Equity Bottom-Up

In this briefing:

1. Prataap Snacks Ltd – Q2 Results; Will Acquisition of Avadh Snacks Be a Game Changer for Prataap
2. Thai Telcos: Outstanding Liabilities to CAT/TOT Loom Post DTAC’s Partial Settlement
3. Sell General Electric (GE US): Lots of Liabilities, Limited Cashflow – Target $1
4. New Oriental (EDU): Do Not Fear Q2 Record Losses, 27% Upside
5. Meet, Beat or Miss Q4 Estimates, Both Las Vegas Sands and Sands China Are Solid Bets

1. 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.

2. 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.

3. 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…

4. 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.

5. 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

In this briefing:

1. Indonesian Telcos: Mobile Pricing Should Continue to Recover. Telkom Remains Our Top Pick
2. Z IN
3. TSMC. Reiterating Our Bullish Stance After Earnings
4. Keppel-KBS US REIT – Positioned for Defensive Growth. Still Attractively Priced.
5. Thailand – KTC Defies the Sceptics

1. 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.

2. 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.

3. TSMC. Reiterating Our Bullish Stance After Earnings

While Taiwan Semiconductor Manufacturing Company‘s Q4 2018 earnings were in line with expectations at ~$9.4 billion, the company’s revenue forecast for Q1 2019 was down 22% sequentially to $7.3 billion. TSMC predicts a tepid 2019 with semiconductor growth of 1%, down from ~6% last year. Like many of its peers, TSMC sees challenges relating to inventory overhang, waning smartphone unit sales and global macro uncertainty weighing on the company in the first half and expects business to recover to modest growth in the second half. The bottom line is that the company anticipates a no-to-low growth year of the Pig. 

In spite of the downbeat outlook for the year, the company reiterated its belief that it will hit its 5-10% growth CAGR through 2021. To meet that goal, it is clear that TSMC now expects both 2020 and 2021 to be double digit growth years and, as we outlined in our SmartKarma Originals report A Bull Investment Case for TSMC (In-Depth Version), much of that growth will come from TSMC’s new-found markets for processors and AI acceleration in the data center.

From a process technology leadership perspective, a fundamental tenet of our bull case for the company, TSMC noted that its 7nm process accounted for a staggering 23% of revenues in the fourth quarter, 7nm+ (with EUV) is on track for volume ramp in the second quarter and 5nm remains on track to follow just one year later. 

Investors shrugged of the negative outlook for the year with the company’s share price barely registering the news. We reiterate our bullish stance on the stock and our growth CAGR of 8.36% through 2022.

4. 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%.

5. 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.

In this briefing:

1. South Korea’s Plummeting Population Growth – Long Term Structural Impact on Korean Banks
2. UFO Moviez-Q2FY19 Results Update
3. Som Distelleries-Q2FY19 Results Update
4. CapitaLand Ltd – Premium Price for Ascendas-Singbridge
5. Samsung C&T: A Restructuring of Fashion Business Is Likely After the Stepping Down of Lee Seo-Hyun

1. South Korea’s Plummeting Population Growth – Long Term Structural Impact on Korean Banks

It was reported that South Korea’s population increased only 0.09% YoY at the end of 2018. The population growth has been declining in the past three decades in Korea. The population growth rate of 0.09% YoY in 2018 is even lower than the growth rate of 0.16% YoY in 2017. (Source: Korean Ministry of the Interior and Safety) The previous general estimates by various government agencies/research institutes of when the population in South Korea would decline were around 2028-2032. 

With the new available data, it is likely that these estimates will be revised drastically. In fact, it is possible that South Korea’s population could start declining around 2020-2022, contrary to previous estimates that suggested that South Korea’s population to start declining around 2028-2032.

The two leading Korean banks including Shinhan Financial (055550 KS) and Kb Financial Group (105560 KS) have been in a decade plus bear market. While these stocks may move up or down 10-15% within a short period of time, we think they are a structural, long-term short. Bank of Korea has been hesitant on raising the base interest rate. There are simply an overwhelming pressure to not to crash the real estate market. Because of this enormous pressure, the Korean banks have been losing out on the higher interest rate spreads they could have earned if the interest rates were raised much higher.  

2. UFO Moviez-Q2FY19 Results Update

Ufo Moviez India (UFOM IN) Q2FY19 results were in line with our expectations. While revenues declined by 4% YoY in Q2 FY19, PAT also declined by 4% YoY in the same period primarily due to the impact of D-Cinema sunset. We have mentioned in our earlier reports (click here and here) that the company is phasing out its distributor revenues from the Hollywood studio that may only last till FY20. We analyze the result.

