Thursday, May 14, 2015

SIGN - The SIGNal is finally here.


I have been waiting to write this post and thinking the title for about 1 month since i first write a research on this stock (See my research here). And finally, here you are, the breakout and my post. 

Today the stock finally make a breakout and hence give a technical buy SIGNal.

My deduction is that there was a surge in retail buying after TA Securities's give a higher TP in a report published yesterday (13May). However, unlike CIMB's last-month-report that caused a massive buying on 27Apr, which later met with supply of stock and drive the price back to its limbo. This time, the supply was not there. Then a virtuous cycle that i have been waiting for happen, Quick traders anticipated the breakout, buy in prediction of the breakout and then fulfilling the prophecy themself. The whole reflexive successfully caused the breakout.

OK. There was a breakout, everyone reading this blog knows. But what is next? Rally? Yes, it will be most probably be one because 
SIGN Hourly Chart (Chart by HLeBroking Platform)
SIGN Daily Chart

SIGN Weekly Chart

1. Fundamental Analysis support so
My TP is at RM3.70. TA just change his mind to a higher RM3.65 while CIMB still keeping their always-the-highest TP at RM4.23. I am not going to reiterate the fundamental selling points but my research.

2. The stock has been very resilient, even swimming against the tides
Some may think the stock has been weak in the past 1 month. However, I think it is very resilient against the tides, i.e.

a. SIGN's major and long-time shareholder's HSC Healthcare SB has sold over 6% of SIGN's total share in April. Yet, stock price stay flat and boring even under such a heavy selldown or, perhaps, perceived bad news.

b. Market was in correction last 2 weeks but SIGN is still resilient.

That shows there are strong buyers accumulating the stocks and they are not selling. Probably institutional investors as CIMB Research is promoting SIGN to local and overseas Fund Managers, or it could be intentional syndicate.

3. There was a reduced supply of stock

below RM2.40. Trading volume drop significantly last week. It was an early, though not solid, signal that most of the supply of stock have taken out from the market.

4. At the right time of market sentiment improvement
There is a great improvement in market sentiment today especially with smaller-cap stocks with higher number of winners compared to last 1 week.

5. Upturn in Volatility
Stock price's volatility is cyclical. It moves back-and-forth from low to high volatility. Volatility have been low in the past 1.5 months and Bolinger Bands have been squeezing SIGN to suffocation. Now volatility just swing from low to high. I expect it to remain for some time.

6. The coming Q3 FY15 result's effect.
Tentatively on 26 May (according to Bloomberg). I expect there will be extraordinary jump in revenue and perhaps significant improvement in profit margin. But this is expected (well, I did said "I expect") due to pre-GST delivery acceleration. What will happen will be the classical Sell-On-News scenario. In case you don't know, the stocks price is expected to

i. move up as intentional traders accumulate the stock in advance while attracting market's attention
ii. after result announcement the late-believers that "will knew for sure it would happen" (or Hindsight Bias) will become the buyers for the abovementioned sellers.

Want a Dry Run? Look at Matrix Concept Bhd.

If that happen. It is not necessary to sell it. It depend on your trading plan.

Hence, the recommendation is to buy at pullback, which is reasonably expected for a breakout after 1.5 months of limbo. Traders want to take profit fearing of getting back to limbo. Risks of this prediction is that the stocks are mostly in Longer-term investors hands, hence supply is not enough to overcome trend-followers' demand. As usual, trade carefully, have plan and stop loss.

Possible Catalysts 
PRIMA - if SIGN manage to secure any projects from PRIMA project, which they are eyeing according to CIMB's Research.

Significant margin improvement - due to lower material price or operation efficiency. There was a significant margin improvement in Q2 result. If the trend persists, it would be a good news.

Disclaimation : Despite high conviction, that only increase the probability of favorable outcome but not guarantee. So trade carefully, "Market is always right" but I am not.

Murphy Law - What can go wrong will go wrong.

Wednesday, April 15, 2015

SIGN - Selling Fast. Last Call?

Latest Market Development

SIGN has been under heavy selling by its ex-substantial shareholder, HSC Healthcare SB (HSC), especially throughout April. However, I view this a test to see the true strength of the share and market interest and the result is that SIGN's share price is still resilient with slight upward-bias throughout the month. HSC has on 14 APR cased to be a substantial shareholder after selling 3.5m shares on the same day. I believe the trend will go on where HSC will continue to sell the remaining 4m + share in the coming week riding on the high buying interest as witnessed from the resilient share price and high volume. It is high possible that HSC may eventually sell all the remaining shares before end of next week. After that, supply of SIGN share will become limited and this could possibly start driving the share price if the demand is sustainable.

