Equity Bottom-Up

In this briefing:

1. Tesla. SEC Contempt Filing & Ludicrous Autopilot Claims Engulf Delusional Musk
2. Indonesia Property – In Search of the End of the Rainbow – Part 2 –  Bumi Serpong Damai (BSDE IJ)
3. Baidu (BIDU): Stagnant in 4Q18, Wrong Change Feeds a 24% User Increase to Google
4. Ho Bee Land – 4Q Earnings Hit by Unexpected Tax Provision

1. Tesla. SEC Contempt Filing & Ludicrous Autopilot Claims Engulf Delusional Musk

The US Securities and Exchange Commission (SEC) requested a federal judge to hold Tesla CEO Elon Musk in contempt of court yesterday regarding recent misleading tweets about the company’s unit production volumes for 2019. This latest move comes not long after Musk bragged that he does not respect the SEC and that his tweets were not being censored by the Board according to the terms of the agreement reached with the SEC following his controversial “Am considering taking Tesla private at $420. Funding secured” tweet on August 8’th last.  

Separately, Musk has been talking up the capabilities of the company’s Autopilot technology, claiming that it will deliver “Full Self Driving” by the end of the year, that its in-house developed hardware is 2000% better than NVIDIA’s and that by the end of next year, it would be safe for somebody to fall asleep with Autopilot in control. We find these claims to be ludicrous and Elon Musk delusional in thinking that the SEC would stand idly by while he publicly admits to ignoring the terms of his settlement with them barely four months ago. 

2. Indonesia Property – In Search of the End of the Rainbow – Part 2 –  Bumi Serpong Damai (BSDE IJ)

In this series under Smartkarma Originals, CrossASEAN Research insight providers Angus Mackintosh and Jessica Irene seek to determine whether or not we are close to the end of the rainbow and to a period of outperformance for the property sector. Our end conclusions will be based on a series of company visits to the major listed property companies in Indonesia, conversations with local banks, property agents, and other relevant channel checks. 

The second company we explore is leading township developer Bumi Serpong Damai (BSDE IJ), with exposure ranging from landed housing, shophouses, condominiums, as well as the defensive and growing buffer of nearly 20% of revenues coming from recurrent rental income.

Bumi Serpong Damai (BSDE IJ) has one of the largest land banks of any developer, with a land bank of over 4,000 ha, more than half of which is in its flagship township of BSD City in Serpong.

Given its breadth of exposure to the property segment, the company has the flexibility to switch its exposure between different segments depending on the health of the overall market. 

Its projects are well connected by toll-roads and railway but it is well positioned to benefit from new infrastructure such as the new MRT, LRT, as well as new toll road extensions, which will enhance the attractiveness of its developments.  

Management suggests that they will take a cautious start to the year ahead of the election but see a window for a pick-up in marketing sales in May, with the potential for a much better 2H19. 

Despite a run-up in the share price since the start of the year, valuations do not look challenging from a historical basis especially looking at its PBV. It also trades at a significant discount to NAV of 67%, as well as being below its 5 yr historical mean on a forward PER basis.

Catalysts ahead include a post-election pick-up in activity leading to more project launches, completion of infrastructure projects, aggressive mortgage lending by the banks, and a more dovish interest rate outlook. Valuations are already attractive but a rise in property market activity should also lead to earnings upgrades, which if sustained, may lead to property prices moving upwards.

3. Baidu (BIDU): Stagnant in 4Q18, Wrong Change Feeds a 24% User Increase to Google

• Baidu posted a weak result for 4Q2018.
• We believe it is a wrong decision to change Baidu into an in-house search engine.
• Alphabet Inc Cl C (GOOG US) ’s monthly active users in mainland China increased 24% QoQ in January 2019.
• We believe Baidu’s stock price has been fairly impacted.

4. Ho Bee Land – 4Q Earnings Hit by Unexpected Tax Provision

Ho Bee Land Ltd (HOBEE SP) (“HBL”) reported it 4Q 2018 financial results this evening.

PATMI for 4Q18 dropped 20.5% YoY to S$81.4 mil. Excluding the impact of the tax provision for Hotel Windsor, underlying PATMI would have remained stable at approximately S$101.7 mil.

HBL’s real estate business had performed within expectations. There were also improvements in the financial position of HBL, such as the increase in cash balance, lower net gearing ratio, refinancing of bridging loan and extension of debt maturity.

Fair value of HBL is pegged at S$3.32 per share, translating to an upside of 32%. REIT listing remains a potential catalyst. I maintain my BUY rating on HBL.

In this briefing:

1. Indonesia Property – In Search of the End of the Rainbow – Part 2 –  Bumi Serpong Damai (BSDE IJ)
2. Baidu (BIDU): Stagnant in 4Q18, Wrong Change Feeds a 24% User Increase to Google
3. Ho Bee Land – 4Q Earnings Hit by Unexpected Tax Provision
4. Notes from the Silk Road: Nine Dragons Paper Holdings (2689.HK) – Potential Volatility Risk

1. Indonesia Property – In Search of the End of the Rainbow – Part 2 –  Bumi Serpong Damai (BSDE IJ)

In this series under Smartkarma Originals, CrossASEAN Research insight providers Angus Mackintosh and Jessica Irene seek to determine whether or not we are close to the end of the rainbow and to a period of outperformance for the property sector. Our end conclusions will be based on a series of company visits to the major listed property companies in Indonesia, conversations with local banks, property agents, and other relevant channel checks. 

The second company we explore is leading township developer Bumi Serpong Damai (BSDE IJ), with exposure ranging from landed housing, shophouses, condominiums, as well as the defensive and growing buffer of nearly 20% of revenues coming from recurrent rental income.

Bumi Serpong Damai (BSDE IJ) has one of the largest land banks of any developer, with a land bank of over 4,000 ha, more than half of which is in its flagship township of BSD City in Serpong.

Given its breadth of exposure to the property segment, the company has the flexibility to switch its exposure between different segments depending on the health of the overall market. 

Its projects are well connected by toll-roads and railway but it is well positioned to benefit from new infrastructure such as the new MRT, LRT, as well as new toll road extensions, which will enhance the attractiveness of its developments.  

Management suggests that they will take a cautious start to the year ahead of the election but see a window for a pick-up in marketing sales in May, with the potential for a much better 2H19. 

