Equity Bottom-Up

In this briefing:

1. US Speciality Lenders – Worse Credit Metrics, Especially Personal Loans
2. Credit Bank of Moscow: A Highly Ranked EM Opportunity
3. Rides War Has Shifted To Share of Wallet
4. Indonesian Telcos: Mobile Pricing Should Continue to Recover. Telkom Remains Our Top Pick
5. Z IN

1. US Speciality Lenders – Worse Credit Metrics, Especially Personal Loans

We look at credit metrics of three specialty lenders in the US, for newly announced results. Discover Financial Services (DFS US) mostly provides credit card loans, but additionally it provides student loans and personal loans. The last category is where there is the most deterioration in the just-reported 4Q18 results, and it goes to our concerns about the reported ‘robustness’ of the US economy.  The company’s charge off rate in personal loans rose to 4.49% in 4Q18. The figure was 3.62% in 4Q17 and 2.70% in 4Q16. This is considerable deterioration. Even where some of the credit metrics in credit card loans is not as dire, the direction is of concern. All said, perhaps this is one reason that DFS falls into our growing bucket of financial companies with declining QoQ profit in 4Q18? Credit metrics at Sallie Mae and Synchrony Financial, do not leave us sanguine about the US consumer either. 

2. Credit Bank of Moscow: A Highly Ranked EM Opportunity

Founded in 1992 and acquired by Mr. Roman Avdeev in 1994,Credit Bank Of Moscow Pjsc (CBOM RM) benefits from an entrenched market position and strong brand recognition in its strategic market of Moscow which represents 25% of Russian GDP. CBM is an established operation in Moscow and the Moscow region with over 7,000 devices in high traffic locations.

CBM has expanded fast, from commanding a mere 0.7% share of system Assets in 2013 to 2.9% today.

The bank has a defined strategy underpinned by blue-chip, large, and medium-sized corporate services (fees, settlements, cash handling); high-margin consumer lending; and investment banking (SOVA Capital synergies, interbank, ECM, DCM, M&A). CBM commands a client-base of 15k corporates: companies represent 87% of loans. The bank has 1.5MM retail customers: accounting for a third of deposits.

In 2015 CBM acquired Inkakhran, swelling its nationwide cash handling market share to 17%. In this segment, CBM commands a client-base of 3k, of which 164 are banks, with 876 armoured vehicles covering 33k collection points.

Management is focused on above-system growth, based on a relatively robust liquid Balance Sheet, reducing funding costs, and enhancing operating efficiency and productivity. 2018 was marked by building up liquidity and strengthening capital adequacy as well as managing Balance Sheet risk -after 5 years of forceful growth- while maintaining profitability and cost efficiencies.

Technology highlights include the Your Bank Online system, MKB Business, and Foreign Exchange Control Dashboard.

Avdeev’s Rossium, a domestic group with interests in agriculture, timber, oil and a pharmacy chain, is the majority shareholder (56%) while the EBRD holds a position which reduces the float (18%). The supervisory board contains 5 out of 10 independent non executives while 2 more are nominees of minority shareholders. Related party lending is 3.5% of the loan book. Rosneft exposure though represents a caveat to CBM and to the system in general though some view this more of a strength.

3. Rides War Has Shifted To Share of Wallet

Grab is not just challenging the usual passengers-ride and taxi market; it has upped its game by selling monthly subscription plans, which can build recurring users. It is also looking to take bigger slices of business trips, traditionally the more lucrative pie for local taxi companies and niche car rental companies.

This report explains why Grab has gone into this promotional strategy, and is divided into five parts:

1. Monthly Subscription Plans 

2. Better Allocation of Resources 

3. The Juicy Corporate Pie

4. Fare comparison between Grab, Go-Jek, CD

5. Conclusions

4. Indonesian Telcos: Mobile Pricing Should Continue to Recover. Telkom Remains Our Top Pick

Over the past three years, an aggressive price war has pushed Indonesian data prices down 80% to unsustainable levels. With the exception of India, and Jio’s moves there, Indonesia now has the cheapest data in markets we track globally. However, there have been signs recently of tariff stability, with Telkomsel’s tariff rising 7%. Investors’ main concern, and the key risk to being bullish on the sector in Indonesia, is the risk a price war breaks out again. We think that is unlikely. The smaller telcos are not making sufficient returns to cover capex and finance costs and market share gains alone will not save them. Something needs to give: either prices rise and/or smaller players consolidate. Rumors swirling around Indosat (ISAT IJ) in recent days suggest consolidation may be under consideration again. 

Our view is that the price cycle has turned in Indonesia and consolidation is likely. That underpins our positive view on Indonesian telcos. We look for Telkom Indonesia (TLKM IJ) to deliver strong growth from its two major engines: mobile through Telkomsel and fixed line (broadband). The stock has done reasonably well since mid-2018, but we see upside and rate the shares a Buy with a raised target price of IDR5,250. We continue to like the re-rating story at XL Axiata (EXCL IJ), and remain Buyers with a price target of IDR5,200. Indosat’s share price has soared in recent days and we have now cut the stock to a Sell with the target price retained at IDR2,040.

5. Z IN

In spite of a stellar quarter (Q3 FY19), we remain cautious on Zee Entertainment Enterprises (Z IN) and the prospects of broadcasters in India. Hindi GEC is consolidating, and most of the growth is likely to happen in regional channels which remain competitive. Global data suggests ad spends as a % of revenue for many broadcasters and cable operators has been disrupted and couple of year’s down the line, India should be no exception. Contrary to consensus, driven by millennials and non-affordability of second television, cord cutting in India could accelerate sooner than excepted. With an hyper competitive OTT landscape, uncertainty post TRAI Tariff implementations, in an industry suspect to easy value migration, the long term outlook for Zee Entertainment Enterprises (Z IN) and the broadcast Industry warrants attention. The only near term positive for the stock is the potential stake sale to a strategic partner, which is likely to keep the stock price buoyant but only in the near term.

In this briefing:

1. Tesla–The Struggle to Stay Afloat in 2019
2. Olympus Corporation (7733 JP): Overvalued with Too Many Controversies
3. TRACKING TRAFFIC/Containers & Air Cargo: December Box Rates & Volume Firm
4. Subaru: Continuing Quality Issues and Employee Suicide Point to Sustainability Issues
5. The Race For Osaka’s Integrated Resort License: Our Take: Buy A “Japan Portfolio”.

