Cheap stocks all over

Monday August 25, 2008


WITH all the negative newsflow about headwinds, it must have been a relief to investors that this is shaping up into a fairly benign results season.

While the season peaks and ends this week, the results released so far showed a number of companies that performed above analysts’ expectations.

Plantations and steel companies - both segments of steel millers and downstream steel products - reported huge profits as did companies in other sectors, in particular, consumer goods.

There isn’t a celebrative mood, however, as their performance was not recognised in the stock market.

One reason is that analysts have cut their forecast profits for almost all companies for the second half of the year, which may not be right in all cases.

At the same time, shares of big companies were de-rated to price/earnings ratios (PE) of about 10 times, while their small cap counterparts are stuck at around five times.

This is due to the outflow of foreign portfolio funds. The outflow of foreign funds from the Asia ex-Japan region in the first seven months this year reportedly exceeded their inflow during the whole of last year.

Their departure, for a variety of reasons, brought prices to their current levels.

Even at these levels, stocks here do not attract fund managers as share prices are at similarly depressed levels throughout the region, with many small caps elsewhere trading at five times PE too.

In the oil and gas (O&G) sector, valuation of stocks here range from 10 to 15 times.

However, the owners of oil reserves like Exxon Mobil Corp trades at a PE of 8.4 times while Royal Dutch Shell is at 6.7 times, which is lower than most of the valuations of the O&G stocks. That poses a conundrum for the stocks, which is a barrier to upside for the local stocks.

The economic conditions and financial liquidity in the developed countries would not turnaround the flow of foreign funds. It would take an inflow to turn the markets.

That could take some more months, but when that occurs, the companies that delivered outperformance should be well rewarded.

Presentable performance

UMW Holdings Bhd produced a fat 42% increase in its net profit to RM152mil for Q2.

Although it’s usually billed as an automotive cum O&G stock, the earnings outperformance was driven entirely by its Toyota division, according to analysts. Most of the contribution from its O&G division is believed to be at associate company level.

UMW’s results point to strong earnings from other automotive companies that recorded higher sales and managed to control costs.

Kossan Rubber Industries Bhd lived up to its reputation for consistent performance. It reported on Friday a 23% expansion in net profit to RM14mil for Q2.

This did not come without a cost as the earnings growth came from an expanded plant capacity and output while net profit margin declined to 6.5% from 7.1% a year ago.

Even so, it is a creditable performance to have earnings growth in the face of record latex prices.
It said some 22% of its total capacity was in the nitrile category and this would double when 11 new production lines were ready by November. It is believed that would raise profit margins as nitrile gloves provide higher margins than natural rubber gloves.

Tanjung Offshore Bhd announced on Friday that its seven vessels were revalued, giving rise to a revaluation surplus of RM95mil. It added the surplus would be incorporated into its financial statements next year.

This is unusual as owners of ships do not usually do this.

Malaysian Bulk Carriers Bhd, for instance, also own ships that it could sell for a large profit but it books the profits only upon a sale of the ships.

But these are unusual times, and the value of offshore vessels have appreciated more than assets on the land. As Tanjung Offshore put it, it would reflect the current values of its vessels.

Pizza Hut operator QSR Brands Bhd and its associated company KFC Holdings Bhd reported firm earnings growth. QSR’s rise of 44% in its net profit for Q2 reflects a trend among consumers towards pizza.

Some of the Q2 results were appetising but the proof of the pudding will be in the third quarter against the backdrop of an economic slowdown.

What’s cooking?

A fairly new term seems to have seeped into our financial lexicon namely, “kitchen sinking.”
This phrase refers to releasing the bad news all at once instead of in stages, and was derived from the idiom everything but the kitchen sink.

Here, analysts use the term for banks although it’s also used for companies in other sectors. This course of action taken by companies also tends to be leaked to analysts or the media a little earlier so that it is explained to avoid a sudden shock to investors.

The term is frequently used in relation to banks because they tend to take large loan loss provisions - which analysts call kitchen sinking - after a change of top management, and such changes became commonplace in the consolidation of banks.

AMMB Holdings Bhd, for instance, reported a pre-tax loss of RM691mil in its fourth quarter ended March 31, 2007 on a more stringent loss provisioning policy upon the entry of Australia and New Zealand Banking Group Ltd as a shareholder. Analysts forewarned of that loss as an act of kitchen sinking.

Likewise, they recently forewarned of kitchen sinking at EON Capital Bhd. True enough, the company announced last week it incurred a pre-tax loss of RM98.9mil in Q2 as it raised its loan loss coverage.

That followed the entry of Primus Pacific Partners as the new single largest shareholder in EON Capital in June.

There were some disappointments in banking results this season although Alliance Financial Group Bhd did not let investors down.

Alliance reported a 31% jump in its net profit to RM124mil for its first quarter ended June 30.

That followed its own kitchen sinking that caused a pre-tax loss of RM327mil for the quarter ended Sept 30, 2005, after Singapore’s Temasek Holdings became a major shareholder.

One reason for kitchen sinking measures is that new management wants to write off all the legacy problems so that they do not become a drag on results under their watch.

In some cases, there would be substantial recoveries of these write-offs which would boost results for the following one or two years.

It’s quite clear that when there is a change of management in a bank, investors can expect there will be kitchen sinking soon after.

http://biz.thestar.com.my/news/story.asp?file=/2008/8/25/business/1875581&sec=business