Hence, I reiterate my Buy rating on SIGN based on 1) current cheap forward valuation at 6.3x FY16's EPS based on optimistic earning growth projection 2) expected end of HSC's selling 3) CIMB Investment Bank's recent regional promotion on Small Cap Counters

Diminishing Market Supply
Chart from ChartNexus software
 Share price is still resilient even though heavy selling by substantial shareholders.

HSC may finally dispose all their shareholding soon. 

HSC's disposal has been the major supply of share in the market for the past 1 week. Yet share price still surged at 2.7% indicating strong market demand. If this trend persist, supply from HSC should be ended by next week. 

Rising Demand due to

Cheap forward valuation and strong growth ahead 
As per my previous recommendation

CIMB IB's Promotion of Small Cap Counter
In a Strategy Flash Note publised on 13 Apr 2015, Nigel Foo, analyst of CIMB IB mentioned that they have been marketing smallcap stocks in Singapore, HK and KL since early of Apr. They have met 74 fund managers (FM) from 32 institutions. The note mentioned that interest in smallcaps was strong in Singapore and KL. As SIGN is one of their highlights at the promotional activities, together with other stocks like OWG, IFCAMSC and others, I believe this effort have created awareness and possibly interest among FMs, though how it has generated the actual buying is not known.   

My TP remain at RM3.70 based on 10x FY16 EPS, which have not include SIGN's investment properties and their factory in Kota Damansara. CIMB IB has estimated the KD land alone is worth RM95m (RM0.79/share) based on RM300psf. Besides the KD factory, Together with their investment properties with Book Value of RM31m (as per 2014 Annual Report), this could increase SIGN's total value by RM1.05 per share. 


HSC's disposal is based on pessimistic outlook or possessing of insider knowledge 
However, HSC is only a shareholder but not involved in the day to day operation. Thus possibility of possession of insider knowledge is not high. The exit looks more like a earlier-planned action as Dr Lim Yin Chow, an ex-Non-Independent Non-Executive Director of SIGN who also has shareholding in HSC has resigned on 10 Jan 2014, much earlier than HSC's disposal. In conclusion, that is no material evidence supporting this risk, this make it a mere speculative concern. 

Other Business Operation Risk 
As per my previous post

Monday, April 13, 2015

Landmark Bhd - An Unhunted "Treasure" (TP RM2.74)

1.0 Investment Summary

Landmark Bhd (Landmark), the master developer of Treasure Bay Bintan(TBB), may see its share price enjoy better valuation soon with the opening of Phase 1 in Q2 this year. TBB is an ambitious RM11.6-billion waterfront resort city development project in Bintan, Indonesia that could potentially become the next island-and-beach tourism hotspot in SEA, just like Phuket and Bali. The coming opening and any news on new partnerships or SPAs signed may catalyze the stock price re-valuation. I am giving a Buy rating on Landmark with SOP Target Price at RM2.74(97% upside potential)  based on positive long-term outlooks of TBB as below:

TBB's Master Plan
Source: Company

Strategic proximity to Singapore - next to Bintan Bandar Telani Ferry Terminal, it is just 45-min ferry ride away from Singapore. This geographic advantage make TBB a convenient destination to Singapore's 15 million annual visitors, 5.4m population as well as 54m air passengers. Bintan is also set to attract more international visitors with the opening of new Bintan International Airport in 2016, which is 25-min drive away from TBB. Besides that, there have been increasing Indonesia-Singapore cooperation on the promotion and development of Bintan, which make Bintan a special economic zones (SEZ) that receives investor-friendly policies that help attracting FDI.


Emerging tourism hotspot with ambitious development  - Bintan share various tourism attractions, like clean-white-sand beaches with clear ocean water, tropicana weather and forests as well as its unique architecture and cultural value, with peers such as Langkawi Island, Phuket and Bali. Bintan is currently at the early-stage of various long-term and large-scale master-planned development, most notably are the 1300-hectares Lagoi Bay development by Gallant Venture Ltd of Singapore as well as TBB by Landmark. Compared to its peers, which are in more mature stage, BI offer investors an earlier opportunity to invest in this emerging development. 

Many developments are happening in Bintan Island

Bintan Resorts attracted almost half a million tourists in 2012. With more hotels rooms available, it should grow at a faster rate moving forward.

Source: Lagoi Bay Investment Guide

Fast-growing Tourism Industry in Indonesia -  Based on World Travel and Tourism Concil (WTCC), Indonesia's Tourism GDP is expected to grow by 5.3% pa from 2014's IDR325 trillion to IRD581 tn by 2025. Besides that, they forecast international tourist arrival to Indonesia and their expenditure to grow by 5.5% pa in the next 10 years. This growth will attract international investors interest to  invest in the industry and hence, Bintan should be one of the beneficial of this trend. WTCC also sees the industry's capital investment to grow at 7.1% pa over the next 10 years. With this positive investment trend, TBB have great opportunity to attract more investment to their development project through various methods such as land sales, partnership with hotel operators and build-and-sales properties.

