Small-cap stocks still the favourite

  • Business
  • Saturday, 20 Dec 2003

The fund managers and research heads believe that the CI will scale to higher levels in 2004, although there is a difference of opinion on just when that will take place and whether the KLSE will be a tale of two halves. 

One thing they seem to agree on is that small-cap stocks will still find as much favour from investors next year as they did during the second half of 2003.  

In the second and final part of a discussion on the stock market for 2004 with StarBiz assistant news editor JAGDEV SINGH SIDHU and reporter ELAINE ANG, the two fund managers – KLCS Asset Management executive director/chief investment officer Connie Ong and Fortress Capital Asset Management chief executive officer Thomas Yong – together with three research heads – AmResearch executive director Gan Kim Khoon, OSK Research’s Pankaj Kumar, and K&N Kenanga’s Seow Choong Liang – tell us just what type of stocks they are looking at. 


STARBIZ: What are some of your favourite sectors and companies, and why? 

Connie: I think stock picking and timing are going to be the key next year. There is going to be a lot of liquidity making the market volatile, whilst at the same time the stocks are not cheap. That is why you have to pick the right stock. The sectors that I would stay with are technology, export beneficiaries, construction stocks related to water rather than roads, and local consumables. Stocks that I like tend to be the smaller caps because I don't see a lot of growth in the big caps and they are not exactly very cheap. 

Some of the smaller caps hold a lot more value but you have to really pick the right stock with the niche products to benefit. I am looking at stocks like Suiwah Corp Bhd, Englotechs Holding Bhd, Silverbird Group Bhd, even Octagon Consolidated Bhd, which are moving into some interesting waste-to-energy expansion, and lastly UEM Builders Bhd. 

Suiwah has got the best of both worlds. It's got the retail side – which is the Sunshine Square Supermarket brand name which holds a huge share of the Penang retail market – and it's got the upside from IT. The IT segment is made up of its flexible printed circuit boards operations through Qdos Holdings. Their recent acquisition of the entire stake in Qdos Holdings bodes well for the stock as it was transacted at single-digit price earnings (PEs) and management now has full control of the company. Also, Suiwah is only trading at around 10 times price-to-earnings ratio. 

We like Englotechs more from the export point of view. They have a venture with Austins Marmon Ltd, one of the larger glove companies in the world to actually manufacture for them. Even their own customers like Ansell are giving much bigger orders and Englotechs is expanding its plants to China.  

We like Silverbird as a consumer stock with a very good marketing strategy. I like their strategy in relation to their contract manufacturing. It is really going to increase their revenues without putting in a lot of fixed overheads. And this is a good strategy given economic growth may not be fantastic. 

We also like Octagon for the new waste-to-energy and power ventures they are getting into and once that is announced, it is going to be a stock with a very low price-earnings ratio. Waste-to-energy is going to be a big environmental thing that will soon be widely promoted. 

We like UEM Builders from the angle that they are likely to have a lot more projects going forward after replacing UEM as the Malaysia Inc in construction. 

Thomas: In line with what the economic future is going to be like, most of us would be looking at export-based manufacturers who will benefit from a pick-up in exports. 

We also like the semiconductor companies and high-tech manufacturing. Another sector which we think would benefit is actually the media sector as advertising revenue is very strong, and is another play towards domestic consumption. 

We also think banking is a sector to look at for its exposure to a lot of smaller companies that are not represented in the market as well as being a beneficiary from the broader recovering economy. 

Last of all, we are looking at the oil and gas sector. I know it is a sector that is a bit difficult to pinpoint in terms of valuation and stocks, but I think it is a sector that is relatively new in the market and we are picking the sector, given the amount of investment that is flowing into it. 

For tech manufacturing, we are actually looking at Unisem (M) Bhd and Pentamaster Corp Bhd. Most of the indicators are pointing towards a recovery in volume. Another reason why we have chosen these two is because we are a bit concerned about the suit against Malaysian Pacific Industries Bhd, which is why it has been taken out. We also think the valuations of Unisem and Pentamaster are better. 