3. Som Distelleries-Q2FY19 Results Update

Som Distilleries And Breweries (SDB IN) Q2FY19 results were in line with our expectations. While revenues witnessed a flat growth, PAT declined by 37% YoY in Q2 FY19 primarily due to seasonality impact on the beer volumes and higher depreciation on the new Karnataka plant. We analyze the results.

4. CapitaLand Ltd – Premium Price for Ascendas-Singbridge

CapitaLand Ltd announced yesterday that it will be acquiring Ascendas-Singbridge (“ASB”) from Temasek Holdings.

The agreed enterprise value for ASB was S$10,907 mil and the equity value of ASB payable to Temasek Holdings was S$6,036 mil.

This is a transaction that makes good strategic sense. CapitaLand and ASB’s businesses, sector and geographical exposures complement each other well.  Any tangible benefits from the synergies are likely to be seen over the mid to long term.  The increase in AUM and addition of new capital recycling platforms will make CapitaLand more appealing as a real estate fund manager to institutional investors and sovereign wealth funds.

However, the acquisition consideration for ASB is not cheap. CapitaLand is acquiring ASB at a price-to-book ratio of 1.15x. But this is a necessary step that CapitaLand has to take in order to execute its CapitaLand 3.0 strategy. 

From an investor’s perspective, concerns on the valuation of the deal, CapitaLand’s worsening credit metrics, and execution of the integration plan are likely to affect CapitaLand’s short-term share price performance. Management needs to demonstrate the ability to extract quantifiable synergistic value from the acquisition in order to justify the premium paid but this can only happen over the longer term.

5. Samsung C&T: A Restructuring of Fashion Business Is Likely After the Stepping Down of Lee Seo-Hyun

Lee Seo-Hyun (age 46), the billionaire second daughter of the Samsung Group Lee Gun-Hee, recently stepped down from her position as the CEO of Samsung C&T (028260 KS)‘s fashion business. After resigning from Samsung C&T, Lee Seo-Hyun will become a chairperson of the Samsung Foundation, focusing on corporate social responsibility activities.

Among the various fashion brands, the most problematic has been the 8 Seconds SPA brand, which has been continuing to lose money. Despite big ambitions to make 8 Seconds as one of the leading global SPA brands, this plan has fluttered, especially in the overseas markets such as China. This strongly suggests that there could be a big restructuring of the company’s fashion business in the coming months. 

Our NAV analysis of Samsung C&T suggests a range of 122k won to 139k won, which would represent an upside of 11% to 27%. In our NAV analysis, the investment stakes in affiliates were 19.2 trillion won, core business operating value was estimated at 9.9 trillion won (using 8x consensus OP in 2019), net cash of 2.2 trillion won, and Samsung Everland land value (post 50% taxes) of 1.8 trillion won. The range of value reflects the different discount for the quasi-holdco structure (20-30% discount).

In this briefing:

1. Khi (7012) Given Expected Recovery in Profits, Shares Are Now Too Cheap.
2. Brazil Banks: Banco Do Brasil Focus – Prospects for Improved Returns, Narrowing PBV Discount
3. Yaskawa Electric: We Are Probably Now Close to the Bottom for This LT Structural Growth Story
4. CRRC: Earnings Booming With Raised New Rail Line Delivery Target
5. Starbucks (SBUX): Could Starbucks’ Beans Start to Lose Their Magic?

1. Khi (7012) Given Expected Recovery in Profits, Shares Are Now Too Cheap.

The shares have underperformed TOPIX by 25% over the last 12 months and in terms of book, see chart below, are trading at near 5 year lows. Earnings for 3/19 were revised down after 1Q (operating profit from Y75bn to Y66bn due to write-off in the rolling stock division). The current forecast in our view is achievable and next year, in the absence of further write-off and growth in other parts of the business, we would expect operating profits to recover to the Y80bn level. This is a big conglomerate with many moving parts, some good and some not so good, but there is a price for everything and given where the shares are now, and where we think earnings are going, we are happy to buy here with the company trading at 0.9x book and the shares yielding just under 3%.