1. Tesla–The Struggle to Stay Afloat in 2019

Profit Warning for Q4 2018 and Q1 2019: Two Fridays ago, Elon Musk warned that Q4 profits came in lower than Q3’s, despite an 8% QoQ rise in vehicle sales during Q4. He also announced a 7% cut in Tesla’s workforce, as Tesla is now facing “a tiny profit” in Q1 that will be achieved with “great difficulty, effort and some luck”. These are extremely bearish comments from a perennial optimist like Musk. If true, however, it kills the growth story at Tesla. And with the average 15% price cut of the Model 3 in the US and 17% in China, it also shows that Tesla may have misread the demand environment for its high-priced electric sedan. 

Model 3 Demand in the US has Clearly Been Exhausted: September 2018 saw peak monthly sales of 22,250 units in the US, which fell to an average monthly rate of 18,039 units in Q4. There are no more wait lists for the Model 3 at current prices: Tesla’s website says delivery can be made in under 2 weeks. In the January 18th profit warning, Musk admitted that Tesla must now sell its lowest-end version for $35,000 from May, or see production fall. At this price, Tesla’s Model 3 probably just breaks even, by our estimates. 

Weak Model 3 Launch in Europe: It was hoped that the Model 3’s European launch this March would make up for waning demand in the US. But since opening up configurations for reservation holders on December 7th, Tesla only received 13,773 orders, which is a whopping 24% lower than recent monthly sales in the US. Musk was forced to open up configurations to non-reservation holders, but this led to only 2,436 extra orders over the following 2 weeks.  In the US, Tesla opened up the Model 3 floodgates to non-reservation holders 12 months after launching the car. In Europe, it took less than 4 weeks.  

No Hopes for Tesla in China Either in 2019: Tesla’s registrations in China for October and November 2018, combined, fell by 72% YoY and overall auto demand is weakening there. Musk proclaimed that Tesla would start production of the Model 3 in Shanghai by 2019-end.  The factory site is a barren plot of land (see Figure-5). It took VW 23 months to build its latest factory in China and Toyota’s new Alabama plant will require 28 months. Why should we believe that Tesla only needs 11 months?    

Watch the Competition for Tesla in 2019: Tesla will face true competition this year for its first time as 4 new European EVs hit the market. During Q4 of 2018, Jaguar’s new I-Pace outsold Tesla’s Models S and X, combined, in the Netherlands–Tesla’s number two market after the US.  Audi’s e-Tron SUV–due out next month–had over 20,000 orders as of December 7th last year. Porsche’s new Taycan–a powerful rival for Tesla’s Model S–has sold out its first year of production, with most orders coming from Tesla owners. The Models S/X provided 50% of automotive gross profit in the 2H of 2018, by our estimates. A fall in volume will heavily impact profits. 

Spending Will Spike in 2019 and Lead to Negative FCF: Tesla was able to squeeze out a profit during the 2H of 2018 largely because of suppressed spending on R&D and infrastructure. In order to roll out the new Shanghai plant and bring the new Model Y to market, both capex and R&D must rise significantly in 2019. Our list of “spending needs” (see Figure-1) shows that capex should nearly double to $4.5bn in 2019. Including debt obligations and payables, Tesla’s total cash needs in 2019 come to $9.3bn, which is over twice its equity.  A highly dilutive public share offering appears inevitable. 

Why 2019 Could Be the End of Tesla: Tesla proved in 2018 that, even with higher sales volumes and lofty pricing for the Model 3, it could only attain an estimated 2H operating margin of 1.7%, excluding environmental credits, one-offs, and stock-based compensation. 2019 will be incredibly harder as 1) Tesla faces stiff competition for the first time since its inception; 2) a lower-priced Model 3 will not generate enough profit to cover falling profitability of the Models S/X; and 3) most significantly, a steep rise in capex and R&D will lead to higher losses and negative FCF. Tesla may need a bailout by a deep-pocketed suitor this year. But this could only occur at a much lower share price. 

2. Olympus Corporation (7733 JP): Overvalued with Too Many Controversies

Olympus Corporation is currently trading at JPY4,525 per share which we believe is overvalued based on our EV/EBIT valuation. The company generates nearly 80.0% of its revenue from its Medical Business where it is the global market leader for gastrointestinal endoscopes. Despite Olympus’ market share and technology leadership, the segment has been hit by investigations related to its duodenoscopies and has been fined for violating safety regulations. In addition, the Medical Division is also subject to several bribery-related investigations by the US Department of Justice and could risk losing its market share if the allegations are proven given the industry is highly competitive. Meanwhile its Imaging Business which offers cameras and lenses, is operating in a contracting market, where the segment continues to see declining revenues and is loss making.

To add to all of the above, the company is under scrutiny for governance-related issues such as lack of board diversity as well as poor corporate culture. On the positive side, the management has announced a plan to transform its business, including appointing three new (non-Japanese) directors to its board, all due to the pressure from its largest shareholder ValueAct Capital. The Management has mentioned that they will be proposing one of the partners of ValueAct as one of the three new directors at its shareholder meeting in April 2019, which is encouraging. However, that being said, we are yet to witness any tangible improvement in the way the company has conducted itself since the exposure of its accounting fraud in 2011 and has not been able to stay free of controversy. Hence, in our opinion the hefty premium at which the shares are currently trading is not justified suggesting to us that the potential turnaround in governance quality is being priced in too fully at this point. It is uncertain what other skeletons may be in Olympus’ closets and it seems premature to afford the stock a premium valuation.

3. TRACKING TRAFFIC/Containers & Air Cargo: December Box Rates & Volume Firm

Tracking Traffic/Containers & Air Cargo is the hub for all of our research on container shipping and air cargo, featuring analysis of monthly industry data, notes from our conversations with industry participants, and links to recent company and thematic pieces. 

Tracking Traffic/Containers & Air Cargo aims to highlight changes to existing trends, relationships, and views affecting the leading Asian companies in these two sectors. This month’s note includes data from about twenty different sources.