Pentamaster, basically a manufacturing stock, will benefit at a later stage. We think most assemblers have not been adding capacity for a while, so there could be a rise in demand. 

In terms of export beneficiaries, we are actually looking at Top Glove Corp Bhd, a small-cap stock but one of the largest rubber product producers. 

For banks, we are looking at Commerce Asset-Holding Bhd instead of the safer Malayan Banking Bhd and Public Bank Bhd for a bit more leverage from further recovery in the economy. 

For the media sector, there isn't much choice except Star Publications (M) Bhd. Nexnews Bhd is a bit of a wild card, but there isn't enough data for us to make a conclusive decision on the stock. We were most tempted but it was almost like a wild hit. 

Gan: We touched earlier on there being an absence of any single outstanding sector in Malaysia, so when you ask for sector picks the same problem arises. Ultimately, it all boils down to the same old sectors. 

Largely, I have sectors that agree with Thomas' selection, which includes the banks. Clearly, if the economy is going to grow strongly in 2004, it could potentially translate into higher demand for credit, which is a reflection of the private sector rebuilding its capacity or increasing its output which would then translate into higher GDP growth. So banking and finance is definitely one of the sectors. 

The other one that we like is also the media sector. Advertising spending typically trails economic recovery by up to a year, so if 2003 was already a good rebound for the economy, we could begin to see a significant pick-up in advertising expenditure in 2004 and onwards. 

I am not referring to just the print media but also the electronic media. Of course, stocks like Star and New Straits Times Press (M) Bhd have only just recently raised their ad rates again by 8% to 12%, I think, so that would also translate into better margins for them, notwithstanding the initial adjustments in terms of volume sales. 

We also like the transportation sector primarily because such stocks, for example, those in the aviation industry, would benefit from a pick-up in tourism. Increased regional trade would also translate into a larger cargo load factor for companies like Malaysia Airline System Bhd and even Transmile Group Bhd, which is beginning a new route to China. All of this would eventually translate into better earnings for the aviation companies. 

Even on the shipping side, we are seeing higher freight rates and we had only just felt the impact of higher rates for the past few months. Shipping companies would most probably feel the full 12-month impact of higher freight rates next year. 

On the stock picks, we have a lot but I'll just narrow the list to the small caps and forget about the large-cap index component stocks. One small or mid-cap stock that we like is AKN Messaging Technologies Bhd. We expect positive news flow from its tie-up in China and the commencement of its operations in Singapore and Thailand as well. 

We have another, the once loved but now largely ignored Kian Joo Can Factory Bhd. Its recent nine- month results were very much better than expected, in fact they were only RM2mil off our full-year forecast for the company, so we have raised our forecast by 24% to 30% for 2004 and 2005. 

For United U-Li Corp Bhd, the boost in their earnings could possibly come from their contract with Sime Darby Bhd and possibly another one with Malaysia Mining Corp Bhd, which is in the pipeline although not secured yet. The PE ratio at 11 times is still relatively undemanding based on prospects of the company. 

The last one is Silverbird. I think Connie has already said that contract manufacturing is going to be one of the drivers for the group but I also understand that they are going to do something potentially exciting in the first quarter next year. This is apart from the full-year impact from Stanson Group Sdn Bhd, a company which they acquired, which would be felt in 2004. 

Seow: It is tough to pick stocks that are going to perform in 2004, partially because the market has been quite efficient in pricing in all these stories. In fact, some of the stocks which we like hit their targets in like 3, 4, or 5 days after we recommended them. What I am going to say is that we generally like a lot of stocks in 2004, but I think the favourite ones would of course be the growth stocks and they could come from exports, from an industry which has already consolidated and now has pricing power, or from a domestically oriented industry like Kian Joo, where we have seen strong consumer growth after many, many years. 

But generally speaking our recommendationas far as the favourite stocks are concerned is to buy laggards and trade in 2004. The market is going to be volatile, rotational play is definitely going to come in, and to be just invested in, let's say, five counters is not going to be advisable in 2004. I think you should take profit whenever prices have moved up and get into other sectors that have not. I think there is going to be a widespread recovery in share prices in 2004. 

