Daily Equities Bottom-Up: Snippets #18: Naughty CEOs, Southern Crusades and more

In this briefing:

1. Snippets #18: Naughty CEOs, Southern Crusades
2. Lloyds Banking Group (LLOY LN): Growth Who Needs It?
3. Centrica PLC (CNA LN): Lots of Gas but No Fizz
4. TAL Education (TAL): Online Courses Improved Margin in 3Q19, Parents Returning, 44% Upside
5. US Speciality Lenders – Worse Credit Metrics, Especially Personal Loans

1. Snippets #18: Naughty CEOs, Southern Crusades

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

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

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

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

Lloyds Banking: What does it do ?

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

Why is it in the long portfolio ?

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

What are the risks ?

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

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

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

Centrica PLC: What does it do ?

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

Why is it in the short portfolio?

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

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

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

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

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

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