Source: WTTC

The Buy Rating is also supported by:

TBB is entering fast-growth phase - TBB has finished the long gestation stage as a greenfield site previously and now is ready to enter the next phase of development. Started in 2006 with the land acquisition, TBB has been in gestation stage since then with few master plan revision and delay in development especially due to Global Financial Crisis in 2008. However, I believe TBB is entering a fast-growth phase soon with the opening of Phase 1 in Q2 2015. 

In 2014, Canyon Ranch, the world's leading wellness brand, announced it will develope Canyon Ranch Bintan(CYB) in TBB. The management mentioned that they are currently in talk with several interested parties for potential partnership or investment. Any new investment announcement is going to give more certainties on the prospect of TBB and support land valuation appreciation. That will eventually translate to Landmark's share price appreciation. 

Large discount to RNAV provide massive revaluation potential - Using 11 Apr 2015's closing price of RM1.37, Landmark is currently trading at 73% discount to my RNAV (RM5.15) or 64% discount to its Book Value(BV) of RM3.68. Landmark has been trading at steep discount to its BV in at least the past 5 years, which is not unreasonable as TBB was still a greenfield project in the past where investment risk and uncertainties were still high. However, with the opening of Phase 1 in this quarter, TBB's prospect will become more visible. Any announcement on new partnership, investment or S&P signed will catalyze the stock revaluation. One of the possible example is that following the announcement of CYB development in Jun 2014, Landmark share price surge over 40% in the following month, Aug. Though the share price has since retreated and the surge may just a market speculation, any more positive announcements in the future may sparks more long-term investors' interest.

Based on a Sector Update on Property Developers by Kenanga Research on Apr 2015, the sector is currently trading at an Overall Sector Average Discount of 50% to Kenanga's FD RNAV. The huge discount on the sector is based on pessimistic outlook on Malaysia's property market. However, Landmark beg to differ the sector average and should be trading at a lower discount because it's a very unique investment opportunity. Landmark is perhaps the only stock that provide direct opportunity to invest in such a large scale resort city project in Indonesia, compared to the many property developers in Malaysia competing in the same landscape. The next closer alternative is Gallant Venture Ltd(GV), the master-developer of Lagoi Bay Bintan, in Singapore. However, GV is in diversified business, Landmrk is a more straight-forward investment as Landmark other business (besides TBB) provide about 10% of its RNAV. Hence, my 40% discount to RNAV is reasonable.

Gaming license a possible future wildcard - Last but not least, Landmark, a 30%-Genting Bhd owned company, could potentially opened the first casino in TBB. In 2008, Landmark has received consent from Indonesia authority to operate gaming business in TBB. However, there are no much development after that and starting a gaming business in a country that do not have casino before can be challenging from politic and social point-of-view. Hence, it is safer not to incorporate this development into the valuation, but it can be a wildcard in the future.

2.0 Business Background

Landmark listed in Bursa Malaysia (known as KLSE that time) in 1990, is in the business of hospitality and property development. Prior to 2006, the company was involved in development of (1)3 hotels in Labuan and Langkawi (2) Bandar Baru Wangsa Maju township (through equity interest in MSL Properties SB, a subsidiary of IJM Corp) and (3) the new township of Cyberjaya (through a JV with Setia Haruman SB). The company also previously on Sungai Wang Plaza as their investment. Since 2006, the Group re-positioned itself to focus on the TBB project. The new focus make Landmark to dispose most non-core businesses. 

Currently, Landmark have businesses in these 3 areas:

1) TBB
2) The Andaman, a 170-room luxury hotel in Langkawi
3) The development of Bandar Baru Wangsa Maju through 20% + 1 equity interest in MSL

The Andaman has undergone some major refurbishment in 2013, which caused significant drop in revenue and loss-making in FY2013. After that, the strategy start to bear fruits with its revenue raise to its 5-years-high due to better room-selling-price and occupancy rate.

Shareholding structure

Genting  Bhd has on 2008 acquired 30% share in Landmark Bhd at share price of around RM2.00 per share (44% above current price) and has since become the largest shareholder of the company.

3.0 TBB

The latest known project GDV is at RM11.27 bil based on a news by TheEdge in 2014.