Every stock is my favourite stock, that is how bullish we are. But for today and not 2004, I agree with Pentamaster. We are going to upgrade it to a buy for its strong earnings growth potential from its existing capital equipment business in the semiconductor sector, which is showing a cyclical recovery. They have a small base and when the cycle recovers, the number of new customers they have will just lead to tremendous growth in their bottom line. They are also adding new business lines to their operations. Their shop floor management system software and hardware through the conveyor belt systems are doing well because there has recently been new investment in those sectors and existing companies are re-investing, such as Dell which is not their customer. 

We also like companies in the export sector like Chin Well Holdings Bhd. Although its share price has moved quite a bit since we recommended it, we think there is still upside. They are the top player in the export market, and they would benefit from the appreciation of the euro against the US dollar because a big part of their market is Europe. They have received over the years very strong loyalty from their customers for their fasteners, and it is sort of paying off in terms of their ability to gain market share and introduce new product lines.  

Another export story is Eksons Corp Bhd in the timber sector. They manufacture thin plywood and they are one of the rare plywood factories that only manufacture thin plywood. The investment case for them is very strong earnings growth.  

We see a doubling in their bottom line for this financial year and within the next two years, we could see another doubling in their bottom line. It is very easy to see an upside in their share price.  

The reason is that the consolidation in the timber sector looks like it's over. The major plywood players in China which set up operations in 1998 have been foreclosed and the plants shut down.  

So the number of players has actually been reduced and the amount of illegal logs coming out of Indonesia and going to China to be processed has actually tapered off. The plywood industry has got a very high fixed cost and the moment prices recover to a level above your fixed costs and operating costs, the impact on your bottom line is just tremendous.  

Pankaj: There are still a lot of buys out there and we still have 20-plus stocks that are in our buy list that can give investors at least a 15% upside going into 2004. Stocks people will buy really depend on their risk appetite. 

We are still excited about certain sectors in the market, like the banking sector, gaming, selected construction stocks, selected property stocks, and consumer stocks.  

If you look at the banking sector, for example, it is a main beneficiary of the recovery story we have seen. Loans growth is not that great but it can be better and non-performing loans have been well managed. 

We like stocks like Commerce-Asset in the banking sector. In the gaming sector, based on what we are seeing in terms of numbers, especially for Genting Bhd and Resorts World Bhd, the numbers do tell a story. We like the leisure and hospitality division as it has shown very strong momentum in the third quarter and we think that could follow through in 2004. 

In the consumer sector, we are looking at this stock called Degem Bhd, which is quite interesting. It is basically a manufacturer and jeweller. They have two brand names in the market, PYT Jewellers and Diamond & Platinum, which are expanding their outlets in the country and that number should be quite exciting in 2004. 

Among larger caps in the consumer sector, we still like stocks like British American Tobacco (M) Bhd and OYL Industries Bhd. OYL should benefit from its translation gains coming from its operations in Europe because of the pick-up of the euro. 

In the property sector, our stock picks have been quite limited. We like SP Setia Bhd as well as LBS Bina Group Bhd. These are some of the stocks to recommend as the wealth effect from the stock market will spill over into the property sector in 2004. 

In the transportation sector, I think Malaysia International Shipping Corp Bhd's story will continue into 2004. Its unit American Eagle Tankers should show full contribution in 2004, and that will definitely add value to the company. 

In the telco sector, we like Maxis Communications Bhd. We think that in terms of subscriber growth, there may not be a substantial increase but the average revenue per user (ARPU) rate has stabilised. Maxis' integration with TimeCel Sdn Bhd has been quite successful and we think that will add value to investors. 

Last but not least, I would like to add that investors should look out for warrants. These are perfect bull market instruments. Some of the names we have been mentioning, stocks like Maxis, MISC and even Commerce-Asset, their call warrants are out there for investors to look at. Some of these could be very interesting in terms of returns to investors. 

