Tuesday, 24 March 2020

GAMUDA IS BETTER OFF KEEPING ITS HIGHWAYS


From the Editor-In-Chief of The Pelham Blue Fund

I remember having a conversation with an analyst in the middle of last year. We were discussing the prospects of Gamuda Bhd and its proposed RM6.2 billion sale of four Klang Valley highways to the Government - well, the old Pakatan Harapan government, to be precise.

My question : "Why is this deal good? They're going to lose a Penang-sized chunk of revenue and damn vital recurring income source, bro"

The analyst : "But you see, this is good for everyone. Once sale finalised, got big special dividend coming bro. Everybody's happy"

Me : "So now you're saying people are buying the stock just to get the dividends? And after the sale they're going to put all their chips on all the Penang Transport Masterplan stuff?"

Analyst : "Yes, pretty good short term yields, isn't it?"

Me : "But how about the lost revenue and long term recurring income..."

Analyst : "You obviously don't understand, so let me explain to you again..."

 Source : company filing

And he did. I enjoyed getting thorough explanations without having to do much but listen intently. I also tend to see the explainer's biases. Indeed, the sale is a good move, if you look at it solely in a short term context. Fat dividends tend to do that, and you know how fund managers are always under severe pressure to meet their KPIs.

Before I get into the details, you're probably wondering why I'm talking about GAMUDA now. It's because the deadline to finalise this highway takeover agreement is going to end on 31 March, 2020.


The second bit is that in case you haven't noticed, we had a change in government recently. This deal has nothing to do with the new government. It looks unlikely that this would be pushed through.

From a taxpayer and local citizen perspective, I've always thought this deal was a 'what's going on?' kind of transaction. Call me naive, but from a shareholder's perspective, I fail to see the long-term economic benefit for the company.


The logic for the rakyat also escaped me : so, in order to reduce the toll burden of Klang Valley motorists, the Government was going to buy the highways and grow its overall debt burden, which in turn will likely cost Malaysian taxpayers (all over the country) more in the long run?

And the company's giving up a stable income source, or to put it indelicately, its main cash cow?

How fat is the cow? In GAMUDA's last full financial year, the concession business generated revenue of RM496 million. It's pretax profits from that? RM303 million. The business generates 7% of GAMUDA's total revenues but a full one third - 33% - of its pretax profits. You can see why investors like highways; the concession business has a pretax margin of sixty percent.

Last year, the promise of a big payoff led to intense interest to buy the shares. One estimate put the potential special dividend - one-off payment from the proceeds of disposal - of between 48 and 96 sen per share

Below is GAMUDA's share price performance from February 2019, when the takeover was announced, to February 2020, just before the Pakatan Harapan government's collapse. That's a 52% gain in the stock.


And... that was the top. Below is the seubsequent Perikatan Nasional period stock performance (late February onwards) looks like this. A 40% decline.


This highway deal is likely dead in the water anyway as it was the previous MOF's baby. The current government has more pressing things to commit funds on to save the economy and prevent a recession.

It's not just that the highway takeover does not make sense at a fundamental level; this was no impediment to many 'successful' transactions in the past.

But structurally it was never meant to happen in the first place. When you have too many moving parts (multiple listed entities, cross-shareholdings by institutional funds, related party transaction hurdles, regulatory scrutiny, the political angle, etc), that's when a major deal crumbles. Just like any of the proposed bank mega mergers in the last decade.

The baby was... ugly. It's not loved, because you couldn't exactly see if the rakyat benefits from this proposed takeover of four highways. There was the whole brouhaha with the proposed PLUS sale that amounted to nothing except oh, wait for it... cheaper tolls now in return for having to pay tolls for another 38 years.
For this highway deal, I can understand that at least three parties want it to happen : the management, fund managers holding GAMUDA, and the old MOF. Maybe the intent was to take the cash and pivot towards Penang. 

As for the rest, I really don't know, but if one has a five-to-ten year viewpoint that isn't clouded by a special dividend, literally everybody else would probably say "I don't mind owning some highways to get me through tough times". Hardly a radical viewpoint.
  