TBB Information:
- 45 min ferry ride from Singapore
- 75 mins car ride from Kijang Airport. 25mins away from new Bintan International Airport to be opened in end 2016
- To be fully developed in 20 years

Phase 1:
- 90 hectare with DGV of RM2.1bil
- Featuring Cystal Lagoon, 6.3-ha man-made lagoon with trademarked technology of Crystal Lagoon, which help made crystal clear inland lagoon (more info:
- A center attraction for leisure, water activities and with surrounding F&B and retail outlets
- 1,700 room keys 
- 8 hotels and a wellness resort by Canyon Ranch

Phase 2: (ecpected to be launched in the next 3 years
- Launching and selling of Ring Resorts, Waterfront villas, Marina Private Residences
- Private Mangrove Park
- Commercial areas
- Second wellness resort by Chiva-Som

Phase 3:
- Town centre, Hospital, Education Campus, Retail, Residences

Current site condition
Source: Project Facebook Site

Various hotel/resorts in Bintan
Source: Bintan Resorts

Number of room keys are booming in the coming years and may reach 8890 room keys by 2018. 

With Lagoi Bay expected to have 5000 room keys before 2020 and 1700 room keys in TBB Phase 1, hotel rooms is expected to experience oversupply condition in the early stage. 

Possible source of return - TBB may generate return via the following means:
- Sales of hotel/resort development lands to hospitality investor or operator. This will generate immediate large amount of return.
- Lease of land for hotel/resort development; to generate recurring income
- Operate retail, F&B outlets and leisure activities
- Develop and own hotel to be operated by reputable hotel operators
- Build and operate hotel
- Build-to-sales villas, residential and commercial units

The choice of operandi modius will affect Landmark future income structure.

4.0 Finance

Landmark's Asset largely dominated by TBB's land which, together with Property Development Costs, were about RM2.0 bil. Net Cash dropped from RM146mil 2 years ago to current net debt of RM6mil. Net Gearing is nil..

Though the hospitality (The Andaman) and Property development business are profitable, Landmark has been loss making in the past due to high operating cost in developing the TBB land.

5.0 Risks

Unable to secure new partnership or receive new investment in the medium term or retreat of agreed investment - this will create doubt on the prospect of TBB. However, involvement Canyon Ranch and Chiva-Som give an early indication of TBB's ability to attract investment.

Drop in investment to Indonesia and the tourism industry - any negative change in future growth outlook may affect foreign investment. Rising cost of capital due to Fed rate hike and strengthening of USD against IRD will also discourage investment. However, this can partially offset by the easing monetary condition in Europe, Japan and possibly China. 

Oversupply of hotel rooms delay future new investment or Phase 2 - large amount of hotel rooms are going to be developed in the next 2-3 years on expectation of rapid-rising of visitors. If growth in visitors amount unable to match with growth in hotel room supply, overcapacity will pressure occupancy rate and selling price and  may eventually slow down new investment. However, hotel investor normally have long-term investment period and is expecting to make investment decision based on their confidence on the longer-term outlook.

Unfavorable global economy condition - the TBB project was previously delayed due to 2008 Global Financial Crisis. If global recession occur again before any significant development taken place, it will seriously affect investment.  

6.0 Valuation

40% discount to RNAV is given since TBB is at its early stage of development. The current market discount is at 73%, which is very low as I expect more positive news flow coming in the next 12 months, especially after opening of Phase 1 in Q2 2014. 

Based on Kenanga's report on Property Sector, the sector's stocks is currently trading at overall average discount of 50% of their FD RNAV. Landmark beg to differ as it's in resort city development project in Indonesia compared to the listed property developers that are mostly involved residential and commercial projects in a competitive environment. 

To incorporate the possibility that no new development (status quo) or partnership announcement in the next 12 months, I further adjust my TP based on Probability-weighted on these 2 possible scenarios. 

In conclusion, I give Landmark a Buy rating with TP of RM2.74, which provide 97% upside potential.

7.0 Summary

i) Buy rating on Landmrk with TP at RM2.74 based on 40% discount to RNAV and 15% probability of no new development 

ii) Positive long-term outlook on TBB due to its proximity to Singapore, growth in no. of 
visitors and tourism industry as well as rising investment in Indonesia Tourism

iii) Expecting revaluation for Landmark share price catalyzed by opening of TBB's Phase 1 and potential announcement of new partnership

iii) Despite current depressed valuation in Malaysia property sector stocks, Landmark offer unique investment opportunity to large-scale long-term resort city development in Indonesia. Hence, a niche. 

iv) The risk are a) no major development in the next 12 months or retreat of agreed development b) drop in investment in Tourism industry c) oversupply of hotel rooms d) unfavorable global economic condition

8.0 Technical Analysis

Landmrk is in long, medium and short term uptrend based on MA. Price Momemtum is bullish with RSI and Stochastic above 50% in the past 3 months with gradually rising average Volume. Immedite Resistance has turned to Support at RM1.38. The next 2 resistance is at RM1.55 and RM1.66. 