Despite a run-up in the share price since the start of the year, valuations do not look challenging from a historical basis especially looking at its PBV. It also trades at a significant discount to NAV of 67%, as well as being below its 5 yr historical mean on a forward PER basis.

Catalysts ahead include a post-election pick-up in activity leading to more project launches, completion of infrastructure projects, aggressive mortgage lending by the banks, and a more dovish interest rate outlook. Valuations are already attractive but a rise in property market activity should also lead to earnings upgrades, which if sustained, may lead to property prices moving upwards.

2. Baidu (BIDU): Stagnant in 4Q18, Wrong Change Feeds a 24% User Increase to Google

• Baidu posted a weak result for 4Q2018.
• We believe it is a wrong decision to change Baidu into an in-house search engine.
• Alphabet Inc Cl C (GOOG US) ’s monthly active users in mainland China increased 24% QoQ in January 2019.
• We believe Baidu’s stock price has been fairly impacted.

3. Ho Bee Land – 4Q Earnings Hit by Unexpected Tax Provision

Ho Bee Land Ltd (HOBEE SP) (“HBL”) reported it 4Q 2018 financial results this evening.

PATMI for 4Q18 dropped 20.5% YoY to S$81.4 mil. Excluding the impact of the tax provision for Hotel Windsor, underlying PATMI would have remained stable at approximately S$101.7 mil.

HBL’s real estate business had performed within expectations. There were also improvements in the financial position of HBL, such as the increase in cash balance, lower net gearing ratio, refinancing of bridging loan and extension of debt maturity.

Fair value of HBL is pegged at S$3.32 per share, translating to an upside of 32%. REIT listing remains a potential catalyst. I maintain my BUY rating on HBL.

4. Notes from the Silk Road: Nine Dragons Paper Holdings (2689.HK) – Potential Volatility Risk

On the eve of the Chinese New Year holiday Nine Dragon Paper (NDP) released a profit warning regarding their H1 FY19 fiscal earnings. This warning came ahead of the 26th February 2019 Board Meeting.

Management guidance calls for a decrease for H1-2019 of approximately 45% YoY and revenue line of not less than RMB2.4bn. NDP cites an increase in raw materials and a decrease in the selling price of the products. 

Despite the negative news, the share price has rallied 15% since the announcement. We examine the implications.

In this briefing:

1. IQiyi (IQ): In 4Q18, Baidu’s Growth Engine Lost Control Over Content Cost

1. IQiyi (IQ): In 4Q18, Baidu’s Growth Engine Lost Control Over Content Cost

• We notice that the growth rate of cost of revenues exceeded the growth rate of membership revenues.
• We believe that the margins will continue to decline even if the advertising business recovers.
• IQ has the largest monthly active users in the video market, but it does not have an obvious advantage over Tencent Holdings (700 HK) .

In this briefing:

1. IQiyi (IQ): In 4Q18, Baidu’s Growth Engine Lost Control Over Content Cost
2. HK Connect Discovery Weekly: Geely, Great Wall Motor and Sands China (2019-02-22)
3. CSE Global: Gaining Momentum

1. IQiyi (IQ): In 4Q18, Baidu’s Growth Engine Lost Control Over Content Cost

• We notice that the growth rate of cost of revenues exceeded the growth rate of membership revenues.
• We believe that the margins will continue to decline even if the advertising business recovers.
• IQ has the largest monthly active users in the video market, but it does not have an obvious advantage over Tencent Holdings (700 HK) .

2. HK Connect Discovery Weekly: Geely, Great Wall Motor and Sands China (2019-02-22)

In our Discover HK Connect series, we aim to help our investors understand the flow of southbound trades via the Hong Kong Connect, as analyzed by our proprietary data engine. We will discuss the stocks that experienced the most inflow and outflow by mainland investors in the past seven days.

We split the stocks eligible for the Hong Kong Connect trade into three groups: component stocks in the HSCEI index, stocks with a market capitalization between USD 1 billion and USD 5 billion, and stocks with a market capitalization between USD 500 million and USD 1 billion.

In this week’s HK Connect Discovery, we highlight the strong inflow to automobile stocks and Sands China. 

3. CSE Global: Gaining Momentum

• Investors who have bought CSE Global on dips since my last note would have profited ~18%.
• The upbeat guidance by management and supply-demand environment should give some legs to the recent rebound.
• While risks of slower global growth may weigh on the stock, the stock is trading below its five-year average PE despite significantly improved cash flow from operations and a healthy order intake (three-year high). 

In this briefing:

1. IQiyi (IQ): In 4Q18, Baidu’s Growth Engine Lost Control Over Content Cost
2. HK Connect Discovery Weekly: Geely, Great Wall Motor and Sands China (2019-02-22)
3. CSE Global: Gaining Momentum
4. Indonesia Property – In Search of the End of the Rainbow – Part 1 – Ciputra Development (CTRA IJ)

1. IQiyi (IQ): In 4Q18, Baidu’s Growth Engine Lost Control Over Content Cost

• We notice that the growth rate of cost of revenues exceeded the growth rate of membership revenues.
• We believe that the margins will continue to decline even if the advertising business recovers.
• IQ has the largest monthly active users in the video market, but it does not have an obvious advantage over Tencent Holdings (700 HK) .

2. HK Connect Discovery Weekly: Geely, Great Wall Motor and Sands China (2019-02-22)

In our Discover HK Connect series, we aim to help our investors understand the flow of southbound trades via the Hong Kong Connect, as analyzed by our proprietary data engine. We will discuss the stocks that experienced the most inflow and outflow by mainland investors in the past seven days.

We split the stocks eligible for the Hong Kong Connect trade into three groups: component stocks in the HSCEI index, stocks with a market capitalization between USD 1 billion and USD 5 billion, and stocks with a market capitalization between USD 500 million and USD 1 billion.

In this week’s HK Connect Discovery, we highlight the strong inflow to automobile stocks and Sands China. 

3. CSE Global: Gaining Momentum

• Investors who have bought CSE Global on dips since my last note would have profited ~18%.
• The upbeat guidance by management and supply-demand environment should give some legs to the recent rebound.
• While risks of slower global growth may weigh on the stock, the stock is trading below its five-year average PE despite significantly improved cash flow from operations and a healthy order intake (three-year high). 

