Equity Bottom-Up

In this briefing:

1. Alkem Laboratories – En Route to Recovery, Valuations Attractive
2. Swaraj Engines: Positive Outlook But Growth Is Slowing and Valuation Is Rich
3. Okinawa Cellular (9436 JP): Warm Tropical Breezes with KDDI
4. KRI (KRI MK): Continued Capacity Expansion to Meet Solid Demand
5. Kalbe Farma (KLBF IJ): Navigating Through the New Pharma Dynamics

1. Alkem Laboratories – En Route to Recovery, Valuations Attractive

Alkem Laboratories (ALKEM IN) produces branded generics, generic drugs, active pharmaceutical ingredients and neutraceuticals, which it markets in India and over 50 countries internationally. With a portfolio of over 700 brands covering all the major therapeutic segments and a pan-India sales and distribution network, Alkem has been ranked amongst the top ten pharmaceutical companies in India by sales for the past 13 years.

We are optimistic about Alkem because-

• Alkem continues to grow significantly ahead of the segment growth rate of ~16% in the chronic therapy areas of Cardiac, Antidiabetic, Neuro / Central nervous system (CNS) and Derma. Alkem continues grow in the acute therapy areas of Anti-infective, Gastro-intestinal, Pain/ Analgesic and Vitamins / Minerals /Nutrients.

• We expect India revenues to grow at CAGR 13% (FY18-21E) to Rs 64,687 mn in FY21E from Rs 44,900 mn in FY18. We expect US revenues to grow at CAGR 31% (FY18-21E) to Rs 30,438 mn from Rs 13,667 mn in FY18 and other international business revenues to grow at CAGR 11% (FY18-21E) to Rs 6,443 mn in FY21E from Rs 4,670 mn in FY18.

• We expect EBITDA to grow at CAGR 21% (FY18-21E) to Rs 18,638 mn in FY21E from Rs 10,566 mn in FY18 and EBITDA margins to expand by ~ 190 bps to 18.4% in FY21E from 16.5% in FY18. We expect PAT to grow at CAGR 27% (FY18-21E) to Rs. 12,979 mn in FY21E from Rs 6,289 mn in FY18 and we expect PAT margins to expand by ~ 300 bps to 12.8% in FY21E from 9.8% in FY18.

• We expect RoE to expand by ~530 bps to 19.0% in FY21E from 13.7% in FY18 and RoCE to expand by ~390 bps to 21.1% in FY21E from 17.2% in FY18

We initiate coverage on Alkem with fair value of Rs. 2,260/- representing a potential upside of 21% in the next 12 months. We arrived at the fair value by applying 22x multiple to September 20E EPS of Rs 102. Currently, the stock trades at 21x and 17x its earnings estimates for FY20E and FY21E respectively. After a very volatile 2018, we believe Alkem share price may have smooth upwards move in 2019 driven by strong PAT growth in the next 3 quarters.  

2. Swaraj Engines: Positive Outlook But Growth Is Slowing and Valuation Is Rich

Swaraj Engines (SWE IN) (SEL)is primarily manufacturing diesel engines for fitment into Swaraj tractors manufactured by Mahindra & Mahindra Ltd. (M&M). The Company is also supplying engine components to SML Isuzu Ltd used in the assembly of commercial vehicle engines. SEL was started as a joint venture between Punjab Tractor Ltd (now acquired by M&M Ltd) and Kirloskar Oil Engines Ltd. M&M holds 33.3% stake in SEL and is its key client.  

We are positive about the business because:

• SEL’s growth is correlated with M&M’s tractor business growth. SEL supplies engines to the Swaraj division of M&M. M&M expects tractor growth to be around 12% YoY in FY19E. We forecast SEL’s tractor engine volumes will grow at a CAGR of 12% for FY18-21E.
• The growth of the company is dependent on the monsoon and rural sentiments. We expect the profitability to improve with normal rainfall and government initiatives towards the rural sector. We expect the revenue/ EBITDA/ PAT CAGR for FY18-21E to be 14%/ 15%/ 14% respectively.
• SEL is debt free and a cash generating company. It has a healthy and stable ROCE and ROE. SEL has increased its capacity from 75,000 engines in FY16 to 120,000 engines in FY18. We expect the capacity utilisation to reach 97% by FY20E from 90% in 1HFY19. SEL funds its capex through internal accruals. We forecast a capex of Rs 600 mn for FY19E to FY21E considering the requirement of the additional capacity, R&D and testing costs for new and higher HP engines & for upgradation of engines according to the TREM IV emission norms for >50 HP engines.

We initiate coverage on SEL with a fair value objective of Rs 1,655/- over the next 12 months. This represents a potential upside of 15% from the closing price of Rs 1,435/- (as on 26-12-2018). We arrive at the fair value by applying PE multiple of 18x to EPS of Rs 87/- to the year ending December-20E and add cash of Rs 82/- per share. While the business outlook is good, we think the upside in the share price is limited due to rich valuation.

3. Okinawa Cellular (9436 JP): Warm Tropical Breezes with KDDI

As the colder winter weather is felt and the icy blast of industry tariff cuts continues to chill sentiment, we seek some respite (at least mentally) in the warmer climes of Okinawa. Okinawa Cellular is a unique company. It’s a small cap telecom network operator in Japan with a focus on the sub-tropical islands of Okinawa Prefecture. As part of the KDDI group, the company benefits from its parent’s economies of scale, but with its local presence, it also benefits from being the hometown hero. 

Because the stock is relatively small, from an investment perspective it runs into liquidity constraints that the other telcos do not have, so it’s a different type of investment but one that we think is worth looking at. Over the past 12 months Okinawa Cellular’s stock has fallen by 12.3%, but over the past year the stock has delivered a return in the middle of its peer group and has outperformed the broad TOPIX by about 5.5%. Like most telcos, Okinawa Cellular is also ramping its dividend payments, and the current yield is about 3.5%.

4. KRI (KRI MK): Continued Capacity Expansion to Meet Solid Demand

• More attractive to analysts, low price-to-sales, and low correlation with Western stock markets relative to its sector
• To meet strong demand, KRI recently commissioned Plant 17, which increased capacity by 1.5bn. Upcoming Plants 18 and 19 to commission in 2019 should add another 5.5bn or a 20% capacity increase
• High barriers to entry for medical gloves due to stringent compliance to regulatory requirement aids KPI market shares
• Trades above ASEAN Health Care at 19CE* 4.1x PB, in line with offering a better ROE
• Risks: Sudden jump in raw materials prices

* Consensus Estimates

5. Kalbe Farma (KLBF IJ): Navigating Through the New Pharma Dynamics

The healthcare industry in Indonesia has undergone a massive change since the introduction of the National Health Insurance (JKN) in 2014. Although the program allows for better healthcare access for over 200mn Indonesians, the industry dynamics have shifted and Kalbe Farma (KLBF IJ) is one of the companies that has been on the losing side during this adjustment period.

With the Health and Social Security (BPJS) deficit forecast to grow to IDR16t by end of 2018, and with a continuing roll out of coverage to 250mn people by end of 2019, all parties in the healthcare industry are expected to continue subsidizing the program.  Hospitals and drug manufacturers have had to cope with relatively flat pricing from the INA-CBG (reimbursement) tariff since 2014, despite cost pressures stemming from the currency depreciation and inflation. KLBF has reported declines in its overall pharmaceutical margin, as well as low growth rates for its licensed and OTC (over the counter) drugs over the past five years.

Our recent meeting with the company revealed that to mitigate the JKN impact, KLBF has launched several strategies, including expanding into niche specialty products such as oncology and biosimilar drugs, as well as preventive and herbal supplements. We are also at a tipping point where KLBF’s non-OTC consumer health and nutritionals revenues are finally larger than the pharmaceutical revenues for the first time. In this insight, we will discuss whether the worst is already behind us, and if it is now time to take another look at the stock. 

In this briefing:

1. GMO Internet (9447 JP) – Grossly or Modestly Overrated?
2. 58.com Inc. (NYSE: WUBA): Regulatory Pressure Has Long Term Implications
3. Tuan Sing: Beneficiary of Exuberant Demand for Prime Office Investment Properties
4. ICT (ICT PM): Beneficiary of Higher Trading Activity
5. Infosys Ltd (INFO IN): Another Buyback Coming? Not a Bad Idea, but How Much It Can Really Help?

