moved from the banks (system) to the hands of the consumers but some of it ended up in the market. I have originally thought that the institutional guys (such as funds) would be keeping funds to pick up the debt instruments. It has yet to really happen.

Market valuation is a not a fix situation

One of the reason I have never put a price onto a stock - although I generally think what a price would be for me to be interested. When interest rates go to zero in US and in Malaysia, dropped by more than 1%, that investments or savings would tend to move somewhere else. The opportunity investments from bonds or fixed deposits would be other asset classes. In finance, we call this risk free rates. So now risk free rates has dropped, so when we do a discounted cashflows, the other alternative asset would increase in price. Example for this, risk free rate drop to 2% - generally this means I am willing to take risk of a straight line PE (better still DY) of 50x (not encouraging the thinking that a 50x PE is a fair value but just as example). In the past, when risk free rate was 4%, that PE I was willing to tolerate was 25x. That is a 1 single X factor increase.

Will this trend last?

I hope it does last long enough. Nothing beats the need to rekindle or beefing up the Main Streets. However, the market itself can play a role as happy investors will translate into happy consumers. This is the way generally the poorer income group (here we call them B40) can get helped besides giving cash alone.

The financial economy (includes capital markets) is also a part of the economy, and we need to get this to be more active.

Saturday, June 6, 2020

Why some highways are less profitable

I do not quite agree when we put it that it is very difficult to project the cashflow projections of highways. Unless we are talking of flying cars and changing habits over transportation over the next 30 - 40 years, this business will be more consistent than many businesses. Yes, we do not know what the future entails but so are many other businesses. As long as cars, trucks and buses are not replaced roads will still be used.

I have been asked on why then some of the highways are not profitable or rather seemed to be not or less profitable. Take a read over this news - PLUS Expressway's profits for FY2016 was RM288 million i.e. not great for a company this size.

For FY2010, let me show what the number was. FY2010, it was already doing RM1.3 billion PAT. What happened then?


Did the traffic dropped. It obviously did not drop. By 2019, PLUS was already doing RM4 billion revenue. Let's look at this news. Post delisting, PLUS raised a RM30 billion debt. Much of the money went back to the short term funds raised and for repaying to EPF.

I provide a simple P&L calculation as below. Let's assume a project in middle of its concession and the P&L is as provided below. If the cashflow is consistent, I do not need to do much, many Investment Bankers will be approaching the company.



With good ratings, the funding rate would allow the owner of the business to take money upfront and use the funds to venture into other projects. So, when people like Warren Buffett says he has $130 billion cash, it does not mean he has no debt, he has carved out his good assets such as the utilities and made available funds for his other acquisitions. So is YTL.

Let's say the highway has 20+ years to run (and revenue is growing), when approached, the company would raise a RM20 billion debt at probably 5% and the P&L would look like below.

Now, immediately the profits is now 0. Of course, overtime the profitability would increase as it is needed to pay principal for the debt instrument but we usual investors are probably being misrepresented if we do not know the actual exercised behind it. Usually, this kind of projects may be candidates for delisting and then relisting.

The similar situation was probably seen for MTD Capital (which went delisting as well in 2011), the owner for East Coast and KL-Karak Highway.


Today, as provided to me, ECE and KL-Karak Highway together are not making much profits which is not true in actual cashflow per se.

This the reason why I mentioned of cashflow rather than profits for concessions such as highways.

Thursday, June 4, 2020

Challenging the Gloves valuation - Top Glove as example

This article is going to be hugely unpopular. But let me put it, I am a supporter of Malaysian gloves business, you can do a search on my write-ups. The recent events on increasing valuation for gloves not just by retail investors but analysts' recommendations really surprised me. Let me take the largest of the gloves maker - Top Glove which is the largest maker by far. I have no doubt that the demand-supply had gone out of whack. However, how is it that the valuation can be this high.

Two analysts put it at around RM20, another put it at RM23. Today, Top Glove's price is around RM15.60. That translates to RM52.6 billion, RM60.5 billion and RM41 billion valuation respectively. Numbers are just numbers. I am taking those numbers and try to present where it is based on that valuation and what are the risks by picking those prices, especially at RM23 and RM20.

Below are the most aggressive numbers based on a RM23 valuation. The analyst presented the numbers for the subsequent 3 years between 2020 to 2023 and went silent on numbers further down the road. It is obvious the next 2 years will be period where numbers are going to be very high - I do not dispute. I am thinking even at 2022/23 (PAT RM836.6 million), if the profits is going to double the numbers for the normal period of 2019/20 - that is a stretch.


