Equity Bottom-Up

In this briefing:

1. Mercari (4385) A Great Business but over Priced
2. Tencent Music: A Case of Failing to Live up to Hyped Expectations
3. Tencent Music (TME): Problems Come from Corporate Clients and In-House Contents, 35% Downside
4. Indian Mobile – ARPUs Inflect as the Worst May Be over for Bharti, Although Not for Vodafone IDEA
5. RBI Says Kotak Tried to “Take It for a Ride”: Shareholders Should Expect the Consequences

1. Mercari (4385) A Great Business but over Priced

Established in 2013, this has been a huge success story in Japan. The company operates the largest C to C mobile app that allows customers to trade in second hand goods with each other. Growth has been phenomenal. In the year to 6/15, Mercari had revenue of Y4.2bn, three years later (6/18) this had risen to Y35.7bn. This growth carries on, first half revenue this year to December 2018 rose 45% to Y23.7bn. It has begun an operation in the US, currently loss making, and has just introduced “Merpay”, a prepaid card incorporated into one’s mobile phone along the lines of Suica that allows users to purchase goods and pay bills. Funds can be deposited following a sale on Mercari’s site or transferred from a bank. Revenue will probably continue to grow at a rapid pace and whilst there are some that will jump on board, it is impossible to come up with any sensible valuation that can really justify a purchase here. There is no p.e.r. and the company will be loss making for the next couple of years. Its market cap of Y440bn means that it is trading on perhaps 6x 6/20 sales. On top of this, there are risks with regards to the viability of its US operation. Management appear to be aware to this and have set certain time limits for a turn around. There are many BUYS out on this name, thematically it has much going for it, but the valuation leaves us cold.

2. Tencent Music: A Case of Failing to Live up to Hyped Expectations

• One word to describe Tencent Music Entertainment’s (TME US) first conference call post IPO is uninspiring.
• Management does not provide concrete 2019/1Q19 guidance, but hints margin pressures persist largely due to investments in music contents.
• We expect that consensus still has to revise down TME’s 2019-20E net profits forecast by 17-26%.
• On our earnings forecast, TME unattractively trades at 46.3x/37x 2019-20E PE, a whopping 48-52% premium to peers average.

3. Tencent Music (TME): Problems Come from Corporate Clients and In-House Contents, 35% Downside

• Stripping music subscription revenues, we find TME’s revenues from corporate clients are not stable.
• We believe in-house products will negatively impact margin in 2019.
• We believe the main business line, social entertainment, will grow strongly. However, we also believe the market is over optimistic about the margin.
• We believe the stock price has downside of 35%.

4. Indian Mobile – ARPUs Inflect as the Worst May Be over for Bharti, Although Not for Vodafone IDEA

Chris Hoare sees increasing signs that the worst is over, at least for Bharti Airtel (BHARTI IN). ARPUs and therefore revenues are bottoming. The 3Q numbers were the first quarter where the market as a whole grew sequentially (+2.5% QoQ) since Jio launched. We expect profits to follow. Signs of stabilization are much clearer for Bharti, as the performance gap vs Vodafone Idea (IDEA IN) remains wide. Both Bharti and IDEA are raising around $3.5bn of new equity. However, as we wrote previously, we do not think this is enough for Vodafone IDEA and expect the company to continue to lose market share. By contrast, Bharti’s capital increase puts the company in a strong position going forward and allows investors to fully discount extreme stress scenarios.

5. RBI Says Kotak Tried to “Take It for a Ride”: Shareholders Should Expect the Consequences

The language used in the writ petition filed by Kotak Mahindra Bank (KMB) in Bombay High Court against the banking regulator should have alarmed shareholders. They would be even more apprehensive if they read the language used by the Reserve Bank of India (RBI) in its reply. That a bank should take the regulator to court and publicly challenge its authority in order to prevent a dilution in its founders’ shareholding is itself telling of the founder-CEO’s excessive influence on the board. The harsh, critical language used by the RBI in its court filing (“wilful misrepresentation”, “mala fide intent” taking the regulator “for a ride”) indicates its extreme displeasure with the bank, and the troubles that await the bank if the High Court rules in the regulator’s favour. In such an event, the RBI would probably demand a restructuring of the KMB’s board of directors, and may even force the removal of the founder as a CEO. 

In this briefing:

1. XL Axiata Results Show a Strong Turnaround Underway in Indonesia
2. Fortis Healthcare: OK Results and a Cost-Cutter CEO

1. XL Axiata Results Show a Strong Turnaround Underway in Indonesia

Xl Axiata’s  (EXCL IJ) 4Q18 results triggered a very strong rally last week that continues this week. The market has been very concerned about competitive pressures in Indonesia and extremely low data prices. We believe that Indonesia is now past the worst and there is evidence that data pricing is starting to rise modestly. That is delivering a powerful tail wind for Indonesian telcos in 2019, with XL Axiata likely to report several very strong quarters.

XL Axiata now reporting strong sequential revenue growth (% QoQ)

2. Fortis Healthcare: OK Results and a Cost-Cutter CEO

Fortis Healthcare (FORH IN) ‘s hospital business continued to improve in FQ3 while the lab business remained stable. This Insight briefly focuses on the highlights of the results and their implications. The hiring of a CEO out of Narayana Hrudayalaya (NARH IN) signals continued (and likely intensified) focus on efficiency to improve profitability. 

