SINGAPORE (Oct 15): Stock markets around the world succumbed to another wave of intense selling pressure. This time, the US market was not spared, which is not entirely a surprise, given that its recent record run has further widened the valuation gap with the rest of the world.
Bellwether indices in the region are all in a sea of red. Chinese stocks caught up with the selloff after a week-long holiday in the previous week. Stocks on Bursa Malaysia suffered one of the worst weeks in years.
Aside from external pressure, sentiment on Bursa was likely affected by the ongoing tussle between the Ministry of Finance and the MMC-Gamuda consortium over costing for the underground construction of the Mass Rapid Transit 2 (MRT2) project. We have read and heard many opinions from both sides of the divide.
As a businessman, I fully empathise with the arguments for sanctity of contracts and its importance in maintaining investor confidence, the associated costs in terms of market losses for shareholders and the potential longer-term impact on the capital market.
Gamuda launched an unprecedented campaign on social media, calling for the government to reconsider or face the loss of 20,000 jobs. I do not question that there will be pain.
But who are the stakeholders in this issue? Is it just the 12,000- and 8,000-plus shareholders of Gamuda and MMC Corp as well as the 20,000 employees whose jobs are on the line? Should we not take into consideration the interest of the 2.3 million taxpayers and 32 million Malaysians who will ultimately be footing the bill?
There is no good solution that would satisfy everyone. But does that mean we do not do what is right or, more specifically, right what was wrong?
We know the previous government abused the system. Indeed, we voted it out for precisely this reason. The people stood up and made it heard that we want a clean government, transparency, accountability and, ultimately, a better livelihood for all, not just the few.
The MRT2 project is just one of many infrastructure projects that had been dished out since 2014, after the 13th general election, and some were awarded just before GE14. Some of these contracts were awarded without open tender, were lopsided and against the public interest, or were simply unnecessarily extravagant (making them very expensive). They should be reviewed.
Hence, the outcome of this contract dispute is important, in that it will be a precedent that will set the tone for future renegotiations. In this respect, while the government should handle the matter with care and fairness, it must also fulfil its promise to reform the system — a promise made to all Malaysians.
Without doubt, there will be a price to doing what is right, but I think the people will gladly pay that price. For investors, it is high time they looked beyond just how much profit a company makes, to how those profits are made.
I added a few stocks to my Global Portfolio recently, namely US-based defence contractor Northrop Grumman, Hong Kong-listed Ausnutria Dairy Corp and China Sunsine Chemical Holdings, which is listed on the Singapore Exchange. The portfolio is now almost fully invested.
Northrop is one of the five largest defence contractors in the world, with a strong focus on aerospace solutions, unmanned aircraft (drones), autonomous vehicles on land, sea and undersea as well as missile defence systems.
Defence-related stocks are expected to benefit from a projected increase in government spending around the world. Defence spending, including in the US, has fallen sharply since the end of the Cold War, but appears to have turned the corner — especially given the rise of Russia and China as well as extremist groups such as the Islamic State.
The US, under President Donald Trump, has expanded significantly its defence allocation in the past two years. A higher US$716 billion ($988 billion) budget for 2019 was recently approved. The president has also been pressing allies, including North Atlantic Treaty Organization members, to step up their defence spending. Most currently have military budgets well below the 2% of GDP guideline, a target NATO aims to achieve by 2024. More than just expanding existing resources, countries cannot ignore new military technologies.
In May 2018, Congress approved US$11.5 billion for the Missile Defense Agency (MDA), its highest ever allocation. One of its core upcoming programmes is the Ground Based Strategic Deterrent system (GBSD). Northrop and Boeing are in competition to develop this system for the US Air Force.
GBSD is an overhaul of the existing intercontinental ballistic missiles system (ICBM). Over 600 new missiles are to be built, to replace the Minuteman 3 missiles, which were first introduced in the 1970s.
The acquisition of rocket and missile maker Orbital ATK in June 2018 further expanded Northtrop’s product portfolio and capability in manufacturing technologically advanced combat platforms and in particular, the space market (satellites, spacecraft components as well as commercial space-launch systems). Orbital is one of only two US manufacturers for solid rocket motors, which are used to power missiles and space launches.
While the US military is its biggest customer, Northrop also sells to other countries. In September, the US State Department approved the sale of up to nine E-2D Advanced Hawkeye Airborne Early Warning and Control System (AWACS) aircraft to Japan, a growing market for US defence contractors. Earlier in June, the Australian government announced plans to purchase the Northrop-built Triton unmanned aircraft system. Total cost for six of the long-range surveillance drones is estimated at US$5.1 billion. In April, the US approved the sale of four Tritons to Germany.
Northrop has a market cap of around US$54 billion and its shares are trading at a forward price-to-earnings of about 16 times. Current order backlog stands at some US$52.2 billion, a record high.
Ausnutria Dairy Corp is an integrated dairy products company. Its operations include milk sourcing, R&D, processing, blending, packaging, marketing and distribution of its own branded products — specialising in infant formula milk powder — and catering primarily to the Chinese domestic demand.
The company went through a series of mergers and acquisitions over the past few years, which underpinned its strategic transformation. These include acquiring production facilities (and intellectual property) and subsequent expansion in the Netherlands, Australia, New Zealand and China.
Crucially, Ausnutria expanded strategically from the highly competitive cow milk market segment into the niche market for goat milk. All of its goat milk formula products are produced in the Netherlands and marketed under the “Kabrita” brand worldwide.
China has very strict regulations for registration of infant formula — following a series of tragic scandals involving contaminated milk — which also serves as a barrier to entry. Ausnutria’s factories in China (for blending and repackaging) were among that first batch of factories granted the National Infant Formula Enterprise Production Permit. The factory in the Netherlands is also one of the first infant milk formula manufacturers to obtain import licences for overseas products.
Ausnutria adopts a multi-branding strategy to penetrate different market segments. Cow milk products are sold under its own brands such as A Series Gold, Allnutria, Augood, Puredo, Hyproca 1897 and Mygood. It has widened its product range to include older children and adults (including mothers-to-be) as well as nutrition products such as supplements and vitamins.
The company undertakes contract manufacturing for other customers, but this accounts for an increasingly smaller portion of total revenue, dropping from 55% in 2014 to less than 20% currently. This shift has underpinned Ausnutria’s margins expansion, despite intense competition in the cow milk segment. Nevertheless, the original equipment manufacturer (OEM) business is a good way to maximise utilisation at new factories at the start-up stages.
Its first-mover advantage into goat milk market is bearing fruit — Ausnutria’s sales (worldwide) have grown more than sixfold since 2014. There was a corresponding increase in return on equity, from 8% in 2014 to 28% in the trailing 12 months.
Net profit in 1H2018 of RMB327 million, or $65.2 million (RMB266 million excluding one-off gains) was significantly higher than the RMB153 million in 1H2017 and exceeding the RMB308 million for full-year 2017. Net gearing remains modest at 28%, after recent capacity expansions. Its shares are now trading at roughly 15 and 11 times estimated earnings for 2018-2019, respectively.
The Global Portfolio continued to lose ground amid the selloff. Total portfolio returns since inception dropped to -8.6%, underperforming the MSCI World Return index, which is up 0.9% over the same period.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