Chart from ChartNexus Software

9.0 References
5. Appendix 

TP Sensitivity Analysis

Tuesday, April 7, 2015

Signature International Bhd (SIGN) - At the sweet spot of booming housing completion

1.0 Investment Summary

Signature International Bhd, a branded distributor, manufacturer and retailer of modular kitchen system under the brand name of Signature Kitchen, is at the sweet spot of booming number of service apartment/condominium (SA/Condo) completion in 2015-2017.

Housing starts for SA/Condo in Malaysia has plateuaed in year 2013-2014 while completion data is still below half-of-2008's peak. As historically, completion lagged starts 3 years, number of SA/Condo completion is set to boom beginning from year 2015 and is projected to overtake 2008's peak in 2016-2017. While this is a bad news for the property market, SIGN will be the clear winner from this development as 70% of SIGN's FY2014 sales is derived from Project Sales, where SIGN partners with Property Developers to provide kitchen systems to SA/Condo projects-near-completion.

I give a Buy rating on SIGN with TP of RM3.70 (64% upside) based on 10x FY16 earning, which is generally in line with forward PE given to furniture/particleboard and FBMSmallCap stocks. The Buy rating is based on:

i. SIGN's PAT is projected to double in FY15 and grow at 2-Years-CAGR of 24% for FY16-17 as a) strong sales growth in FY15-17 (CAGR 22%) riding on the booming number of SA/Condo-to-be-completed b) margin improvement from greater economic of scale (Q2FY15 EBIT Margin at 24.7% vs FY14 at 15.6%)

Source: NAPIC

ii. Average trading volume recently surged to 5 years high. SIGN's stock used to have low liquidity.. The improved market interest will provides better trading liquidity and will support better valuation.

Source: Yahoo Finance

iii. SIGN's stock is still undervalued. Though gaining 190% in 2 years time, with TTM PAT have grown 785% for the same period, valuation is still at 3-years-low at trailing TTM PE of 8.4x and FY16 PE of 6.1x. The current valuation is unreasonable given FY15 will be a record-breaking year for SIGN for its sales, profit and margin. SIGN is an undervalued growth stock.

Source: Yahoo Finance, Company

2.0 Business Description

The brand name of Signature Kitchen under SIGN is the largest and, in my view, most-well-known kitchen system provider in Malaysia. With over 20 retail showrooms in Malaysia as well as various marketing and branding activities, SIGN has built-up its name toward Malaysians. SIGN is also in the affordable kitchen market under brand "Kubiq" launched in 2009. Pricing of Kitchen set for Signature Kitchen starts from RM20,000 while Kubiq's starts from around RM5,000.

As in FY14, 70% of SIGN's sales derived from Project Sales where SIGN secures projects from developers to provide kitchen to SA/Condo units as part of the developers' promotional strategy to attract buyers. While there are others premium kitchen brands available in the market, the brand Signature Kitchen has a competitive edge over other competitors due to better branding and popularity. In the past, Project sales have been cyclical following housing market cycle. This is explainable as SIGN only come in to provide kitchen for a project near its completion stage. Hence, SIGN's project sales generally correlate with SA/Condo's completion volume as SIGN provide kitchen to SA/Condo projects.

The remaining 30% of sales contributed from retail business generated via its retail outlets. SIGN's key strength is its branding. As it adopt pull-marketing strategy, retail customers are generally walk-in customers. Hence, headcount in retail outlets can be minimized since sales activities are minimal for retail segment. This also provides better operational efficiency. Unlike project sales, retail sales are non-cyclical and have been stable at the range of RM40m-50m annually even during Global Financial Crisis in 2008-2009.

Over 95% of SIGN sales are from local market. Besides providing kitchen system, SIGN also provide kitchen white goods (appliances) to its customer under third-party brands as well as interior design services. These are mostly value-add service. Kitchen business is still the core income generator.

Based on Initiation report done by CIMB Research in Oct 2013, 75% of SIGN's production cost comes from raw materials, while the rest are subcontractor fees (14%) and kitchen white goods (11%). The major raw materials used are wood-based like chipboard and medium-density fibreboards (MDF), comprises of 40% of raw material cost. At the same report, also mentioned is that SIGN is able to adjust its production capacity quickly as most of the high-volume raw-materials (like MDF) are outsourced. Only the low-volume-high-value-added products are handled by own factory. SIGN is using sub-contractors for the kitchen installation.

2.1 SWOT Analysis

3.0 Financial

4.0 Projection & Valuation

5.0 Risks

Project delay 
SIGN come into a property development project at its final stage. Any delay in project completion will defer SIGN's sales.

Material cost hike
As time from securing projects to work start for project sales can be long, any increase of material cost during this period may not be transferable to the customers.

