Sunday, 1 December 2019


Many of us would fail to answer this question frankly, and truthfully : what do you suck at?

Self-denial will probably paralyse the truth-telling part of our brain, causing us to come up with ever more feeble excuses for failure of comprehension. After all, the three hardest words in the English language is 'I don't know'. The nine hardest words? 'I don't want to admit I suck at anything'.

Being good at trading is all about humility, and repeatedly absorbing painful lessons. A bad trade idea can be met with self denial, but the money that was lost would force you to accept things as they were. The reality was : you sucked at that trade.

Amongst our many fatal flaws is one particular thing that we suck at : analysing conglomerates. DRBHICOM is one such example; we had a very rosy view of its short term prospects, but we have been proven to be over-optimistic.


Imagine conglomerates as a big ship. It's made up by many parts, but those parts have to be sturdy for the ship to remain afloat. One leak can bring down the ship, similar to how one underperfoming business can bring down the overall (consolidated) profits of a conglomerate.

To take this analogy further, the ship is made up of complicated parts. People who maintain them may not even see the leaks at first. You can guess how far a ship with holes can go - nowhere fast.

Conglomerates used to be en vogue - ten years ago they were, but not anymore. In a market upcycle, where growth and optimism are boundless, scale is everything. Bigness for the sake of bigness. Waves of consolidation and mega mergers. And best of all - the stuffing of unrelated businesses into a 'diversified' and 'synergistic' business portfolio.

The word 'synergy' triggers a sensation of vomiting in our mouths. It's the kind of one-size-fits-all word that essentially means and proves nothing. Synergy is a band-aid to rationalise a vague solution to a concrete problem. And you should know how the corporate sector loves their synergies.

In a sprawling family business with diversified interests - retail, real estate, and manufacturing as part of a portfolio of business interests, for example - the conglomerate structure may make sense. But as scale reaches its plateau, and with the business cycle heading to an inevitable downturn, it becomes more compelling to break the structure apart.

This tends to happen when the business owners start seeing the dreaded 'conglomerate discount' becoming wider and wider in their share price (Editor's Note : in other words, the discount of the stock price compared to net asset value).

When the pooled group of diversified businesses are valued at less than the sum of its parts, it's time to consider chopping them up.

Case in point is the Sime Darby demerger exercise. The group had their fun during the boom times as a giant conglomerate - plantations, automotive, real estate, industrials, et cetera. The merger happened in 2007, and the demerger in 2017. That's one (or two) good business cycles for ya. Our point is, when a structure stops making sense, corporates are wise to break the conglomerate structure apart. 

A breakup of a conglomerate brings multiple benefits. You 'spin off' the main business (the main holding company) because you realise the individual parts are worth more than the sum. Just by doing this very basic readjustment of structures, you can unlock billions in value

Why is it beneficial? Because shrewd investors prefer exposure to specific businesses they like. With SIMEPLT for example, they can get pure exposure in plantations, without worrying about volatility in the automotive distribution segment, or lousy near term prospects in the real estate business. 

The second benefit is even simpler: individual businesses can now be fairly judged by the market. Again, the sum of the parts - the classic conglomerate structure of a 'parent' holding company holding stakes in all these different businesses - may not get optimal valuation. Because there's fear: you think the nonperforming businesses will erode the earnings contributed by the better performing ones. 

You might even get confused and become unable to value the business properly, like us. We suck  at analysing conglomerates, because sometimes we miss the leaks in a ship that looked sturdy at first glance.

The SIME case was a well-timed exercise to derive value from a market of investors that are hungry to chase yields. Other conglomerates remain glued to their existing structures, and DRBHICOM is a prime example.


PROTON makes up an overwhelming majority of DRBHICOM's revenue. You would think that the group lives or dies by the strength of the carmaker's performance. And they have performed superbly, with PROTON cars literally becoming *gulp* a status item for some people. The X70 received rave reviews for its classy interior and classy design. 

To a nearsighted uncle, the PROTON X70 that his son-in-law's driving sort of looks like a Land Rover from a distance.  The son-in-law parks the car a few houses down the street to keep up appearances. Everybody's happy.

PROTON kept breaking sales records in 2019. Sales increased by 46% year-on-year! By September 2019, they sold as many cars as they did in the whole of 2018!

But it's not enough, at least for the stock. Despite PROTON's wonderful performance, and despite the automaker singlehandedly swinging DRBHICOM into massive profits, the stock has stagnated.