We continue to think that Fortis is a promising turnaround story. Refer to the Insight Stream for the history of this situation.

In this briefing:

1. New J. Hutton Exploration Report (Week Ending 15/02/19)

1. New J. Hutton Exploration Report (Week Ending 15/02/19)

• Gold Road Resources (GOR AU) continued strong BUY
• Mineral Resource increased 2% to 6.61Moz
• 2019 attributable production guided at 50–60koz Au
• AISC est. between A$1,050 to $1,150/oz, is realistic
•  Using $1,300/oz attributable 2019 EBIT will be between US$7.5-15m
• 2020 attributable EBIT of 150k/oz conservative $A54m
• Price/EBIT ratio now 10.9 to 16.8 (previous est. 8 to 9.1)
• Expand AIM & ASX coverage to 397 companies from next week
• Gold Road Resources (GOR AU), Azumah Resources (AZM AU), Millennium Minerals (MOY AU), Metals X Ltd (MLX AU), De Grey Mining (DEG AU) , Resolute Mining (RSG AU), Andromeda Metals (ADN AU)  

In this briefing:

1. Tencent Music (TME): Problems Come from Corporate Clients and In-House Contents, 35% Downside
2. Indian Mobile – ARPUs Inflect as the Worst May Be over for Bharti, Although Not for Vodafone IDEA
3. RBI Says Kotak Tried to “Take It for a Ride”: Shareholders Should Expect the Consequences
4. XL Axiata (EXCL IJ) – The Crown Prince of Data – On the Ground in J-Town
5. Sell Prada (1913 HK): Accounting Inflates Margins and Facilitates Excessive Dividends

1. Tencent Music (TME): Problems Come from Corporate Clients and In-House Contents, 35% Downside

• Stripping music subscription revenues, we find TME’s revenues from corporate clients are not stable.
• We believe in-house products will negatively impact margin in 2019.
• We believe the main business line, social entertainment, will grow strongly. However, we also believe the market is over optimistic about the margin.
• We believe the stock price has downside of 35%.

2. Indian Mobile – ARPUs Inflect as the Worst May Be over for Bharti, Although Not for Vodafone IDEA

Chris Hoare sees increasing signs that the worst is over, at least for Bharti Airtel (BHARTI IN). ARPUs and therefore revenues are bottoming. The 3Q numbers were the first quarter where the market as a whole grew sequentially (+2.5% QoQ) since Jio launched. We expect profits to follow. Signs of stabilization are much clearer for Bharti, as the performance gap vs Vodafone Idea (IDEA IN) remains wide. Both Bharti and IDEA are raising around $3.5bn of new equity. However, as we wrote previously, we do not think this is enough for Vodafone IDEA and expect the company to continue to lose market share. By contrast, Bharti’s capital increase puts the company in a strong position going forward and allows investors to fully discount extreme stress scenarios.

3. RBI Says Kotak Tried to “Take It for a Ride”: Shareholders Should Expect the Consequences

The language used in the writ petition filed by Kotak Mahindra Bank (KMB) in Bombay High Court against the banking regulator should have alarmed shareholders. They would be even more apprehensive if they read the language used by the Reserve Bank of India (RBI) in its reply. That a bank should take the regulator to court and publicly challenge its authority in order to prevent a dilution in its founders’ shareholding is itself telling of the founder-CEO’s excessive influence on the board. The harsh, critical language used by the RBI in its court filing (“wilful misrepresentation”, “mala fide intent” taking the regulator “for a ride”) indicates its extreme displeasure with the bank, and the troubles that await the bank if the High Court rules in the regulator’s favour. In such an event, the RBI would probably demand a restructuring of the KMB’s board of directors, and may even force the removal of the founder as a CEO. 

4. XL Axiata (EXCL IJ) – The Crown Prince of Data – On the Ground in J-Town

A conversation with the management of Xl Axiata (EXCL IJ) following news that the company has started putting up prices in earnest for its existing customers revealed a more positive outlook for ARPUs and margins in 2019. 2018 was a difficult year with the impact of compulsory SIM registration in the first half plus a more intense competitive environment at the same time.

4Q18 results already reflected a better picture with QoQ growth for the quarter in service revenue, data revenue, and EBITDA confirming a positive trend established in the previous quarter.

Competition from other major players such a Telekomunikasi Indonesia (TLKM IJ), Indosat Tbk PT (ISAT IJ) and Hutchison has become more rational with the latter two operators raising prices in 2019 paving the way for Xl Axiata (EXCL IJ)‘s recent increases in renewal packages versus acquisition products previously. 

The availability of cheap but highly functional locally Chinese smartphones and XL’s own Xtream 4G handsets continues to drive data growth which now makes up 82% of services revenues for XL. 

4G subscribers, which now make up more than 55% of XL’s subs, also consume far more data than those using 3G. XL has been successfully monetising its more data-centric subscriber base in 2H18, reflected in its higher ARPU’s, which increased from IDR32,000 in 3Q18 to IDR33,000 in 4Q18. 

The increasing push by content players such as iFlix, Vidio.com, and other OTT players and digital advertisers into the mobile space will only increase the appetite for data in the mobile space.