However, let us just say I am going to be hugely bullish i.e. after the period 2022/23, it will still grow at 10% per year for the next 6 years. Based on the above situation, I have put up 3 situations i.e. at what average PE would the company be given their price of RM23, RM20 and RM15.60. The average PEs for 10 years would be very high indeed - 64x (at RM23), 55.5x (RM20) and 43.3x (RM15.60)

To go for a more humble situation, I would not challenge the numbers for the next 3 years but let us put the 2023/24 PAT at a more realistic number. Post 2023, the PAT will drop by 20% - even then its number would be 84% higher from its normal year i.e. 2019/20. Subsequently, the profit numbers would grow 5%. That translates to 80.51x PE for price of RM23, 70x PE (RM20) and even a very high 54.61x PE for its current price of RM15.60.


Even, at a price of RM10 (which is not something we can expect given it is now RM15.60, the average PE would have been 35x, given the scenario above. See below's table. That is still high.


Now, let's look at the economics of rubber gloves.

Remember, rubber gloves while at today's situation it is difficult to create enough supply to meet demand, however are we saying that the demand-supply will still be abnormal after COVID-19. In fact, with the creation of extra capacity at large quantities, it is possible that there could be oversupply situation by then i.e. 3 years after this pandemic started in Jan 20.

Rubber gloves business is not a monopolistic business, although there are situations where certain companies such as Top Glove, Kossan and Hartalega are the larger of the manufacturers. Are we saying that with COVID-19 assuming to be still around after this 2 years, there will not be ramp up of supplies by these guys who would act as check and balance of each other in terms of competition? What about the other players?

How long does it take to create new factories and new lines? More than a year?

I cannot see the economics of it as this business is not in a situation where barriers of entry is very high. No player has huge advantage over the other except for some extra efficiencies and economies of scale. Given the huge margins today, many new companies will not even bother with scale. There could even be new entrants - have any of the analysts thought of this given it is so lucrative?

There are just too much unknowns and many of these are not put into considerations. For many businesses, by putting a overly high price, they run into risks of being shun when situation becomes normal. Typically for this business, it is about long term relationships. I understand that some of them had created a new idea by putting a percentage of their supplies on the spot market (meaning let it be done through bids). However, business like this is not done in such manner. It is not our typical commodities.

Tuesday, June 2, 2020

Why there're flaws in the most extensive written piece on WCE

I must say I am impressed with a fellow blogger on the piece about WCE titled "Why Highways are gruesome industry - WCE Holdings Berhad". This article has been pointed to me, and I feel that since I have been a promoter of this asset and stock, I do have a duty to write and provide my opinion.

In his article, he pointed out that WCE is worth 25 sen which is around the pricing it is trading at currently.

Let me go point by point but I try to be brief:

- assumptions and cashflow projections - I would like to thank him for providing a brief on RAM's base numbers for the calculation of the highway's rating and cashflow. It is highlighted as below that the base case scenario for the cashflow provided by RAM is RM461 million on average for the first 5 years of its full operations. That I assume will be for year of 2022/2023 where this project has been delayed to. I have done my own cashflow (extensive) and it is very difficult to share it and I have to say that the numbers which I have is very close.

My basis for the first full year of operation is based on PLUS's numbers as well as the traffic that the west coast is able to generate by itself. Choivo puts it that the first full year of revenue will be RM200 million which I do not think is right. At the moment (prior to the 18% discount), PLUS is doing about RM4 billion a year. About 78% of that comes from North-South Expressway (NSE). Hence, on that basis, we can project some numbers for WCE. NSE has 772km whereas WCE has 233km (actual length is 316km as some portion are free). Lets assume that with the opening of WCE, it will take about 35% of the traffic from PLUS. The numbers will hence be something like this:

Total PLUS revenue x NSE portion x 35% x total WCE's length compared to PLUS x 233 (i.e. the tolled portion) / 316
= RM4,000 million x 78% x 35% x 316 / 772 x 233 / 316
= RM329 million a year

Besides that I am sure that WCE is generating its own traffic as the path that it passes through has its own base which is from Klang to Lumut and right up to Penang port. That to me should be around 20% of additional traffic. So let's say

RM329 million x extra 20% = RM394.8 million

The first few years, the growth should be high, hence let's put a 7% onto the growth of the revenue.
So we should be able to get numbers like RM395m, RM422m, RM452m, RM484m, RM517m. So let's say my calculation provides a revenue of RM454 million for the first 5 years on average. This is pretty close to the ones provided by RAM. RAM as in its usual practice will put a sensitised case where it provides RM275 million. That in our language is the worst case scenario. One must note that RAM looks at whether the bond is payable while I look at the investability of the project (which margins of safety) See below.