1. GMO Internet (9447 JP) – Grossly or Modestly Overrated?

Source: Japan Analytics

THE GMO INTERNET (9449 JP) STORY – GMO internet (GMO-i) has attracted much attention in the last eighteen months from an unusual trinity of value, activist and ‘cryptocurrency’ equity investors.

• VALUE– Many traditional, but mostly foreign, value investors have seen the persistent negative difference between GMO-i’s market capitalisation and the value of the company’s holdings in its eight listed consolidated subsidiaries as an opportunity to invest in GMO-i with a considerable ‘margin of safety’.
• ACTIVIST – Since July 2017, the activist investor, Oasis, has waged a so-far-unsuccessful campaign with the aim of improving GMO’s corporate governance, removing takeover defences, addressing a ‘secularly undervalued stock price we are not able to tolerate’ (sic), and redefining the role and influence of the company’s Chairman, President, Representative Director and largest shareholder, Masatoshi Kumagai.
• ‘CRYPTO!’ – In December 2017, GMO-i committed to spending more than ¥35b or 10% of non-current assets. The aim was threefold: to set up a bitcoin ‘mining’ headquarters in Switzerland (with the ‘mining’ operations being carried out at an undisclosed location in Scandinavia), to develop proprietary state-of-the-art 7nm-node ‘mining chips’, and, in due course, to sell GMO-branded and developed ‘mining’ machines. The move was hailed in the ‘crypto’ fraternity as GMO-i became the largest non-Chinese and the first well-established Internet conglomerate to make a major investment in ‘cryptocurrency’ infrastructure.

OUTSTANDING – Following the December 2017 announcement, trading volumes spiked into ‘Overtraded’ territory – as measured by our Volume Score. Many investors saw GMO-i shares as a safer way of gaining exposure to ‘cryptocurrencies’, even as the price of bitcoin began to subside. By early June 2018, GMO-i’s shares had reached a closing price of ¥3,020: up 157% from the low of the prior year and outperforming TOPIX by 135%. Whatever the primary driver of this outstanding performance, each of our trio of investor groups no doubt felt vindicated in their approach to the stock.

CRYPTO CLOSURE – On December 25th 2018, GMO-i’s shares reached a new 52-week low of ¥1,325, a decline of 56% from the June high. Year to date, GMO-i shares have now declined by 31%, underperforming TOPIX by nine percentage points. On the same day, GMO-i announced that the company would post an extraordinary ¥35.5b loss for the fourth quarter, incurring an impairment loss of ¥11.5b in relation to the closure of the Swiss ‘mining’ headquarters and a loss of ¥24b to cover the closure of the ‘mining chip’ and ‘mining machine’ development, manufacturing and sales businesses. GMO-i will continue to ‘mine’ bitcoin from its Tokyo headquarters and intends to relocate the ‘mining’ centre from Scandinavia to (sic) ‘a region that will allow us to secure cleaner and less expensive power supply, but we have not yet decided the details’. Unlisted subsidiary GMO Coin’s ‘cryptocurrency’ exchange will also continue to operate, and the previously-announced plans to launch a ¥-based ‘stablecoin’ in 2019 will proceed. In the two trading days following this announcement, the shares have recovered 13% to ¥1,505. 

RAIDING THE LISTCO PIGGY BANK – As we shall relate, this is the second time since listing that GMO-i has written off a significant new business venture which the company had commenced only a short time before. In both cases, the company was forced to sell stakes in its listed consolidated subsidiaries to offset the resulting losses. On this occasion, the sale of shares in GMO Financial (7177 JP) (GMO-F) on September 25 2018, and GMO Payment Gateway (3769 JP) (GMO-PG) on December 17 2018, raised a combined ¥55.6b and, after the deduction of the yet-to-be-determined tax on the realised gains, should more than offset the ‘crypto’ losses. According to CFO Yasuda, any surplus from this exercise will be used to pay down debt. Also discussed below and in keeping with this GMO-i ‘MO’, in 2015, the company twice sold shares in its listed subsidiaries to ‘smooth out’ less-than-desirable operating results.

2. 58.com Inc. (NYSE: WUBA): Regulatory Pressure Has Long Term Implications

● We notice that Anjuke’s Oct.-Nov. traffic declined. We attribute this decline to the tightening of registration requirement in various cities, which will reduce the number of housing leads on WUBA platform;

● We, however, believe new home business will deliver strong revenue for WUBA this year, contributing Rmb2bn in revenues by our estimate;

● We rate the stock Buy and cut TP from US$84 to US$79.

3. Tuan Sing: Beneficiary of Exuberant Demand for Prime Office Investment Properties

Gaw Capital is said to be paying a CLSA-managed fund S$710 mn for 77 Robinson, which is just 3 minutes’ walk away from Tuan Sing-owned prime freehold office building, Robinson Point. This works out to around S$2,300 psf based on NLA. 77 Robinson has a balance lease of 74 years. 

Evidently, institutional buying interest in Singapore’s prime commercial buildings remains strong as the Singapore office market is now still a “landlords’ market”. Grade A CBD office rents are expected to continue their upward growth trajectory into 2019.  Tuan Sing is a beneficiary of the strong office rental upturn as its prime freehold commercial assets in Singapore – 18 Robinson, Robinson Point, and 896 Dunearn – make up more than two-third of its total property portfolio value. Tuan Sing’s share price is down 17% in the last six months and lately, the company has been busy buying back its own shares at around S$0.33-0.345/share.

4. ICT (ICT PM): Beneficiary of Higher Trading Activity

• Low downside risk, low correlation with Western stock markets, and good price momentum relative to its sector
• Growing demand from emerging markets as seen by increase in trading activities e.g. Asia sales increased 10% YoY in 3Q18
• Planned terminal expansions in Manila, Mexico, Iraq, and Honduras are underway and should provide about 7% capacity growth by end 2019
• Trades below ASEAN Transportation at 19CE* 17.1x PE and offers much better EPS growth
• Risk: Foreign exchange risk, disruption from US-China trade war

* Consensus Estimates

5. Infosys Ltd (INFO IN): Another Buyback Coming? Not a Bad Idea, but How Much It Can Really Help?

As per reports, Infosys Ltd (INFO IN) may consider a proposal for a share buyback of $1.60 billion very soon. The buyback announcement is likely to be made on January 11 when the company board meets to consider the 3Q FY19 results. Before this, in November 2017, Infosys Ltd (INFO IN) had announced a buyback and spent Rs130 bn to buy a total of 113mn equity shares. This fresh buyback could be an important development and could be an important support for the stock, it is also sensible for other reasons. 

There are no major acquisitions in recent times by Infosys Ltd (INFO IN) and if this is likely to be the trend for near future, share buyback is not a bad idea. The company is still struggling with some of the legacy issues and the priority as of now is to streamline the organic growth. We think Infosys Ltd (INFO IN) is also cautious with inorganic growth opportunities as the company had serious issues with acquisitions in the past. What could be another key driver behind this is that in valuation terms, Infosys Ltd (INFO IN) is not very expensive.

In this briefing:

1. SoftBank Corp (9434 JP) & Arteria Networks (4423 JP): A Tale of Two IPOs
2. GUNKUL (GUNKUL TB): Solar to Drive Top-Line Growth
3. ASAP: Weak Profitability Priced In, While Growth Still Intact
4. Maruti Suzuki- Q2FY19 Results Update
5. FGEN (FGEN PM): New Contract with Meralco to Support Cash Flow

1. SoftBank Corp (9434 JP) & Arteria Networks (4423 JP): A Tale of Two IPOs

During the second half of December 2018, Japan saw two telecom companies list on the Tokyo Stock Exchange: Softbank Corp (9434 JP) and ARTERIA Networks (4423 JP). After years of industry consolidation, which saw several stocks delist, this felt like a Christmas miracle (at least for those watching the sector’s stocks).

It would be hard to find two companies in the same industry that are so different – both in their business models as well as in how their IPOs were positioned to investors. One stock is 100 times larger than the other, but this is not a story of David and Goliath. It is two unique stories in parallel. 

While each company took a very different approach to selling its stock, both have suffered from the subsequent broader market weakness, irrespective of company specifics. We can’t say it has been the worst of times, but it certainly has been a tough time with SoftBank Corp down 13% and Arteria down 20% from their IPO prices.

In this Insight we explore how each company approached its IPO and how each has fared since. 