The wild card on the competition front is Smartfren Telecom (FREN IJ) owner by Sinar Mas Group, which continues to push out aggressive data packages, although this had been tempered this year after it was hauled up by the regulator for breaking the pre-paid SIM rules.  

After a tough start to 2018, Xl Axiata (EXCL IJ) began to more effectively monetise its data and more importantly its 4G advantage in 2H18 and more holistically in 1Q19. If this momentum continues this year, it looks set to move back to headline profitability. Valuations look attractive, with the company trading on an EV/EBITDA of 4.2x FY19E, according to Capital IQ consensus estimates. After moving into profitability in 2019, it is forecast to see EPS growth of +63% and +68% for FY20E and FY21E respectively, implying an FY21E PER of 14.8x. Given the improvement in data pricing and strong growth in data, especially from 4G subscribers, consensus estimates appear conservative with room for upgrades to earnings estimates. 

5. Sell Prada (1913 HK): Accounting Inflates Margins and Facilitates Excessive Dividends

In our first report on Prada S.P.A. (1913 HK): An expensive luxury, we explained how creative accounting was disguising their business reality.  Since then, the stock has fallen 44% and the dividend has been cut. However, we think the key issues have yet to be addressed. They report growth, good operating cashflow and a solid financial position, but in-store sales are stagnant, margins falling, inventory rising and credit quality declining. It seems that profits are being inflated in order to pay dividends, largely to the controlling family.

In this briefing:

1. Indian Mobile – ARPUs Inflect as the Worst May Be over for Bharti, Although Not for Vodafone IDEA
2. RBI Says Kotak Tried to “Take It for a Ride”: Shareholders Should Expect the Consequences
3. XL Axiata (EXCL IJ) – The Crown Prince of Data – On the Ground in J-Town
4. Sell Prada (1913 HK): Accounting Inflates Margins and Facilitates Excessive Dividends
5. Quick Update on ZTO Express: Results OK, but Guidance Unimpressive

1. Indian Mobile – ARPUs Inflect as the Worst May Be over for Bharti, Although Not for Vodafone IDEA

Chris Hoare sees increasing signs that the worst is over, at least for Bharti Airtel (BHARTI IN). ARPUs and therefore revenues are bottoming. The 3Q numbers were the first quarter where the market as a whole grew sequentially (+2.5% QoQ) since Jio launched. We expect profits to follow. Signs of stabilization are much clearer for Bharti, as the performance gap vs Vodafone Idea (IDEA IN) remains wide. Both Bharti and IDEA are raising around $3.5bn of new equity. However, as we wrote previously, we do not think this is enough for Vodafone IDEA and expect the company to continue to lose market share. By contrast, Bharti’s capital increase puts the company in a strong position going forward and allows investors to fully discount extreme stress scenarios.

2. RBI Says Kotak Tried to “Take It for a Ride”: Shareholders Should Expect the Consequences

The language used in the writ petition filed by Kotak Mahindra Bank (KMB) in Bombay High Court against the banking regulator should have alarmed shareholders. They would be even more apprehensive if they read the language used by the Reserve Bank of India (RBI) in its reply. That a bank should take the regulator to court and publicly challenge its authority in order to prevent a dilution in its founders’ shareholding is itself telling of the founder-CEO’s excessive influence on the board. The harsh, critical language used by the RBI in its court filing (“wilful misrepresentation”, “mala fide intent” taking the regulator “for a ride”) indicates its extreme displeasure with the bank, and the troubles that await the bank if the High Court rules in the regulator’s favour. In such an event, the RBI would probably demand a restructuring of the KMB’s board of directors, and may even force the removal of the founder as a CEO. 

3. XL Axiata (EXCL IJ) – The Crown Prince of Data – On the Ground in J-Town

A conversation with the management of Xl Axiata (EXCL IJ) following news that the company has started putting up prices in earnest for its existing customers revealed a more positive outlook for ARPUs and margins in 2019. 2018 was a difficult year with the impact of compulsory SIM registration in the first half plus a more intense competitive environment at the same time.

4Q18 results already reflected a better picture with QoQ growth for the quarter in service revenue, data revenue, and EBITDA confirming a positive trend established in the previous quarter.

Competition from other major players such a Telekomunikasi Indonesia (TLKM IJ), Indosat Tbk PT (ISAT IJ) and Hutchison has become more rational with the latter two operators raising prices in 2019 paving the way for Xl Axiata (EXCL IJ)‘s recent increases in renewal packages versus acquisition products previously. 

The availability of cheap but highly functional locally Chinese smartphones and XL’s own Xtream 4G handsets continues to drive data growth which now makes up 82% of services revenues for XL. 

4G subscribers, which now make up more than 55% of XL’s subs, also consume far more data than those using 3G. XL has been successfully monetising its more data-centric subscriber base in 2H18, reflected in its higher ARPU’s, which increased from IDR32,000 in 3Q18 to IDR33,000 in 4Q18. 

The increasing push by content players such as iFlix, Vidio.com, and other OTT players and digital advertisers into the mobile space will only increase the appetite for data in the mobile space.

The wild card on the competition front is Smartfren Telecom (FREN IJ) owner by Sinar Mas Group, which continues to push out aggressive data packages, although this had been tempered this year after it was hauled up by the regulator for breaking the pre-paid SIM rules.  