In this issue readers will find:

Although slowing demand growth is unlikely to generate impressive top-line improvements, firmer pricing combined with lower fuel costs should support an ongoing improvement in profitability for container carriers in the near-term. Meanwhile, the slump in air cargo demand has not yet hit air cargo yields, but it’s becoming clearer that an economic slowdown is hurting demand for this relatively expensive mode of transport.

4. Subaru: Continuing Quality Issues and Employee Suicide Point to Sustainability Issues

Our thesis on Subaru has maintained for some time that margins were inflated due to under-spending and that these costs would surface in one form or the other over time.

As it turns out, the costs were incurred through recalls as Subaru downgraded its FY OP guidance from ¥300bn to ¥220bn on 5 Nov. What continues to concern us is the constant stream of negative news flow on quality and sustainability-related issues. While the latest announcements do not imply excessive direct costs for the company, they continue to raise the question of whether corners were being cut and thus create doubt about the formerly excellent and still very high OPMs generated by Subaru.

We remain negative on Subaru as we expect margins to remain under pressure and believe top line may stagnate or shrink over the next one to two years.

5. The Race For Osaka’s Integrated Resort License: Our Take: Buy A “Japan Portfolio”.

• Osaka official targets Q3 this year for decision on the winning bid, citing a more the merrier attitude on the number of licensee presumptives.
• Bidders estimate investment for Osaka at anywhere between US$7bn. TO US$10bn.
• Top competitors for Osaka in our view are: MGM Resorts, Galaxy Entertainment Group, Melco Resorts and Entertainment, Las Vegas Sands and Wynn Resorts. Our view: Buy all five at current great entry points.

In this briefing:

1. JKN: Prime Content Distributor Eyes Big Opportunities in ASEAN Market

1. JKN: Prime Content Distributor Eyes Big Opportunities in ASEAN Market

We initiate coverage of JKN with a BUY rating, based on a target price of Bt8.80, pegged to the the 14.8xPE’19E mean of the Asia ex-Japan Consumer Discretionary Sector.

The story:

• Plenty of opportunities in the ASEAN market
• Harvest season is imminent
• New contracts with three new channels confirm 2019 domestic growth
• Mild recovery for domestic digital TV industry in 2019E

Risks: Heavy reliance on a few major customers, probability it will have to set provisions for doubtful debts and potential inability to renew contracts with customers.

In this briefing:

1. Centrica PLC (CNA LN): Lots of Gas but No Fizz
2. TAL Education (TAL): Online Courses Improved Margin in 3Q19, Parents Returning, 44% Upside
3. US Speciality Lenders – Worse Credit Metrics, Especially Personal Loans
4. Credit Bank of Moscow: A Highly Ranked EM Opportunity
5. Rides War Has Shifted To Share of Wallet

1. Centrica PLC (CNA LN): Lots of Gas but No Fizz

The political decision to exit the European Union has unpredictable negative consequences for both the UK economy and stockmarket. My purpose is to identify a portfolio of UK shorts and occasional longs.  

Centrica PLC: What does it do ?

Centrica, through its operating subsidiary British gas is the largest of the six major energy supply companies operating in the UK. The core activity, and providing around 70% of revenues, is energy supply to households and businesses in the UK, US and Canada. The group has a 28% share of the home energy market in the UK and 13% of the market in US. In energy supply to businesses, Centrica is the second largest supplier in the US where it claims a 15% market share. Beyond energy supply Centrica has three established business, Services, Trading, and E&P, and two nascent high growth businesses Distributed Energy & Power and Connected Home

Why is it in the short portfolio?

Energy Supply is dominated by regulation and price conscious consumers which has lead management to predict a flat revenue outcome over the long term. Customer numbers are declining, the recently introduced default tariff price cap will eat into revenues, and higher gas prices are unhelpful.

Recognizing the problem management intend to treat Energy Supply as a cash-cow re-investing its cash-flow into the growth businesses. However the available upside from these new ventures may not provide sufficient compensation. More immediately consideration of cash-flow suggests the dividend, currently supporting the shares with a near 9% yield, may not prove sustainable.

2. TAL Education (TAL): Online Courses Improved Margin in 3Q19, Parents Returning, 44% Upside

• We believe that parents of primary school children will bring their children back to tutoring schools when they become aware of the competition in junior high schools.
• The expansion of online business and the change towards small classes are improving both the revenue growth and the margins.
• We believe that the requirement of educator license is not a concern.
• The 5-year P/E band suggests an upside of 44% for the share of TAL Education.

3. US Speciality Lenders – Worse Credit Metrics, Especially Personal Loans

We look at credit metrics of three specialty lenders in the US, for newly announced results. Discover Financial Services (DFS US) mostly provides credit card loans, but additionally it provides student loans and personal loans. The last category is where there is the most deterioration in the just-reported 4Q18 results, and it goes to our concerns about the reported ‘robustness’ of the US economy.  The company’s charge off rate in personal loans rose to 4.49% in 4Q18. The figure was 3.62% in 4Q17 and 2.70% in 4Q16. This is considerable deterioration. Even where some of the credit metrics in credit card loans is not as dire, the direction is of concern. All said, perhaps this is one reason that DFS falls into our growing bucket of financial companies with declining QoQ profit in 4Q18? Credit metrics at Sallie Mae and Synchrony Financial, do not leave us sanguine about the US consumer either. 

4. Credit Bank of Moscow: A Highly Ranked EM Opportunity

Founded in 1992 and acquired by Mr. Roman Avdeev in 1994,Credit Bank Of Moscow Pjsc (CBOM RM) benefits from an entrenched market position and strong brand recognition in its strategic market of Moscow which represents 25% of Russian GDP. CBM is an established operation in Moscow and the Moscow region with over 7,000 devices in high traffic locations.

CBM has expanded fast, from commanding a mere 0.7% share of system Assets in 2013 to 2.9% today.

The bank has a defined strategy underpinned by blue-chip, large, and medium-sized corporate services (fees, settlements, cash handling); high-margin consumer lending; and investment banking (SOVA Capital synergies, interbank, ECM, DCM, M&A). CBM commands a client-base of 15k corporates: companies represent 87% of loans. The bank has 1.5MM retail customers: accounting for a third of deposits.