4. Indonesia Property – In Search of the End of the Rainbow – Part 1 – Ciputra Development (CTRA IJ)

In this series under Smartkarma Originals, CrossASEAN insight providers AngusMackintosh and Jessica Irene seek to determine whether or not we are close to the end of the rainbow and to a period of outperformance for the property sector. Our end conclusions will be based on a series of company visits to the major listed property companies in Indonesia, conversations with local banks, property agents, and other relevant channel checks. 

The first company that we explore is Ciputra Development (CTRA IJ), a township developer with 38 years of track record. With 75 ongoing township projects in 33 cities, CTRA has the widest coverage of any developer in Indonesia. However, tightening policies by the Bank Indonesia (BI), in particular the presales mortgage disbursement regulation caused a significant drop in operating cashflow and increased gearing level.

Earnings have been on a downtrend, as slower revenue recognition coupled with higher interest costs have weighed on the bottom line. As BI has recently started to relax property regulations, we may begin to see some positive impact on cash flows over the next few quarters, although earnings are likely to remain weak from declining presales over the past three years.

As we enter the election year, presales announcements may not be positive in the short term, but activities may improve after the electoral contest, helped by a pick up in sentiment and boosted by a better interest rate environment and positive regulatory tailwinds. Potential portfolio inflow to high beta stocks and rising risk appetite for smaller cap underperforming stocks should also drive CTRA’s share price outperformance in 2019. We see a 50% upside to our target price of IDR1,352 per share.

Summary of this insight:

• The property development product portfolio includes landed housing, high-rise condominiums, and offices. Landed housing projects are still CTRA’s bread and butter, comprising more than half of the company’s revenue and more than two-thirds of presales. As the property demand is currently dominated by the end-users, CTRA’s product offering is shifting towards smaller more affordable units. We have put together an example mortgage calculation and determine a key affordability level based on the average income per capita in the Greater Jakarta to illustrate how much should a housing unit be worth for the end users market.
• The investment properties portfolio consists of 4 malls, 9 hotels, and 4 hospitals across the major cities in Indonesia, making up 13%, 8%, and 6% of 9M18 total consolidated revenues respectively. This is a 68% increase in revenue contribution versus five years ago. The company has been actively building its investment property portfolio to weather out the volatility in the non-recurring or development revenue.
• Accessibility is a key factor to land appreciation and hence, company’s total NAV. With the traffic worsening around the Greater Jakarta area, time to commute is an increasingly important factor in determining where to stay and access to public transportation such as MRT and LRT will be a powerful driver going forward. CTRA has a very diverse property development portfolio, hence the benefit of the infrastructure rollout is more widespread across the different projects.
• 65% of CTRA’s presales are generated from units priced IDR2bn and below, which indicate that the majority of CTRA’s buyers are in the middle to middle-low segments. These buyers are price sensitive and are highly dependent on financing. CTRA’s mortgage and in-house installment proportion is one of the highest in our property universe, making the company more susceptible to the changes in the property mortgage regulation by the Central Bank (BI).

• The property mortgage regulation in Indonesia has had few rounds of changes in the past decade, with a series of tightening measures taking place between 2013-2014, and the start of loosening measures in 2016-2018. We will discuss in depth the various property regulations issued and its impact on CTRA’s cashflow. We also constructed a cashflow simulation time series for a sample housing sale to determine the time needed for the project to turn net cashflow positive and when can the developer reinvest for future landbank of equivalent value.
• Pros: as we expect a better rate of cash inflow from future mortgages, our model shows that the advances-to-inventory ratio, which is an indicative figure for the property developers’ working capital, will begin to rise in 2019, leading to an inflection point for CTRA’s FCF. One-off adjustment in the earlier booking of 2019’s first mortgage disbursement is the key driver. 

• Cons: CTRA booked three consecutive years of negative presales growth with a decline rate of -11% Cagr. This indicates that the accounting revenue growth will more likely be weaker over the next 12-18 months. We also estimate that margin should continue to trend down until 2020. As we continue to see a larger proportion of units priced below IDR1bn in the past 2 years, it is unlikely to see a pick up in margin in 2019-2020.

• Cons: Election year to election year, we may see some similarity between the 2014 and 2019’s quarterly presales split. 1Q14 and 2Q14 contributed 41% to total FY14 presales, while 4Q14 contributed a chunky 33%. If we assume the same quarterly split for 2019 presales target, we may potentially see 13%-27% YoY declines in the next three quarters of presales reporting. Note however that the BI issued its first round of tightening regulations at the end of 2013 and this may have an impact to the 1H14 presales. Also there is a difference in the election schedules as the 2014 election was dragged on until late August, while the 2019 contest will be done by end of April.
• Recommendation & catalyst: CTRA share price has underperformed the JCI by 24% in the past 12 months. Though the share price has a nice 28% rebound from its 5-year low point, CTRA’s discount to net asset value (NAV) and price-to-book (PB) ratio is still at more than -1 standard deviation below its historical mean. Its price-to-earnings (PE) ratio however is only slightly below the historical mean. Improving risk appetite for high beta stocks, better interest rate environment, accomodative policies from the government, and potential pick up of activity after the election are a few of the key catalysts for the stock and sector. This underlines our BUY recommendation on CTRA with 50% upside. Our bull case scenario of rerating to +1 standard deviation above mean valuation offers 26% additional upside to our TP. 

In this briefing:

1. China Mobile 4Q18 Trends Improved Slightly. It Remains Most Exposed to 5G Capex Uncertainty.
2. China Telecom Mobile Business Recovered in 4Q. Broadly in Line with Expectations
3. China Unicom Weak 4Q18 Mobile Results Offset by Strength in Fixed Line Business
4. F&F: Time to Take Profits – Up 95% This Year Driven by MLB Baseball Hats Potential in China
5. Fujitec (6406) Value Buy

1. China Mobile 4Q18 Trends Improved Slightly. It Remains Most Exposed to 5G Capex Uncertainty.

Chris Hoare downgraded China Mobile (941 HK) some time ago on rising concerns that 5G capex would be higher than expected. While China Unicom (762 HK) and China Telecom (728 HK) both laid out very modest 2019 5G capex plans, China Mobile did not.  And despite what we saw as reasonable results, earnings guidance was weak and the lack of a rising dividend payout suggests internal concerns over 5G spending.  We had seen China Mobile as a defensive stock, but recent strong performance and rising 5G worries led us to downgrade our recommendation. It remains at Reduce with a HK$75 target. 

