Monthly Strategy - Ending a Volatile Year Calmly
- Key events – OPEC meeting this week and mid-Dec FOMC meeting.
- STI to end 2016 at around 2850; December trading range 2800 to 2900.
- Buy-on-pullback beneficiaries of Trump’s policies– ST Eng, Bumitama Agri, Indofood Agri, UOB and OCBC.
- O&G sector hinges on OPEC meeting outcome – Picks are Sembcorp Industries and Ezion.
Looking back at November
- Financial markets were rocked by Donald Trump’s presidential election victory over Democratic candidate Hillary Clinton. The USD strengthened against other currencies in anticipation that US inflation pressure is set to rise as his policies to potentially cut both corporate and individual taxes as well as increase infrastructure spending will spur growth. Emerging markets’ currencies weakened with the MSCI EM Currency Index down 3.1% month-to-date on concerns that Trump’s protectionist stance will hurt emerging markets economies most. The USDSGD strengthened 3% for the month.
- The benchmark STI rose 2% m-o-m to 2870. In percentage terms, the O&G sector gained the most, in line with the rebound in oil price in anticipation that OPEC will be successful in implementing a production cut at the upcoming OPEC meeting this week in Vienna.
- Bank stocks rose, riding on one of Trump’s focus to deregulate the financial sector. A steepening of the US yield curve as a result of Trump’s pro-inflation policies is seen as positive for US banks that could eventually lead to a re-rating of global banks. Ceteris paribus, higher interest rates lead to better net interest margins (NIM). Concerns on non-performing loans (NPL) in the O&G sector could subside following the latest MTI measures to enable bridging loans of up to S$15m to help Singapore-based Marine & Offshore Engineering companies to finance their operations and bridge short-term cash-flow gaps.
- The MAS 10-year yield, a measure of risk-free rate, has risen 60bps since October to 2.42%. Understandably, SREITs performed the worst in anticipation of higher interest rates going forward. The Telco sector also performed poorly as the case for a 4th Singapore operator is now a near certainty after MyRepublic and TPG Telcom were both pre-qualified as candidates for the New Entrant Spectrum Auction (NESA).
December Market Outlook
OPEC meeting in Vienna
- The next important event to watch will take place even before the new month starts - the OPEC meeting in Vienna this week. Oil producers (OPEC and non-OPEC) will meet to iron out the final terms of the Algiers supply accord that could lead to the first production cut in eight years.
- Obstacles remain as producers continue to bicker on who should share the burden of cuts. For example, Iran, which is OPEC’s third-largest producer, is insisting it should be allowed to keep increasing output to pre-sanctions level of about 4 million barrels per day (bpd). According to Russian Energy Minister Alexander Novak, OPEC has asked nonmembers to cut production by 500k bpd, but Novak is insisting that non-OPEC nations are only willing to freeze production at current record levels.
- The outcome of the OPEC meeting will have a meaningful impact on O&G stocks. We think a lack of agreement from countries such as Nigeria and Libya seeking exemption remains the key risk to a deal on 30 Nov, though in that case we think the result could be a deferral rather than a complete abandonment of the deal.
- In the event that the Vienna meeting is inconclusive, O&G stocks will likely give back their recent gains. On the other hand, the sector is expected to recover further if an agreement is reached on production cuts each country should shoulder. Our sector picks are Sembcorp Industries and Ezion.
FED poised to raise rates
- The FED meets on mid-December to decide on interest rates for the final time this year. Odds for the FED funds rate to increase 25 basis points (bps) to 0.75% jumped to 100% from around 50% just over a month ago, prior to Donald Trump’s election victory. Investors believe Trump’s pro-growth policies and inflationary pressures could also accelerate the normalisation of interest rates. The odds for FED funds rate to rise a further 50bps to 1.25% by the end of next year has also risen to 58.7%.
- Rising interest rates is negative for SREITs and companies with higher gearing. Among the SREITs, we are cautious on Cambridge Industrials, SPH REIT and Suntec REIT because of their relatively low potential total returns (target return + dividend) compared to peers.
- Ceteris paribus, higher interest rates lead to better NIM for banks.
Straits Times Index to end the year around 2850
- The seasonal December holiday lull is just around the corner. Trading activity during this period tends to ebb to a low where it is common for total daily value of shares traded to fall to around SGD600m or less in the final two weeks.