2. GUNKUL (GUNKUL TB): Solar to Drive Top-Line Growth

• Good payout ratio, good growth in core profit, and strong long-term sales growth relative to its sector
• Acquisition of 49% stake in a 30MW solar farm in Malaysia with a commercial operation date (COD) set for 1Q20 to support revenue growth
• High volume of solar rooftop installation projects planned for Charoen Pokphand Foods Pub (CPF TB) and other private firms to boost GUNKUL’s construction revenue
• Attractive at 19CE* PEG ratio of 0.5 relative to ASEAN Industry at 1.6
• Risk: Lower than expected electricity demand, unfavorable weather conditions

* Consensus Estimates

3. ASAP: Weak Profitability Priced In, While Growth Still Intact

We maintain a BUY rating on ASAP with new 2019E target price of Bt3.80 (from Bt6.50), derived from 19.6xPE, which is 1.0x PEG of earnings growth in 2019-20E.

The story:

• Trimmed 2018-20F earnings forecast by 35%
• Not a falling knife, but fallen angel
• Potential disruptor in car rental industry
• Expect a 20% CAGR for earnings in 2019-20E

Risks:

• Contract termination of airport space leases
• Participating in a highly competitive industry
• Cash-flow management will be a challenge in a growth phase

4. Maruti Suzuki- Q2FY19 Results Update

Maruti Suzuki’s Q2FY19 results were below our expectations. Sales grew by only 2% YoY in Q2FY19 led by a 3.7% increase in realization per unit. But the volumes declined by 1.5% YoY in the same period. We analyze the results.

5. FGEN (FGEN PM): New Contract with Meralco to Support Cash Flow

• Low correlation to the Thai market, low correlation with Western stock markets, and cheap on a PE basis relative to its sector
• Stable cash flow from new contract for FGEN’s San Gabriel plant to sell its entire capacity of 414 MW to Meralco Manila Electric Company (MER PM)  until 2024
• Geothermal-energy producer EDC has been delisted through a share buyback tender offer, FGEN to benefit from higher equity stake (47% vs 42%) and more control over the firm to implement longer-term strategies
• Trades at discount to ASEAN Utilities at 19CE* 6.5x PE and offers much better EPS growth
• Risks: Facility breakdowns, uncertainty regarding plans for LNG facility

* Consensus Estimates

In this briefing:

1. TRACKING TRAFFIC/Containers & Air Cargo: Container Rates Up
2. LIC Housing Finance Ltd. – Builder Loans and LAP to Drive Growth in Loan Book
3. COM7 (COM7 TB): Acquisition to Support Aggressive Expansion
4. TRACKING TRAFFIC/Chinese Express & Logistics: Parcel Pricing Weak, Again
5. Elastic: Why Is It Outperforming In Recent Tech Carnage?

1. TRACKING TRAFFIC/Containers & Air Cargo: Container Rates Up

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:

2. LIC Housing Finance Ltd. – Builder Loans and LAP to Drive Growth in Loan Book

Lic Housing Finance (LICHF IN), founded by Life Insurance Corporation of India, is the 2^nd largest Housing Finance Company (HFC) in India with a total outstanding loan book portfolio of Rs 1,759 bn as of 2QFY19. 94% of the company’s loans were to retail customers as home loans & Loan Against Properties (LAP) and the balance 6% were to project developers as of 2QFY19.

We like the business of LICHF for following reasons:

• LICHF focuses on the salaried segment. 86% of the customers as of 2QFY19 were from the salaried class. This provides the company with stability in earnings and better asset quality. We expect the NIMs & Spreads to be stable at 2.4% & 1.2% respectively for the period of FY18-21E.
• We expect LICHF’s total loan book to grow at a CAGR of 16% over the period of FY18-21E. This growth will be supported by LAP and Developer loans. We expect the retail home loan portfolio to grow at a CAGR of 11% over the same period.
• As the company focuses on LAP & developer segment to grow the total loan book, we expect this to affect the asset quality adversely. We expect the Gross Non-Performing Assets (GNPA) & Net Non-Performing Assets (NNPA) to increase to 1.3% (from 1.2% as of Sept-18) & 0.5% (from 0.4% as of Sept-18) respectively.

We initiate coverage on LICHF with a fair value estimate of Rs 570/- over the next 12 months. This implies a potential upside of 19% from the closing market price of Rs 481 as on 20^th December 2018.  This is arrived by applying P/ABV (Price to Adjusted Book Value) multiple of 1.7X to our Adjusted Book Value Estimate of Rs 337 per share for the period ending Sept-20E.

3. COM7 (COM7 TB): Acquisition to Support Aggressive Expansion

• Improving asset turnover, good risk adjusted price momentum, and relatively strong analyst recommendations relative to its sector
• Larger distribution channel through acquisition of DNA Retail Link to add 95 more stores to current 518 stores
• New mobile product launches in 4Q18 and COM7’s focus on high margin products, such as Android smartphones, should support high earnings growth which was up 56% YoY in 3Q18
• Attractive at a 19CE* PEG of 0.9 versus ASEAN sector at a PEG of 2.7
• Risks: Lower-than-expected demand for new IT products, slower-than-expected store expansions

* Consensus Estimates

4. TRACKING TRAFFIC/Chinese Express & Logistics: Parcel Pricing Weak, Again

Tracking Traffic/Chinese Express & Logistics is the hub for our research on China’s express parcels and logistics sectors. Tracking Traffic/Chinese Express & Logistics features analysis of monthly Chinese express and logistics data, notes from our conversations with industry players, and links to company and thematic notes. 

This month’s issue covers the following topics:

5. Elastic: Why Is It Outperforming In Recent Tech Carnage?

• Elastic NV (ESTC US) has been one of the best tech IPOs globally in 2018. Its current price is $62.53, up 74% from its IPO price of $36. Elastic’s share price has been holding up very nicely since its IPO on October 5th, 2018. Meanwhile, from October 5th to December 21st 2018, many tech stocks have experienced brutal declines. Elastic’s ability to outperform the top US tech stocks in a very difficult environment for the stock market sets the stage for a continued out-performance once the stock market starts to stabilize. 
• Since the IPO, the company reported better than expected second quarter results (quarter ending October 31, 2018) on December 4th. The company’s adjusted net loss in FY2Q19 was $0.38 per share, beating analysts’ consensus estimate by 9 cents. It generated revenue of $63.6 million, up 72% YoY. Calculated billings were also strong at $88.5 million, up 73% YoY. 
• The company’s guidance for FY3Q19 (quarter ending January 31, 2019) is to generate revenue in the range of $64 million to $66 million, representing a 56% YoY growth rate at the midpoint of the guidance. It expects to generate operating margin of negative 28% to negative 30% in FY3Q19. 
• A combination of major investors shifting their assets away from FAANG and semiconductor stocks has resulted in some improved performance of many software related stocks in recent months relative to other major tech stocks. In general, these stocks face less negative impact from a prolonged trade war between China and the US. Plus, they are not as exposed to the higher cycle volatility as the semiconductor related stocks. In many respects, Elastic shares many business similarities with these software driven companies, and thus has been more immune from the decline in the stock prices since early October. We remain positive on Elastic NV (ESTC US).

In this briefing:

1. KRI (KRI MK): Continued Capacity Expansion to Meet Solid Demand
2. Kalbe Farma (KLBF IJ): Navigating Through the New Pharma Dynamics
3. GMO Internet (9447 JP) – Grossly or Modestly Overrated?
4. 58.com Inc. (NYSE: WUBA): Regulatory Pressure Has Long Term Implications
5. Tuan Sing: Beneficiary of Exuberant Demand for Prime Office Investment Properties

1. KRI (KRI MK): Continued Capacity Expansion to Meet Solid Demand

• More attractive to analysts, low price-to-sales, and low correlation with Western stock markets relative to its sector
• To meet strong demand, KRI recently commissioned Plant 17, which increased capacity by 1.5bn. Upcoming Plants 18 and 19 to commission in 2019 should add another 5.5bn or a 20% capacity increase
• High barriers to entry for medical gloves due to stringent compliance to regulatory requirement aids KPI market shares
• Trades above ASEAN Health Care at 19CE* 4.1x PB, in line with offering a better ROE
• Risks: Sudden jump in raw materials prices

* Consensus Estimates

2. Kalbe Farma (KLBF IJ): Navigating Through the New Pharma Dynamics

The healthcare industry in Indonesia has undergone a massive change since the introduction of the National Health Insurance (JKN) in 2014. Although the program allows for better healthcare access for over 200mn Indonesians, the industry dynamics have shifted and Kalbe Farma (KLBF IJ) is one of the companies that has been on the losing side during this adjustment period.