In 2015 CBM acquired Inkakhran, swelling its nationwide cash handling market share to 17%. In this segment, CBM commands a client-base of 3k, of which 164 are banks, with 876 armoured vehicles covering 33k collection points.

Management is focused on above-system growth, based on a relatively robust liquid Balance Sheet, reducing funding costs, and enhancing operating efficiency and productivity. 2018 was marked by building up liquidity and strengthening capital adequacy as well as managing Balance Sheet risk -after 5 years of forceful growth- while maintaining profitability and cost efficiencies.

Technology highlights include the Your Bank Online system, MKB Business, and Foreign Exchange Control Dashboard.

Avdeev’s Rossium, a domestic group with interests in agriculture, timber, oil and a pharmacy chain, is the majority shareholder (56%) while the EBRD holds a position which reduces the float (18%). The supervisory board contains 5 out of 10 independent non executives while 2 more are nominees of minority shareholders. Related party lending is 3.5% of the loan book. Rosneft exposure though represents a caveat to CBM and to the system in general though some view this more of a strength.

5. Rides War Has Shifted To Share of Wallet

Grab is not just challenging the usual passengers-ride and taxi market; it has upped its game by selling monthly subscription plans, which can build recurring users. It is also looking to take bigger slices of business trips, traditionally the more lucrative pie for local taxi companies and niche car rental companies.

This report explains why Grab has gone into this promotional strategy, and is divided into five parts:

1. Monthly Subscription Plans 

2. Better Allocation of Resources 

3. The Juicy Corporate Pie

4. Fare comparison between Grab, Go-Jek, CD

5. Conclusions

In this briefing:

1. REIT Discover: Frasers Commercial Trust (FCOT SP) At Inflection Point
2. Korean Stubs Spotlight: A Pair Trade Between SK Telecom & SK Hynix
3. Ramayana Lestari Sentosa (RALS IJ) – The Changeling – On the Ground in J-Town
4. Snippets #18: Naughty CEOs, Southern Crusades
5. Lloyds Banking Group (LLOY LN): Growth Who Needs It?

1. REIT Discover: Frasers Commercial Trust (FCOT SP) At Inflection Point

REIT Discover is an insight series featuring under-researched and off-the-radar REITs in an attempt to uncover hidden gems and gems in-the-making. In this insight, we give a lowdown on Frasers Commercial Trust (FCOT SP), which appears to be at an inflection point after seven consecutive quarters of falling net property income stemming from a downward trending occupancy rates.

At the centre of its conundrum is a key property, Alexandra Technopark (ATP), whose committed occupancy as at 31 December 2018 was a dismal 68.6%. 

In the meantime, there are three things happening that could help to spruce up FCOT’s operational metrics.

1. S$45mn asset enhancement initiative (AEI) at ATP to create a new contemporary business campus is nearing full completion. The AEI is aimed at creating a business campus environment to enhance property’s profile.
2. S$38mn AEI to rejuvenate the retail podium at China Square Central (CSC) which will increase its NLA from the current 64,000 sf to 78,000 sf upon completion by mid-2019. The concurrent launch of 304-room Capri by Fraser Hotel abut CSC will bring increased activity to CSC and benefit retail tenants.
3. Current gearing of 28.4% is one of the lowest among S-REITs, giving FCOT additional debt headroom estimated at about S$418mn to pursue growth initiatives. 

Following the recent run-up in the prices of S-REITs, FCOT trades at 0.9x P/NAV (ex-DPU). At current price, annualized FY19 DPU yield of 6.7% represents a differential of about 200 basis points above that of sector leaders like Capitaland Commercial Trust and Keppel REIT, a reflection of the Grade B profile of FCOT’s commercial properties. 

Interestingly, FCOT’s distributable income was growing in spite of the downtrend in gross revenue. This was likely the result of the new contribution from its UK asset acquired in January 2018. As such, FCOT was able to maintain DPU at a stable 2.40 cts for the past seven quarters. In the medium term, earnings upside will come from the organic growth of its revamped Singapore property portfolio and potential acquisitions in its sponsor’s key markets, Australia and Europe (likely UK). Any developments relating to the Brexit process will therefore have an impact on FCOT. In the near term, the built-in step-up rents mechanism in 47% of its leases in FY19 and FY20 should provide support to gross revenue. All things considered, FCOT’s future is worth a bet. 

2. Korean Stubs Spotlight: A Pair Trade Between SK Telecom & SK Hynix

In this report, we provide an analysis of our pair trade idea between SK Telecom (017670 KS) and SK Hynix Inc (000660 KS). Our strategy will be to long SK Telecom (017670 KS) and short SK Hynix Inc (000660 KS). Our base case strategy is to achieve gains of 8-10% on this pair trade. Our risk control is to close the trade if it generates 4-5% in combined losses. Cost of commissions are not included in the calculations and closing prices as of January 25th are used in our pair trade. [Long SK Telecom – $0.5 million; Short SK Hynix – $0.5 million for total of $1.0 million].

The following are the major catalysts that could boost SK Telecom shares higher than SK Hynix shares within the next six to twelve months: 

• Finally, a Higher DPS for SK Telecom is Likely, but Market Has Not Fully Factored In
• SK Hynix’s Plan for a 40% Lower Capex in 2019 Implies an Excess Inventory Condition
• 5G Service Ready to Start in March; Higher ARPU Typically Results in Higher Share Price
• SK Telecom’s Establishment of an Intermediate Holding Company Will Take Place in 2019 

3. Ramayana Lestari Sentosa (RALS IJ) – The Changeling – On the Ground in J-Town

Ramayana Lestari Sentosa (RALS IJ) continues to upgrade its stores and bring in new tenants, such as cinemas and F&B such as Starbucks, as its closes loss-making supermarkets. A revamped store is expected to see a 20-25% sales enhancement. It will transform a further 30 stores in 2019, including cinemas into the mix. 

The company continues to see strong performance from its consignment and fashion sales, with the drop off in supermarket sales lessening and this business no longer losing money. 

Ramayana Lestari Sentosa (RALS IJ) strives to be the leader in providing fashion for the masses and continues to use celebrities to endorse its own brands.