2. Brazil Banks: Banco Do Brasil Focus – Prospects for Improved Returns, Narrowing PBV Discount

• A rising pro-market tide has lifted the big-cap banks, but now it is time to be more selective. We see further potential for stock re-rating among the Brazilian banks, as the new Bolosonaro administration executes its pro-market policies.
• Our top pick is Banco Do Brasil Sa (BdoBAS3 BZ) , with a target price of BRL57, which implies 19% re-rating potential. We believe that Banco do Brasil (BdoB) shareholders are set to benefit from less of a “social programme” agenda which in turn should help improve ROE going forward.
• Yet the PBV discount between BdoB and its private sector peers – especially against Itaú Unibanco at 52% – has barely narrowed, and we believe that the discount has potential to narrow further as BdoB’s ROE expands and narrows the gap with its private sector peers.

3. Yaskawa Electric: We Are Probably Now Close to the Bottom for This LT Structural Growth Story

Following Yaskawa’s second downward revision at 3Q earnings, we are shifting towards a more positive stance on the stock, even from a long-term perspective. We had been negative on the stock from late 2017 and as the stock tumbled we maintained that it was still too early buy for the long-term, though by mid-late 2018 we did (incorrectly) feel that there was the potential for a short term rally due to the severity of underperformance.

With the stock selling off harshly in the recent market fall but rebounding following its weak earnings we feel that much of the bad news is now priced in and expectations have corrected to the point where this is once again interesting on the long side.

4. CRRC: Earnings Booming With Raised New Rail Line Delivery Target

Based on CRC’s (China Railway Corporation) 2019 plan on rail investment, CRRC’s earnings from rail business might be better than estimated. With a 45% increase on new rail delivery mileage, and significantly increase on HSR train (Multiple Units) repair demand, we estimate CRCC’s EPS increase by another 20% yoy to RMB0.53 in 2019E, following a 17% yoy increase in 2018E.

Also, a better earnings outlook might trigger a mild valuation re-rating. The stock trades at 12.8x P/E 2019E (our estimates), attractive vs. its 15.5x historical P/E average since the merger in 2015.

5. Starbucks (SBUX): Could Starbucks’ Beans Start to Lose Their Magic?

Three key emerging risks to the Starbucks’ growth story: 1) New entrant poses a threat to China growth story; 2) New CEO is missing the magic of the beans; and 3) New Uber partnership could erode Starbucks’ brand equity.

In our January 8 research note, we cautioned that Starbucks had outperformed the NASDAQ by 37% since we turned positive on August 8 but we were concerned about two new developments that we viewed as red flags: shelving of Reserve coffee bar expansion and aggressive China expansion plans of Luckin Coffee. While we do not believe this represents a short opportunity, we do believe it foreshadows emerging risks to Starbucks’ long-term growth story.

In this briefing:

1. Golden Agri:  Reduced Risk of El Niño Pushes Out CPO Price Recovery into 2020
2. A Bear Investment Case for TSMC (In-Depth Version)
3. A Bull Investment Case for TSMC (In-Depth Version)
4. A Bear Investment Case for TSMC (Summary Version)
5. A Bull Investment Case for TSMC (Summary Version)

1. 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. 

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

3. 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. 

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

5. 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. 

In this briefing:

1. Samsung C&T: A Restructuring of Fashion Business Is Likely After the Stepping Down of Lee Seo-Hyun
2. Prored Partners (7034) – A Fast Growing Recent Listing in Japan.
3. Apple (AAPL): Reduces Prices in Mainland China – Right Action, But Not Enough
4. HK Connect Discovery Weekly: China Tower, Tencent, New China Life (2019-01-11)

1. Samsung C&T: A Restructuring of Fashion Business Is Likely After the Stepping Down of Lee Seo-Hyun

Lee Seo-Hyun (age 46), the billionaire second daughter of the Samsung Group Lee Gun-Hee, recently stepped down from her position as the CEO of Samsung C&T (028260 KS)‘s fashion business. After resigning from Samsung C&T, Lee Seo-Hyun will become a chairperson of the Samsung Foundation, focusing on corporate social responsibility activities.

Among the various fashion brands, the most problematic has been the 8 Seconds SPA brand, which has been continuing to lose money. Despite big ambitions to make 8 Seconds as one of the leading global SPA brands, this plan has fluttered, especially in the overseas markets such as China. This strongly suggests that there could be a big restructuring of the company’s fashion business in the coming months. 

Our NAV analysis of Samsung C&T suggests a range of 122k won to 139k won, which would represent an upside of 11% to 27%. In our NAV analysis, the investment stakes in affiliates were 19.2 trillion won, core business operating value was estimated at 9.9 trillion won (using 8x consensus OP in 2019), net cash of 2.2 trillion won, and Samsung Everland land value (post 50% taxes) of 1.8 trillion won. The range of value reflects the different discount for the quasi-holdco structure (20-30% discount).