This is what market apathy looks like. After peaking at RM2.96 on 23 August 2019, the stock has dropped 21% as of 29 November.

As a final gut punch, DRBHICOM reported great net profits in the second quarter of RM44.08 million. For context, a year ago they recorded an RM11 million loss. How did the market respond? The stock fell by 3% the day after the announcement (28 November).

At present, the stock is close to its lowest point in four months. By the time you read this, it would likely have headed even lower.

 From DRBHICOM's latest media release. Link.

In an imaginary world where DRBHICOM was broken up, with PROTON as a separate listed entity (like it once was), the automaker's stock would likely have doubled (or even tripled) on a yearly basis. But the conglomerate structure rears its ugly head yet again.


Look, everybody and their uncle knows that PROTON is an earnings driver for DRBHICOM. It's the biggest and might even be the only profit driver. But unlike SIME, this is one conglomerate that is not going to be broken up anytime soon.

The myriad rescue packages by the government, and the complicated politics behind the ownership of DRBHICOM makes this an 'unbreak-able' conglomerate. And unlike SIME, they are involved in businesses that directly serve national interests, such as in defense as well as (yes) the automotive industry.

But the main drag is the postal service. POS, a 54% - owned associate of DRBHICOM, has seen its business prospects fall faster than your expected delivery time for a PosLaju package.
Things are not rosy in the postal service business right now. It is an asset heavy business that are burdened by legacy issues. It employs a large workforce and can't afford to pay well.

POS hurts DRBHICOM's stock mainly in two ways:

1) Stock price deterioration

2) Contribution of losses to the shareholder

(1) is self explanatory. This is the most recent chart for POS. In the below daily chart, the peak-to-trough decline (from its July peak) is 27%. You can do the math as to how DRBHICOM's value of the POS shares it owns is impacted by this price movement.

The stock price movement comes as no surprise : POS's losses simply widened. It's still awaiting that postal fee hike : the government seems to be in no hurry to impose this.

Speaking of losses, POS's has gotten worse, with a fifth straight quarter in red ink.

POS latest quarterly earnings. Link.

This inevitable affected the parent, with POS's performance classified as part of DRBHICOM's 'Services' segment.

From DRB's latest quarterly earnings report. Link.

The second reason behind DRBHICOM's lousy stock price performance is more apparent. As a government linked company, the stock simply tracks the FBM KLCI. In this regard, it has obediently followed the stock market downwards.

The symptoms behind DRBHCOM's stock price ailment seems apparent. So this brings us to the most important question : what lies ahead for the stock? Or in uncle parlance, "can still buy onot u sure ah??"


The short answer is, yes. But prepare to endure some near term pain. We think investors have just begun giving up on the stock; there will be precipitous declines, perhaps some major selldowns. Perhaps the stock will touch new lows.

But hey, remember how we always like to think about relative comparison? It's when the question is not 'why the stock fell so hard', but 'why it shouldn't have fallen so hard'?

We are believers in PROTON's continuing growth story; the fundamentals speak for themselves. There are further opportunities for market share attainment. The CKD X70 rollout, and the X50 introduction, will continue to hurt the Hondas and Toyotas of this world.

The management team at PROTON clearly knows what it's doing. It's a turnaround story that comes along once in a generation. We don't merely think PROTON will be saved; it has been saved already. This means that an investment opportunity is there.

In other words, we expect PROTON to continue being a massive profits driver for DRBHICOM. But what about POS and its losses? We have an answer to that too.

We anticipate the continuing losses to have been factored into the POS stock price; recall that massive 27% price decline. Any small positive news would likely straighten up the stock again. It's the 'normalise slightly' principle : when things are bad, it just needs to improve a little bit for a recovery in sentiment. We are far too pessimistic to anticipate profits, so let's just say... lower losses?

Our thinking is that PROTON's profits will continue to offset losses contributions from DRB's other units. We do think the automotive market in Malaysia as finite : it's not a pie that's growing larger. But with the strength of the product, PROTON can capture a bigger piece of that pie, weak TIVs notwithstanding.

So as DRBHICOM's stock gets lower, we will consider an entry. We will pay special attention to the weekly candlestick chart. Any signs of long term recovery trend is a trigger to buy for us. With the right kind of environment, and improved fundamentals, a return to RM3 is not an impossibility.

We are not in a hurry. This one is a long game.

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