This beginning number is very important as it is a basis for subsequent years. In cashflow projections, only few things are important: inflow, growth, costs. Once we have the first full year inflow right, the next thing which is important is growth. Highways will have high growth in first few years and as we know for WCE, many developers are already preparing themselves for the completion of this highway as the project act as nucleus for growth from the west coast to southern Selangor. Remember Abdul Wahid (ex TM, Maybank CEO)  was very keen for the growth of southern Selangor through Klang and Port Klang when he was the EPU Minister.

- The project is 50 + 10 years. The writer only uses 50 years for his cashflow projection. The PLUS10 is when WCE does not meet the minimum required IRR (which I assume is at around 9%). As we know, there is a huge difference between total 50 years vs if we are able to collect another 10 more years. Remember, the last 10 years are the best 10 years. Obviously, if WCE is able to achieve the minimum IRR, then the toll collection should end at year 50, then we should be not debate about how profitable the highway is.

- The writer mentioned highway is rarely profitable. It is not true, many highways in Malaysia are profitable. Some highly. He puts in the numbers for PLUS. That is not right and misleading. PLUS was built at a costs of RM5 billion. How did it have RM30 billion debt today. This is because the owners were taking money upfront and used the cashflow to sell debt. That I believe had been done various times. Basically, PLUS is about using the cashflow to increase the debt. When the debt is high, obviously the interests is proportionately high as well - hence the losses, which coincidentally reduces the tax rates. So, for the profitable highway guys, it is about increasing the debt with low interests and reducing the taxes. I believe the restructuring for KL-Karak and ECE are pretty much the same. Let me put it this way, why is it that even less than a year ago several parties were keen on PLUS and they were putting a price of up to RM39 billion on PLUS. One must know that some of the bidders have been advised by the same group of people whom are advising for the WCE project.

Although SPRINT is not profitable, this is because it is part of the continuous project from LDP. The strategy is SPRINT feeds the traffic to LDP, where the latter is the most profitable highway in Malaysia. Such is the cleverness of Gamuda. Yes!, The Storm water project is not supposed to make money as Gamuda-MMC already took the money from the difficult construction project. Although some highways are not profitable, they have been poorly studied and are usually built by PNB or some contractors whom did not do enough study. I do not want to name them.

- IJM's track record - The company is second to Gamuda at studying, building and managing highways through its subsidiary Road Builder. Such highways are NPE, Besraya and eventually LEKAS will be profitable as well. IJM will not want to depend on traffic consultant to provide the numbers or projection as their skin is in the game. Why would IJM be negotiating hard on the contract when it knows it would have been losing money on the project.

- WCE is not really northern region - in fact WCE is taking away the more profitable portion of PLUS's NSE - which is why it stops at Banting and Taiping.

- The meat is not for the highway owners but rather the contractors and maintenance companies, as mentioned. NOT TRUE. In the case of PLUS - yes. Why? PLUS is owned partially by us (through EPF) while UEM's subsidiary - Edgenta - maintains the highway. Let me put it this way, if I am owner and contractor, I have liberty of allocating the profits. In the case of WCE, IJM is not making much profits as it is putting attention at keeping the costs within the budget - as it has also been overrun. Talking about PLUS, if the maintenance is given to another company, and WCE is from within, how much savings would WCE be having?

In the case of WCE, the listed company will be the owner (80%) and maintenance company as well.

Generally my mistakes is by putting much early thoughts into a very long term project, as I put myself into a position where if provided an opportunity to buy a highway like this, at what price would I commit. That obviously is not in the mind of many investors as they would rather see the money now - hence the difference between greenfield and brownfield projects.

To me, it is not even meaningful to put WCE at a price of around RM700 million which is the value the market provides for it today. If it is a loss making highway, it would be zero value for the highway (without including the 40% property owned at Rimbayu). Anyway, the highway and property division is clearly demarcated and the liabilities are not intertwined. Why is RM700 million an unimaginable valuation then? There are mainly few probabilities -

1) what is the probability of the project not completed - well it is now about 70% completed.
2) what is the probability of it being loss making which makes the project not meaningful - think of the additional 10 years assuming it does not achieve the targeted IRR.
3) what is the delay on the portion which is free and build by the government

Hence, when looking at it, it is about the probabilities as RM700 million is about 2 of initial years of collection for a project which has 50 or more years to receive its cashflows. The latter years, what the inflow will be I do not even need to share as in highway, it is about continuous growth albeit at lower growth for latter years. Think through this carefully.