With the Health and Social Security (BPJS) deficit forecast to grow to IDR16t by end of 2018, and with a continuing roll out of coverage to 250mn people by end of 2019, all parties in the healthcare industry are expected to continue subsidizing the program.  Hospitals and drug manufacturers have had to cope with relatively flat pricing from the INA-CBG (reimbursement) tariff since 2014, despite cost pressures stemming from the currency depreciation and inflation. KLBF has reported declines in its overall pharmaceutical margin, as well as low growth rates for its licensed and OTC (over the counter) drugs over the past five years.

Our recent meeting with the company revealed that to mitigate the JKN impact, KLBF has launched several strategies, including expanding into niche specialty products such as oncology and biosimilar drugs, as well as preventive and herbal supplements. We are also at a tipping point where KLBF’s non-OTC consumer health and nutritionals revenues are finally larger than the pharmaceutical revenues for the first time. In this insight, we will discuss whether the worst is already behind us, and if it is now time to take another look at the stock. 

3. GMO Internet (9447 JP) – Grossly or Modestly Overrated?

Source: Japan Analytics

THE GMO INTERNET (9449 JP) STORY – GMO internet (GMO-i) has attracted much attention in the last eighteen months from an unusual trinity of value, activist and ‘cryptocurrency’ equity investors.

• VALUE– Many traditional, but mostly foreign, value investors have seen the persistent negative difference between GMO-i’s market capitalisation and the value of the company’s holdings in its eight listed consolidated subsidiaries as an opportunity to invest in GMO-i with a considerable ‘margin of safety’.
• ACTIVIST – Since July 2017, the activist investor, Oasis, has waged a so-far-unsuccessful campaign with the aim of improving GMO’s corporate governance, removing takeover defences, addressing a ‘secularly undervalued stock price we are not able to tolerate’ (sic), and redefining the role and influence of the company’s Chairman, President, Representative Director and largest shareholder, Masatoshi Kumagai.
• ‘CRYPTO!’ – In December 2017, GMO-i committed to spending more than ¥35b or 10% of non-current assets. The aim was threefold: to set up a bitcoin ‘mining’ headquarters in Switzerland (with the ‘mining’ operations being carried out at an undisclosed location in Scandinavia), to develop proprietary state-of-the-art 7nm-node ‘mining chips’, and, in due course, to sell GMO-branded and developed ‘mining’ machines. The move was hailed in the ‘crypto’ fraternity as GMO-i became the largest non-Chinese and the first well-established Internet conglomerate to make a major investment in ‘cryptocurrency’ infrastructure.

OUTSTANDING – Following the December 2017 announcement, trading volumes spiked into ‘Overtraded’ territory – as measured by our Volume Score. Many investors saw GMO-i shares as a safer way of gaining exposure to ‘cryptocurrencies’, even as the price of bitcoin began to subside. By early June 2018, GMO-i’s shares had reached a closing price of ¥3,020: up 157% from the low of the prior year and outperforming TOPIX by 135%. Whatever the primary driver of this outstanding performance, each of our trio of investor groups no doubt felt vindicated in their approach to the stock.

CRYPTO CLOSURE – On December 25th 2018, GMO-i’s shares reached a new 52-week low of ¥1,325, a decline of 56% from the June high. Year to date, GMO-i shares have now declined by 31%, underperforming TOPIX by nine percentage points. On the same day, GMO-i announced that the company would post an extraordinary ¥35.5b loss for the fourth quarter, incurring an impairment loss of ¥11.5b in relation to the closure of the Swiss ‘mining’ headquarters and a loss of ¥24b to cover the closure of the ‘mining chip’ and ‘mining machine’ development, manufacturing and sales businesses. GMO-i will continue to ‘mine’ bitcoin from its Tokyo headquarters and intends to relocate the ‘mining’ centre from Scandinavia to (sic) ‘a region that will allow us to secure cleaner and less expensive power supply, but we have not yet decided the details’. Unlisted subsidiary GMO Coin’s ‘cryptocurrency’ exchange will also continue to operate, and the previously-announced plans to launch a ¥-based ‘stablecoin’ in 2019 will proceed. In the two trading days following this announcement, the shares have recovered 13% to ¥1,505. 

RAIDING THE LISTCO PIGGY BANK – As we shall relate, this is the second time since listing that GMO-i has written off a significant new business venture which the company had commenced only a short time before. In both cases, the company was forced to sell stakes in its listed consolidated subsidiaries to offset the resulting losses. On this occasion, the sale of shares in GMO Financial (7177 JP) (GMO-F) on September 25 2018, and GMO Payment Gateway (3769 JP) (GMO-PG) on December 17 2018, raised a combined ¥55.6b and, after the deduction of the yet-to-be-determined tax on the realised gains, should more than offset the ‘crypto’ losses. According to CFO Yasuda, any surplus from this exercise will be used to pay down debt. Also discussed below and in keeping with this GMO-i ‘MO’, in 2015, the company twice sold shares in its listed subsidiaries to ‘smooth out’ less-than-desirable operating results.

4. 58.com Inc. (NYSE: WUBA): Regulatory Pressure Has Long Term Implications

● We notice that Anjuke’s Oct.-Nov. traffic declined. We attribute this decline to the tightening of registration requirement in various cities, which will reduce the number of housing leads on WUBA platform;

● We, however, believe new home business will deliver strong revenue for WUBA this year, contributing Rmb2bn in revenues by our estimate;

● We rate the stock Buy and cut TP from US$84 to US$79.

5. Tuan Sing: Beneficiary of Exuberant Demand for Prime Office Investment Properties

Gaw Capital is said to be paying a CLSA-managed fund S$710 mn for 77 Robinson, which is just 3 minutes’ walk away from Tuan Sing-owned prime freehold office building, Robinson Point. This works out to around S$2,300 psf based on NLA. 77 Robinson has a balance lease of 74 years. 

Evidently, institutional buying interest in Singapore’s prime commercial buildings remains strong as the Singapore office market is now still a “landlords’ market”. Grade A CBD office rents are expected to continue their upward growth trajectory into 2019.  Tuan Sing is a beneficiary of the strong office rental upturn as its prime freehold commercial assets in Singapore – 18 Robinson, Robinson Point, and 896 Dunearn – make up more than two-third of its total property portfolio value. Tuan Sing’s share price is down 17% in the last six months and lately, the company has been busy buying back its own shares at around S$0.33-0.345/share.

In this briefing:

1. Larsen & Toubro (LT IN): Slowdown in New Orders Is Risk for 3Q, Markets Can’t Ignore It for Long
2. Prabhat Dairy Ltd – Update: Revenues and Margins Continues to Increase in Line with Our Expectations
3. Alkem Laboratories – En Route to Recovery, Valuations Attractive
4. Swaraj Engines: Positive Outlook But Growth Is Slowing and Valuation Is Rich
5. Okinawa Cellular (9436 JP): Warm Tropical Breezes with KDDI

1. Larsen & Toubro (LT IN): Slowdown in New Orders Is Risk for 3Q, Markets Can’t Ignore It for Long

Larsen & Toubro (LT IN) has reported the new orders worth only Rs95 bn after 2Q FY19 results (reported on 31st October 2018). This is much lower run rate as compared to 2Q FY19 (Rs419 bn) or 1H FY19 (Rs781 bn). All these orders by Larsen & Toubro (LT IN) have been received from construction segment where margins are relatively poor e.g. the construction and infrastructure segment of Larsen & Toubro (LT IN) in 2H FY19 has reported 6.8% EBITDA margin, much lower than 11.8% for the company on an overall basis.

Unless new orders pick up in next few weeks, there is a strong likelihood that there could be a negative surprise in 3Q results on order inflow for Larsen & Toubro (LT IN) . This is despite the fact that overall number reported for a quarter for order inflow is a bit higher than the sum of individual orders announced and reported by the company. While the market has not noticed decline in new orders so far and may have been still hopeful about a recovery in order wins, it is highly unlikely that this will continue to get ignored by investors if the trend doesn’t change and get better in next couple of weeks.

