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STI valuations not stretched but investors should stay defensive, says UOB Kay Hian

Chan Chao Peh
Chan Chao Peh • 6 min read
STI valuations not stretched but investors should stay defensive, says UOB Kay Hian
SINGAPORE (Jan 23): Despite 2019 ending on a cheerful high, markets turned jittery when the new year started with old enemies US and Iran provoking each other, raising tensions in the Middle East and worldwide by a few notches. Investors, therefore, shoul
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SINGAPORE (Jan 23): Despite 2019 ending on a cheerful high, markets turned jittery when the new year started with old enemies US and Iran provoking each other, raising tensions in the Middle East and worldwide by a few notches. Investors, therefore, should adopt a more defensive stance. “To me, this is a known unknown — there is always a risk that something would happen,” says Adrian Loh, UOB Kay Hian’s head of research, at a recent forum.

The geopolitical tensions — marked throughout 2018 and 2019 by the US-China trade war — suggests a potentially more turbulent year for 2020. There’s more. In 2019, there were three attacks on oil assets in the Middle East, which remains the most critical oil producing and exporting region. Two of those attacks were on oil tankers, and the third and most serious incident, using drones, involved the oil process facilities of Saudi Arabia. These incidents were largely “discounted” by the market but from the perspective of UOB Kay Hian, investors need to pay more attention to the risks.

The US Energy Information Administration estimates that Opec, the oil exporting cartel, has spare capacity of just 1.88 million barrels per day as at December 2019. This means in the event of a prolonged disruption to major oil supplies, the market will be tapping into the strategic petroleum reserves.

Besides oil, China is likely to weather further slowdown, and with the trade war continuing, there is risk of weaker-than-expected deceleration. UOB Kay Hian points out that there are more incidents of companies, including stateowned enterprises, defaulting on their bonds.

The Straits Times Index (STI) is now trading at around 12 times estimated 2020 earnings. At this level, the valuations are deemed “not stretched”, for the average valuation between 1995 and 2019 is 14.8 times. However, against the current macroeconomic backdrop, UOB Kay Hian suggests that investors keep a portfolio of 60% defensive/large-cap vs 40% growth/small-cap. The brokerage’s top largecap picks for this year include Ascott Residence Trust, DBS, Keppel Corp, Frasers Centrepoint Trust, Netlink NBN Trust, Mapletree Industrial Trust, SATS and ST Engineering.

UOB Kay Hian’s research team has shortlisted three small-cap stocks for this year as well. According to John Cheong, the brokerage’s Head of Small Mid Cap and Retail Research, these three picks are CSE Global, Penguin International and Koufu Group. These three counters have three common characteristics: they are trading at deep value, they will enjoy near-term catalysts, and they have good operating track records. Compared to other small-caps, which are more volatile, these three companies are considered “safe bets”, says Cheong, at the same seminar.

CSE Global

CSE Global was previously focused mainly on providing engineering services for customers in the oil and gas sector. When oil prices started dropping, CSE’s share price suffered in tandem. Now, oil prices have increased from US$50 per barrel at the start of 2019, to some US$70 at the end of 2019.

In 2018, Malaysian company engineering company Serban Dinamik bought a strategic stake of nearly 25% in CSE Global for nearly $58 million. This new substantial shareholder is now a key contractor to Petronas, and CSE therefore has a better chance of winning Petronas-related contracts down the road, adding to CSE Global’s current roster of blue chip clients such as Shell and ExxonMobil.

On the other hand, CSE Global has been actively building capabilities to serve a new sector: infrastructure. Customers in this new segment include the Singapore and Australian governments. While the infrastructure business generated just a quarter of CSE Global’s revenue, it accounts for half its earnings, notes Cheong.

In the third quarter of 2019, CSE Global won some $100 million in new orders, which has brought its total order book to more than $300 million. The company is constantly in talks with other potential customers and Cheong is confident CSE Global can convert some of these negotiations into new firm orders. “2020 will be a strong year,” says Cheong.

Along with the higher earnings potential, Cheong believes the company will increase its dividend payout. CSE Global has maintained a track record of rewarding shareholders with annual dividends that gives them a yield of 5%. “With earnings growth, chances are dividend will grow too,” he says.

Penguin International

For years, Penguin International was known to be a ferry operator, plying popular routes such as between Singapore and Batam, and between Singapore mainland and Pulau Tekong.

The company has since moved to a new main business of building a class of ships known as aluminium fast crafts. According to Cheong, this is a specialised type of vessel that is favoured by oil rig operators to ferry their crew to the offshore platforms. Many of these oil rig crews used to be transported via helicopters. However, as oil prices are no longer trading at the peak, chartering helicopters at a rather expensive rate of US$4,000 per hour is no longer a luxury many companies want to pay for. Instead, fast crafts — the type built by Penguin International — are increasingly used as substitutes. Charter rates, says Cheong, is US$4,000 per day.

Besides a much more economical operating cost, the boats can carry around 80 passengers per trip, compared to a maximum of 20 for helicopters. There is also more space for cargo. The only disadvantage, says Cheong, is that the while helicopters can fly at 160 knots, the boats can travel at 30 knots. However, this is a shortcoming the rig operators can live with.

Cheong observes a pattern shown by Penguin International’s stock price in the past year: after each quarterly earnings announcement, the share price enjoyed a significant kick up. From 30 cents at the start of 2019, the company’s shares more than doubled by year-end. Yet, Cheong believes Penguin International still has legs.

In 2018, the company delivered 15 vessels; in 2019, the number was doubled. This year, the company is expected to deliver 40 vessels. “This is a very good growth stock,” says Cheong, who has a target price of 85 cents. At 75.5 cents as of Dec 31, 2019, Penguin International shares were valued at 8.6 times estimated FY2019 earnings and 6.8 times estimated 2020 earnings.

Koufu Group

Cheong observes that leading food court operator Koufu is able to report earnings of around $30 million. By contrast, other leading listed F&B companies, such as BreadTalk Group, and Kimly, manage to report just around $10 million.

The business model of food courts is a defensive one. Earnings are likely to remain resilient, even during economic downturns. Consumers eat at food courts almost out of habit; eating at higher-end restaurants is discretionary and so susceptible to higher volatility. Food courts are also a highly cash-generative business as customers do not enjoy credit terms and pay cash.

As at Sept 30, 2019, Koufu has a cash and equivalent balance of $93.5 million, which works out to around a quarter of the company’s market capitalisation. It is trading at around 10 times earnings, which is a more than 10% discount off its other F&B peers. Besides the inherent value, Koufu is steadily opening new outlets, not just in Singapore but also overseas. “The market’s price discovery will continue,” says Cheong.

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