Saturday, May 30, 2020

Where do we look for Malaysia in the new normal

I started my career at almost the similar timeframe as September of 2019 in this crisis, but 22+ years past. During then, the market was really hot especially among the second boards (then there was a second board which later was merged into the Main Board). Back then, I was tasked to maintain a group of 40+ loan accounts and look for new ones. I remembered the 2 earlier business accounts that I met up with which was my first time to Batu Pahat and Muar, situated in southern Malaysia were furniture makers. Both of them were doing relatively well. One whose business was selling to the entire country with lorries delivering furniture comprising from simplest of low costs RM30 furniture to sofas. The other was doing purely exports, run by a Taiwanese family.

Of course, 6 months later the Asian financial crisis hit Malaysia. We knew about it but my lack of experience caused me to not know what to do and expect as it was my first real experience of what a crisis was. In a matter of hours Malaysian Ringgit was devalued by easily double digit percentage. The business community whom were caught did not know what to do. So was the entire nation. I can vouched however, there is a huge difference though during then compared to today. During then, the banks would have pulled back the banking lines that were unutilised as they feared of facing more exposures. (Today, quickly BNM imposed a 6 months moratorium on payment for the businesses - This would have given some breather although we have yet to see the impact after that 6 months)

Of course, when RM plunged - it was a tale of two stories for the furniture makers. The one that was selling within the country saw its sales plunged (and later went under receivership) while the one that was doing exports later on became very big and it subsequently got listed and has a huge operations in Vietnam today. We know the main reasons as sales was in USD through exports to US and Europe while the local one was holding a combined foreign and local costs while sales was a mere fraction of what it used to be when the crisis hit.

Today, that situation we faced 21 years ago has its similarities. BNM and the Finance Ministry this time would not have the challenge of defending the Ringgit but we have an economy that was almost on standstill for 2-1/2 months - especially on buying the non-essential items (furniture is one of them). We are going to face worse as time passed when people are now more careful on their spending. That spiralling effect of less-spending would cause local domestic economy to suffer. This time around though, the sales to US for some goods will not enjoy a similar profile as the US, UK, Japan, China's Main Streets are also suffering the same.

However, as one can vouched, this crisis (as people call it will turn to a new normal - and that new normal does not look good for Malaysia) is going to change the business landscape. What is the new normal then? It is going to be more of the digital normal - which means usage of services, purchases of goods are almost borderless. Today, I am sitting at home working using cloud services provided by Google and Amazon. My company is buying more servers with components and equipment made by Intel, AMD, Cisco just to address this period. There is this imagination that the new normal would also mean many globally would subscribe to services and products that are provided by just a handful - Amazon, Google, Microsoft, Facebook, Netflix, Alibaba, Tencent, ByteDance. Many people are buying goods direct from China through Lazada and Shopee - I am not sure our government realise this but the retail market share is more and more getting away from Malaysian companies.

Where do we go then? It is going to be late if we want to compete against the Amazon(s) and Alibaba(s). Rubber glove is a good situation for Malaysia but it is not the new normal. It is the current normal and it may go away. We as a country has to build and encourage up a group of businesses that will be trading globally. Rubber gloves gave us some business safety net. We have a country which geographically and infrastructure-ly built for international trade. The Trade War which is back after 3 months of hiatus - we Malaysia is going to take advantage of it. We are going to use Klang, Johor's ports as an advantage.

Already some of the businesses that are resilient - we can see is made out of this infra and positioning. Those names are Scientex, Dialog, Guan Chong (maybe even MSM) - mainly comprise of producers, traders and manufacturers of essential and daily used items. We have to get Malaysian companies to be strong with digital exposures.

What we have tried to do through our digital initiatives did not really bear much fruits. We were followers. If in US or China a digital business model is successful, we tried to copy them. This is not taking advantage of what we are strong in. Malaysia is a nation which is exposed to the world. US and China, when they built on an idea - they have a huge internal consumption to test on those ideas. We do not have that. I am sure when Spotify was created it was not meant for the Swedish market.

So where do we go in terms of the stock market? All things are not lost. We have enough of these companies and entrepreneurs. When I was exposed to the rubber gloves makers back in 2000, those companies were nowhere near what we imagine they are today. We can recreate many of these similar companies in many different industries. Scientex is one huge example. So was Press Metal. Back 18 years ago, I was not impress with the company - again I am mistaken.

I think this crisis, which is yet to show its true-devil self, would still present opportunities and the way to look for it is less of the inward looking ones but search for the ones that would go outward of this country.