Singapore Market Monitor - Capital preservation bias dominates our picks
Eight that we like and four we don’t
- Although our base case end-2017 FSSTI target at c3,000 holds minimal upside, we believe selective stock picking could provide 10%+ returns as has been witnessed YTD 2016 where a third of our covered stocks delivered 14-50% upside driven by company-specific dynamics against a flattish FSSTI YoY.
- On a bottom-up basis, we screen our coverage stocks for low earnings cyclicality, cashflow stability and low balance sheet risk within a preference framework of secular growth drivers over cyclical ones and businesses models with demonstrated track record.
- Our top picks are CapitaLand Commercial Trust, Keppel REIT, Venture Corporation, Raffles Medical Group, United Overseas Land, Bumitama Agri, Jumbo Group and Ezion. We also highlight ST Engineering and DBS as two stocks best leveraged to USD strength although we have HOLD ratings on both based on our valuation estimates.
- Our top SELL recommendations are OCBC, Genting Singapore, Keppel Corp and MobileOne — stocks where we believe the market is currently underestimating and mis-pricing business risk.
Stock pick details
Key BUY ratings
CapitaLand Commercial Trust (CCT SP)
- CCT is well-positioned to ride through near-term headwinds in the sector with its favourable lease expiry profile and strong WALE of 6.8 years.
- 2015-18E DPU growth of 1.8% pa from its acquisition of CapitaGreen.
- Impending redevelopment of Golden Shoe should allow CCT to capture a potential recovery in 2021.
- Unlike distributions for its office peers that are supported by non-core distributions, CCT’s reflects the underlying fundamentals of its properties.
- Valuations that imply a 14% discount to the value of its SG offices. Its implied cap rate of 5.0% looks generous against the low-3% cap rates in recent office transactions.
- Key risks to thesis: Sharper-than-expected declines in office rents of occupancy. Cost overruns in the redevelopment of Golden Shoe.
- Valuation basis: We rate CCT as BUY with TP of SGD1.81, based on target yield of 5.0%.
Keppel REIT (KREIT SP)
- Most favourable lease expiry profile with only 10% of office leases up for renewal in 2017/18. Income stability from strong WALE of 6.1 years.
- Best proxy to elevated prices for office assets in Singapore and aggressive land bids for Central Boulevard imply it is trading below the replacement cost of assets.
- Key risks to thesis: Slower-than-expected recovery in office rent. Bigger exposure to interest rate spikes than peers due to higher leverage (mitigated by 74% debt locked to fixed rates).
- Valuation basis: Stock is trading at just 0.7x P/BV and should see strong NAV support. Any sale of assets at prevailing market could lift stock closer to book value.
Venture Corporation (VMS SP)
- Zeroing on industries, products with structural growth and good margins plus a strategy to engage with customers that are market leaders is the backbone of Venture’s strategy.
- A focus on low volume but high margin business has been proven to be more resilient in a slow growth environment than most peers that are high volume driven (at the expense of margins).
- Key risks to thesis: Failure of target industries to ramp up volumes according to expectations. Some of Venture’s high-growth customers are in new industries such as 3D printing. Political protectionism that could reverse or slow the outsourcing / offshoring by its customers.
- Valuation basis: We value Venture at 15x P/E vs. its customers rather than other EMS firms due to an atypical business model which is more IP-intensive and includes sharing in the revenue/profit pool of its customers (through product design etc.).
Raffles Medical Group (RFMD SP)
- Singapore's leading integrated healthcare organisation with robust track record and exciting development plans in China.
- Local expansions to support medium-term growth, while China expansion to drive long-term growth.
- The catalysts from expansion, especially in China, have not been fully priced in yet.
- Key risks to thesis: Higher execution risks for Shanghai hospital, its first outside Singapore. Higher-than-expected start-up costs in major expansion markets such as China. A structural decline of medical tourism in Singapore.
- Valuation basis: Our DCF-based TP is SGD1.85 (WACC 7.1%, LTG 1.5%).
- Singapore operation is valued at SGD1.47, while the upcoming Shanghai Hospital is SGD0.38. Stock is trading at 32x FY17 P/E based on current price of SGD1.47. The price only reflects Singapore operation and has yet to account for China.
UOL Group Ltd (UOL SP)
- We expect UOL to be a relative outperformer in a tough operating environment for property developers. It has the highest share of recurring income base amongst covered developers.
- Conservative residential portfolio with high pre-sales and no exposure to QC penalties over the next two years.
- Strong downside support with the market pricing in a massive 43% discount to the underlying market value of its assets.
- Key risks to thesis: Poor land acquisition strategy. Sharp increase in interest rates could hit demand for properties and drive down asset prices.
- Valuation basis: We value UOL as BUY with TP of SGD7.37, implying a 24% discount to its RNAV of SGD9.67.