After a tough start to 2018, Xl Axiata (EXCL IJ) began to more effectively monetise its data and more importantly its 4G advantage in 2H18 and more holistically in 1Q19. If this momentum continues this year, it looks set to move back to headline profitability. Valuations look attractive, with the company trading on an EV/EBITDA of 4.2x FY19E, according to Capital IQ consensus estimates. After moving into profitability in 2019, it is forecast to see EPS growth of +63% and +68% for FY20E and FY21E respectively, implying an FY21E PER of 14.8x. Given the improvement in data pricing and strong growth in data, especially from 4G subscribers, consensus estimates appear conservative with room for upgrades to earnings estimates. 

4. Sell Prada (1913 HK): Accounting Inflates Margins and Facilitates Excessive Dividends

In our first report on Prada S.P.A. (1913 HK): An expensive luxury, we explained how creative accounting was disguising their business reality.  Since then, the stock has fallen 44% and the dividend has been cut. However, we think the key issues have yet to be addressed. They report growth, good operating cashflow and a solid financial position, but in-store sales are stagnant, margins falling, inventory rising and credit quality declining. It seems that profits are being inflated in order to pay dividends, largely to the controlling family.

5. Quick Update on ZTO Express: Results OK, but Guidance Unimpressive

After reviewing 4Q18 results and guidance for 2019, we retain our negative view of ZTO. For 2019 and 2020, we continue to expect slower top-line growth, margin compression, and a sharp increase in CapEx requirements. Our 2019-20 EPS forecasts and target price of $13.31 remain unchanged.

With help from a sharp increase in non-operating income, ZTO’s 4Q18 Adjusted EPS met consensus expectations of $0.24per ADS. But FY19Adjusted Net Profit guidance fell short of expectations, and management’s decision to withdraw quarterly guidance altogether is also disappointing.

ZTO’s gross margin fell ~370 bps in 4Q18 due to cost pressures and the rapid growth of certain low-margin businesses. We believe the same factors will continue to put downward pressure on margins in 2019 and 2020.

ZTO stated during the earnings call that Capex this year would increase by 50-100% compared to the 4bn RMB the company spent in 2018. According to management, much of the increase will go into building out ‘last-mile’ and rural infrastructure and we suspect the initial returns on these investments will be poor

In this briefing:

1. Chinese Telcos: Rising 5G Capex Risk Leads to Another Downgrade
2. XL Axiata Results Show a Strong Turnaround Underway in Indonesia
3. Fortis Healthcare: OK Results and a Cost-Cutter CEO
4. New J. Hutton Exploration Report (Week Ending 15/02/19)

1. Chinese Telcos: Rising 5G Capex Risk Leads to Another Downgrade

We recently downgraded the Chinese telcos on rising concerns that the telcos will be required to do “national service” to support China’s technological leadership in 5G.  The closure of many overseas markets to Chinese equipment suppliers (esp Huawei, but also Zte Corp H (763 HK)) means the risk of a more aggressive 5G roll-out has increased.  Markets have started to take notice but the initial reaction has been positive on excitement over the 5G opportunity. Given the lack of a strong business case for 5G currently, we don think additional capex is a positive. We model what an extreme roll-out could look like and the impact on the telcos. Along with a weakening macro outlook, we have further downgraded target prices for all three operators and cut China Mobile (941 HK) and China Telecom (728 HK) to Reduce and China Unicom (762 HK) to Neutral.

2. XL Axiata Results Show a Strong Turnaround Underway in Indonesia

Xl Axiata’s  (EXCL IJ) 4Q18 results triggered a very strong rally last week that continues this week. The market has been very concerned about competitive pressures in Indonesia and extremely low data prices. We believe that Indonesia is now past the worst and there is evidence that data pricing is starting to rise modestly. That is delivering a powerful tail wind for Indonesian telcos in 2019, with XL Axiata likely to report several very strong quarters.

XL Axiata now reporting strong sequential revenue growth (% QoQ)

3. Fortis Healthcare: OK Results and a Cost-Cutter CEO

Fortis Healthcare (FORH IN) ‘s hospital business continued to improve in FQ3 while the lab business remained stable. This Insight briefly focuses on the highlights of the results and their implications. The hiring of a CEO out of Narayana Hrudayalaya (NARH IN) signals continued (and likely intensified) focus on efficiency to improve profitability. 

We continue to think that Fortis is a promising turnaround story. Refer to the Insight Stream for the history of this situation.

4. New J. Hutton Exploration Report (Week Ending 15/02/19)

• Gold Road Resources (GOR AU) continued strong BUY
• Mineral Resource increased 2% to 6.61Moz
• 2019 attributable production guided at 50–60koz Au
• AISC est. between A$1,050 to $1,150/oz, is realistic
•  Using $1,300/oz attributable 2019 EBIT will be between US$7.5-15m
• 2020 attributable EBIT of 150k/oz conservative $A54m
• Price/EBIT ratio now 10.9 to 16.8 (previous est. 8 to 9.1)
• Expand AIM & ASX coverage to 397 companies from next week
• Gold Road Resources (GOR AU), Azumah Resources (AZM AU), Millennium Minerals (MOY AU), Metals X Ltd (MLX AU), De Grey Mining (DEG AU) , Resolute Mining (RSG AU), Andromeda Metals (ADN AU)  

In this briefing:

1. Security Bank: Something Makes Me Feel Insecure
2. Thai Telecoms: Slowdown in Mobile Business Continues.
3. China Tower. How Far Will It Rally?
4. Philippine National Bank – The Beginning of Recognition
5. After You Looks Beyond Thailand For Opportunities

1. Security Bank: Something Makes Me Feel Insecure

Security Bank (SECB PM) trades at a premium to Asian banks on a P/Book, franchise valuation, earnings yield, and total return ratio basis.