2. China Telecom Mobile Business Recovered in 4Q. Broadly in Line with Expectations

China Telecom (728 HK), having delivered strong revenue growth but weak margins in 3Q18, delivered better 4Q numbers. Like its peers however, the business is under some pressure with ARPUs weak despite strong data growth.  We see the Chinese Telcos as vulnerable to policy demands for accelerated 5G spending. While the market may like the look of a joint roll-out of 5G with China Unicom (762 HK), that may be simplistic. Chris Hoare thinks the cost of a combined roll-out is likely to be even higher than China Mobile (941 HK). Recent price strength makes our Reduce recommendation clearer.

3. China Unicom Weak 4Q18 Mobile Results Offset by Strength in Fixed Line Business

China Unicom’s (762 HK) recent 4Q18 results were not great. The overall figures look ok due to strength in the fixed line business which offset weakness in mobile. However, they were the weakest of the three operators and the stock, which has had a strong run, now looks due for a pause. We have turned more cautious on the Chinese telcos on concerns that 5G spending could be higher than expected. Chris Hoare believes a major reason for the Chinese telcos outperforming in the past year has come from declining capex spending expectations. That trend may now start to reverse. While China Unicom has guided for only modest 5G capex in 2019 the focus will turn to 2020 where it is a much bigger issue and while we expect China Unicom to do a joint roll-out with China Telecom (728 HK) we expect the scale of the spending to be larger than an individual build. 

4. F&F: Time to Take Profits – Up 95% This Year Driven by MLB Baseball Hats Potential in China

F&F Co Ltd (007700 KS) shares have been soaring this year (up 95% YTD), versus KOSPI which is up only 5% YTD. F&F Co has been one of the top performing stocks in KOSPI this year. We believe it is time to take profits on this name and take it out of our model portfolio. 

One of the main reasons why F&F Co has been soaring this year has been due to the MLB (Major League Baseball) apparel business expansion in China. In February 2019, F&F Co secured the selling rights of the MLB branded apparel products in China from the MLB headquarters in the US. 

Baseball is becoming increasingly popular in China. According to the Chinese Baseball Association, more than 4 million Chinese play the game. The historical resistance to baseball is breaking down in China. For example, In April 2018, Tencent announced a deal to live stream 125 MLB games on platforms such as its its Tencent Sports app to Chinese audiences via their computers and mobile devices.

5. Fujitec (6406) Value Buy

The shares are cheap. The company is cash rich and owns 10% in treasury stock; it owned more last year but has cancelled 4%. It has some Y6bn in long term investment. EV in our view is Y57bn vs the current market cap of Y110bn. With ebitda next year coming in at Y15bn, EV/ebitda is under 4x. The shares yield 3.4% and trade at book. They have slightly underperformed the market over the last 12 months. For now, we view this as a defensive buy. There remain many issues longer term as to its place in the global elevator world. A potential positive, however, is that in May the company will announce a new mid-term plan and in it, they will outline their view as regards to shareholder returns for the next three years. They are aware that they are very over capitalised, so greater returns are a real possibility.

In this briefing:

1. Cracking the Keyence Conundrum
2. Dali Foods (3799:HK) FY18 Results: Revenue Growth Collapses in H2, But Margins Hold Up So Far
3. Ping An Bank: Not Cheap Enough
4. Samsung Electronics Voluntary Red Flag on 1Q Earnings
5. China Zheshang Bank – A Look Beyond Doubling Impairment Costs

1. Cracking the Keyence Conundrum

Keyence Corp (6861 JP) has long been a standout within the Japanese machinery sector for its exceptional margins, with only Fanuc Corp (6954 JP) and perhaps Smc Corp (6273 JP)  really operating in the same the stratosphere. But while Fanuc has faded, with its OPM now struggling to stay over 30% and SMC has only recently peaked its head over the 30% level, Keyence has been powering ahead and is on the cusp of recording five straight years over 50% OPM.

With relatively limited disclosures to go along with such stellar performance it is understandable then that some investors are concerned that the story is too good to be true, and even the FT has written a series of articles with a slightly critical bent: 1 2 34

Having recently visited the company, we analyse below, the nature of its competitive advantages by comparing it with its most similar peer Cognex Corp (CGNX US).

2. Dali Foods (3799:HK) FY18 Results: Revenue Growth Collapses in H2, But Margins Hold Up So Far

We launched coverage of Dali Foods Group (3799 HK) in February with a Sell rating and a HK$4.18 target price. FY18 financial results, which were released late Tuesday March 26th, appear to confirm at least half of our negative thesis (slowing revenue growth), though the other half (margin compression) has failed to materialize so far.

Dali Foods appears to have met — just — the FY18 consensus EPS target of HK$0.307 per share. The company cut its Final dividend from HK$0.10 to HK$0.075 per share. 

However, the pace of revenue growth plummeted in H218. From solid growth of +11.4% YoY in H118, H218 revenues actually declined by -0.6% YoY in the latter half of the year. This result was beyond even our pessimistic view and we believe bulls on the company will be forced to revisit their overly optimistic assumptions about double-digit revenue growth in 2019e.

Besides assuming slower revenue growth going forward, the other leg of our negative thesis on Dali Foods was the expectation of margin compression due to rising raw materials costs, specifically for paper and key food and beverage ingredients. Although H218 gross margin declined versus H217 (to 37.7% from 37.8%), it did so only marginally, and probably due to a change in product mix (ie, a decline in high-margin beverage sales). 

After reviewing FY and H218 results, we see no reasons to change our negative view of Dali Foods, and our HK$4.18 price target (-26% potential downside) and Sell rating remain unchanged.

3. Ping An Bank: Not Cheap Enough

Ping An Bank Co Ltd A (000001 CH) results show gradual erosion in fundamental trends. We believe that positive fundamental momentum (within our quantamental approach) leads to higher stock prices.