2. Prored Partners (7034) – A Fast Growing Recent Listing in Japan.

Prored Partners is a business consulting company founded in 2009 by the CEO, Mr Satani (who retains 60% of the equity). Prior to setting up Prored, he worked as a business consultant at a consultancy firm subsequently acquired by PwC Consulting. The shares were registered on the Mother’s exchange at the end of July 2018. Unfortunately, it is a micro-cap (market cap Y24bn) but should be of interest to those looking for a very fast growing small cap name. It trades on 17x our forecasts for this year to 10/19.  The company has been growing at a fast pace over the last few years. We expect this strong rate of growth to continue, see below.

3. Apple (AAPL): Reduces Prices in Mainland China – Right Action, But Not Enough

• Tim Cook passed the buck to the weak sales in China. However, we believe China’s retailing is running well based on our visits to shopping malls with Apple stores.
• Luxury goods sold better in China than all other major markets in the world in 2018.
• We believe that the price reduction in Mainland China is just taking market share from Apple Stores in Hong Kong, but not from competitors.
• We also believe that the app review process is the fatal shortcoming for AAPL.

4. HK Connect Discovery Weekly: China Tower, Tencent, New China Life (2019-01-11)

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

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

We see the Financials sector led the outflow by mainland investors last week with 201 million USD of net selling. We also highlight a few companies this week: China Tower (788 HK), Tencent Holdings (700 HK), New China Life Insurance (1336 HK), and Ping An Good Doctor (1833 HK).

In this briefing:

1. Starbucks (SBUX): Could Starbucks’ Beans Start to Lose Their Magic?
2. South Korea’s Plummeting Population Growth – Long Term Structural Impact on Korean Banks
3. UFO Moviez-Q2FY19 Results Update
4. Som Distelleries-Q2FY19 Results Update
5. CapitaLand Ltd – Premium Price for Ascendas-Singbridge

1. Starbucks (SBUX): Could Starbucks’ Beans Start to Lose Their Magic?

Three key emerging risks to the Starbucks’ growth story: 1) New entrant poses a threat to China growth story; 2) New CEO is missing the magic of the beans; and 3) New Uber partnership could erode Starbucks’ brand equity.

In our January 8 research note, we cautioned that Starbucks had outperformed the NASDAQ by 37% since we turned positive on August 8 but we were concerned about two new developments that we viewed as red flags: shelving of Reserve coffee bar expansion and aggressive China expansion plans of Luckin Coffee. While we do not believe this represents a short opportunity, we do believe it foreshadows emerging risks to Starbucks’ long-term growth story.

2. South Korea’s Plummeting Population Growth – Long Term Structural Impact on Korean Banks

It was reported that South Korea’s population increased only 0.09% YoY at the end of 2018. The population growth has been declining in the past three decades in Korea. The population growth rate of 0.09% YoY in 2018 is even lower than the growth rate of 0.16% YoY in 2017. (Source: Korean Ministry of the Interior and Safety) The previous general estimates by various government agencies/research institutes of when the population in South Korea would decline were around 2028-2032. 

With the new available data, it is likely that these estimates will be revised drastically. In fact, it is possible that South Korea’s population could start declining around 2020-2022, contrary to previous estimates that suggested that South Korea’s population to start declining around 2028-2032.

The two leading Korean banks including Shinhan Financial (055550 KS) and Kb Financial Group (105560 KS) have been in a decade plus bear market. While these stocks may move up or down 10-15% within a short period of time, we think they are a structural, long-term short. Bank of Korea has been hesitant on raising the base interest rate. There are simply an overwhelming pressure to not to crash the real estate market. Because of this enormous pressure, the Korean banks have been losing out on the higher interest rate spreads they could have earned if the interest rates were raised much higher.  

3. UFO Moviez-Q2FY19 Results Update

Ufo Moviez India (UFOM IN) Q2FY19 results were in line with our expectations. While revenues declined by 4% YoY in Q2 FY19, PAT also declined by 4% YoY in the same period primarily due to the impact of D-Cinema sunset. We have mentioned in our earlier reports (click here and here) that the company is phasing out its distributor revenues from the Hollywood studio that may only last till FY20. We analyze the result.