Thursday, March 19, 2015

Prolexus's key customer earning's update - Nike Inc. Profit Beat Analysts' Estimate

Yesterday (28 Feb 2015), Nike Inc. (Nike) reported an overachieving quarterly report ended on 28 as more higher margin shoes and apparel were sold. Share price up 4.5% to $102.75 in heavy after-hours trading.

This update mainly focus on Nike's performance that facilitate projection of Prolexus's future performance and Q2FY2015's performance, due to announced tentatively on today (20 Mar). Keynotes as below:

-  Nike's Worldwide Apparel sales growth 9% yoy excluding currency changes (ex-forex) or 3% if inclusive of currency changes
- Future orders of Nike Brand growth 11% ex-forex or 2%
- Future orders growth would have been even higher if not compared to strong growth last year due to the soccer World Cup
- Inventories up 12% due to higher inventories in wholesale business and growth in Direct to Customer
- Wholesale inventories increase 17% in units, but offset 5% by changes in average product cost and Forex change.

Positive implication of Prolexus's earning:
- Higher growth in current sales and future orders indicate strong apparel orders to Nike's worldwide suppliers. Prolexus should be one of Nike's supplier that receive strong order, hence boosting potential sales growth
- Nike's reporting of market-beating earning result shows, one again, Nike's continuous ability in growing its business worldwide, even amid challenging macroeconomic condition. This indicate Nike need to rely on its supplier in the long-run to achieve sustainable success.

- Strong demand from Nike may not be met by Prolexus due to capacity constraint or any delay in production expansion. Hence, risking losing order or damping relationship with Nike.

- Given the opportunity to ride on Nike's high sales growth, Prolexus should expand aggressively to (i) fulfill Nike's higher demand (ii) expand its market share of Nike's order (iii) but most importantly, to achieve a better economic of scale to stay competitive among this competitive industry. Apparel industey is very competitive. In order to stay relevant and competitive in the long-term, Prolexus has to gain a competitive edge in production cost through better economic of scale. Although aggressive expansion to cater Nike's need increase its risk due to higher fixed cost and higher reliance on single-customer, this is a necessary step to strengthen its relationship with Nike. Besides that, Prolexus's strong balance sheet and OCF allow them to take the necessary risks of expansion.

View on Investment:
Prolexus's share price has appreciated significantly (+63% YTD) and now have a valuation of TTM PE at 9.35x, which is relatively high compare to its PE in the past 2 years. Market is giving a high valuation due to expectation of impressive Q2 earning result (to be announced tentatively today). Q2 have been one of the best quarter of Prolexus in term of revenue achieved. The strong expected revenue is further boosted by strengthening of USD (around + 8% QOQ).

At this valuation, I would give Prolexus a HOLD rating pending on the earning announcement later of today due to:
i) concern on its ability to make timely production expansion to meet the higher demand
ii) relatively high valuation - which has exceeded my previous DCF/SOP-based TP of RM1.89
iii) although its key customer's demand is growing rapidly, but the positive macro-situation is offset by its production capacity constraint and the risks due to (i) intense competition (ii) high customer concentration risk

Thursday, March 12, 2015

LTKM - The Omitted Egg

Poultry and layers farms have been the current theme-play due to higher selling price of eggs and chicken as well as falling feed price. With some of the industry players' stock (e.g. QL, TeoSeng, CAB & PW) have been under coverage by sell-side analysts, I tried to research on company that is currently not under coverage. I have looked into LTKM, a long-time layers farm company listed in Bursa Malaysia since 2000. It is the 5th largest egg producer in Malaysia with daily production capacity at 1.8mil eggs.

1.0 Summary

LTKM is a pure-play on the egg production story with 98% of its sales comes from layers business. LTKM recently reported a strong financial report with 9MFY15's operating profit margin at 23%, which is unprecedented in the past 10 years due to (i)higher selling price of eggs to Singapore (LTKM exports over 40% of the egg production to Singapore and Hong Kong) (ii) declining feed price in the past 2 years.

Looking forward, I expect LTKM to sustain the current profitability in FY2016 as (i) feed price is expected to stay low and stable and  (ii) eggs' ASP is expected to remain high in CY2015.

After FY2016, Revenue and PBT are expected to decline slowly due to (i) gradual recovery of feed price and (ii) normalized of eggs' ASP (iii) lack of capacity expansion plan.

Overall, I still see upside potential of the stock with SOP TP at at RM7.55 (14% upside) as (i) Feed price increase will be gradual and stable in the next 5 years, which do not hurt LTKM's margin significantly (ii) ASP, though fluctuating, is generally rising in the long-term. (iii) Recent market's focus on poultry-theme play due to the former 2 factors as well as investors shift to recession-proof consumer-sector amid concern over GST and slower economic growth will dampen consumer spending. 