It has decentralised sourcing of products and incentivised stores managers at the EBIT level rather than for sales. It has also introduced a strict process for discounting, which is enhancing profitability.

The company will introduce a further 20 new consignment brands in 2019 to help grow this side of the business and move up the value chain. Shoes are one of the most important growth categories. 

Ramayana Lestari Sentosa (RALS IJ) is in the midst of a significant metamorphosis, which could see the company truly realise the value of its nationwide franchise, and move up the value to become less reliant on Lebaran sales. It continues to transform its store portfolio, introducing more consignment vendors and complementary tenants into its stores to increase footfall. According to Capital IQ consensus, the stock trades on 18.3x FY19E PER and 17.3x FY20E PER, with estimated EPS growth of +9% and +6% for FY19E and FY20E respectively. These growth expectations look to be conservative given the positive direction that management is taking both on its merchandising, brands, and tenant mix. 

4. Snippets #18: Naughty CEOs, Southern Crusades

In this review, we highlight five new unrelated developments that might impact the Thai stock market if you happen to hold the affected stocks.

• Skeletons in the closet. CIMB’s Thai CEO went on voluntary leave to clear his name regarding a legacy case back in his KTB days, while one of Thailand’s highest profile tycoon Dr. Prasert has been implicated in a stock manipulation case of Bangkok Airways from way back in 2015.
• Religious wars? As the southern insurgency spreads to economically vibrant province of Songkhla, insurgents attack a Buddhist temple and kill two monks, possibly in an effort to turn the crisis into a religious war. Doesn’t sound great for overall stability.
• A rare bump in the Baht. Despite QE unwinding, the Baht has risen almost 3% against the greenback. Bad news for exporters (eg. TUF, DELTA) good news for serial acquirers (think Thai Beverage, Banpu).
• Government-inspired deals. Is the government driving M&A in Thailand these days? They certainly had a hand in the TMB-Thanachart deal and now are rumored to be buying Thaicom, the country’s only satellite operator.
• Air quality takes a dive thanks to diesel and aggressive skytrain construction programs. Stores selling face mask and companies that substitute ethanol to diesel are set to benefit, while BTS might hit headwinds as government forces them to slow down construction.

5. Lloyds Banking Group (LLOY LN): Growth Who Needs It?

The political decision to exit the European Union has unpredictable negative consequences for both the UK economy and stockmarket. My purpose is to identify a portfolio of UK shorts and occasional longs.   

Lloyds Banking: What does it do ?

Lloyds Banking Group is the UK’s largest retail bank with a 20% share of both consumer credit and mortgage lending. It has no investment banking activities or overseas activities.

Why is it in the long portfolio ?

After a 10 year period of rehabilitation post the Financial Crisis the group is now profitable at the statutory level and generating a healthy double return on tangible equity (ROE). This year the consensus expectation is for a dividend of 3.3p per share (+7%) leaving the shares on a yield of 5.7%. In addition management completed a GBP1bn share buyback, the combination of buy-back and divided represents 4.7p per share or an effective yield of 8.1%. If future projections prove correct then the ROE should morph into the mid-teens by 2020. A return at this level should be sufficient to lift the shares well above book value. 

What are the risks ?

A key risk is economic dislocation from Brexit. Management believe that EU exit along the lines of the current withdrawal agreement will be compatible with only a marginal increase in credit losses.

In this briefing:

1. Workman Vs. Decathlon: The Upcoming Battle for Japan’s Sports Market
2. Dr Lal Pathlabs: Pricing Pressure, Lower Earnings Growth Leave Room for Downside
3. Autohome (ATHM): Commission Conflict with Dealers, as Auto Industry Suffers First Decline Since 1990

1. Workman Vs. Decathlon: The Upcoming Battle for Japan’s Sports Market

Decathlon is a category killer sans pareil and will finally open its first store in Japan in March. If Decathlon implements its store roll out well, the French sports retailer will cause a major disruption in Japan’s sports market.

Large domestic sports retailers like Xebio Holdings (8281 JP) and Alpen Co Ltd (3028 JP) will be gearing up to compete in some categories but are far behind in private label development and cost performance, and the major sports brands will have to accelerate their plans for retail stores while reviewing pricing (downwards). Sports firms like Mizuno (8022 JP), with relatively low perceived brand value, could face challenges in the newly polarised market that will emerge from Decathlon’s entry.

A major source of competition for Decathlon will come from a more unlikely retailer: the uniforms to outdoor apparel/gear firm, Workman (7564 JP). While still small, Workman is already manoeuvring to hinder Decathlon’s growth in Japan, and looks like having establishment backing to do so – and echoes the growth of Uniqlo after Gap entered the Japanese market in the 1990s and the rise and rise of Nitori (9843 JP) after IKEA’s launch in 2006.

Both Gap and IKEA have relatively small operations in Japan today compared to their early potential. Decathlon will need to expand rapidly if it is to gain sufficient share to stop Workman emerging with a clear lead in its market. 

2. Dr Lal Pathlabs: Pricing Pressure, Lower Earnings Growth Leave Room for Downside

• Dr Lal Pathlabs (DLPL IN) is the largest pathology chain in India and caters to the Rs 600 bn market growing at 15% Cagr. It is strongest in the lucrative NCR and Kolkata markets.
• Management has the best capital allocation track record in the pathology chain space. Network expansion mirrored patient volume growth.
• Patient volume growth has been the strongest among peers.
• However, revenue/patient has been declining as competitive pressure forced them to do away with price hikes for 2 consecutive years (2017-18). Increasing bundling of tests without adequate price hikes leading to sharp decline in revenue/sample.
• Expansion into eastern India with second central reference lab will drive down realizations
• Revenue growth deceleration and Ebitda margin contraction over FY17-18 looks to have stabilized now but are unlikely to revive.
• We expect Revenue and PAT Cagr of 15% and 16% respectively over FY18-21 against 21% and 34% respectively delivered over FY13-16.
• At CMP of Rs 996, Dr Lal trades at 36.1x FY20 EPS. Dr Lal’s steep multiples could see some compression with the lower growth trajectory and once the faster-growing Metropolis lists in the market. Our target price (30x FY20F) is Rs 827 implying 17% downside.