Behind the headline numbers, there lies an acute rise in funding costs in excess of the growth in interest income on earnings assets. As elsewhere in China, there is a festering asset quality issue too. While not as toxic versus diverse peers, it is notable: the impaired asset portfolio more than doubled YoY.

Valuations are not especially cheap relative to the region (including Japan). Franchise Valuation at 10% and P/Book of 0.94x are at a premium to the regional medians of 8% and 0.77x, respectively. The Total Return Ratio is <1x.

In conclusion, we do not see a lot that has changed for the better at Ping An Bank (funding, liquidity, efficiency, profitability and asset quality) though the headline deterioration is not so drastic. Underlying concerns lie with core interest income generation given sky-high funding expenses and pervasive asset quality issues.

4. Samsung Electronics Voluntary Red Flag on 1Q Earnings

• SamE voluntarily red flagged its 1Q19 earnings even before 1Q ends. SamE mentioned two things: 1. Falling memory chip prices and 2. slowing demand for display panels. Given the ‘usual’ profit size of DP business, this should be all about memory chips, specifically server DRAM.
• Memory chip price falling should not be enough to explain this much 1Q profit loss. It must be that SamE has decided to reflect huge inventory losses and pay bills from Amazon and Google on the book in this first quarter. Of course, SamE wouldn’t want to talk about this explicitly.
• SamE shares aren’t reacting to this a lot right now. It is mainly because local street already heavily adjusted 1Q OP to as low as ₩6.5~7tril. This 1Q earnings shock factor must have been already reflected into the price. Even below ₩6tril level wouldn’t be taken as a huge surprise.
• SamE said last month that memory sales would be revived starting 2H this year. I think this is still a valid and crucial point. This suggests that server DRAM demand from Amazon and Google will likely be back starting 3Q19. This means SamE is confident that it can handle the server DRAM optimization issue by then.
• I’m still sticking to my previous OP forecast for FY19. It should be ₩8tril more than the current street consensus. At this, SamE Common is trading at a 8.73x PER. SamE is scheduled to deliver 1Q19 interim numbers next week on Apr 5.

5. China Zheshang Bank – A Look Beyond Doubling Impairment Costs

It should be no surprise to see China Zheshang Bank (2016 HK; “CZB”) reveal a dramatic rise of impairment costs in 4Q18. It is one of only few China banks to yet announced quarterly results, and here it reported profit at -12% YoY in 4Q18.  The doubling of impairment costs in the period goes to our long-standing concerns of continued credit tdeterioration in China and well more than headline figures suggest. This is partly based on our China corporate analysis of interest cover and debt/ebitda, which remain weak. It is also notable that CZB has been one of the faster growing banks in the country, putting its ‘unseasoned’ loans higher than many others; where we believe these banks are more likely to see higher impairment costs. Perhaps that is now coming through? And with RMB250bn of write-offs in December 2018 for China’s bank system, this suggests there will have to sizeable impairment costs to replenish balance sheet provisions.

In this briefing:

1. CSE Global: Gaining Momentum
2. Indonesia Property – In Search of the End of the Rainbow – Part 1 – Ciputra Development (CTRA IJ)
3. Maxis Revenues Stabilizing. Ambitious Long Term Goals in Enterprise and Connectivity

1. CSE Global: Gaining Momentum

• Investors who have bought CSE Global on dips since my last note would have profited ~18%.
• The upbeat guidance by management and supply-demand environment should give some legs to the recent rebound.
• While risks of slower global growth may weigh on the stock, the stock is trading below its five-year average PE despite significantly improved cash flow from operations and a healthy order intake (three-year high). 

2. Indonesia Property – In Search of the End of the Rainbow – Part 1 – Ciputra Development (CTRA IJ)

In this series under Smartkarma Originals, CrossASEAN insight providers AngusMackintosh and Jessica Irene seek to determine whether or not we are close to the end of the rainbow and to a period of outperformance for the property sector. Our end conclusions will be based on a series of company visits to the major listed property companies in Indonesia, conversations with local banks, property agents, and other relevant channel checks. 

The first company that we explore is Ciputra Development (CTRA IJ), a township developer with 38 years of track record. With 75 ongoing township projects in 33 cities, CTRA has the widest coverage of any developer in Indonesia. However, tightening policies by the Bank Indonesia (BI), in particular the presales mortgage disbursement regulation caused a significant drop in operating cashflow and increased gearing level.

Earnings have been on a downtrend, as slower revenue recognition coupled with higher interest costs have weighed on the bottom line. As BI has recently started to relax property regulations, we may begin to see some positive impact on cash flows over the next few quarters, although earnings are likely to remain weak from declining presales over the past three years.

As we enter the election year, presales announcements may not be positive in the short term, but activities may improve after the electoral contest, helped by a pick up in sentiment and boosted by a better interest rate environment and positive regulatory tailwinds. Potential portfolio inflow to high beta stocks and rising risk appetite for smaller cap underperforming stocks should also drive CTRA’s share price outperformance in 2019. We see a 50% upside to our target price of IDR1,352 per share.

Summary of this insight:

• The property development product portfolio includes landed housing, high-rise condominiums, and offices. Landed housing projects are still CTRA’s bread and butter, comprising more than half of the company’s revenue and more than two-thirds of presales. As the property demand is currently dominated by the end-users, CTRA’s product offering is shifting towards smaller more affordable units. We have put together an example mortgage calculation and determine a key affordability level based on the average income per capita in the Greater Jakarta to illustrate how much should a housing unit be worth for the end users market.
• The investment properties portfolio consists of 4 malls, 9 hotels, and 4 hospitals across the major cities in Indonesia, making up 13%, 8%, and 6% of 9M18 total consolidated revenues respectively. This is a 68% increase in revenue contribution versus five years ago. The company has been actively building its investment property portfolio to weather out the volatility in the non-recurring or development revenue.
• Accessibility is a key factor to land appreciation and hence, company’s total NAV. With the traffic worsening around the Greater Jakarta area, time to commute is an increasingly important factor in determining where to stay and access to public transportation such as MRT and LRT will be a powerful driver going forward. CTRA has a very diverse property development portfolio, hence the benefit of the infrastructure rollout is more widespread across the different projects.
• 65% of CTRA’s presales are generated from units priced IDR2bn and below, which indicate that the majority of CTRA’s buyers are in the middle to middle-low segments. These buyers are price sensitive and are highly dependent on financing. CTRA’s mortgage and in-house installment proportion is one of the highest in our property universe, making the company more susceptible to the changes in the property mortgage regulation by the Central Bank (BI).