2. Prabhat Dairy Ltd – Update: Revenues and Margins Continues to Increase in Line with Our Expectations

Prabhat Dairy Ltd’s quarterly result is in line with our expectation. In Q2 FY19, the company registered a growth of 8.53% YoY, EBITDA margin was 9.4% improving by 119 bps since the same period last year, EBITDA grew by 24.2% YOY; the profit margin was at 2.95%  improving by 60 bps YoY, Net Income grew by 35.86% YOY.  For more details about the company, please refer to our initiation report  Prabhat Dairy Ltd – An Emerging Star in the Indian Milky Way. B2B business contributed to 70% of revenue and the remaining 30% was driven by B2C business. Value Added Products contributed to 25% of revenue in Q2FY19.

The stock is trading at 16.3x its TTM EPS, 13.8x its FY19F EPS. Margins have improved over the past quarters due to lower cost of raw materials, we expect raw materials to continue to be lower than their historic average in short term. Lower cost of raw material along with the improving contribution from B2C will lead to higher margins in medium to long term. The company also wants to increase its B2C contribution aggressively from the current 30% to 50% by 2020.

We will monitor the stock closely to firm up our views further, albeit we remain positive on the long-term prospects of the company.

3. Alkem Laboratories – En Route to Recovery, Valuations Attractive

Alkem Laboratories (ALKEM IN) produces branded generics, generic drugs, active pharmaceutical ingredients and neutraceuticals, which it markets in India and over 50 countries internationally. With a portfolio of over 700 brands covering all the major therapeutic segments and a pan-India sales and distribution network, Alkem has been ranked amongst the top ten pharmaceutical companies in India by sales for the past 13 years.

We are optimistic about Alkem because-

• Alkem continues to grow significantly ahead of the segment growth rate of ~16% in the chronic therapy areas of Cardiac, Antidiabetic, Neuro / Central nervous system (CNS) and Derma. Alkem continues grow in the acute therapy areas of Anti-infective, Gastro-intestinal, Pain/ Analgesic and Vitamins / Minerals /Nutrients.

• We expect India revenues to grow at CAGR 13% (FY18-21E) to Rs 64,687 mn in FY21E from Rs 44,900 mn in FY18. We expect US revenues to grow at CAGR 31% (FY18-21E) to Rs 30,438 mn from Rs 13,667 mn in FY18 and other international business revenues to grow at CAGR 11% (FY18-21E) to Rs 6,443 mn in FY21E from Rs 4,670 mn in FY18.

• We expect EBITDA to grow at CAGR 21% (FY18-21E) to Rs 18,638 mn in FY21E from Rs 10,566 mn in FY18 and EBITDA margins to expand by ~ 190 bps to 18.4% in FY21E from 16.5% in FY18. We expect PAT to grow at CAGR 27% (FY18-21E) to Rs. 12,979 mn in FY21E from Rs 6,289 mn in FY18 and we expect PAT margins to expand by ~ 300 bps to 12.8% in FY21E from 9.8% in FY18.

• We expect RoE to expand by ~530 bps to 19.0% in FY21E from 13.7% in FY18 and RoCE to expand by ~390 bps to 21.1% in FY21E from 17.2% in FY18

We initiate coverage on Alkem with fair value of Rs. 2,260/- representing a potential upside of 21% in the next 12 months. We arrived at the fair value by applying 22x multiple to September 20E EPS of Rs 102. Currently, the stock trades at 21x and 17x its earnings estimates for FY20E and FY21E respectively. After a very volatile 2018, we believe Alkem share price may have smooth upwards move in 2019 driven by strong PAT growth in the next 3 quarters.  

4. Swaraj Engines: Positive Outlook But Growth Is Slowing and Valuation Is Rich

Swaraj Engines (SWE IN) (SEL)is primarily manufacturing diesel engines for fitment into Swaraj tractors manufactured by Mahindra & Mahindra Ltd. (M&M). The Company is also supplying engine components to SML Isuzu Ltd used in the assembly of commercial vehicle engines. SEL was started as a joint venture between Punjab Tractor Ltd (now acquired by M&M Ltd) and Kirloskar Oil Engines Ltd. M&M holds 33.3% stake in SEL and is its key client.  

We are positive about the business because:

• SEL’s growth is correlated with M&M’s tractor business growth. SEL supplies engines to the Swaraj division of M&M. M&M expects tractor growth to be around 12% YoY in FY19E. We forecast SEL’s tractor engine volumes will grow at a CAGR of 12% for FY18-21E.
• The growth of the company is dependent on the monsoon and rural sentiments. We expect the profitability to improve with normal rainfall and government initiatives towards the rural sector. We expect the revenue/ EBITDA/ PAT CAGR for FY18-21E to be 14%/ 15%/ 14% respectively.
• SEL is debt free and a cash generating company. It has a healthy and stable ROCE and ROE. SEL has increased its capacity from 75,000 engines in FY16 to 120,000 engines in FY18. We expect the capacity utilisation to reach 97% by FY20E from 90% in 1HFY19. SEL funds its capex through internal accruals. We forecast a capex of Rs 600 mn for FY19E to FY21E considering the requirement of the additional capacity, R&D and testing costs for new and higher HP engines & for upgradation of engines according to the TREM IV emission norms for >50 HP engines.

We initiate coverage on SEL with a fair value objective of Rs 1,655/- over the next 12 months. This represents a potential upside of 15% from the closing price of Rs 1,435/- (as on 26-12-2018). We arrive at the fair value by applying PE multiple of 18x to EPS of Rs 87/- to the year ending December-20E and add cash of Rs 82/- per share. While the business outlook is good, we think the upside in the share price is limited due to rich valuation.

5. Okinawa Cellular (9436 JP): Warm Tropical Breezes with KDDI

As the colder winter weather is felt and the icy blast of industry tariff cuts continues to chill sentiment, we seek some respite (at least mentally) in the warmer climes of Okinawa. Okinawa Cellular is a unique company. It’s a small cap telecom network operator in Japan with a focus on the sub-tropical islands of Okinawa Prefecture. As part of the KDDI group, the company benefits from its parent’s economies of scale, but with its local presence, it also benefits from being the hometown hero. 

Because the stock is relatively small, from an investment perspective it runs into liquidity constraints that the other telcos do not have, so it’s a different type of investment but one that we think is worth looking at. Over the past 12 months Okinawa Cellular’s stock has fallen by 12.3%, but over the past year the stock has delivered a return in the middle of its peer group and has outperformed the broad TOPIX by about 5.5%. Like most telcos, Okinawa Cellular is also ramping its dividend payments, and the current yield is about 3.5%.

In this briefing:

1. Tesla Motors Inc: Come Hell or High Water
2. FutureBright (703 HK): Typhoon Dampens 3Q Results
3. Nintendo: Is the Hype Surrounding the Switch Slowly Dying Down?
4. Recruit Holdings Down 30% From October; Still Not Cheap
5. Hotel Properties Ltd– Dissolution of Wheelock-OBS Partnership Could Pave Way for Privatization Offer

1. Tesla Motors Inc: Come Hell or High Water

It is our view, that come hell or high-water, in 2019, Tesla Motors (TSLA US) will establish itself as the pre-eminent large-cap growth stock. Those that are short would cover the position at a loss and those that are long are looking at another Apple Inc (AAPL US) or Amazon.com Inc (AMZN US) in the making. The ride may be volatile, but will be worth it. 

2. FutureBright (703 HK): Typhoon Dampens 3Q Results

We recently met with management to discuss the company’s 3Q results and outlook for the coming year.

There was clear disappointment that goals for 2018 had not been achieved: rising opex dampened the recovery in EBITDA, despite solid SSSg, the Hengqin Land sale is racked with yet further delays, and the key rental property is still untenanted. That said, we feel much of the frustration is due to positive outcomes on all front being just around the corner.

This note aims to give a brief update on the key pillars forming our thesis.

3. Nintendo: Is the Hype Surrounding the Switch Slowly Dying Down?

Nintendo reported their 2QFY03/19 in October with results showing growth at both the top line and bottom line albeit not living up to consensus expectations. Top line grew by 4.0% YoY to JPY388.9bn in 1H03/19 while OP grew by 53.9% YoY to JPY61.4bn. OP in the last quarter (2QFY03/19) was the second highest the company has experienced over the last five years. This growth has been mainly driven by the sales of Nintendo Switch hardware which sold just over 5m units in 1HFY03/19. However, YoY growth remained at 3.4% compared to 4.9m units sold in 1HFY03/18. This has left investors worried about Nintendo’s aggressive target of selling 20m units of the Switch for FY03/19. Of this target, the company has managed to achieve only around 25.0% in 1H. Nintendo’s financial performance follows a seasonal trend with the December quarter showing stronger performance due to increased sales during Christmas. While the company’s current quarter is likely to show strong results, we remain skeptical about the company reaching the aforementioned target for FY03/19.