Key small-mid cap BUY ideas
Bumitama Agri (BAL SP)
- BAL is one of the fastest-growing plantation companies in our coverage universe, having planted an average of ~9,000 ha of nucleus area p.a. over the past 10 years. It has a sizeable nucleus planted area of 120,000 ha with relatively young oil palm trees.
- At an average age of ~8 years old, we expect BAL to grow its FFB output at ~10% CAGR over 2015-18.
- 9M16’s earnings were affected by lagged effect of 2015-16 drought in Kalimantan whereby output fell 11% YoY. Fast forward to 2017, we expect FFB yields to normalize and BAL’s FFB output to grow sharply by 25% (2016: -7% YoY).
- Key risks to thesis: BAL’s FFB output comes in below expectations.
- Valuation basis: We expect BAL to chalk up an impressive 68% EPS growth in FY17, driven by a rebound in FFB output. At 11x FY17 P/E, BAL trails its peers which trade at 14x. BUY with TP of SGD0.97 based on 14x 2017 P/E (pegged at -1SD of 4-year historical mean).
Ezion Holdings (EZI SP)
- Relatively more resilient exposure to production and maintenance services allows Ezion to keep most of its assets utilised and to generate free cashflows from FY16-18E.
- High chance of surviving downturn as it has no immediate balance sheet risks while it: 1) restructures its bank debts, 2) exercises capex discipline and 3) looks for opportunities to deploy assets for windfarm installations and as MOPUs as diversification.
- Five new assets scheduled for contribution in 1H17 could drive sequential EPS growth providing a near-term stock catalyst.
- Key risks to thesis: Oil price falls below USD40/bbl for a sustained period leading to severe cut back even in production and maintenance activities. Customers cancel contracts or withhold payments, weakening cashflows. Banks withdrawing credit facilities resulting in Ezion not being able to meet its operational requirements and financial liabilities.
- Valuation basis: GGM based P/BV of 0.5x based on ROE of 8.5% and cost of equity of 18% to account for higher risks. This yields a TP of SGD0.42.
Jumbo Group (JUMBO SP)
- Premium pricing and fast turn, high volume business sustainable through (1) focus on seafood with wide clientele appeal, local and foreign, (2) strong branding makes it the default choice for seafood, and (3) choice outlet locations.
- Core Singapore market provides stable incremental growth while overseas markets (China for now, but could include Thailand in the future via franchise strategy) are expected to provide higher growth quantum in coming years.
- Key risks to thesis: Company-specific risks are failure to manage store expansion properly to deliver expected growth and shortage of critical ingredients of its bestselling seafood dishes, eg mud crab. Key external risks are changes to China's food safety laws or import restrictions that affect ingredient sourcing ability and / or economic slowdown severely crimping consumer spending power.
- Valuation basis: Valuation based on a blend of DCF (WACC 7.7%, LTG 1%) and P/E (21x FY17E). Leading names in this sector trade at 25x and above.
HOLD ratings but best beneficiaries from USD : SGD strength
ST Engineering (STE SP)
- We see STE as a beneficiary of the recent USD strength. i) Income from its US operations (24% of sales) will be translated at a higher rate as well as a proportion of non-US revenue (we estimate c20-25%) that has USD based pricing, ii) Currency mismatch (USD sales vs local currency costs) could also boost profitability of USD priced contracts.
- There are no clear signs of a rebound in aviation MRO workload. Airlines have accelerated fleet replacement in recent years in response to high oil. New aircraft has much lower maintenance requirements. However PTF conversion work could correspondingly see a pick-up.
- We expect headwinds for its shipbuilding business to persist. Order wins in recent years were low and we see few signs of any imminent rebound.
- Key risks to thesis: Sharp fall in USD and longer-than-expected persistent weakness in aviation MRO workload.
- Valuation basis: We rate STE as HOLD with TP of SGD3.17, based on 18x FY17 EPS, 0.5 SD below historical average to reflect our expectations of lower returns in the near term. The stock has underperformed over the past three years after a series of earnings disappointments and market expectations are low in our view.
DBS Holdings (DBS SP)
- DBS is the best leveraged amongst the three Singapore banks to relative USD:SGD strength as it has the largest USD loan exposure at 33% of its loan book vs peers’ 19-23%. From translational FX gains alone, we estimate DBS’s FY16-17E pretax profits will increase the most, by 2-4% vs OCBC’s 0.8-1.7% and UOB’s 0.7-1.4%. OCBC’s and UOB’s gains are partly offset by their relatively bigger exposure to ASEAN.
- The risk to this reasoning is that credit costs could be higher too if customers and corporates are not able to repay USD debt when their domestic currencies depreciate further.
- We expect further asset quality deterioration in the banks as tail risks from the oil and gas sector are not fully factored in. Domestic loan demand environment remains with system loans contracting YoY since early 2016 but in contrast the Singapore banks have been growing their respective loan books over this period likely at the cost of spreads.