4. Som Distelleries-Q2FY19 Results Update

Som Distilleries And Breweries (SDB IN) Q2FY19 results were in line with our expectations. While revenues witnessed a flat growth, PAT declined by 37% YoY in Q2 FY19 primarily due to seasonality impact on the beer volumes and higher depreciation on the new Karnataka plant. We analyze the results.

5. CapitaLand Ltd – Premium Price for Ascendas-Singbridge

CapitaLand Ltd announced yesterday that it will be acquiring Ascendas-Singbridge (“ASB”) from Temasek Holdings.

The agreed enterprise value for ASB was S$10,907 mil and the equity value of ASB payable to Temasek Holdings was S$6,036 mil.

This is a transaction that makes good strategic sense. CapitaLand and ASB’s businesses, sector and geographical exposures complement each other well.  Any tangible benefits from the synergies are likely to be seen over the mid to long term.  The increase in AUM and addition of new capital recycling platforms will make CapitaLand more appealing as a real estate fund manager to institutional investors and sovereign wealth funds.

However, the acquisition consideration for ASB is not cheap. CapitaLand is acquiring ASB at a price-to-book ratio of 1.15x. But this is a necessary step that CapitaLand has to take in order to execute its CapitaLand 3.0 strategy. 

From an investor’s perspective, concerns on the valuation of the deal, CapitaLand’s worsening credit metrics, and execution of the integration plan are likely to affect CapitaLand’s short-term share price performance. Management needs to demonstrate the ability to extract quantifiable synergistic value from the acquisition in order to justify the premium paid but this can only happen over the longer term.

In this briefing:

1. Pasona : Interim Update – Still More Upside
2. Khi (7012) Given Expected Recovery in Profits, Shares Are Now Too Cheap.
3. Brazil Banks: Banco Do Brasil Focus – Prospects for Improved Returns, Narrowing PBV Discount
4. Yaskawa Electric: We Are Probably Now Close to the Bottom for This LT Structural Growth Story
5. CRRC: Earnings Booming With Raised New Rail Line Delivery Target

1. Pasona : Interim Update – Still More Upside

INTERIM UPDATE – Pasona Group (2168 JP) released their second-quarter results on January 11th. This Insight updates our recent Insight Pasona Non-Grata and re-iterates our buy recommendation. Pasona shares have risen by 15% this year to the intra-say high last Friday. Our target price remains ¥1,500 – a further 18% upside from today’s level. 

2. Khi (7012) Given Expected Recovery in Profits, Shares Are Now Too Cheap.

The shares have underperformed TOPIX by 25% over the last 12 months and in terms of book, see chart below, are trading at near 5 year lows. Earnings for 3/19 were revised down after 1Q (operating profit from Y75bn to Y66bn due to write-off in the rolling stock division). The current forecast in our view is achievable and next year, in the absence of further write-off and growth in other parts of the business, we would expect operating profits to recover to the Y80bn level. This is a big conglomerate with many moving parts, some good and some not so good, but there is a price for everything and given where the shares are now, and where we think earnings are going, we are happy to buy here with the company trading at 0.9x book and the shares yielding just under 3%.

3. Brazil Banks: Banco Do Brasil Focus – Prospects for Improved Returns, Narrowing PBV Discount

• A rising pro-market tide has lifted the big-cap banks, but now it is time to be more selective. We see further potential for stock re-rating among the Brazilian banks, as the new Bolosonaro administration executes its pro-market policies.
• Our top pick is Banco Do Brasil Sa (BdoBAS3 BZ) , with a target price of BRL57, which implies 19% re-rating potential. We believe that Banco do Brasil (BdoB) shareholders are set to benefit from less of a “social programme” agenda which in turn should help improve ROE going forward.
• Yet the PBV discount between BdoB and its private sector peers – especially against Itaú Unibanco at 52% – has barely narrowed, and we believe that the discount has potential to narrow further as BdoB’s ROE expands and narrows the gap with its private sector peers.

4. Yaskawa Electric: We Are Probably Now Close to the Bottom for This LT Structural Growth Story

Following Yaskawa’s second downward revision at 3Q earnings, we are shifting towards a more positive stance on the stock, even from a long-term perspective. We had been negative on the stock from late 2017 and as the stock tumbled we maintained that it was still too early buy for the long-term, though by mid-late 2018 we did (incorrectly) feel that there was the potential for a short term rally due to the severity of underperformance.

With the stock selling off harshly in the recent market fall but rebounding following its weak earnings we feel that much of the bad news is now priced in and expectations have corrected to the point where this is once again interesting on the long side.