Look, imagine if your plate of nasi lemak is cut by half. Some random guy - me - comes over and takes away your sambal, eggs and anchovies, leaving you with nasi lemak that's only fit to serve on certain airplanes.

Highways contribute RM200 million plus to GAMUDA's annual net income. Without that, how's your nasi lemak going to look?

What's going to fill the hole? Your income proportion out of revenue from digging holes is much less. This is a company that has massive tunnel boring machines - they should know all about digging and filling holes.

The PTMP is effectively on ice without federal funding assistance, so let's not go there. But I would not want realised present value income (that dividend) in exchange of lost future income that is likely worth multiples.

Bersenang dahulu, bersusah kemudian? No thanks.


The highways is a cash flow lifeline and income stabiliser, and will help GAMUDA weather the current economic turmoil and incredibly lousy sentiment in the construction sector right now. 

The stock was hit by a triple whammy recently - the new government taking over, already weak sector sentiment, as well as the sudden shock in the stock markets. When a stock is hit especially hard, and probably unfairly, it makes our ears prick up. Perhaps there's an artificial mispricing situation there?

As an observer on the sidelines, it made me keen to explore if GAMUDA's worth an investment. And it might very well be at current prices.

Recent fear-driven selling likely has led to the shares being undervalued, and we do not mind collecting some. From our own estimates, we have a fairly conservative target of RM3 and above for the stock over the next 12 months.
 
The economy needs boosting somehow. Infrastructure spending is the easiest avenue to spur growth; there will be some slices for the company somewhere. Name us another construction company that is ahead in line for major projects, or anyone in the construction business who stand a chance to be more profitable. 

I do not mind having a stake in a company that can still record hundreds of millions of ringgit in net income during probably the worst period for the Malaysian economy  in at least 15 years.

Don't feel bad about GAMUDA not taking off anytime soon in Penang. It's got other things going for it. What it needs now is to attain new projects to replenish its orderbook, which is massively dominated by existing MRT2 related obligations. This will be a headache for now, but over the longer term, it will survive and thrive.

Source : AmInvestment Research

To summarise:

First in line for any significant rail transport infrastructure projects, although don't expect the margins to be exciting.

Earnings shortfall from construction/property segments cushioned by highways contribution.

Dividend yield upside of 4.5% at current stock price, according to one analyst estimate.

To be frank, keeping the highways would be the best thing could happen to them right now. 

Thursday, 19 March 2020

STOCK MARKETS COLLAPSING... IS A RECESSION COMING?

Time the crash? We all failed.

What a difference 20 days can make. Since peaking at all time highs in mid-February, US stocks have fallen by a staggering 30% - the fastest drop in history. The FBM KLCI did its best to catch up and fell 20% (!) this year. Maybe we should mention that it's only March.

Everything was pummeled, and everything was shred to pieces. Your portfolios are probably suffering. So is ours. Pity our fund managers and their favorite stock picks this year.

Oh no...

We have been flagging the risks inherent in the markets for quite a while.. but it doesn't matter as we failed to see this crash coming. Neither did Trump or the Fed, of course.

In our blog post in December 2018, we did nothing but predict doom and gloom. Little did we know that US markets would skyrocket all throughout 2019.

But now, suddenly we are being catapulted straight towards a prolonged recession on a global scale.

You'd have thought the experts would know when one was coming, but name us one President / US Fed chair who had correctly anticipated a recession and we will eat a hat.

 Article from Feb 2020 - not even a month has gone by! Source

But to be frank, we were also gobsmackingly wrong on so many things. The markets were irrational for far longer than we anticipated; it literally took years.

The collective herd in the markets - the animal spirits - became detached from all reason and started having faith in Trump and Fed's pronouncements: they were the cheerleaders of a historic rally.

This includes many who think that the president is a complete doofus but still expects him to 'save the stock market'!