- Risks to thesis: Risks to our fundamentally bearish view on the sector lie in i) higher interest income, ii) higher non-interest income, and iii) more benign credit costs than expected.
- Valuation basis: We value DBS on GGM at FY17E P/BV at c0.9x, close to 1sd below historical mean to reflect lower forecast ROE compared to prior periods. Our sustainable ROE is 9.6% and assumed COE and growth rate 10.5% and 3.5% respectively.
Key SELL ratings
Oversea-Chinese Banking Corp (OCBC SP)
- More reliant on volatile non-interest income for growth and thus earnings may be of lower quality and earnings momentum may not sustain in weaker market conditions.
- Based on our quantitative analysis, we found OCBC to be less sensitive to repricing rate interval (i.e. 3M SIBOR), and thus it may benefit less than peers should SIBOR rise.
- We think asset quality deterioration may not have fully run its course amid the turning credit cycle. With rising NPLs, provisions may be inadequate with provision coverage at 101%.
- Key risks to thesis: NIM improvement from repricing of loans at higher rates and credit spreads. Higher non-interest income from wealth management and higher contributions from Great Eastern. Better-than-expected benign credit costs. We currently assume 39bps of credit costs for FY17-18E. We estimate that if our FY17-18E credit costs estimate is lowered by 10bps, FY17-18E net profit will increase by c.6%, ceteris paribus.
- Valuation basis: OCBC is currently trading at 1x FY17E P/BV, close to 1SD below its historical mean since 2005. We value it at 0.8x FY17E P/BV close to 2SD below historical mean to reflect our forecast for ROEs to remain below 2008-2015 mean. The 0.8x P/BV is maintained (sustainable ROE of 9.3%, COE of 10.5% and growth rate of 3.5%).
Keppel Corp (KEP SP)
- Weak O&M order replenishments with only SGD0.5b secured YTD but revenue run-rate was SGD6.2-8.6b over the last three years. Out of outstanding orderbook of SGD4.1b, only about SGD1b was not affected by deferments.
- Took only SGD230m of provisions in FY15, do not rule out potential for more significant amount of writedowns.
- Loss of O&M as a key cash generator may affect its ability to fund dividends and investments in other business segments, which means current gearing of 0.6x at Sep 2016 may trend up. Property earnings insufficient to fill the gap left by O&M.
- Key risks to thesis: Rig market turns such that customers take delivery of their rigs at original pricing leading to strong cashflows from back-end loaded payments. Sete Brasil’s bankruptcy plans yield favourable results leading to positive writebacks. Property segment sales surprise on the upside especially in China.
- Valuation basis: SOTP-based TP of SGD4.57. O&M is valued at book value adjusted for our assessment of potential writedowns. Property is valued at 0.75x P/BV, in line with comparable peer, CapitaLand. Implied FY17E P/E and P/BV are 8.9x and 0.7x respectively.
MobileOne (M1 SP)
- Entry of new competitor likely to see it raid M1 first for subscribers given its purely mobile service offerings with no bundled options that could lock in subscribers. We think the winner is likely to be TPG Telecom, with an ultra-competitive attitude likely and deep pockets courtesy of parent company TPG listed in Australia.
- Dividend payout at risk. Company already cut dividends 19% in FY15 and we forecast another 12% cut this year.
- Key risks to thesis: New entrant turns out to have a tamer attitude than expected toward market share gains. But we think the probability of this happening is low given the need to recoup expensive network investments in as short a time as possible before its investors run out of patience.
- Valuation basis: Valuation based on long-term (10 years) two-stage (specific and non-specific) DCF with a WACC of 9.3% and terminal growth rate of 0.5%.
Genting Singapore (GENS SP)
- Singapore increasingly less favoured by Chinese VIPs. The tax amnesty in Indonesia is also sending Indonesian gaming potential away and the weakening MYR is deterring Malaysian VIPs.
- The high margin mass market is also deteriorating. SCPRs account for ~75% of the Singapore mass market and they are under pressure from unemployment concerns.
- Growth options from new ventures have also narrowed with planned divestment of stake in Resorts World Jeju and foray into Japan far from certain and likely to be some time away.
- Key risks to thesis: GENS has been rationalising direct rebates to VIPs and marketing costs to preserve or improve margins but that risks market share loss to Marina Bay Sands or casinos in other jurisdictions.
- More Chinese crackdowns on direct marketing teams (e.g. Crown Resorts) will further weaken the VIP market. Full blown recession in Singapore will weaken the mass market.
- Valuation basis: GENS is trading at 10x FY17E EV/EBITDA or -0.5 SD to LT mean. Our target price is based on 8x FY17E EV/EBITDA or -1SD to LT mean given the company’s deteriorating fundamentals and limited nearterm new growth options. .