• The property mortgage regulation in Indonesia has had few rounds of changes in the past decade, with a series of tightening measures taking place between 2013-2014, and the start of loosening measures in 2016-2018. We will discuss in depth the various property regulations issued and its impact on CTRA’s cashflow. We also constructed a cashflow simulation time series for a sample housing sale to determine the time needed for the project to turn net cashflow positive and when can the developer reinvest for future landbank of equivalent value.
• Pros: as we expect a better rate of cash inflow from future mortgages, our model shows that the advances-to-inventory ratio, which is an indicative figure for the property developers’ working capital, will begin to rise in 2019, leading to an inflection point for CTRA’s FCF. One-off adjustment in the earlier booking of 2019’s first mortgage disbursement is the key driver. 

• Cons: CTRA booked three consecutive years of negative presales growth with a decline rate of -11% Cagr. This indicates that the accounting revenue growth will more likely be weaker over the next 12-18 months. We also estimate that margin should continue to trend down until 2020. As we continue to see a larger proportion of units priced below IDR1bn in the past 2 years, it is unlikely to see a pick up in margin in 2019-2020.

• Cons: Election year to election year, we may see some similarity between the 2014 and 2019’s quarterly presales split. 1Q14 and 2Q14 contributed 41% to total FY14 presales, while 4Q14 contributed a chunky 33%. If we assume the same quarterly split for 2019 presales target, we may potentially see 13%-27% YoY declines in the next three quarters of presales reporting. Note however that the BI issued its first round of tightening regulations at the end of 2013 and this may have an impact to the 1H14 presales. Also there is a difference in the election schedules as the 2014 election was dragged on until late August, while the 2019 contest will be done by end of April.
• Recommendation & catalyst: CTRA share price has underperformed the JCI by 24% in the past 12 months. Though the share price has a nice 28% rebound from its 5-year low point, CTRA’s discount to net asset value (NAV) and price-to-book (PB) ratio is still at more than -1 standard deviation below its historical mean. Its price-to-earnings (PE) ratio however is only slightly below the historical mean. Improving risk appetite for high beta stocks, better interest rate environment, accomodative policies from the government, and potential pick up of activity after the election are a few of the key catalysts for the stock and sector. This underlines our BUY recommendation on CTRA with 50% upside. Our bull case scenario of rerating to +1 standard deviation above mean valuation offers 26% additional upside to our TP. 

3. Maxis Revenues Stabilizing. Ambitious Long Term Goals in Enterprise and Connectivity

In late January, we upgraded our view on the Malaysian telecom sector after 6 years of being negative. We also and noted that Maxis was best placed to benefit from increased bundling and Enterprise opportunities (due to low cost access to Telekom Malaysia’s (T MK) (TM) fibre infrastructure).  We see signs the current round of results (4Q18) as being supportive of this view. While Maxis 4Q numbers were affected by one offs, the key is a return to service revenue growth while we think the market will view Maxis’ long term revenue guidance positively. Longer term, Maxis announced aggressive longer term revenue targets based on a move into Enterprise and fixed connectivity which should deliver significant revenue growth.

In this briefing:

1. CSE Global: Gaining Momentum
2. Indonesia Property – In Search of the End of the Rainbow – Part 1 – Ciputra Development (CTRA IJ)
3. Maxis Revenues Stabilizing. Ambitious Long Term Goals in Enterprise and Connectivity
4. BBTN: Indonesia Has Special Mention Problems Too

1. CSE Global: Gaining Momentum

• Investors who have bought CSE Global on dips since my last note would have profited ~18%.
• The upbeat guidance by management and supply-demand environment should give some legs to the recent rebound.
• While risks of slower global growth may weigh on the stock, the stock is trading below its five-year average PE despite significantly improved cash flow from operations and a healthy order intake (three-year high). 

2. Indonesia Property – In Search of the End of the Rainbow – Part 1 – Ciputra Development (CTRA IJ)

In this series under Smartkarma Originals, CrossASEAN insight providers AngusMackintosh and Jessica Irene seek to determine whether or not we are close to the end of the rainbow and to a period of outperformance for the property sector. Our end conclusions will be based on a series of company visits to the major listed property companies in Indonesia, conversations with local banks, property agents, and other relevant channel checks. 

The first company that we explore is Ciputra Development (CTRA IJ), a township developer with 38 years of track record. With 75 ongoing township projects in 33 cities, CTRA has the widest coverage of any developer in Indonesia. However, tightening policies by the Bank Indonesia (BI), in particular the presales mortgage disbursement regulation caused a significant drop in operating cashflow and increased gearing level.

Earnings have been on a downtrend, as slower revenue recognition coupled with higher interest costs have weighed on the bottom line. As BI has recently started to relax property regulations, we may begin to see some positive impact on cash flows over the next few quarters, although earnings are likely to remain weak from declining presales over the past three years.

As we enter the election year, presales announcements may not be positive in the short term, but activities may improve after the electoral contest, helped by a pick up in sentiment and boosted by a better interest rate environment and positive regulatory tailwinds. Potential portfolio inflow to high beta stocks and rising risk appetite for smaller cap underperforming stocks should also drive CTRA’s share price outperformance in 2019. We see a 50% upside to our target price of IDR1,352 per share.