The PH Score™ of 5.3 is neither good nor bad. (Asia median is 5.7).

In terms of fundamental traction, efficiency has eroded and interconnected profitability has narrowed. “Jaws” are negative. Funding cost growth is sharply in excess of interest income growth. On the other hand, liquidity and capital adequacy are moving in the right direction or are stable.

Asset quality seems to have dramatically improved. Headline non-performing loans are now very low due to adoption of PFRS9. These are calculated now as loans aligned to a default criteria. The bank seems to have reclassified part of “stage 3” impaired loans back into “stage 2”. “Stage 2” is comprised of assets which have experienced a SICR (significant increase in credit risk) since initial recognition, such as substandard, past-dues, and SMLs, and are not classified as NPLs. “Stage 2” represents almost 4% of the loan book versus a headline impaired or problem loan ratio of just 0.64%. In addition, unimpaired past-due loans (73% of headline NPLs) climbed 57% YoY. Charge-offs soared 47% YoY. Perhaps the asset quality is not as pristine as the NPL ratio intimates.

When we look back from 2004, we see an explosive increase in loans (+10x since 2004) coinciding with lower profitability over this period. This is not a good sign. As the bank shifts to consumer lending for growth, up 10x since 2012, we wonder whether a similar pattern will emerge.

In short, the bank resides in the bottom decile of our global VFM (Valuation, Fundamentals, Momentum) rankings.

2. Thai Telecoms: Slowdown in Mobile Business Continues.

The Thai mobile market reported another weak quarter in 4Q18, with trends deteriorating at all three operators. The weakness was partly due to the cheap unlimited fixed speed offers which were popular in 2018 but which have now been removed from the market. Growth should recover by 2H19.  With Total Access Communication (DTAC TB) having acquired spectrum in 2018, it will no longer cede market share without a struggle. That suggests competitive risks are high in Thailand, with all three operators aiming to boost market share. We remain cautious on the sector and are also worried that the government seems keen to push on with 5G spectrum auctions despite a lack of use cases.

3. China Tower. How Far Will It Rally?

China Tower (788 HK) has rallied strongly in recent months and the question raised repeatedly in recent client meetings was “how much further is China Tower likely to rally?”. Chris Hoare sees China Tower’s position as unusual as the price moves are not driven by earnings upgrades or changed 5G expectations. Rather is is a sustained move post the IPO when the information in the market was incomplete and expectations were much lower. We were negative at the time of the IPO but changed our views as more information became available.  We remain positive on the scope for revaluation in China Tower given its rapid revenue growth and low valuations vs EM peers. While the recent results were somewhat disappointing, we see good upside as the market factors is lower capex and higher returns.

4. Philippine National Bank – The Beginning of Recognition

It has taken some time, but finally Philippine National Bank (PNB PM) is being recognized by the market.  To us though, this is only the beginning. The story with PNB has for a long time been about a turnaround, moving from a sleepy state-owned bank focused on large corporate loans and with a high level of bad loans, to a more invigorated bank with far better credit quality and a new focus on the consumer.  The recent milestone of paying a special dividend was a clear sign of how the bank improved since the Asian Financial Crisis (AFC).  The market is now awakening to what a new CEO can do with PNB and one who comes from HSBC Philippines. Still PNB’s market capitalization is only 9% of assets compared with 14-20% for the largest three peer banks. There appears a lot more to come. 

5. After You Looks Beyond Thailand For Opportunities

We met up with management of two companies whose industries couldn’t have been more different. This is the quick run-down on what they are up to recently:

• After You posted 14% earnings growth on the back of 20% revenue growth. While this remains healthy, it realizes that domestic market opportunities will become more limited and has started to look abroad with HK as its first market.
• Locally, the desserts leader is still planning a slew of new products and some in exclusive partnerships with various airlines such as Air Asia and Thai Smile.
• In an effort to reduce storefront expenses, they will start selling certain products outside stores and even online, now 3% of total sales.
• Amata’s earnings crashed 28% in 2018 on the back of 2% revenue decline, as Vietnam retroactively forbid certain land sales and even fines the company for past transactions that abided with the law back then!