StarBiz: What about Mesdaq counters? 

Connie: Well, we look at it on a case-by-case basis. I think at this point there are good Mesdaq companies like AKN Messaging out there but for a lot of them, the good news is already priced in. 

Also, Mesdaq counters offer a higher risk profile than the second boarders and small caps as they are normally new companies with a good marketing idea but have only been profitable in the last 12 months or so. Therefore, as an investor, I have to be more careful in my analysis, i.e. whether the idea and the business model are going to carry them sustainably in the future.  

Pankaj: We've looked at some Mesdaq counters and we like some of the names. We are selective in terms of where those stocks are trading now, in terms of valuations and earnings going forward.  

Yes, the stories can be fantastic in terms of earnings growth but whether they are able to deliver on what they have been saying is left to be seen. Nevertheless, we do have some recommendations for our clients.  

Stocks like NOVA MSC Bhd and Orisoft Technology Bhd are on our buy list, together with eBworx Bhd and Scope Industries Bhd, which have interesting business models. But I think investors will perhaps look at the next one to two quarters in terms of the ability of these small companies to deliver on earnings. 


StarBiz: Can you wrap up your expectations for 2004? 

Connie: I think I am the most cautious one. I see the momentum going through the first quarter where you are going to see the CI probably hitting 900 points. In this instance, most stocks will run up. 

Therefore, the core warrants that Pankaj was talking about, I would say yes, they would be good instruments to look at. But going forward, I still hold the view that we could have disappointments, either in earning numbers, or interest rates prematurely going up.  

Therefore, I would be careful going beyond the first quarter. That's when a good stock-picking strategy must come in. Be very critical about the companies you are investing in.  

I am not so keen on general sector plays because there will be good and bad companies in every sector and you will need to weed them out very carefully to make money in 2004.  

Like what Seow said, timing is also very critical because it is going to be a volatile year going forward. 

Why? Because liquidity and market momentum are very reliant on investors' sentiment, which can turn around overnight between positive and negative.  

Thomas: We took quite a bit of profit from our portfolio about two months back and we are actually rebuilding our equity exposure at this point. We think there is one more leg for the market. The focus will be where we think the main leverage sectors are, like export beneficiaries mixed with stronger exposure to the domestic consumption patterns together with the sectors we mentioned earlier.  

We are rebuilding our equity exposure but there will come a point when we will be looking to liquidate our portfolio, which is likely to be within the first half next year. 

Our price targets had changed a lot throughout this year, and we typically don't sell stocks when they hit their target, but sell them if there is any correction in the stock price. This is why the liquidation came in so late this year.  

Similarly for next year, we will be looking at a 20% target and we think that if it comes from selected stocks by the first half next year, we could hang on and see whether the recovery can continue. 

Gan: We are still fairly bullish on the stock market. We still see equities as probably the one asset class that could still give you relatively better returns compared to bonds or fixed deposits or even property in the short run.  

My preferred investment option would be equities, even if I am only looking at a target of 920 some time towards the late third quarter next year. That still offers you 15% or so returns. That's just capital gain and does not include the dividends that you may get from some of these stocks, and increasingly the KLSE is also becoming a yield play because the market is offering you a gross dividend yield of 3%, on par with the 3-month fixed deposit rate. 

Helping our case is the switching that has been taking place from bond funds to equities. Equities are still my preferred asset class. 

Seow: If our reading of the business cycle is correct, then it portends a very strong stock market in 2004. The reason is that corporate earnings growth will be strong and it is a confluence of factors like economic growth and liquidity that could drive the market to a super bull phase. I think this is the best time for an investor to actually take advantage of the stock market as an investment opportunity. 

Pankaj: I think the equity market in 2004 will still provide the best exposure to investors in terms of returns. If you look at what Gan said, to gain 10% in 2004 in equities would not be an issue really. It again all boils down to stock pickings in terms of what stocks you want, your risk appetite, and being not greedy at the same time. 

For the market outlook link to part one:Part One: Positive market outlook for 2004  

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