Irony of Rate Cuts & The Response

The theme for this week would be rate cuts by central banks round the world including our very own Bank Negara and the big surprise from Fed last night.

This is the cut in respond to Covid-19 slowdown for the broad economy. Clearly, China alone had been reporting a major slowdown based on the purchasing manager’s PMI that showed drastic contraction moving forward. So, it is coming!

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Going back to the headline, what’s the irony of a rate cut? We always assume that a rate cut could propel the economy forward from these instances.

i) Lower rates at the bank means you will spend more money rather than keeping it

ii) Cheaper mortgage and hire purchase which you might be interested

iii) Lower rates meant higher corporate borrowing to finance their capital expenditure

iv) Lower rates meant the government’s financing just got cheaper

True to the fact that these are the scenarios which we were taught in the 1st year economics on the effects of interest rate changes. As one progresses to year 3 of the course, things began to change. What was thought earlier could presumably be wrong after all in the real world. As though you’ve wasted year 1 altogether.

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Take for example from point (i),
Lower rates at the bank which leads to you saving less and spending more money?

True. But these effects are for the long term and irrelevant for short term responses. In response to Covid-19, the government lowers rate and the stimulus package presented last week wanted to put more money in your pockets by allowing you to lower your EPF rate.

Rather than seeing increase in consumption by implementing these policies, the government is actually sending negative sentiment down the line to everyone in the country. Prior to the stimulus package, if you’re working in manufacturing, you would have experienced a slowdown such as shutting down a day every week and such.

When these policies came into the picture, this would solidify their view that a slowdown is imminent as it had been addressed at the national level. The irony here would be that central banks are providing incentives for people to spend but public sees this as bad sign as a slowdown is coming pulling back spending even more that they should.

Worst if we talk about point (iii)
Lower rates provide corporate to finance their CAPEX.

Nobody is a fortune teller here and most management can only except or predict what is going to happen. Nobody isn’t to commit fully on to a huge expenditure looking at how cheap the rates had become. When in doubt, just stay out.

Companies with cash are better off to wait for the right opportunity while companies who uses debt financing might hold back in times of uncertainty. A wrong move could see them having debt problems in the future.

Then there’s what the government can do from point (iv)

The stimulus packaged revealed last week seems to have the markets expecting construction projects to be awarded under the stimulus package. But the fact is that no infrastructure projects were thrown out to stimulate the economy.

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The stimulus mainly focused on giving some leeway to the hospitality sector. At least this is something that we can applause but nevertheless, this doesn’t buff up sentiment and the economy.

Does a Rate Cut Really Help?

The big answer is NO. Nobody is going to run out and buy a house or a car just because the government lowered rates. No companies are going to further their investment not knowing how the virus issue would turn out next 3 months. It all depends on the government to move this economy from here on.

This is the reason why extreme cases can happen where a contraction can be long as well as and expansion.

SUCCESS Transformer Corp

Back in December, CIMB posted a report and gave a 86% upside to this counter. SUCCESS is the name. When the report was first released. The share price spiked past RM1.00 in early December. The priced had came down once again and it starts to get interesting.

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A Little About The Company

SUCCESS provides transformer capabilities and LED lighting specific to industrial usage. Transformer package covers a wide extent from measuring to monitoring. The LED lighting solutions provided are under the distribution of the brand Nikkon. (not your camera)

Nikkon specializes in industrial lighting under LED or HID types which are the products in demand for companies adopting efficient energy consumption. The most common product by volume would be LED street lamps we see everyday.

The Conviction

CIMB stated that the the higher demand in LED street lighting would propel SUCCESS’ business forward. In particular, only the street lighting alone for Peninsula Malaysia is looking at 1.3 million replacements.

Just back in November, the company had successfully disposed off their loss making entity and should be carrying less baggage moving forward. This translates to a higher net profit and also EPS.

The reason for the high price target comes from the ability for market to re-rate this company when sales returns by year end. Of course there would be risk with a slower action on the government’s side but price stabilized at what it is now.

Our Take

Great fundamentals for the company with merely 13% debt and stable margin seems to be the selling point for now. Although we believe that the expansion in business still marks a big unknown, we believe that price had gone cheaper than what it was.

The virus related news had seen pressure on the share price and recently, we saw heavy buying from one of their substantial investors.

We believe that something is brewing and it is okay to be collecting some at current price. Meanwhile, here’s the report by CIMB.

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CIMB on VS Industry

Although we called for a sell earlier on VS, the recent chart seems to be interesting as it is consolidating heading upwards with the right catalyst. But this catalyst hasn’t been clear yet. Look out for abnormal volume surges to determine a break-out trend in the near term.

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Meanwhile in the latest report by CIMB, they attended their quarterly briefing yesterday and remained neutral with no major surprises. Have a look at the latest report!

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Weirdly Optimistic Market

Just about 5 trading days ago, the Dow Jones & S&P500 looked like tanking at least another 10% with tweets by Trump on escalating the trade wars once again. Within two days, the cloud clears up and with market was set free to climb trying to reach the all-time highs.

At this stage, we get a ‘weird optimism’ feeling somewhat similar to when someone tells you that “everything is going to be alright” but you are pretty sure it’s not.