Summary of this insight:

• The property development product portfolio includes landed housing, high-rise condominiums, and offices. Landed housing projects are still CTRA’s bread and butter, comprising more than half of the company’s revenue and more than two-thirds of presales. As the property demand is currently dominated by the end-users, CTRA’s product offering is shifting towards smaller more affordable units. We have put together an example mortgage calculation and determine a key affordability level based on the average income per capita in the Greater Jakarta to illustrate how much should a housing unit be worth for the end users market.
• The investment properties portfolio consists of 4 malls, 9 hotels, and 4 hospitals across the major cities in Indonesia, making up 13%, 8%, and 6% of 9M18 total consolidated revenues respectively. This is a 68% increase in revenue contribution versus five years ago. The company has been actively building its investment property portfolio to weather out the volatility in the non-recurring or development revenue.
• Accessibility is a key factor to land appreciation and hence, company’s total NAV. With the traffic worsening around the Greater Jakarta area, time to commute is an increasingly important factor in determining where to stay and access to public transportation such as MRT and LRT will be a powerful driver going forward. CTRA has a very diverse property development portfolio, hence the benefit of the infrastructure rollout is more widespread across the different projects.
• 65% of CTRA’s presales are generated from units priced IDR2bn and below, which indicate that the majority of CTRA’s buyers are in the middle to middle-low segments. These buyers are price sensitive and are highly dependent on financing. CTRA’s mortgage and in-house installment proportion is one of the highest in our property universe, making the company more susceptible to the changes in the property mortgage regulation by the Central Bank (BI).

• The property mortgage regulation in Indonesia has had few rounds of changes in the past decade, with a series of tightening measures taking place between 2013-2014, and the start of loosening measures in 2016-2018. We will discuss in depth the various property regulations issued and its impact on CTRA’s cashflow. We also constructed a cashflow simulation time series for a sample housing sale to determine the time needed for the project to turn net cashflow positive and when can the developer reinvest for future landbank of equivalent value.
• Pros: as we expect a better rate of cash inflow from future mortgages, our model shows that the advances-to-inventory ratio, which is an indicative figure for the property developers’ working capital, will begin to rise in 2019, leading to an inflection point for CTRA’s FCF. One-off adjustment in the earlier booking of 2019’s first mortgage disbursement is the key driver. 

• Cons: CTRA booked three consecutive years of negative presales growth with a decline rate of -11% Cagr. This indicates that the accounting revenue growth will more likely be weaker over the next 12-18 months. We also estimate that margin should continue to trend down until 2020. As we continue to see a larger proportion of units priced below IDR1bn in the past 2 years, it is unlikely to see a pick up in margin in 2019-2020.

• Cons: Election year to election year, we may see some similarity between the 2014 and 2019’s quarterly presales split. 1Q14 and 2Q14 contributed 41% to total FY14 presales, while 4Q14 contributed a chunky 33%. If we assume the same quarterly split for 2019 presales target, we may potentially see 13%-27% YoY declines in the next three quarters of presales reporting. Note however that the BI issued its first round of tightening regulations at the end of 2013 and this may have an impact to the 1H14 presales. Also there is a difference in the election schedules as the 2014 election was dragged on until late August, while the 2019 contest will be done by end of April.
• Recommendation & catalyst: CTRA share price has underperformed the JCI by 24% in the past 12 months. Though the share price has a nice 28% rebound from its 5-year low point, CTRA’s discount to net asset value (NAV) and price-to-book (PB) ratio is still at more than -1 standard deviation below its historical mean. Its price-to-earnings (PE) ratio however is only slightly below the historical mean. Improving risk appetite for high beta stocks, better interest rate environment, accomodative policies from the government, and potential pick up of activity after the election are a few of the key catalysts for the stock and sector. This underlines our BUY recommendation on CTRA with 50% upside. Our bull case scenario of rerating to +1 standard deviation above mean valuation offers 26% additional upside to our TP. 

3. Maxis Revenues Stabilizing. Ambitious Long Term Goals in Enterprise and Connectivity

In late January, we upgraded our view on the Malaysian telecom sector after 6 years of being negative. We also and noted that Maxis was best placed to benefit from increased bundling and Enterprise opportunities (due to low cost access to Telekom Malaysia’s (T MK) (TM) fibre infrastructure).  We see signs the current round of results (4Q18) as being supportive of this view. While Maxis 4Q numbers were affected by one offs, the key is a return to service revenue growth while we think the market will view Maxis’ long term revenue guidance positively. Longer term, Maxis announced aggressive longer term revenue targets based on a move into Enterprise and fixed connectivity which should deliver significant revenue growth.

4. BBTN: Indonesia Has Special Mention Problems Too

Bank Tabungan Negara Persero (BBTN IJ) appears to have a nasty combination of high Special Mention Loans (SMLs) and elevated “past due but unimpaired Loans”.

The implication is that provisioning levels are insufficient in an environment of eroding asset quality.

But the bank continues to grow credit by around 20% YoY.

The bank is hugely exposed to the retail real estate market (91% of Loans).

In fact, the Indonesian Banking Sector is rife with high SMLs and in some cases elevated “past due but unimpaired Loans”.

SMLs are traditionally associated with Chinese under-reporting of underlying bad loans, and hence the production of a somewhat flattering Asset Quality picture.

Maybe, the health and valuation of the Indonesian Banking Sector needs to be reassessed with implications for IDR.

In this briefing:

1. Micron. Things May Be Getting Worse But They Are Still Remarkably Good.
2. Zozo: Never Meet a Margin Call
3. China New Higher Education: Negatives Mostly Baked-In
4. Indonesia Property – In Search of the End of the Rainbow – Part 5 –  Summarecon Agung (SMRA IJ)
5. Kosmos Energy: The Standout Internationally-Focused E&P Company

1. Micron. Things May Be Getting Worse But They Are Still Remarkably Good.

On Thursday March 21’st 2019, Micron announced latest quarter (Q2FY19) revenues of $5.8 billion, at the bottom end of their forecast range and down 26% sequentially. The midrange of their forecast for the current quarter (Q3FY19) will see revenues drop another 17% sequentially to $4.8 billion, roughly equivalent to the same quarter two years ago. On the earnings call, CEO Sanjay Mehrotra stated that the company would be cutting back both DRAM and NAND production by ~5% in response to a further deterioration in the CY2019 demand outlook. Furthermore, he refused to be drawn as to whether or not the current quarter would be the downturn trough despite reiterating his belief in the widely anticipated 2H CY2019 recovery thesis.

The challenging environment notwithstanding, there were some key positives also from the earnings call. The company is taking decisive and unprecedented actions to reduce their bit supply, actions we believe will be matched by Samsung Electronics  and SK Hynix. Gross margin coming into this downturn was a historic high at 61% and NAND gross margins have remained in the high 30% range despite ASP’s falling for five of the past six quarters. Furthermore, as forecasted three months ago, Micron still expects DRAM bit shipments to increase in the current quarter.