It took a worldwide pandemic to bring markets down, but collapse the markets did. And now, in a matter of weeks, suddenly we find ourselves in a world of pain: markets, deleveraging, recession, ineffective policy, companies going bust, unprecedented travel curbs, national lockdown... you think anyone contemplated any of these in January?

For future reference - this shit will happen again - it's important to note the key triggers for the collapse.

1) The COVID-19 outbreak turning into a global pandemic

2) Emergency rate cuts by the Fed, signaling recessionary concerns

The Fed's been bumbling around : it suddenly did an emergency rate cut of 50 basis points, and this action carried all sorts of Armageddon-ish implications. Do you know when the Fed usually does rate cuts? On the eve of recessions, or at the peak of a bubble.
Note the 'emergency' term in the rate cut. It is not seen primarily as an economy support measure; instead, it's a recession indicator. On 15 March, the Fed cut rates to zero. It did not bother waiting for a scheduled 18 March meeting to announce because the whole world now knows; it's an emergency, and markets are in a panicked state.

After seeing that this further cut had absolutely no effect on the markets (rate cuts are not very effective at warding off new viral strains, it turns out), the markets threw an absolute fit. Everybody ran for the exits in record time. It was a stampede of bulls throwing themselves off a cliff. The message is "The Fed can't save us, and no one will".

The day after the zero rate cut, in a truly historic rout, we got this - the biggest decline since 1987's Black Monday. Wall Street wishes that the markets would just close already.


While we do believe that the market collapse is fundamentally justified, it was exacerbated, and accelerated, by the coronavirus. Whatever feel-good grandmother stories we had about perpetual US economic growth and jobs growth were banished by reality.

The economic concept of sudden stops suddenly dominated the news, and it's as virulent as the one infecting us right now.

We just popped this generation's bubble, so now let's get ready for that impending recession. 

It is happening as you read this.

But we do not feel vindicated by our predictions, because they do not matter. Now is the time to be really, really concerned. So, what happens next?

The below formulation is reproduced from our November 2018 blog post, where we explored the chain of events that would lead to a market bubble popping, and then an economic recession. We will expand on these themes for your knowledge.

The gist is : we are in the middle of this impending economic downturn which will be catastrophic for some businesses and people.

Jobs may be lost, companies you didn't think would go bankrupt will eventually do, and all you can do now is prepare for the storm.


CHAIN OF EVENTS LEADING TO RECESSION

A bear market can bring about a vicious self-perpetuating cycle, but we don't want to be emotional or fear driven in our thinking. Let's look at the broader market environment sequentially, which means that as one thing occur in a long chain of events, the greater the likelihood of the next thing in the chain occurring.

Here we outline a progression of events that are already happening in the world today.

Scenario A (Macroeconomic): Global economic growth slowdown ----> Lower demand for key commodities (palm oil and crude oil) ----> Malaysia's economic growth slows down ----> corporate earnings (banks, construction, property companies etc) slows down ----> added pressure from even weaker ringgit (due to our weak fiscal position) ----> [Scenario B] for Bursa Malaysia stocks

Scenario B (Markets/Sentiment) : Lower investors' expectation ----> stocks lose premiums over book value ---> lousy sector prospects ---- > lower investors' expectation ---> further stock market declines


And, to cap it all off:

Scenario A and Scenario B occurring concurrently ----> steadily weaker quarterly GDP growth ----> negative GDP ----> recession scenario.

Blue = Events that are already happening as you read this
Green =  Events that are at risk of happening soon (give it six months)
Red = Apocalyptic worst case scenario that will probably cut the KLCI's value by half


What previous stock market crises look like. Black is where we are now!

Let's run through them to get an idea of the current progression.

Scenario A:

1) Global economic growth slowdown : HAPPENING, the world is now expecting this.

2) Lower demand for key commodities (palm oil & crude oil) :  HAPPENED with the OPEC+ collapse brought about by the Saudi-Russia price war, driving down prices even more. Randomly rhymed there. At the time of writing, we just hit $26 per barrel of Brent crude. Shit.