Prior to the drop that we converted much of our positions back to cash & locking in profits that we made earlier. What’s left would be positions in the Hong Kong market where we consider that it is trading at a big discount versus other majors. For obvious reason, we believed that the market had corrected in response to the city’s rising tension. Our exposure there isn’t quite Hong Kong companies in generally, but mainly the Chinese H-shares which we felt cheap and has a re-rating potential.

Comparing with the Malaysian market, our optimism dropped significantly after lackluster a Budget 2020 prospects and even a mulling on a possibility of a recession in the US that could possibly cause a worldwide spread. Most of the counters who moved up had some relations to the US market for example OEM or machine makers for the multinational corporations (MNC) situated specifically in Penang. We believe as well these had been fully valued for now.

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The oil sector sees huge growth this year, but too bad we didn’t cover most of it other than our heavy holding in Serba Dinamik. But one must understand that the growth seen on the oil sector this year came from the contribution of oil price climbing to the $70-80s back in 2018. Contracts were awarded then and as we see the prices cool off once again this year, we can expect less CAPEX to come from the major oil companies, translating into lower share prices in the future.

Already seeing KLCI trading with a double bottom nearing 1,550, it’s pretty clear how investors felt on the development for Malaysia going forward. The heavy weights of KLCI with the likes of banks already factor in a rate cut earlier and could see performance deteriorating as it goes. It seems though we could no longer escape a possibility of a rate cut in the near term while the only question being ‘when’ and by ‘how much?’. The sentiment moving forward is getting weaker while the ringgit factor paints a bad picture for foreign holding as well.

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With US climbing back to all time highs, we felt that the buying on the Malaysian end seems a little to optimistic and that is what we meant by a ‘weird optimism’ this time around. As market rebounds at this level, it really creates a dilemma especially to investors holding on to a large cash pile. Buying at the double bottom scenario pretty much proves that you got the best price and great when market goes up. The likelihood to outperform pretty much writes itself with this strategy.

But if the double bottom breaches which and that is what we believe would happen in our view, the positions bought would have under performed in the coming months. Cash holding investors who did nothing would appear like heroes who brave through the storm without actually doing anything. That is what we believe the dilemma is!

Professional investors, licensed fund managers or even sit at home retail investors, the problem is the same. Either you come out as hero or laughed at when the market recovers. Also, this problem would persist every single time the market reverses at a slower pace. The most suffering thing to happen in markets is holding on to a share and it declines bit by bit, day by day. When you face a -0.3% decrease every day for 23 trading days, that’s suffering.

Considering that the US market being at all-time high, the market has yet to see a major correction somewhat similar to the situation back in Aug-Sep this year. The possibility for that to happen seems likely as it would have done so 5 days ago merely from a bad tweet. But simply a comparison to KLCI, we are trading at year lows. Another push to the bottom for the US market could be pushing KLCI further down as well. A market doesn’t require much reason to go down as society proves to be more reactive toward elements of negativity. Factors for selling might not need to be clear and surely some would want to realize profits even though it has been reduced.

Patience seems to be the key for now. Hero or not, I think it is not the time to become one just yet. Patience will allow for the best timing and a situation where the stars might have aligned just for you.

 

MYEG Target Price RM1.96?

MYEG posted their latest results and revenue stabilized around the sub RM120 million range. But the reported earnings came with good profits to show even for the lowered revenue quarter.

According to CIMB, the profit for Q4 2019 could have been higher if the recruitment of new foreign workers took off quickly.

We believe that the profit had started to register growth and it is likely that we see stronger profits generated with other parts of their businesses gaining traction. Some of the initiatives adopted recently are a way to transform from their old businesses.

CIMB places a whopping 66% upside to the share price which we believe it too be a little over the edge judging from a few reasons.

  1. The research house factors in upcoming New Foreign Worker registration (100,000 per annum)

    We felt is a little risky as the prospects for growth in our country remained in question. (construction)
    The bilateral talks between Malaysia and Bangladesh had to highlight a continuous supply and it seems though our government isn’t keen to adding more foreign labor if the economic activity declines.

  2. E-Visa project

    We do think that MYEG can be a major contender/winner in bidding for the latest e-visa for especially for the Chinese tourist. But it is still too early to call with the likelihood of a collaborative effort from both ministries taking up the project. A partnership could be form via Ministry of Tourism for both countries and Immigration could disrupt completely MYEG role in this situation.

The target price for CIMB was set with a 21 times PE (currently 17.2) or a 40% premium over the technology sector. That is why we believe that this target was a little too far-fetched.

Our Take

You could start collecting MYEG on its recovery and profits that started pouring in now. But sadly we could only place a target price of RM1.25 which comes to 10% growth in EPS for FY2020. The catalyst for the upside are there but its rather foggy for now…

Meanwhile have a look at CIMB report

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CIMB Reports Q3 2019

The company reported historical high revenue with lower margins due to about RM500 million worth of one-off expenses. We think that the restructuring via closure of branches and MSS paid to employees would result in better margins ahead.

Maybank shifted the target price higher by 13% also anticipating this matter. Have a look at the latest research report.

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