However, as poultry business is cyclical in natural, I do not advice long-term investment in the stock but rather give a Hold or Short-Term Buy rating to the call. Disclaimer: This is just an advice, not a investment recommendation. 

2.0 Background

LTKM listed in Bursa Malaysia in year 2000 and is tightly-held by its director, Datuk Tan Kok with direct and indirect shareholding of 65% of the company. (Hence, free-float available to the market is not much, that is also why it is not covered by any sell-side.) LTKM's egg production capacity is at 1.4mil eggs per day since 2011, up only 40% from 1.0mil egg in 2000. LTKM is the 5th largest egg producer by egg production capacity.

Layers farm is a cyclical business, LTKM has seen its Net Margin swinging in the range of 5.9%-18.2% in the past 8 years. The 2 major factors determined the ups and downs of the company's profitability are (i) Average Selling Price (ASP) of the eggs, which depend largely on the supply condition of the market as demand is stable and predictable as well as inelastic to price change (ii) and feed price. Cost of layers' feeding take up 55-65% of the total cost of layer farms. The main component of the feed are soybean meal and corn, the price of which, like other commodities, have been fluctuating in the last decades and the price of the commodities determined largely the profitability of the business. I have done a regression analysis on the effect of change in feed price to LTKM's Gross Margin. It shows that the later is 90% explained by the former in the past 8 years, which make layer farm business behave like like a commodity business, just the opposite way.

Since 2008, LTKM has ventured into other non-related business and now, besides the core poultry business, they are also in the business of sand mining and extraction as well as property development. In 2009, they have ventured into glass-processing business but have in 2013 discountinued the business with a net loss of RM12.9mil registered in FY2013. Besides that, they also currently own RM40.5m of investment properties and RM33.4mil of investment securities, which are cumulatively 35% of the 3Q2015's total asset.

Sand mining business contributed insignificantly to the group Revenue and PBT. Although property development contributed 16-26% of PBT in the past 2 years, it is not expected to have significant contribution in FY15 as there are no development in progress currently.

LTKM is a company where the key shareholders/directors have most of the say on the company direction. Dividend payout have been meanly low at average of 28% of the Net Profit. This may probably due to cyclical natural of the business and Cash Flow, hence, and the management prefer to hoard cash for raining day. Non-core asset and net cash position now contributed 45% and 54% of the total asset and total equity respectively.

3.0 Key Industry Development

LTKM's Poultry business GPM have been rising in the past 8 quarters from 15% in Q4FY13 to 29% in Q3FY15 mainly due to:

i) Rising average selling price (ASP) of eggs in Singapore
In 2014, ASP of eggs have gone up over 10% in the second half of the year after 3 farms in Malaysia were suspended from selling eggs to Singapore by Agri-Food and Veterinary Authority (AVA), Singapore. The suspension was due to eggs from the farms were found to contain Salmonella enteritidis, a bacterium that causes food poisoning. The 3 farms accounting for less than 8% of Singapore total supply. Currently, 20 Malaysian farms are approved to export eggs to Singapore by AVA, down from 23 previously. LTKM exports over 40% of their eggs to Singapore and Hong Kong. With the higher average selling price (ASP), LTKM's Poultry GPM rise from 23% in 4QFY14 to 29%, which is around the period of the incident.  Beside higher ASP in SGD, Gross Margin is also partially benefited from the strengthening of SGD of about 5% in the past 6 months.

Undersupply of egg in Singapore do not expected to last forever as the invisible hand will work for itself with new source of supply will eventually enter the market to take a share of the economic benefit. Hence, egg price will eventually normalized in Singapore. Teo Seng have already planned to increase their daily capacity by 400k eggs annually in the next 5 years. Will the new capacity get approved from AVA to export to Singapore? Though one of their farms just get suspended last year.

Side story - From game theory point of view, it would be best if all producers do not increase their supply to Singapore market to keep the eggs' price and their margin high. It is called the Socially Optimal Situation(SOS) where all players get to earn more by selling the same amount of eggs. But this SOS will not achieved as players will start to increase supply in concern of others will do it beforehand. Game theorist will predict supply will eventually rise to equilibrium.

Even though ASP in Singapore may normalized eventually, generally ASP of egg in Peninsular have been rising at 5.6% CAGR in 2007-2013, much faster that the inflation rate of 1-3%.

Output have been rising at CAGR of 4.4% in the past 10 years, or average of 370,000 daily eggs output per annual. 

ii) Lower feed price
Beginning in 2013, the price of feed have been declining due to significant increase of supply and stock of soybean and corn internationally.  The surge in the commodities' stocks are due to increased planting, higher yield as well as overestimation of China's demand.