Switch Sales Have Caused an Improvement in Nintendo’s OP….

….Despite a Slowdown in the Growth of Units Sales

Nintendo’s Last Quarter Has Also Failed to Live Up To Consensus Expectations

4. Recruit Holdings Down 30% From October; Still Not Cheap

The share price of Recruit Holdings (6098 JP) has fallen by around 30% over the past three months from an all-time high of JPY3,826 (on 1^st October 2018) to JPY2,705 on 24^th December 2018. Prior to this, Recruit’s share price saw a strong upward rally during May-September following the company’s announcement that it would acquire Glassdoor Inc. (the company which operates the employment information website glassdoor.com).

We expect Recruit’s consolidated revenue to grow 7.7% and 6.5% YoY in FY03/19E and FY03/20E respectively, driven by the acquisition of Glassdoor and steady growth in Japanese staffing operations, partially offset by a likely slowdown in global labour market activity. We also expect Recruit’s consolidated EBITDA margin to improve by around 50bps due to higher margin from Glassdoor.

Despite the recent dip in share price and steady topline and bottom line growth over the forecast period, at a FY2 EV/EBITDA multiple of 14.0x, Recruit doesn’t look particularly attractive to us. Recruit’s internet advertising business and employment business peers, Yahoo Japan (4689 JP) and Persol Holdings (2181 JP) are trading at FY2 EV/EBITDAs of 7.7x and 9.6x respectively.

5. Hotel Properties Ltd– Dissolution of Wheelock-OBS Partnership Could Pave Way for Privatization Offer

Hotel Properties (HPL SP)  (“HPL”) announced on Friday evening a significant change in its shareholdings relating to the HPL shares owned by 68 Holdings Pte Ltd. 

The restructuring of shareholding did not come as a surprise and was within expectations. 

Now, Wheelock holds only a significant minority interest of 22.53% and without a board seat in HPL. Wheelock’s influence in HPL has been reduced significantly. Without control, Wheelock’s investment in HPL is as good as any other non-strategic investment in quoted securities.

In the event that Wheelock Properties decides to sell its HPL shares, Mr Ong will be a likely buyer of the HPL shares. This will present a very good opportunity for Mr Ong to successfully privatise and delist HPL.

In this briefing:

1. TRACKING TRAFFIC/Chinese Express & Logistics: Parcel Pricing Weak, Again
2. Elastic: Why Is It Outperforming In Recent Tech Carnage?
3. Horiba (6856 JP): Bad News Largely Discounted
4. FBN Holdings: A Contrarian Call from Behind the Hydrocarbon Clouds and Shadows

1. TRACKING TRAFFIC/Chinese Express & Logistics: Parcel Pricing Weak, Again

Tracking Traffic/Chinese Express & Logistics is the hub for our research on China’s express parcels and logistics sectors. Tracking Traffic/Chinese Express & Logistics features analysis of monthly Chinese express and logistics data, notes from our conversations with industry players, and links to company and thematic notes. 

This month’s issue covers the following topics:

2. Elastic: Why Is It Outperforming In Recent Tech Carnage?

• Elastic NV (ESTC US) has been one of the best tech IPOs globally in 2018. Its current price is $62.53, up 74% from its IPO price of $36. Elastic’s share price has been holding up very nicely since its IPO on October 5th, 2018. Meanwhile, from October 5th to December 21st 2018, many tech stocks have experienced brutal declines. Elastic’s ability to outperform the top US tech stocks in a very difficult environment for the stock market sets the stage for a continued out-performance once the stock market starts to stabilize. 
• Since the IPO, the company reported better than expected second quarter results (quarter ending October 31, 2018) on December 4th. The company’s adjusted net loss in FY2Q19 was $0.38 per share, beating analysts’ consensus estimate by 9 cents. It generated revenue of $63.6 million, up 72% YoY. Calculated billings were also strong at $88.5 million, up 73% YoY. 
• The company’s guidance for FY3Q19 (quarter ending January 31, 2019) is to generate revenue in the range of $64 million to $66 million, representing a 56% YoY growth rate at the midpoint of the guidance. It expects to generate operating margin of negative 28% to negative 30% in FY3Q19. 
• A combination of major investors shifting their assets away from FAANG and semiconductor stocks has resulted in some improved performance of many software related stocks in recent months relative to other major tech stocks. In general, these stocks face less negative impact from a prolonged trade war between China and the US. Plus, they are not as exposed to the higher cycle volatility as the semiconductor related stocks. In many respects, Elastic shares many business similarities with these software driven companies, and thus has been more immune from the decline in the stock prices since early October. We remain positive on Elastic NV (ESTC US).

3. Horiba (6856 JP): Bad News Largely Discounted

Horiba combines high gearing to semiconductor capital spending with a large and growing automotive test business characterized by upward trending but uneven profitability. At ¥4,545 (Friday, December 21, closing price), its share price has dropped by 53% from an all-time high of ¥9,590 reached last May. Falling demand for semiconductor production equipment and a downward revision to FY Dec-18 sales and profit guidance announced in November appear to be largely in the price. 

The downward revision, which cut projected full-year operating profit growth from 15.5% to 2.5%, followed a 22.2% year-on-year decline in operating profit in 3Q and implies a similar rate of decline in 4Q. The weakness is concentrated in Semiconductor Equipment and Automotive Test, the former due to a cyclical downturn in overall demand, the latter due to M&A-related and other one-time expenses. New Automotive Test orders continued to outpace sales, leading to a 9.5% increase in the order backlog during 3Q.

Automotive Test sales and profits should rise next year, while semiconductor equipment sales and profits seem likely to bottom out. In a report issued on December 17, SEMI (the semiconductor equipment and materials industry organization) forecasts a further decline in wafer fab equipment sales in 1H of 2019, followed by recovery in 2H. Other industry sources we talked to before the report was issued had similar views. 

This scenario could fall apart due to general economic weakness, American attempts to stifle China’s semiconductor industry, or both. On December 21, Reuters reported that Foxconn “…is in the final stages of talks with the local government of the Chinese city of Zhuhai to build a chip plant there with a total investment of about $9 billion… most of which would be shouldered by the Zhuhai government through subsidies and tax breaks…” This looks like a perfect target for the Americans, but whether or not they will notice or care remains to be seen.

Horiba is now selling at 9.6x our EPS estimate for this fiscal year, 13.4x our estimate for next year and 12.1x our estimate for FY Dec-20. These and other projected valuations are near the bottom of their 5-year historical ranges. If the Semiconductor Equipment division does not recover in 2H of 2019, historical data suggest that its operating profit could drop by 70% rather than the 47% we are now forecasting, resulting in a P/E ratio of 17x. Nevertheless, it is time to start considering when and at what price to buy Horiba.

4. FBN Holdings: A Contrarian Call from Behind the Hydrocarbon Clouds and Shadows

FBN Holdings Plc (FBNH NL) is the oldest and second-largest bank in Nigeria with a market share of 14% of domestic loans.

FBN’s solid franchise provides robust revenue generation capacity (especially in e-business and insurance) plus a solid and cheap funding base complemented by a strong liquidity profile. The Group’s solid funding base of low cost retail deposits, mainly CASA, underpins one of the most competitive in the sector.

Under new management, FBN is focused on a legacy asset quality clean-up and enhancing risk controls. The franchise has exhibited resilience in the face of system-wide asset quality problems, related to some extent to the concentration of oil/gas exposures.  Moving forward, profitability can strengthen with improving asset quality though the recent plunge in oil prices represents a threat to this de-risking process. A plus point is the vibrant income streams from e-business and insurance growth drivers.

The operating environment in Nigerian remains challenging: while the country has emerged from a recession, vulnerabilities remain. Lower oil prices, tighter external market conditions, heightened security issues, and delayed policy responses are the main downside risks. The recent fall in oil prices is a concern given Nigeria’s dependency on the commodity and its knock-on effect to the hydrocarbon-exposed Banking System. Although access to foreign currency has eased, due to FX reforms, many borrowers retain limited capacity to service obligations and there are modest opportunities for banks to grow their loan portfolios.  

