Sunday, August 30, 2020

Highway trust is probably the way to go

One of the failings of the previous PH government was that it went full length for its fulfillment of the manifestos without thinking of its consequences. One of it was the abolishment of tolled highways which obviously is not possible. During the 22 months in power, there were 2 main proposals - lengthen the terms of PLUS highway while reducing and maintaining the rates and buying over the Gamuda owned highways. The first they managed to complete while the second I think it would not happen given the situation today.

The plans I would say were not thought of holistically. We now hear that the government is proposing to put together a trust and plans to put in total up to 35 highways into the trust. If I am not wrong, this would make more sense if the government is trying to reduce toll rates for the highways.

Although the plans are still vague, in my opinion the following would be part of the plan.  

The Malaysian highways as I have mentioned many times are complex asset and shareholdings situations. The major shareholders of the highways are consisting of important players such as Khazanah, EPF, PNB, Gamuda, IJM and many bond holders. One must know the holders of highways actually are people's funds to an extent that Gamuda and IJM are held largely by Malaysian funds. We cannot terminate the contract as it would have impacted all of the above - government and people ownership related - not to say the sovereign trust of a country. How do we address the situation without impacting the players actively. A trust fund!

How should the trust fund work then? It is important to note that I am only 1 single individual whereas the government has many corporate thinkers and planners looking at it. Lets say from the 35 tolled highways, the total capital value is RM100 billion. To make the trust workable, Malaysian government would create a something like RM25 to RM30 billion highway trust funds - bond and equity (mainly government) combined. These money would only do 2 things - invest into existing and future highways, and pay dividends to bondholders and shareholders. The shareholders would be Malaysian government largely.

Additionally, the trust fund should not be profit oriented and it should also not be operator of highways. Its role is to purchase off about 20% to 30% of all highways from the current highway operators at the current market rate (with small discounts). The current highway operators shall be allowed to maintain the highways themselves while also be holding a significant controlling stake. This means that the highway trust through the government is a participant of the business but they are not involved in the daily decision making.

How does it help to reduce the toll rates then - where it can help the rakyat?

As most highways are usually profitable and cashflow accretive, they will pay good dividends to the shareholders. The trust fund being a shareholder will be receiving those dividends. The money received can be reinvested into the highways or it can be used to fund the subsidy on the price increase of the toll roads. As we know, many of the tolled highways are already being subsidised. In the past, it came from the government coffers directly i.e. from the yearly budget. Through the trust fund, it can still be directly from the coffers (i.e. partially from the dividends received) or through the extra unutilised funds from the highway trust fund.

Another additional structure which the government can do is to create a REIT like trusts for the highway owners. Through this the already completed highways (mainly) can get this highway REITS listed, where the government highway trust can invest into. This will enhance the capital as well as the bond market as now those are lacking.

Highways are allowed to still compete but at least they compete in the areas of service rather than price. Future and maybe even current technologies such as e-payment system will enable this concept to work better. I do not think in future highways tolling will be fully eliminated but perhaps some small fees will be charged (much like parking charges by municipals) to upkeep the roads. These revenue can be forwarded to the highway trust fund.

Through this method I think the concept of managing and keeping the tolled highways manageable for both users and subsidy providers (government) can be better afforded.   

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.