In this briefing:

1. RBI Says Kotak Tried to “Take It for a Ride”: Shareholders Should Expect the Consequences
2. XL Axiata (EXCL IJ) – The Crown Prince of Data – On the Ground in J-Town
3. Sell Prada (1913 HK): Accounting Inflates Margins and Facilitates Excessive Dividends
4. Quick Update on ZTO Express: Results OK, but Guidance Unimpressive
5. NIO: A Survivor Among All the Chinese Start-Ups

1. RBI Says Kotak Tried to “Take It for a Ride”: Shareholders Should Expect the Consequences

The language used in the writ petition filed by Kotak Mahindra Bank (KMB) in Bombay High Court against the banking regulator should have alarmed shareholders. They would be even more apprehensive if they read the language used by the Reserve Bank of India (RBI) in its reply. That a bank should take the regulator to court and publicly challenge its authority in order to prevent a dilution in its founders’ shareholding is itself telling of the founder-CEO’s excessive influence on the board. The harsh, critical language used by the RBI in its court filing (“wilful misrepresentation”, “mala fide intent” taking the regulator “for a ride”) indicates its extreme displeasure with the bank, and the troubles that await the bank if the High Court rules in the regulator’s favour. In such an event, the RBI would probably demand a restructuring of the KMB’s board of directors, and may even force the removal of the founder as a CEO. 

2. XL Axiata (EXCL IJ) – The Crown Prince of Data – On the Ground in J-Town

A conversation with the management of Xl Axiata (EXCL IJ) following news that the company has started putting up prices in earnest for its existing customers revealed a more positive outlook for ARPUs and margins in 2019. 2018 was a difficult year with the impact of compulsory SIM registration in the first half plus a more intense competitive environment at the same time.

4Q18 results already reflected a better picture with QoQ growth for the quarter in service revenue, data revenue, and EBITDA confirming a positive trend established in the previous quarter.

Competition from other major players such a Telekomunikasi Indonesia (TLKM IJ), Indosat Tbk PT (ISAT IJ) and Hutchison has become more rational with the latter two operators raising prices in 2019 paving the way for Xl Axiata (EXCL IJ)‘s recent increases in renewal packages versus acquisition products previously. 

The availability of cheap but highly functional locally Chinese smartphones and XL’s own Xtream 4G handsets continues to drive data growth which now makes up 82% of services revenues for XL. 

4G subscribers, which now make up more than 55% of XL’s subs, also consume far more data than those using 3G. XL has been successfully monetising its more data-centric subscriber base in 2H18, reflected in its higher ARPU’s, which increased from IDR32,000 in 3Q18 to IDR33,000 in 4Q18. 

The increasing push by content players such as iFlix, Vidio.com, and other OTT players and digital advertisers into the mobile space will only increase the appetite for data in the mobile space.

The wild card on the competition front is Smartfren Telecom (FREN IJ) owner by Sinar Mas Group, which continues to push out aggressive data packages, although this had been tempered this year after it was hauled up by the regulator for breaking the pre-paid SIM rules.  

After a tough start to 2018, Xl Axiata (EXCL IJ) began to more effectively monetise its data and more importantly its 4G advantage in 2H18 and more holistically in 1Q19. If this momentum continues this year, it looks set to move back to headline profitability. Valuations look attractive, with the company trading on an EV/EBITDA of 4.2x FY19E, according to Capital IQ consensus estimates. After moving into profitability in 2019, it is forecast to see EPS growth of +63% and +68% for FY20E and FY21E respectively, implying an FY21E PER of 14.8x. Given the improvement in data pricing and strong growth in data, especially from 4G subscribers, consensus estimates appear conservative with room for upgrades to earnings estimates. 

3. Sell Prada (1913 HK): Accounting Inflates Margins and Facilitates Excessive Dividends

In our first report on Prada S.P.A. (1913 HK): An expensive luxury, we explained how creative accounting was disguising their business reality.  Since then, the stock has fallen 44% and the dividend has been cut. However, we think the key issues have yet to be addressed. They report growth, good operating cashflow and a solid financial position, but in-store sales are stagnant, margins falling, inventory rising and credit quality declining. It seems that profits are being inflated in order to pay dividends, largely to the controlling family.

4. Quick Update on ZTO Express: Results OK, but Guidance Unimpressive

After reviewing 4Q18 results and guidance for 2019, we retain our negative view of ZTO. For 2019 and 2020, we continue to expect slower top-line growth, margin compression, and a sharp increase in CapEx requirements. Our 2019-20 EPS forecasts and target price of $13.31 remain unchanged.

With help from a sharp increase in non-operating income, ZTO’s 4Q18 Adjusted EPS met consensus expectations of $0.24per ADS. But FY19Adjusted Net Profit guidance fell short of expectations, and management’s decision to withdraw quarterly guidance altogether is also disappointing.

ZTO’s gross margin fell ~370 bps in 4Q18 due to cost pressures and the rapid growth of certain low-margin businesses. We believe the same factors will continue to put downward pressure on margins in 2019 and 2020.

ZTO stated during the earnings call that Capex this year would increase by 50-100% compared to the 4bn RMB the company spent in 2018. According to management, much of the increase will go into building out ‘last-mile’ and rural infrastructure and we suspect the initial returns on these investments will be poor

5. NIO: A Survivor Among All the Chinese Start-Ups

Since its announcement on 4Q2018 results and termination of Jiading plant construction, NIO’s share price has been halved. We believe the market has over-reacted on NIO’s cashflow risk. With the expected 30-50% reduction on NEV (New Energy Vehicle) subsidies, all the Start-ups would have worse-than-ever cashflow pressure in 2019. But NIO might survive.