With the bless of cheap feed, LTKM's Cost of Inventories(COI), which is part of the the cost of goods sold, fall from the high of 68% of the sales in FY2013 to 58% in FY2014, which is a 10% cost saving. COI is expected to be lower in FY2015 at projected 53% of the sales. Nevertheless, the benefit of fall in feed price is partially offset by the weakening RM. LTKM's payable in USD is insignificant, its purchase of feed should be done with local suppliers. Although hike in feed price due to currency exchange rate will still be mostly bared by LTKM, but it will be more manageable and less uncertain. 

Source: World Bank; Annual Average Feed Mixture Price represented by 72% Corn/28% Soybean Meal price in RM per Metric Ton.
 COGS (as a % of Sales) move in parallel with the feed price. With the fall in feed price in the past 2 years, COGS is near record low. Hence the Gross Margin is at record high.

Source: World Bank

4.0 Industry Outlook

Due to record high of plantings and yield in US as well as over-planting in China caused by over optimistic projection of China's economic growth, supply surge faster than demand caused stocks-to-use ratio to rise significantly in the past 2 years. This cause the slump of feed price in the past 2 years. In the next 5 years until 2020, stocks-to-use ratio of corn(maize) and soybean are expected to declined steadily, yet still generally higher that the figure 2 years ago. Hence, price of corn and soybean is expected to remain low stable and low in the next few years, which is a very good news for poultry farms. Although feed price is expected to bias upward in the near future as planters start to reduce planting and stocks is declining, the rise is expected to be mild and stable with the still-high stocks-to-use ratio. The recent decline in crude oil price and slow global economic growth should also help to keep feed price lower in the coming years.

LTKM currently has about 10% of the market share by production capacity and no production expansion plan. The production volume is expected to be flat in the future and topline is mainly depends on the ASP of eggs. LTKM's competitor, Teo Seng (Malaysia third largest producer) is planning to expand its production capacity by 400,000 eggs per day annually for the next 5 years. Capacity is planned to grow to 5.1mil eggs from the current 3.1mil in 5 years time and increasing its market share. With Teo Seng's daily production expansion at 400,000 eggs annually, which approximate the average annual rise of output in the past decades, LTKM and other players have no much room for expansion (in egg production) as doing so may risk oversupply. I do not foresee high capex in the coming years of LTKM and production should remain flat. 

5.0 Financial 

Other ratio not available in the common size analysis above

6.0 Current Market Valuation

7.0 Projection & Valuation

My TP is based on SOP/DCF approach. However, market/PE approach is shown here for comparison. Poultry business valued at 8x FY16 Earning which is lower than 13X given by AmResarch to TeoSeng and 9x given to CAB by Kenanga as LTKM do not have expansion plan compared to these 2 competitors. However, 8x PE is reasonable as LTKM's ROE and PAT Margin ranked second among the others players. The discounted value of Investment Properties/Securities is as shown in SOP valuation above. PE-based TP of RM7.43 coincide with my TP (1.6% variance). 

8.0 Risk & Mitigation

i. Any outbreak of birdflu or other type of virus will cause lost of sales, inventories and biological asset impairment loss and reputation damage to LTKM

ii. Suspension by AVA from export eggs into Singapore due to detection of Salmonella enteritidis bacteria will cause lost in revenue and drop in profit margin

iii. Significant rise in feed price due to supply disruption (due to unexpected weather pattern or lower than expected planting) or higher-than-expected demand growth will erode LTKM's Gross Margin. 

LTKM have bio-security system for the farm in addition to control measures put in place by relevant authorities to minimize the risk of contamination. With the current high stock and supply condition for feed commodities as well as sluggish global growth, supply and demand is expected to remain stable except for factors due to weather, which is getting more volatile in the recent years.

9.0 Conclusion

The stock will still have room for appreciation given recent market's attention on poultry play. Among the competitors, LTKM is one of the cheapest and most profitable players. However, the upside is capped by its limited growth potential. My TP is based on SOP/DCF and at RM7.55 suggesting a 14% upside potential. However, investors/traders should be caution as the stock have appreciated significantly in the past 1 years, any shift in stock market sentiment will give reason to  the existing shareholders to take profit. The stock also have high liquidity risk due to the low free float. My advice is to keep holding this stock if you have already entered earlier. If not, you can look at CAB and Teo Seng for better growth prospect. Besides the ASP rise and lower feed price, poultry stocks are recently in favor as investors look at recession-proof consumer-setor amid concern on GST and slower economy growth. Investors' sentiment on consumer stocks have been dampen due to these due to expected lower consumer spending caused by these 2 factors, but poultry stocks offer a defensive play as eggs and poultry consumption have been resilient in the past, regardless of the economic condition.

10.0 Appendices