In this briefing:

1. Recruit Holdings Down 30% From October; Still Not Cheap
2. Hotel Properties Ltd– Dissolution of Wheelock-OBS Partnership Could Pave Way for Privatization Offer
3. Larsen & Toubro (LT IN): Slowdown in New Orders Is Risk for 3Q, Markets Can’t Ignore It for Long
4. Prabhat Dairy Ltd – Update: Revenues and Margins Continues to Increase in Line with Our Expectations
5. Alkem Laboratories – En Route to Recovery, Valuations Attractive

1. Recruit Holdings Down 30% From October; Still Not Cheap

The share price of Recruit Holdings (6098 JP) has fallen by around 30% over the past three months from an all-time high of JPY3,826 (on 1^st October 2018) to JPY2,705 on 24^th December 2018. Prior to this, Recruit’s share price saw a strong upward rally during May-September following the company’s announcement that it would acquire Glassdoor Inc. (the company which operates the employment information website glassdoor.com).

We expect Recruit’s consolidated revenue to grow 7.7% and 6.5% YoY in FY03/19E and FY03/20E respectively, driven by the acquisition of Glassdoor and steady growth in Japanese staffing operations, partially offset by a likely slowdown in global labour market activity. We also expect Recruit’s consolidated EBITDA margin to improve by around 50bps due to higher margin from Glassdoor.

Despite the recent dip in share price and steady topline and bottom line growth over the forecast period, at a FY2 EV/EBITDA multiple of 14.0x, Recruit doesn’t look particularly attractive to us. Recruit’s internet advertising business and employment business peers, Yahoo Japan (4689 JP) and Persol Holdings (2181 JP) are trading at FY2 EV/EBITDAs of 7.7x and 9.6x respectively.

2. Hotel Properties Ltd– Dissolution of Wheelock-OBS Partnership Could Pave Way for Privatization Offer

Hotel Properties (HPL SP)  (“HPL”) announced on Friday evening a significant change in its shareholdings relating to the HPL shares owned by 68 Holdings Pte Ltd. 

The restructuring of shareholding did not come as a surprise and was within expectations. 

Now, Wheelock holds only a significant minority interest of 22.53% and without a board seat in HPL. Wheelock’s influence in HPL has been reduced significantly. Without control, Wheelock’s investment in HPL is as good as any other non-strategic investment in quoted securities.

In the event that Wheelock Properties decides to sell its HPL shares, Mr Ong will be a likely buyer of the HPL shares. This will present a very good opportunity for Mr Ong to successfully privatise and delist HPL.

3. Larsen & Toubro (LT IN): Slowdown in New Orders Is Risk for 3Q, Markets Can’t Ignore It for Long

Larsen & Toubro (LT IN) has reported the new orders worth only Rs95 bn after 2Q FY19 results (reported on 31st October 2018). This is much lower run rate as compared to 2Q FY19 (Rs419 bn) or 1H FY19 (Rs781 bn). All these orders by Larsen & Toubro (LT IN) have been received from construction segment where margins are relatively poor e.g. the construction and infrastructure segment of Larsen & Toubro (LT IN) in 2H FY19 has reported 6.8% EBITDA margin, much lower than 11.8% for the company on an overall basis.

Unless new orders pick up in next few weeks, there is a strong likelihood that there could be a negative surprise in 3Q results on order inflow for Larsen & Toubro (LT IN) . This is despite the fact that overall number reported for a quarter for order inflow is a bit higher than the sum of individual orders announced and reported by the company. While the market has not noticed decline in new orders so far and may have been still hopeful about a recovery in order wins, it is highly unlikely that this will continue to get ignored by investors if the trend doesn’t change and get better in next couple of weeks.

4. Prabhat Dairy Ltd – Update: Revenues and Margins Continues to Increase in Line with Our Expectations

Prabhat Dairy Ltd’s quarterly result is in line with our expectation. In Q2 FY19, the company registered a growth of 8.53% YoY, EBITDA margin was 9.4% improving by 119 bps since the same period last year, EBITDA grew by 24.2% YOY; the profit margin was at 2.95%  improving by 60 bps YoY, Net Income grew by 35.86% YOY.  For more details about the company, please refer to our initiation report  Prabhat Dairy Ltd – An Emerging Star in the Indian Milky Way. B2B business contributed to 70% of revenue and the remaining 30% was driven by B2C business. Value Added Products contributed to 25% of revenue in Q2FY19.

The stock is trading at 16.3x its TTM EPS, 13.8x its FY19F EPS. Margins have improved over the past quarters due to lower cost of raw materials, we expect raw materials to continue to be lower than their historic average in short term. Lower cost of raw material along with the improving contribution from B2C will lead to higher margins in medium to long term. The company also wants to increase its B2C contribution aggressively from the current 30% to 50% by 2020.

We will monitor the stock closely to firm up our views further, albeit we remain positive on the long-term prospects of the company.

5. Alkem Laboratories – En Route to Recovery, Valuations Attractive

Alkem Laboratories (ALKEM IN) produces branded generics, generic drugs, active pharmaceutical ingredients and neutraceuticals, which it markets in India and over 50 countries internationally. With a portfolio of over 700 brands covering all the major therapeutic segments and a pan-India sales and distribution network, Alkem has been ranked amongst the top ten pharmaceutical companies in India by sales for the past 13 years.

We are optimistic about Alkem because-

• Alkem continues to grow significantly ahead of the segment growth rate of ~16% in the chronic therapy areas of Cardiac, Antidiabetic, Neuro / Central nervous system (CNS) and Derma. Alkem continues grow in the acute therapy areas of Anti-infective, Gastro-intestinal, Pain/ Analgesic and Vitamins / Minerals /Nutrients.

• We expect India revenues to grow at CAGR 13% (FY18-21E) to Rs 64,687 mn in FY21E from Rs 44,900 mn in FY18. We expect US revenues to grow at CAGR 31% (FY18-21E) to Rs 30,438 mn from Rs 13,667 mn in FY18 and other international business revenues to grow at CAGR 11% (FY18-21E) to Rs 6,443 mn in FY21E from Rs 4,670 mn in FY18.

• We expect EBITDA to grow at CAGR 21% (FY18-21E) to Rs 18,638 mn in FY21E from Rs 10,566 mn in FY18 and EBITDA margins to expand by ~ 190 bps to 18.4% in FY21E from 16.5% in FY18. We expect PAT to grow at CAGR 27% (FY18-21E) to Rs. 12,979 mn in FY21E from Rs 6,289 mn in FY18 and we expect PAT margins to expand by ~ 300 bps to 12.8% in FY21E from 9.8% in FY18.

• We expect RoE to expand by ~530 bps to 19.0% in FY21E from 13.7% in FY18 and RoCE to expand by ~390 bps to 21.1% in FY21E from 17.2% in FY18

We initiate coverage on Alkem with fair value of Rs. 2,260/- representing a potential upside of 21% in the next 12 months. We arrived at the fair value by applying 22x multiple to September 20E EPS of Rs 102. Currently, the stock trades at 21x and 17x its earnings estimates for FY20E and FY21E respectively. After a very volatile 2018, we believe Alkem share price may have smooth upwards move in 2019 driven by strong PAT growth in the next 3 quarters.  

In this briefing:

1. Swaraj Engines: Positive Outlook But Growth Is Slowing and Valuation Is Rich
2. Okinawa Cellular (9436 JP): Warm Tropical Breezes with KDDI
3. KRI (KRI MK): Continued Capacity Expansion to Meet Solid Demand
4. Kalbe Farma (KLBF IJ): Navigating Through the New Pharma Dynamics
5. GMO Internet (9447 JP) – Grossly or Modestly Overrated?

1. Swaraj Engines: Positive Outlook But Growth Is Slowing and Valuation Is Rich

Swaraj Engines (SWE IN) (SEL)is primarily manufacturing diesel engines for fitment into Swaraj tractors manufactured by Mahindra & Mahindra Ltd. (M&M). The Company is also supplying engine components to SML Isuzu Ltd used in the assembly of commercial vehicle engines. SEL was started as a joint venture between Punjab Tractor Ltd (now acquired by M&M Ltd) and Kirloskar Oil Engines Ltd. M&M holds 33.3% stake in SEL and is its key client.  