3. Autohome (ATHM): Commission Conflict with Dealers, as Auto Industry Suffers First Decline Since 1990

• China vehicle sales volume declined in 2018, which was the first time since 1990.
• Car dealers are negotiating commission rate with Autohome.
• We believe Autohome has more bargaining power than dealers, but will compromise to some extent.
• Our previous financial assumptions had already integrate the potential weakness in automobile industry.
• The stock price has been fully reflected the impact of the negotiation.

In this briefing:

1. A Bear Investment Case for TSMC (In-Depth Version)
2. A Bull Investment Case for TSMC (In-Depth Version)
3. A Bear Investment Case for TSMC (Summary Version)
4. A Bull Investment Case for TSMC (Summary Version)
5. RIO & BHP:  Valuation Gap Gone; Closing Long-Rio/Short-BHP

1. A Bear Investment Case for TSMC (In-Depth Version)

2. A Bull Investment Case for TSMC (In-Depth Version)

Taiwan Semiconductor Mfg Co has dominated the foundry segment over the past two decades. With revenues of $33 billion in 2017, the company had a 56% share of the foundry market and was over five times the size of its nearest competitor, Globalfoundries. Under the visionary leadership of Morris Chang, TSMC effectively invented the fabless model. Originally mocked by former AMD CEO Gerry Sanders who once famously quipped that “real men own fabs”, the fabless model has evolved into a thriving ecosystem, one which has facilitated the meteoric rise of some of the biggest names in the semiconductor segment including Apple, Qualcomm and Nvidia.  

TSMC’s success has been predicated upon the company’s so-called Trinity of Strengths, namely process leadership, manufacturing excellence and customer trust. In today’s highly competitive foundry landscape, those strengths have never been more significant.

While the smartphone processor business has been central to TSMC’s growth in recent years with Apple accounting for some 22% of revenues, the company is well positioned to diversify and benefit from high, secular growth trends in IoT, Automotive and AI acceleration. Even more significantly, TSMC is set to compete for the first time with Intel in the lucrative data center market by virtue of its role in manufacturing server chips for Advanced Micro Devices and a growing swathe of ARM-based server initiatives lead by none other than Amazon. 

Between 2006 and 2017, TSMC grew at a CAGR of 9.8% in NT$ terms, easily outpacing growth of both the broader semiconductor segment and its foundry peers. For the period 2019-2022, we model TSMC growing at a slightly lower CAGR of 8.36%, but nonetheless more than double the anticipated CAGR for the semiconductor segment as a whole. 

3. A Bear Investment Case for TSMC (Summary Version)

4. A Bull Investment Case for TSMC (Summary Version)

Summary

Taiwan Semiconductor Mfg Co has dominated the foundry segment over the past two decades. With revenues of $33 billion in 2017, the company had a 56% share of the foundry market and was over five times the size of its nearest competitor, Globalfoundries. Under the visionary leadership of Morris Chang, TSMC effectively invented the fabless model. Originally mocked by former AMD CEO Gerry Sanders who once famously quipped that “real men own fabs”, the fabless model has evolved into a thriving ecosystem, one which has facilitated the meteoric rise of some of the biggest names in the semiconductor segment including Apple, Qualcomm and Nvidia.  

TSMC’s success has been predicated upon the company’s so-called Trinity of Strengths, namely process leadership, manufacturing excellence and customer trust. In today’s highly competitive foundry landscape, those strengths have never been more significant.

While the smartphone processor business has been central to TSMC’s growth in recent years with Apple accounting for some 22% of revenues, the company is well positioned to diversify and benefit from high, secular growth trends in IoT, Automotive and AI acceleration. Even more significantly, TSMC is set to compete for the first time with Intel in the lucrative data center market by virtue of its role in manufacturing server chips for Advanced Micro Devices and a growing swathe of ARM-based server initiatives lead by none other than Amazon. 

Between 2006 and 2017, TSMC grew at a CAGR of 9.8% in NT$ terms, easily outpacing growth of both the broader semiconductor segment and its foundry peers. For the period 2019-2022, we model TSMC growing at a slightly lower CAGR of 8.36%, but nonetheless more than double the anticipated CAGR for the semiconductor segment as a whole. 

5. RIO & BHP:  Valuation Gap Gone; Closing Long-Rio/Short-BHP

Investment Conclusion:
We recommend closing our long-Rio Tinto Ltd (RIO AU)/short-Bhp Billiton (BHP AU) following recent trading updates from both companies which helped to narrow the previous valuation gap we identified in our Aug-18 note: US$20bn in Lost Market Cap Looks Hard to Justify: Recommend Long Rio; Short BHP

In this briefing:

1. Keppel-KBS US REIT – Positioned for Defensive Growth. Still Attractively Priced.
2. Thailand – KTC Defies the Sceptics
3. Prataap Snacks Ltd – Q2 Results; Will Acquisition of Avadh Snacks Be a Game Changer for Prataap
4. Thai Telcos: Outstanding Liabilities to CAT/TOT Loom Post DTAC’s Partial Settlement
5. Sell General Electric (GE US): Lots of Liabilities, Limited Cashflow – Target $1

1. Keppel-KBS US REIT – Positioned for Defensive Growth. Still Attractively Priced.

Keppel-Kbs Us Reit (KORE SP) (“KORE”) announced its full-year results this evening. 

Income available for distribution to Unitholders was 8.6% higher than the IPO forecast. The outperformance was due to contribution from the Westpark Portfolio which was acquired on 30^th Nov 2018. Excluding the impact of Westpark Portfolio, income from the underlying IPO portfolio was generally in line with the forecast.

For the full year, total income available for distribution to Unitholders was US$43.8 mil.

KORE reiterated that the US tax regulation changes and convergence of Barbados tax rates for domestic and international companies are not expected to have any material impact on NTA and DPU. There will be no further changes expected to the trust structure.

The outlook for KORE remains positive. KORE has positioned itself well for defensive growth in the coming year.

Positive set of results and outlook is expected to continue driving the re-rating of KORE. The immediate price target for KORE is US$0.78 per unit (parity to NAV) that will translate to a forward yield of 7.3%.