In China’s NEV market, NIO’s market position remains unique among all the Chinese Start-ups. Tesla is still NIO’s main competitor. NIO’s ES6 has capability to compete with Tesla’s Model Y, based on our comparison. Tesla and NIO both have to rely on external funding. The other Chinese Start-ups have to compete with traditional OEMs who have much less cash flow pressures.

NIO’s 4Q2018 financial data were in good trend. We estimate its net loss in 2019 to be further narrowed to Rmb6.1bn. With estimated Rmb13.2bn cash balance at end-Feb 2019, NIO have enough money to cover its estimated cash outflow in the next two year. And it would be able to get another round of external funding in 2020/2021, as long as its business operation ramps up as expected.

In this briefing:

1. XL Axiata (EXCL IJ) – The Crown Prince of Data – On the Ground in J-Town
2. Sell Prada (1913 HK): Accounting Inflates Margins and Facilitates Excessive Dividends
3. Quick Update on ZTO Express: Results OK, but Guidance Unimpressive
4. NIO: A Survivor Among All the Chinese Start-Ups
5. Security Bank: Something Makes Me Feel Insecure

1. XL Axiata (EXCL IJ) – The Crown Prince of Data – On the Ground in J-Town

A conversation with the management of Xl Axiata (EXCL IJ) following news that the company has started putting up prices in earnest for its existing customers revealed a more positive outlook for ARPUs and margins in 2019. 2018 was a difficult year with the impact of compulsory SIM registration in the first half plus a more intense competitive environment at the same time.

4Q18 results already reflected a better picture with QoQ growth for the quarter in service revenue, data revenue, and EBITDA confirming a positive trend established in the previous quarter.

Competition from other major players such a Telekomunikasi Indonesia (TLKM IJ), Indosat Tbk PT (ISAT IJ) and Hutchison has become more rational with the latter two operators raising prices in 2019 paving the way for Xl Axiata (EXCL IJ)‘s recent increases in renewal packages versus acquisition products previously. 

The availability of cheap but highly functional locally Chinese smartphones and XL’s own Xtream 4G handsets continues to drive data growth which now makes up 82% of services revenues for XL. 

4G subscribers, which now make up more than 55% of XL’s subs, also consume far more data than those using 3G. XL has been successfully monetising its more data-centric subscriber base in 2H18, reflected in its higher ARPU’s, which increased from IDR32,000 in 3Q18 to IDR33,000 in 4Q18. 

The increasing push by content players such as iFlix, Vidio.com, and other OTT players and digital advertisers into the mobile space will only increase the appetite for data in the mobile space.

The wild card on the competition front is Smartfren Telecom (FREN IJ) owner by Sinar Mas Group, which continues to push out aggressive data packages, although this had been tempered this year after it was hauled up by the regulator for breaking the pre-paid SIM rules.  

After a tough start to 2018, Xl Axiata (EXCL IJ) began to more effectively monetise its data and more importantly its 4G advantage in 2H18 and more holistically in 1Q19. If this momentum continues this year, it looks set to move back to headline profitability. Valuations look attractive, with the company trading on an EV/EBITDA of 4.2x FY19E, according to Capital IQ consensus estimates. After moving into profitability in 2019, it is forecast to see EPS growth of +63% and +68% for FY20E and FY21E respectively, implying an FY21E PER of 14.8x. Given the improvement in data pricing and strong growth in data, especially from 4G subscribers, consensus estimates appear conservative with room for upgrades to earnings estimates. 

2. Sell Prada (1913 HK): Accounting Inflates Margins and Facilitates Excessive Dividends

In our first report on Prada S.P.A. (1913 HK): An expensive luxury, we explained how creative accounting was disguising their business reality.  Since then, the stock has fallen 44% and the dividend has been cut. However, we think the key issues have yet to be addressed. They report growth, good operating cashflow and a solid financial position, but in-store sales are stagnant, margins falling, inventory rising and credit quality declining. It seems that profits are being inflated in order to pay dividends, largely to the controlling family.

3. Quick Update on ZTO Express: Results OK, but Guidance Unimpressive

After reviewing 4Q18 results and guidance for 2019, we retain our negative view of ZTO. For 2019 and 2020, we continue to expect slower top-line growth, margin compression, and a sharp increase in CapEx requirements. Our 2019-20 EPS forecasts and target price of $13.31 remain unchanged.

With help from a sharp increase in non-operating income, ZTO’s 4Q18 Adjusted EPS met consensus expectations of $0.24per ADS. But FY19Adjusted Net Profit guidance fell short of expectations, and management’s decision to withdraw quarterly guidance altogether is also disappointing.

ZTO’s gross margin fell ~370 bps in 4Q18 due to cost pressures and the rapid growth of certain low-margin businesses. We believe the same factors will continue to put downward pressure on margins in 2019 and 2020.

ZTO stated during the earnings call that Capex this year would increase by 50-100% compared to the 4bn RMB the company spent in 2018. According to management, much of the increase will go into building out ‘last-mile’ and rural infrastructure and we suspect the initial returns on these investments will be poor

4. NIO: A Survivor Among All the Chinese Start-Ups

Since its announcement on 4Q2018 results and termination of Jiading plant construction, NIO’s share price has been halved. We believe the market has over-reacted on NIO’s cashflow risk. With the expected 30-50% reduction on NEV (New Energy Vehicle) subsidies, all the Start-ups would have worse-than-ever cashflow pressure in 2019. But NIO might survive.