We are positive about the business because:

• SEL’s growth is correlated with M&M’s tractor business growth. SEL supplies engines to the Swaraj division of M&M. M&M expects tractor growth to be around 12% YoY in FY19E. We forecast SEL’s tractor engine volumes will grow at a CAGR of 12% for FY18-21E.
• The growth of the company is dependent on the monsoon and rural sentiments. We expect the profitability to improve with normal rainfall and government initiatives towards the rural sector. We expect the revenue/ EBITDA/ PAT CAGR for FY18-21E to be 14%/ 15%/ 14% respectively.
• SEL is debt free and a cash generating company. It has a healthy and stable ROCE and ROE. SEL has increased its capacity from 75,000 engines in FY16 to 120,000 engines in FY18. We expect the capacity utilisation to reach 97% by FY20E from 90% in 1HFY19. SEL funds its capex through internal accruals. We forecast a capex of Rs 600 mn for FY19E to FY21E considering the requirement of the additional capacity, R&D and testing costs for new and higher HP engines & for upgradation of engines according to the TREM IV emission norms for >50 HP engines.

We initiate coverage on SEL with a fair value objective of Rs 1,655/- over the next 12 months. This represents a potential upside of 15% from the closing price of Rs 1,435/- (as on 26-12-2018). We arrive at the fair value by applying PE multiple of 18x to EPS of Rs 87/- to the year ending December-20E and add cash of Rs 82/- per share. While the business outlook is good, we think the upside in the share price is limited due to rich valuation.

2. Okinawa Cellular (9436 JP): Warm Tropical Breezes with KDDI

As the colder winter weather is felt and the icy blast of industry tariff cuts continues to chill sentiment, we seek some respite (at least mentally) in the warmer climes of Okinawa. Okinawa Cellular is a unique company. It’s a small cap telecom network operator in Japan with a focus on the sub-tropical islands of Okinawa Prefecture. As part of the KDDI group, the company benefits from its parent’s economies of scale, but with its local presence, it also benefits from being the hometown hero. 

Because the stock is relatively small, from an investment perspective it runs into liquidity constraints that the other telcos do not have, so it’s a different type of investment but one that we think is worth looking at. Over the past 12 months Okinawa Cellular’s stock has fallen by 12.3%, but over the past year the stock has delivered a return in the middle of its peer group and has outperformed the broad TOPIX by about 5.5%. Like most telcos, Okinawa Cellular is also ramping its dividend payments, and the current yield is about 3.5%.

3. KRI (KRI MK): Continued Capacity Expansion to Meet Solid Demand

• More attractive to analysts, low price-to-sales, and low correlation with Western stock markets relative to its sector
• To meet strong demand, KRI recently commissioned Plant 17, which increased capacity by 1.5bn. Upcoming Plants 18 and 19 to commission in 2019 should add another 5.5bn or a 20% capacity increase
• High barriers to entry for medical gloves due to stringent compliance to regulatory requirement aids KPI market shares
• Trades above ASEAN Health Care at 19CE* 4.1x PB, in line with offering a better ROE
• Risks: Sudden jump in raw materials prices

* Consensus Estimates

4. Kalbe Farma (KLBF IJ): Navigating Through the New Pharma Dynamics

The healthcare industry in Indonesia has undergone a massive change since the introduction of the National Health Insurance (JKN) in 2014. Although the program allows for better healthcare access for over 200mn Indonesians, the industry dynamics have shifted and Kalbe Farma (KLBF IJ) is one of the companies that has been on the losing side during this adjustment period.

With the Health and Social Security (BPJS) deficit forecast to grow to IDR16t by end of 2018, and with a continuing roll out of coverage to 250mn people by end of 2019, all parties in the healthcare industry are expected to continue subsidizing the program.  Hospitals and drug manufacturers have had to cope with relatively flat pricing from the INA-CBG (reimbursement) tariff since 2014, despite cost pressures stemming from the currency depreciation and inflation. KLBF has reported declines in its overall pharmaceutical margin, as well as low growth rates for its licensed and OTC (over the counter) drugs over the past five years.

Our recent meeting with the company revealed that to mitigate the JKN impact, KLBF has launched several strategies, including expanding into niche specialty products such as oncology and biosimilar drugs, as well as preventive and herbal supplements. We are also at a tipping point where KLBF’s non-OTC consumer health and nutritionals revenues are finally larger than the pharmaceutical revenues for the first time. In this insight, we will discuss whether the worst is already behind us, and if it is now time to take another look at the stock. 

5. GMO Internet (9447 JP) – Grossly or Modestly Overrated?

Source: Japan Analytics

THE GMO INTERNET (9449 JP) STORY – GMO internet (GMO-i) has attracted much attention in the last eighteen months from an unusual trinity of value, activist and ‘cryptocurrency’ equity investors.

• VALUE– Many traditional, but mostly foreign, value investors have seen the persistent negative difference between GMO-i’s market capitalisation and the value of the company’s holdings in its eight listed consolidated subsidiaries as an opportunity to invest in GMO-i with a considerable ‘margin of safety’.
• ACTIVIST – Since July 2017, the activist investor, Oasis, has waged a so-far-unsuccessful campaign with the aim of improving GMO’s corporate governance, removing takeover defences, addressing a ‘secularly undervalued stock price we are not able to tolerate’ (sic), and redefining the role and influence of the company’s Chairman, President, Representative Director and largest shareholder, Masatoshi Kumagai.
• ‘CRYPTO!’ – In December 2017, GMO-i committed to spending more than ¥35b or 10% of non-current assets. The aim was threefold: to set up a bitcoin ‘mining’ headquarters in Switzerland (with the ‘mining’ operations being carried out at an undisclosed location in Scandinavia), to develop proprietary state-of-the-art 7nm-node ‘mining chips’, and, in due course, to sell GMO-branded and developed ‘mining’ machines. The move was hailed in the ‘crypto’ fraternity as GMO-i became the largest non-Chinese and the first well-established Internet conglomerate to make a major investment in ‘cryptocurrency’ infrastructure.

OUTSTANDING – Following the December 2017 announcement, trading volumes spiked into ‘Overtraded’ territory – as measured by our Volume Score. Many investors saw GMO-i shares as a safer way of gaining exposure to ‘cryptocurrencies’, even as the price of bitcoin began to subside. By early June 2018, GMO-i’s shares had reached a closing price of ¥3,020: up 157% from the low of the prior year and outperforming TOPIX by 135%. Whatever the primary driver of this outstanding performance, each of our trio of investor groups no doubt felt vindicated in their approach to the stock.

CRYPTO CLOSURE – On December 25th 2018, GMO-i’s shares reached a new 52-week low of ¥1,325, a decline of 56% from the June high. Year to date, GMO-i shares have now declined by 31%, underperforming TOPIX by nine percentage points. On the same day, GMO-i announced that the company would post an extraordinary ¥35.5b loss for the fourth quarter, incurring an impairment loss of ¥11.5b in relation to the closure of the Swiss ‘mining’ headquarters and a loss of ¥24b to cover the closure of the ‘mining chip’ and ‘mining machine’ development, manufacturing and sales businesses. GMO-i will continue to ‘mine’ bitcoin from its Tokyo headquarters and intends to relocate the ‘mining’ centre from Scandinavia to (sic) ‘a region that will allow us to secure cleaner and less expensive power supply, but we have not yet decided the details’. Unlisted subsidiary GMO Coin’s ‘cryptocurrency’ exchange will also continue to operate, and the previously-announced plans to launch a ¥-based ‘stablecoin’ in 2019 will proceed. In the two trading days following this announcement, the shares have recovered 13% to ¥1,505. 

RAIDING THE LISTCO PIGGY BANK – As we shall relate, this is the second time since listing that GMO-i has written off a significant new business venture which the company had commenced only a short time before. In both cases, the company was forced to sell stakes in its listed consolidated subsidiaries to offset the resulting losses. On this occasion, the sale of shares in GMO Financial (7177 JP) (GMO-F) on September 25 2018, and GMO Payment Gateway (3769 JP) (GMO-PG) on December 17 2018, raised a combined ¥55.6b and, after the deduction of the yet-to-be-determined tax on the realised gains, should more than offset the ‘crypto’ losses. According to CFO Yasuda, any surplus from this exercise will be used to pay down debt. Also discussed below and in keeping with this GMO-i ‘MO’, in 2015, the company twice sold shares in its listed subsidiaries to ‘smooth out’ less-than-desirable operating results.