2. Thailand – KTC Defies the Sceptics

Krungthai Card (KTC TB) shows all too clearly how to keep profit growth high, rising from 20%, to 33% and to 56%, from 2016 through 2018. There are few financial companies that can compare to the persistent and high and improving rate of profit growth. We must remember that late in 2017, regulations changed lowering the maximum rate on credit card loans and limiting facilities based on a more stringent policy relating to income. Ironically, we believe this supports performance. Customers may have become more careful on defaulting, running the risk of getting cut off and having to re-apply for a personal loan or a credit card. And under new regulations, customers can not receive as high a credit limit as in the past, if their income is less than Bt30,000 or Bt50,000 per month.

3. Prataap Snacks Ltd – Q2 Results; Will Acquisition of Avadh Snacks Be a Game Changer for Prataap

In Q2 of FY19, the company has grown at 10.15% with revenue of INR 2.92 bn. EBITDA was INR 0.24 bn and EBITDA margin stood at 8.4%  down by 167 bps, Net profit stood at 0.113 bn with margins at 3.87% down by 102 bps. Raw materials cost has increased in the first half of the year leading to lower margins. 

The company has acquired 80% in Avadh Snacks, a Gujarat based snacks company for INR1.48 bn, we have discussed the implications in the report.

The stock is currently tradings at its 54x its FY18 EPS (Pre-acquisition) and 42x its FY19 EPS (post-acquisition), we believe the stock is currently overvalued but are positive on the long term prospects of the firm.

4. Thai Telcos: Outstanding Liabilities to CAT/TOT Loom Post DTAC’s Partial Settlement

Total Access Communication (DTAC TB) recently settled a number of outstanding cases with CAT, one of the two Thai Telecom authorities (the other being TOT). DTAC agreed to pay THB9.5bn ($300m) to CAT to settle a number of outstanding disputes. They did NOT clear all their disputes and there are substantial remaining potential liabilities. In the past, The Thai telcos have tended to ignore these cases given the glacial moves through the system (some are 20+ years), but DTAC’s moves suggest it is time to take a closer look. The total numbers for the industry are substantial at around $20bn and, following DTAC’s settlement, Chris Hoare thinks the risk of crystallizing losses has increased. We have cut our target prices as a result. The industry was already facing headwinds from the business revival at DTAC now that it has secured access to spectrum.

5. Sell General Electric (GE US): Lots of Liabilities, Limited Cashflow – Target $1

GE’s business reality is far removed from management’s up-beat message. Creative accounting enabled management to line their pockets, while the underlying business deteriorated. A bloated board sanctioned poor disclosure, leasing, restructuring provisions and asset trading that obscured the decline. In FY 2018, we expect underlying Industrial profits of US$3.4bn and unlevered sustainable cashflow of US$5.1bn, down 50%. Change is coming, but it is too little, too late…

In this briefing:

1. Korean Stubs Spotlight: A Pair Trade Between Amorepacific Group & Shiseido
2. Panasonic Is Bonding with Toyota- A JV Plan for 2020
3. China Meidong (1268 HK): Standout Story in Gloomy Auto Dealership Sector; Luxury Brands Outperform
4. Tosei (8923) An Undervalued and Depressed Japanese Property Developer.
5. Golden Agri:  Reduced Risk of El Niño Pushes Out CPO Price Recovery into 2020

1. Korean Stubs Spotlight: A Pair Trade Between Amorepacific Group & Shiseido

In this report, we provide an analysis of our pair trade idea between Amorepacific Group (002790 KS) and Shiseido Co Ltd (4911 JP). Our strategy will be to long Amorepacific Group (APG) and short Shiseido. As mentioned in our report, Korean Stubs Biweekly Sigma σ (#1): The Inaugural Edition, our base case strategy is to achieve gains of 8-10% on this pair trade. Our risk control is to close the trade if it generates 4-5% in combined losses. Cost of commissions are not included in the calculations and closing prices as of January 23rd are used in our pair trade. [Long APG – $0.5 million; Short Shiseido – $0.5 million for total of $1.0 million].

The following are the major catalysts that could boost APG shares higher than Shiseido shares within the next six to twelve months: 

• Amorepacific Group shares are extremely oversold and forming a base
• THAAD is no longer an issue
• Amorepacific Group’s NAV discount 
• Attractive relative valuations
• Amorepacific’s new headquarters building distraction out of the way
• Chinese tourists are coming back to Korea & slower growth rate of visitors to Japan

2. Panasonic Is Bonding with Toyota- A JV Plan for 2020

It seems that Panasonic Corp (6752 JP) is planning for long term growth by concentrating on building its relationship with Toyota Motor (7203 JP) while witnessing its key customer, Tesla Motors (TSLA US), drifts away. Toyota and Panasonic are in discussion to form a JV by 2020E with the aim of mass manufacturing EV batteries with possible benefits from cost-cutting efforts. We mentioned in Tesla Drifting Away Could Leave Panasonic Struggling to Gain Traction in China, that Tesla is looking for Chinese local players to source its factory in China upon the refusal from Panasonic to join hands with them in investing in their Chinese factory. Panasonic, which seemed to have felt the pressure mounting from Tesla potentially distancing itself from them, given that the majority of their battery sales are currently dependent on Tesla, is now preparing itself for the future by building long terms plans with its not-so-new customer, Toyota. Panasonic entered a partnership agreement with Toyota back in 2017 to develop EV batteries including their traditional prismatic batteries while also aiming to develop new battery solutions for the growing and evolving EV market. Thus, its plan to form a JV with Toyota by 2020E displays the confidence Panasonic has in Toyota while also indicating that the former is paving a path for some steady growth in its battery business being supported by one of the leading automakers.

3. China Meidong (1268 HK): Standout Story in Gloomy Auto Dealership Sector; Luxury Brands Outperform

China Meidong Auto (1268 HK) has been on a rollercoaster ride in 2018. The stock price of Meidong started 2018 around 2.7 HKD and recently has been trading around 2.9 HKD.

Nice and steady ride? Not exactly, as it has swung from 4.3 HKD in June to 2.6 HKD in August. After analyzing how NPAT estimates evolved over the past year there should be no justifications for these wild swings. 