In China’s NEV market, NIO’s market position remains unique among all the Chinese Start-ups. Tesla is still NIO’s main competitor. NIO’s ES6 has capability to compete with Tesla’s Model Y, based on our comparison. Tesla and NIO both have to rely on external funding. The other Chinese Start-ups have to compete with traditional OEMs who have much less cash flow pressures.

NIO’s 4Q2018 financial data were in good trend. We estimate its net loss in 2019 to be further narrowed to Rmb6.1bn. With estimated Rmb13.2bn cash balance at end-Feb 2019, NIO have enough money to cover its estimated cash outflow in the next two year. And it would be able to get another round of external funding in 2020/2021, as long as its business operation ramps up as expected.

5. Security Bank: Something Makes Me Feel Insecure

Security Bank (SECB PM) trades at a premium to Asian banks on a P/Book, franchise valuation, earnings yield, and total return ratio basis.

The PH Score™ of 5.3 is neither good nor bad. (Asia median is 5.7).

In terms of fundamental traction, efficiency has eroded and interconnected profitability has narrowed. “Jaws” are negative. Funding cost growth is sharply in excess of interest income growth. On the other hand, liquidity and capital adequacy are moving in the right direction or are stable.

Asset quality seems to have dramatically improved. Headline non-performing loans are now very low due to adoption of PFRS9. These are calculated now as loans aligned to a default criteria. The bank seems to have reclassified part of “stage 3” impaired loans back into “stage 2”. “Stage 2” is comprised of assets which have experienced a SICR (significant increase in credit risk) since initial recognition, such as substandard, past-dues, and SMLs, and are not classified as NPLs. “Stage 2” represents almost 4% of the loan book versus a headline impaired or problem loan ratio of just 0.64%. In addition, unimpaired past-due loans (73% of headline NPLs) climbed 57% YoY. Charge-offs soared 47% YoY. Perhaps the asset quality is not as pristine as the NPL ratio intimates.

When we look back from 2004, we see an explosive increase in loans (+10x since 2004) coinciding with lower profitability over this period. This is not a good sign. As the bank shifts to consumer lending for growth, up 10x since 2012, we wonder whether a similar pattern will emerge.

In short, the bank resides in the bottom decile of our global VFM (Valuation, Fundamentals, Momentum) rankings.

In this briefing:

1. XL Axiata Results Show a Strong Turnaround Underway in Indonesia
2. Fortis Healthcare: OK Results and a Cost-Cutter CEO
3. New J. Hutton Exploration Report (Week Ending 15/02/19)
4. Sell Bombardier: Core EBIT Fell, Core Cashflow Is Negative, Covenants Maybe Under Stress

1. XL Axiata Results Show a Strong Turnaround Underway in Indonesia

Xl Axiata’s  (EXCL IJ) 4Q18 results triggered a very strong rally last week that continues this week. The market has been very concerned about competitive pressures in Indonesia and extremely low data prices. We believe that Indonesia is now past the worst and there is evidence that data pricing is starting to rise modestly. That is delivering a powerful tail wind for Indonesian telcos in 2019, with XL Axiata likely to report several very strong quarters.

XL Axiata now reporting strong sequential revenue growth (% QoQ)

2. Fortis Healthcare: OK Results and a Cost-Cutter CEO

Fortis Healthcare (FORH IN) ‘s hospital business continued to improve in FQ3 while the lab business remained stable. This Insight briefly focuses on the highlights of the results and their implications. The hiring of a CEO out of Narayana Hrudayalaya (NARH IN) signals continued (and likely intensified) focus on efficiency to improve profitability. 

We continue to think that Fortis is a promising turnaround story. Refer to the Insight Stream for the history of this situation.

3. New J. Hutton Exploration Report (Week Ending 15/02/19)

• Gold Road Resources (GOR AU) continued strong BUY
• Mineral Resource increased 2% to 6.61Moz
• 2019 attributable production guided at 50–60koz Au
• AISC est. between A$1,050 to $1,150/oz, is realistic
•  Using $1,300/oz attributable 2019 EBIT will be between US$7.5-15m
• 2020 attributable EBIT of 150k/oz conservative $A54m
• Price/EBIT ratio now 10.9 to 16.8 (previous est. 8 to 9.1)
• Expand AIM & ASX coverage to 397 companies from next week
• Gold Road Resources (GOR AU), Azumah Resources (AZM AU), Millennium Minerals (MOY AU), Metals X Ltd (MLX AU), De Grey Mining (DEG AU) , Resolute Mining (RSG AU), Andromeda Metals (ADN AU)  

4. Sell Bombardier: Core EBIT Fell, Core Cashflow Is Negative, Covenants Maybe Under Stress

Core EBIT fell: FY2018 EBIT and cashflow were inflated by one-off gains.

Core cashflow remains negative: Bombardier Inc (BBD/B CN) is still unable to fund its annual US$1bn+ capex budget from core operating cashflow.

Covenants maybe under stress: We are very concerned that the consolidated capital structure presented to investors is very different to the structures used in their debt covenants.