3) Malaysia's growth slows down : HAPPENING, with Malaysia's 2020 GDP forecast downgraded further to just above 3%, as per one research house estimate. We did 4.3% in 2019, by the way.

4) Corporate earnings (banks, construction, property) slows down :  HAPPENING. Banks' earnings are closely correlated with economic growth. Let's just put it this way: no one's taking up loans at the moment, hence interest based income will suffer. As for construction and property, forget about earnings growth already lah.

5) Added pressure from a weaker ringgit due to our weak fiscal position : HAPPENING. Ringgit is at its lowest point in nearly three years, while our fiscal deficit is widening.

 The rest of the world is following China's lead

Scenario B :

1) Lower investors' expectations : HAPPENED. The FBM KLCI dropped 16% this month alone. What do you think?

2) Stocks lose premiums over book value : HAPPENING. Several research estimates pegged the FBM KLCI trailing price-to-book at 1.4 times as of end February. The index has dropped by quite a bit since then. We expect it to have dipped to around 1-1.1 times by now, which would be comparable to global financial crisis levels. Once it goes below 1, stocks are no longer trading at a premium to book value, indicating investors' absolute pessimism towards future growth for the companies.

3) Lousy sector prospects : HAPPENING. With overall economic growth weakening, expect lousy performance in a broad range of sectors. You know that tourism and aviation are already in the dumps due to COVID-19. There's also banking, telco, property, manufacturing, construction, etc etc. The silver linings are healthcare and utilities only, and just maybe, our favorite chicken stocks.

4) Lower investors' expectations : HAPPENING. We capture this as Round 2, which means that already weak expectations can go even lower if market conditions are bad enough. And they are already bad enough.  

The next outcomes: 

1) Steadily weaker quarterly growth : HAPPENING. We have cut our GDP expectations for 2020. First quarter will be terrible, if not negative. We already face a loss in GDP of up to RM17 billion this year from COVID-19.

2) Negative GDP : HAS NOT HAPPENED. But if it does...

3) Recession scenario. We'll put it this way. The FBMKLCI was at 1,860 points in April 2018. An economic recession will likely cut it in half, so prepare yourself for the possibility of the index hitting 900 points and below, if it gets bad enough.

Our personal opinion? Expect a lot more of red ink ahead.


Tuesday, 3 March 2020

TRADE OF THE WEEK #32 : MI TECHNOVATION BHD (TECHNICAL BREAKOUT TACTIC)

Outcome
Gross Profit : RM4,300
Return on Investment : 11%
Duration : 2 Days



For once, the breakout isn't the one on our faces. It's in MI, a brilliant company that we have obsessed over since it listed.

We made some good money when MI made its debut on Bursa Malaysia back in 2018 - RM13,000 in four days - but as is the case for short-sighted traders, we would've made multiples had we just held on to the stake. Please lend us a half million ringgit credit line and we promise to hold on to these kinds of golden opportunities, OK?

Since then, the stock has only gone up, then down, then up again. The chart is a thing to behold.


We would not have been able to stomach this kind of volatility, but here's the thing about MI: it proved its worth in the best way. The stock is racing up now simply due to consistently strong earnings. It did take a 55% correction but now it's made up the entire downward phase. Long term shareholders should be pleased.

We are not one of those lucky people, but we do know when to go into the stock : when, and only when, it stages a technical breakout. To do this successfully, and by all accounts, we managed that with an 11% gain overnight, the trick is to be patient. 

Like, stone cold patient, and not of the Steve Austin variety. No head smashing; just stay put, and wait for the right time to open up a can of... well, let's move on.

Our confidence in this play was higher than usual, because we were replicating tried and tested techniques. If you've been reading this blog for a while, you'd probably see that the application is identical to past successes; same play, just a different stock.

To simplify, we'll do just a bit of technical analysis here. First, understand the chart. Then, understand the context, and why MI stood a good chance of breaking out exactly when it did.

We were just waiting to go in, and it took weeks. No biggie; we nailed it as we intended.