5. CRRC: Earnings Booming With Raised New Rail Line Delivery Target

Based on CRC’s (China Railway Corporation) 2019 plan on rail investment, CRRC’s earnings from rail business might be better than estimated. With a 45% increase on new rail delivery mileage, and significantly increase on HSR train (Multiple Units) repair demand, we estimate CRCC’s EPS increase by another 20% yoy to RMB0.53 in 2019E, following a 17% yoy increase in 2018E.

Also, a better earnings outlook might trigger a mild valuation re-rating. The stock trades at 12.8x P/E 2019E (our estimates), attractive vs. its 15.5x historical P/E average since the merger in 2015.

In this briefing:

1. A Bull Investment Case for TSMC (Summary Version)
2. RIO & BHP:  Valuation Gap Gone; Closing Long-Rio/Short-BHP
3. New J. Hutton Exploration Report (Week Ending 18/1/19)
4. Itochu Confirms Intent to Deepen Hold over Descente
5. HK Connect Discovery Weekly: Tencent, Kingsoft, and Yichang HEC (2019-01-18)

1. 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. 

2. 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

3. New J. Hutton Exploration Report (Week Ending 18/1/19)

• Launching weekly exploration report
• Initial coverage of 318 companies
• Eventual ASX, TSX & AIM coverage
• Scientific approach to determine prospectivity
• Selective judgement on announcement materiality
• Preference for gold
• Targeting company maker projects
• Best exploration tenements, Magnesium, graphite, metallurgical coal
• Paladin Energy (PDN AU), Admiralty Resources Nl (ADY AU) , Jameson Resources (JAL AU), Golden Rim Resources (GMR AU), Orion Gold Nl (ORN AU) , Talga Resources (TLG AU), Barra Resources (BAR AU), King River Resources (KRR AU), Korab Resources (KOR AU), Lefroy Exploration Ltd (LEX AU)

4. Itochu Confirms Intent to Deepen Hold over Descente

Itochu (8001 JP) continues a battle of words and equity as it attempts to gain more control over sports firm Descente (8114 JP).

Meanwhile, Descente has brought in Wacoal (3591 JP) as a white knight and made a splash in the business media about its recent success.

Itochu insists that Descente needs Itochu’s management skills, particularly to build a stronger business in China and other overseas markets, and says the only way to make Descente listen is to buy more stock – more than its current nearly 30%.

5. HK Connect Discovery Weekly: Tencent, Kingsoft, and Yichang HEC (2019-01-18)

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

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

In this week’s HK Connect Discovery, we highlight that Tencent topped the weekly inflow by quantum and its shares held by mainland investors via Stock Connect is at one year low. Stocks exposed to mobile game sector experienced inflow too. In addition, we continue to observe that the mainland investors holding on Yichang HEC continue to rise. 

In this briefing:

1. Meituan Dianping: Core Business Progress Toward Profitability an Overlooked Story?
2. Onward Quits Zozo: Another Dent in Zozo’s Reputation
3. Workman Vs. Decathlon: The Upcoming Battle for Japan’s Sports Market
4. Dr Lal Pathlabs: Pricing Pressure, Lower Earnings Growth Leave Room for Downside
5. Autohome (ATHM): Commission Conflict with Dealers, as Auto Industry Suffers First Decline Since 1990

1. Meituan Dianping: Core Business Progress Toward Profitability an Overlooked Story?

• Our deep-dive segment profitability analysis reveals that Meituan Dianping’s (3690 HK) core business (combined food delivery and in-store, hotel & travel) has made good progress toward profitability.
• The ballooning consolidated operating losses mainly stem from new initiatives (particularly car hailing and Mobike).
• Furthermore, lower S&M expenses to sales ratio plus food delivery’s higher take rate suggests that competition with Ele.me is more manageable than anticipated.
• Our SOTP yields intrinsic value of HK$61.07/share, that represents 37% upside potential. 

2. Onward Quits Zozo: Another Dent in Zozo’s Reputation

ZOZO (3092 JP) has been hit from all sides recently, with a major sell-off by investors disturbed by Zozo’s execution of its private brand launch and the resulting impact on the company’s reputation among merchants and consumers alike.

Last month it launched a new campaign which, on the surface, was all about helping customers give back to society, but which drew an immediate negative response from some merchants.

One of these, Onward Holdings, withdrew all its brands from sale on Zozo. This is another damaging dent in Zozo’s reputation. 

3. 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. 

4. 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.

5. 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.