Meidong is likely to report solid FY18 results by late March vs industry peers which are expected to report a weak 2H18. While BMW dealers have been reportedly suffering in China during 2018, Meidong was fortunate to have other luxury brands pick up the slack.

FY19 should be another growth year for Meidong as 1) recently acquired BMW showrooms contribute their maiden results and 2) other luxury brands continue to perform despite overall doom and gloom in the Chinese auto market. Should the Chinese government launch car replacement stimulus measures this would be icing on the cake.

Fair Value lowered slightly from 4.7 HKD to 4.4 HKD (10x 2019E) on lower 2019 profit estimates, which leaves 52% upside excluding dividends.

4. Tosei (8923) An Undervalued and Depressed Japanese Property Developer.

The shares are very cheap. They trade at 0.9x book but there is some Y22bn in unrealised profit on land/buildings (vs. the market cap of Y46bn). If adjusted for this, the shares are less that half book. Meanwhile the dividend has been steadily increasing (both payout ratio and in absolute terms). To 11/19 the payout ratio will be 23% and the dividend will rise to Y37 from Y30 last year. At today’s price of Y950, the yield is thus 3.9%. And the shares trade on multiple of 6x. They rose significantly last year on the back of Morgan Stanley BUY note (from Y800 to Y1,500) but with the market’s correction and the tightening of bank lending to individuals (which has no impact on them), the shares have fallen back to Y950. For those looking for a cheap domestic small cap name, this is worth looking at.  

5. Golden Agri:  Reduced Risk of El Niño Pushes Out CPO Price Recovery into 2020

INVESTMENT VIEW:
The Australian Bureau of Meteorology has just downgraded its risk of El Niño from ‘Alert’ to ‘Watch’, and as a result, we temper our optimism for a near-term rally in CPO prices.  Longer-term, we remain bullish on Golden Agri Resources (GGR SP), but higher CPO prices remain a key catalyst for our bullish call on the shares. 

In this briefing:

1. New Oriental (EDU): Do Not Fear Q2 Record Losses, 27% Upside
2. Meet, Beat or Miss Q4 Estimates, Both Las Vegas Sands and Sands China Are Solid Bets
3. AFFIN Bank: To Affinity and Beyond
4. Thyrocare Technologies: All’s Not Well with This Wellness Pathology Leader
5. ATP30: 100% Secured Client Base Prompt 2019 Growth

1. New Oriental (EDU): Do Not Fear Q2 Record Losses, 27% Upside

• The record net losses were mainly due to a seasonally weak quarter and recognition of the impairment in a subsidiary.
• Q2 revenues did not slow down and management does not believe Q3 revenues will slow down.
• EDU will not be negatively impacted by the new law from the Ministry of Education.
• The P/E band suggests an upside of 27% and a price target of USD90.

2. Meet, Beat or Miss Q4 Estimates, Both Las Vegas Sands and Sands China Are Solid Bets

• LVS shot at Japan license enhanced by his role in lobbying US Justice Department’s reverse opinion on online gambling published last week. Read why in this insight.
• Owning Sands China makes a strong case based on an ROCE analysis vs. the hospitality sector.
• Owning both at current trade is one of the screaming bargains in the entire sector

3. AFFIN Bank: To Affinity and Beyond

Based in Malaysia, AFFIN Bank Bhd (ABANK MK) is the product of two mergers over the last decade. Today AFFIN is a small-medium-sized financial services group, with 107 branches, combining corporate and SME banking; consumer banking (remittance services, vehicle loans, mortgages, personal loans, credit cards, unit trusts, and bancassurance products); Investment/Merchant Banking via AFFIN Hwang (AHAM), including corporate finance, capital market services and investment management; plus underwriting of general and life insurance (an underpenetrated market) through AAGI and AALI. AFFIN Islamic is a wholly owned subsidiary.

The core shareholders are LTAT (the superannuation fund for the Armed Forces), the Bank of East Asia, and Boustead Holdings which limits the float.

Malaysia has a tailwind of a new administration, vowing to overturn many aspects of its predecessor – including cancelling mega infra projects and reducing the “real” National debt.

The economy is pretty buoyant and is slated to generate an average of 4.75% GDP growth over 2018-2022. Inflation has mellowed, supported by the cut in GST, but will still, once these effects diminish, be modest, at around 2%, this year. The current and trade accounts are in surplus.

Malaysia, however, has a high level (by Asian standards) of household (excluding mortgages) indebtedness, dominated by credit cards, auto/vehicle finance, and personal loans. This had led to a moderately high risk in terms of the credit-to-GDP gap. The corporate sector is not excessively leveraged.

4. Thyrocare Technologies: All’s Not Well with This Wellness Pathology Leader

• Thyrocare Technologies (THYROCAR IN) is the fourth largest pathology chain in India and derives 54% of revenues from the wellness/preventive segment (Rs60bn market growing at 20% Cagr). Margins in wellness are ~2x that of illness segment.
• It is positioned as the lowest price provider in the market with some of its tests priced at 50-70% discount to peers.
• It enjoys the highest operating margin in the industry with excellent control of reagent and manpower costs.
• However, hyper competition in the wellness segment is pushing down pricing. Pullback in adspends is leading to loss of market share over FY18-1HFY19.
• Two-thirds of its capital is invested in the radiology business that does not have economies of scale. Business is loss-making and a drag on return ratios.
• We expect Revenue and PAT Cagr of 15% and 12% respectively over FY18-21 in the face of intensified competition against 24% and 19% respectively delivered over FY14-18.
• Softer growth coupled with utilization of free-cash from the clinical pathology business into the capital intensive and loss-making radiology business will weigh on stock performance. We value the stock at 22.5x FY20 EPS- at 25% discount to the industry leader Dr Lal Pathlabs (DLPL IN) . Our target price is Rs 494 implying 10% downside.

5. ATP30: 100% Secured Client Base Prompt 2019 Growth

We maintain a BUY rating for ATP30, based on a target price of Bt2.46 (previous TP: 2.48) and derived from a 30xPE’18E, which is its average trading range in the past one year and 10% discount to Thailand’s transportation sector

The story:

• Active fleet expansion still go on in 2019-20E
• Lower interest expense burden support margin expansion

Risks: Higher than expected in volatility in fuel price and probability that clients will terminate service contracts