- While we do not expect the STI to make much further headway in December after the November gains, we see the index underpinned by the heavyweight bank stocks in anticipation of higher NIM and a bottoming out of the loans contraction trend. NPL concerns in the O&G sector could also subside following the latest MTI measures to enable bridging loans of up to S$15m to help Singapore-based Marine & Offshore Engineering companies to finance their operations and bridge short-term cash-flow gaps.
- Meanwhile, the recent concluded third quarter results season saw a deceleration to earnings downgrades compared to the previous quarter. For stocks under DBS Research’s coverage, we trimmed FY16F earnings by 2.2% and FY17F earnings by 2.0%, much tamer than the respective 7.4% and 6.8% earnings cuts in the second quarter.
- Our earlier view on the STI was that
- we had already seen the year-to-date (YTD) high at 2960 in July, and
- we were looking at a decline to 2670 should Trump win.
- A fall to 2670 looks unlikely now given the recent strength and preference for bank stocks. But our view that the YTD high of 2960 has been reached stays valid as the level coincides closely with 13.64x (average) FY17F PE, a level unlikely to be attained by year-end with the ongoing earnings recession trend.
- We think the STI will continue to trade within the 2800 to 2900 band in December, similar to the pattern seen since August. We peg a year-end target of 2850, which is above 12.87x (-0.5SD) FY17F PE.
Beneficiaries of Trump policies
- Buy-on-pullback stocks that are beneficiaries of Donald Trump’s policies:
- ST Engineering – Its defence division should benefit from increased military spending as US presidential elect Trump called for an increase in US military spending that could amount to US$500bn or more. Going forward, we expect STE to post a reasonable earnings rebound in FY17, following a kitchen-sinking year in FY16. Besides smart city-related contract wins, an additional catalyst could come from increased defence spending. Technically, the stock has firm support at S$3.18.
- Crude palm oil (CPO) stocks Bumitama Agri and Indofood Agri – These two stocks will benefit from the 3.3% rise in USD against the Rupiah since the November 8 US Presidential election as all their revenues are in USD while about half of their costs are in Rupiah. CPO stock should also be underpinned by the current rise in CPO price as recent data showed palm oil inventories in Malaysia increased at a slower-than-expected pace. Technical support for Bumitama Agri is at S$0.78. For Indofood Agri, we are watchful of profit taking as the stock heads for our fundamental TP of S$0.58, but pullback should be supported at S$0.52.
- Bank stocks UOB and OCBC - Trump’s direction to boost fiscal spending and cut corporate and personal taxes has also driven up inflation expectations, leading to a steepening of the US yield curve. This is seen as positive for US banks that could eventually lead to a re-rating of global banks. Ceteris paribus, higher interest rates will lift NIM. Technically, support for UOB shares is at S$19.40 with upside potential to S$20.60 before correction sets in. The support level for OCBC shares is slightly below S$8.80 with upside to S$9.30.
O&G sector hinges on OPEC meeting outcome
- We believe the outcome of the OPEC meeting should determine the direction of O&G stocks in the month ahead and even into first quarter 2017.
- In the event that the Vienna meeting this week is inconclusive, Brent crude should retest the recent low of USD43.5 per barrel and may even head down to USD40.5 per barrel on technical action before finding support. O&G stocks will likely give back their recent gains.
- On the other hand, the sector is expected to recover further if an agreement is reached among the oil producers regarding production cuts each country should shoulder. In this case, we expect Brent crude price to rise to our technical year-end objective of USD62 per barrel. O&G stocks should add to recent gains. Our picks are Sembcorp Industries and Ezion.
- We think the outcome of the OPEC meeting will have a bigger impact on the O&G sector compared to the latest announcement by the Ministry of Trade and Industry to reintroduce the Bridging Loan scheme at a maximum loan quantum of S$15m per group and to expand the Internationalisation Finance Scheme (IFS) from S$30m to S$70m per group for Singapore companies.
- Our O&G analyst notes that firstly, the loan quantum of S$5m per company (or S$15m per group) is not exactly huge, representing just c.4.2% of the SGX-listed Small Mid-Cap O&G players’ short-term debt by our estimates.
- Next, the S$70m IFS facility will have limited usage because O&G service players/shipyards are not planning on expansion amid the protracted downturn, and day-to-day operations are unlikely to qualify for ‘project financing’.
- However as distress situations increasingly present themselves, the IFS facility could help to spark more M&A activity, which we think could be a theme for 2017.
- Within our coverage of SGX-listed OSV players and shipbuilders, our analyst thinks Pacific Radiance (PACRA) and Ezra (including subsidiary EMAS Offshore) qualifies for, and would benefit the most from the S$15m Bridging Loan facility.