Integrating the latest updates from company, we now model Micron revenues declining for two further quarters to reach a trough at $4.5 billion in the company’s Q4FY19. We further model net income in the trough quarter at $1 billion. Thereafter we model a return to modest, sustained growth in the following quarters. Yes, things may be getting worse for Micron but they are still remarkably good.

2. Zozo: Never Meet a Margin Call

Yusaku Maezawa is once again in the news. This time due to speculation that he is auctioning off at least part of his art collection at Sotheby’s in Hong Kong on April 1st.

Following on from the share buyback that was conducted in May last year which:

• Allowed Maezawa to sell 6m out of his then 118.227m shares into a buyback that totalled just 6.35m shares.
• Led to a ¥38.3bn swing in net cash from +¥24.6bn to -¥13.8bn (the buyback totaled ¥24.4bn)
• Was conducted at the same time that share options for up to 31m shares were issued, of which Maezawa could have been allocated more than 90%.

this looks a lot like a sudden need to raise cash.

3. China New Higher Education: Negatives Mostly Baked-In

• China New Higher Education’s (CNHE) share price has more than halved since my bearish note in June last year.
• The fall in share price was caused by a few factors, namely uncertainties caused by regulations, a negative report by a short-seller, and below-consensus earnings.
• Market expectations of the education provider’s growth have come down, providing us an opportunity to relook at the stock.

4. Indonesia Property – In Search of the End of the Rainbow – Part 5 –  Summarecon Agung (SMRA IJ)

In this series under Smartkarma Originals, CrossASEAN insight providers AngusMackintosh and Jessica Irene seek to determine whether or not we are close to the end of the rainbow and to a period of outperformance for the property sector. Our end conclusions will be based on a series of company visits to the major listed property companies in Indonesia, conversations with local banks, property agents, and other relevant channel checks. 

The fifth company that we explore is Summarecon Agung (SMRA IJ), a township developer with over 40 years of track record and a combined development area of over 2,700ha. The company benefits from its exposure to the popular Serpong district, but an over expansion, coupled with tightening property regulations caused its balance sheet to suffer in the following years. Earnings have declined by -19% Cagr over the past five years as a consequence of lower margins and burgeoning debt levels.

The company has plans to divest its retail mall division, which can serve as a positive catalyst in the near term. Improving sentiment and better interest rate environment, as well as positive regulatory tailwinds should be a driver to SMRA’s share price this year. We see a 44% upside to our target price of IDR1,408 per share.

Summary of this insight:

• The success of SMRA’s first township, Kelapa Gading, paved way for the next six township development. The same township model is replicated to its Serpong, Bekasi, Bandung, Karawang, Makassar, and soon Bogor. 
• During the height of the property boom, every cluster launch in the Serpong area is 2-3x oversubscribed. Buyers were a mix of speculators and end-users, and both were happy customers benefiting from over 400% land price appreciation over the course of 2009-2013. Land ASP in 2009 was just below IDR3mn versus IDR12-15mn in 2013.
• Driven by the positive momentum of the property boom, SMRA ambitiously launched three new townships at the trough of the property market (2015-2018), growing its total township development area by more than a third. Poor cashflow management, stemming from the over-expansion during the property downturn took a massive toll on the balance sheet. SMRA turned from net cash in 2013 to holding IDR8.6tn of debt in 9M18 (1.2x gearing) with interest costs making up a chunky 49% of EBIT. 
• We have also seen a massive shift to the end-user market since 2014, as the company started to sell more smaller houses and affordable apartments rather than land lots and shophouses. At the peak, shophouses and land lots made up more than 50% of the company’s development revenues. As of 9M18, that number has declined to a mere 7% of revenues, while 93% comes from houses and apartments. Housing units launched in 2016-2017 are 36% cheaper than units launched in 2011-2014, as the company downsized in the area.

• SMRA has the second biggest retail mall portfolio in our coverage after Pakuwon Jati (PWON IJ) with 258,000sqm net leasable area (NLA). The three malls generate about IDR1.3tn revenue per year, returning 42% EBITDA margin. About 40% of tenants in Bekasi and Serpong are up for a rental renewal in the next three years, and this could serve as a potential upside on the average rental rates. 

• Pros: Bank Indonesia (BI)’s move to loosen mortgage regulations last year, and plans to reduce luxury taxes and allow for friendlier foreign ownership scheme should give a breath of fresh air over the medium term. SMRA targets 18% presales growth in 2019, but they have been missing their presales target by an average of 22% over the past three years. We expect a more modest 5% presales recovery this year.
• Pros: Margin on houses show a massive improvement from 51% in 2014 to 59% in 9M18. The improvement brings up the consolidated property development margin by 600bps YoY. As a segment, this is the first margin uptick since 2014, leading to 44% YoY EBIT growth and 115% YoY NPAT growth in 9M18.
• Cons: The stellar property development growth, however, is diluted by the poor performances from the investment property division that recorded 14% YoY EBIT decline. Despite some improvements on the gross margin level and healthy topline growth, opex has doubled YoY, leading to 700bps reduction in the EBITDA margin. 
• Recommendation & catalyst: SMRA has underperformed the JCI by a steep 71% over the past 36 months as earnings and presales continue to disappoint. Discount to NAV, PE, and PB valuation are standing at -1 standard deviation below mean. Improving risk appetite for high beta stocks, better interest rate environment, accomodative policies from the government, and potential pick up of activity after the election are a few of the key catalysts for the stock and sector re-rating. The divestment of its retail arm should also help to clear some debt off the balance sheet and unlock value. We have a BUY recommendation.

5. Kosmos Energy: The Standout Internationally-Focused E&P Company

We think that Kosmos Energy (KOS US) offers everything that is required from an internationally focused E&P company. It has a highly rated management team, strong balance sheet and free cash flow generation from its existing producing assets, low risk / high value near field exploration potential, selective high risk / reward frontier exploration in which it has a proven track record, it has done recent value accretive acquisitions with room for more, it has demonstrated the ability to farm-down its assets on multiple occasions and is currently in the process of a major asset sell down, which could surprise the market to the upside. Despite this the stock trades on a significant discount to risked NAV, making it a potential acquisition target and has plenty of catalysts coming up this year to close the valuation gap.