ZONE A & ZONE B

We hope you're familiar with these squiggly wiggly charts, cause we're in candlestick territory now.

There's this thing called a consolidation range - basically, a horizontal 'channel' where the stock just fluctuates. It tries to go up but fails a couple of times, and the aggregate outcome is that it went nowhere. Oh, and pesky things like coronavirus scares ended up driving the stock down. But then it went back up after the dust settles.

Below is the recent consolidation range for MI. In this daily chart, we divide this into two distinct rectangles: Zones A and B.

Zone A is the first range of between RM1.80 and RM1.95, where the stock was just hanging around and chilling - it didn't seem to be in a hurry. 

Notice the transition between the zones. There's a succession of price increases which brought the stock to RM2, that pesky, psychological resistance point.

If you're new to this, know that when a stock breaks RM1, RM2, RM3, whatever, it usually takes a while to go beyond. This is why we didn't want to trade as soon as it hit this point in Zone B; we figured that it's going to spend some time trying and failing (just like in Zone A)

Here's the recipe for a sustained technical breakout:

1) stock needs to fumble around for a while, and build some strength. 

2) stock needs to have a collapse in price, then recovery. This is how you know it's well supported by the market.

3) when the breakout eventually comes, it should look obvious. Because when it does, the whole market will jump in and buy into it.

Understandably, you may be wondering what the f are we talking about. But we just put technical concepts in layman's terms. Showing how we traded is probably more illustrative of the concept than us trying to explain it.

In practical terms, all we did was that we kept watching MI throughout January and most of February, waiting for the right time.

ZONE C, AND THE RIGHT INSTRUMENT

Now for the fun part. We planned this meticulously because the eventual breakout beyond Zone B will be spectacular. Why? Because it would be a new all time high breakout, and it's more powerful than the face of a 15-year-old kid with too much testosterone.

Zoom out the chart a bit and you'll arrive in Zone C. We have to go way back for this, so what you see below is the weekly chart for MI.


The last time it was around RM2.10-ish was in September 2018. It took a while for MI to get back into that range where it could plausibly break a new high. We had already estimated that there's a good likelihood of this breakout, and the timing couldn't be better.

Context is oh so important. The next insight is simple : MI is making all these positive moves so close to its next quarterly earnings announcement. 

On balance, it's not too much of a leap to theorise that the current stock price move is related to upcoming earnings. Even more so when a stock tries to break new all time highs. 

We know enough to understand this and to have replicated this type of trade before. It got us RM10,000 profits in GCB in three days, so we were quite confident that we know our shit.

The last important but is not so much insight than a tactical decision : get the right trading instrument to amplify returns. We found that in MI-CG, a recently issued call warrant. We discussed this approach in our VIP Group quite early on.

Commentary on 7 February 2020

Amplifying returns is why warrants exist. You can buy more at a fraction of the mother share price, and boost returns even if the quantum of movement is smaller.

The call warrant was the perfect thing to trade once MI shares break out. And on 19 February 2020, it did so with conviction.

Also, here's the thing about breakouts: the longer the consolidation phase(s), the stronger the price movement is when it goes beyond that range. On 19 February, we actually ended up in MI-CG at what we'd usually consider to be a sub-optimal price : 15.5 sen. It closed at 13.5 sen the day before, so we were obviously late into this.

 Made the call on 19 February

But did being late matter? Not if there's a chance it can move higher. The previous all time high is RM2.21. We entered MI-CG when MI was trading at around RM2.16. There's about 5 sen to contend with, and if our theory was correct, by the time it tries for RM2.21, our call warrant position would already be profitable. 

And let's not forget how exceedingly difficult it is to achieve double digit % gains in 24 hours.. we dedicate our lives to find trades like these.

No prizes for guessing what happened next. 


This range was good enough for us to get to where we wanted to be. At 11% gains? Quite happy to exit. In less than 24 hours, in fact.


Oh, and all that stuff we said about expected earnings? On 20 February, this came out.


 All in all, not too bad.

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