Using his sensitivity analysis, Chow estimates that the fair-value price target for the STI is 3,460. Its latest close was at 3,584. This values the STI at a 10% discount to its average long-term price-to-book ratio, and its mean price-to-earnings ratio (PER). If the STI reverts to its mean P/B ratio, the STI could see a target of 3,650, Chow says.
It is unlikely that there will be a rising tide to lift all boats this year. For one thing, rising interest rates certainly will not float the boats. “Central banks are looking to reverse quantitative easing [QE] because economic growth is strong. Even the European Central Bank [ECB] and the Bank of Japan are looking at tightening,” says Jonathan Koh, banking analyst at UOB Kay Hian.
The ECB has committed not to raise interest rates until after the end of QE, which could run until September this year, putting the first rate hike in March 2019.
“The ECB has tapered bond buying from €82 billion [$132.4 billion] a month last year down to €30 billion a month in January. With one more taper, QE will hit zero next year and the ECB could start raising interest rates. In 2020, the ECB can start reducing its balance sheet [quantitative tightening, or QT],” Koh says. After all, EU industrial production is at an eight-year high, and unemployment at an eight-year low.
Meanwhile the US Federal Reserve started to downsize its balance sheet last October and will ratchet up the pace of QT this year. “Japan has had seven consecutive quarters of growth at around 1.5% a year,” Koh points out. In 2Q2017, Japanese annual growth surged to 2.6%, but receded in 3Q2017 to 1.5%. “The Bank of Japan may start to downsize QE,” he says.
China is in a different cycle altogether. Because of high debt levels in the corporate sector, the People’s Bank of China undertakes regulatory tightening through various means to reduce financial risk and leverage.
Elsewhere, the Bank of Canada raised its overnight funds rate 25 basis points (bps) to 1.25% on Jan 19. Some economists see Australia, Sweden and the UK getting ready to raise rates. The Fed is widely expected to raise rates again in March, the sixth hike since the start of the current rate-hike cycle, which started in December 2016.
Banks to benefit from QT, higher rates
The obvious tightening plays are banks. There is a correlation between US rates and the Singapore Interbank Offered Rates. This correlation is termed “pass-through” by banks and analysts. In FY2017, despite the rise in Sibor, pass-through was not very obvious. However, Sibor shot up in December after the Fed hiked rates by 25bps to 1.50%. “Usually, the pass through is 60% to 70%, but in December, the pass-through was quite strong — 100%,” Koh notes. DBS Group Holdings is the most sensitive among local banks to rising interest rates. Koh expects its net interest margins to expand by 2bps q-o-q to 1.75% for 4Q2017. He sees a further 5bps NIM expansion for this year and another 5bps in 2019.
Oversea-Chinese Banking Corp will also be a beneficiary, and UOB Kay Hian prefers OCBC because of its less expensive valuations. Loan growth for both banks is estimated at 7% to 8% this year. “Because of NIM expansion, net interest income is likely to grow 13% to 14% for DBS and 7% to 8% for OCBC,” Koh says.
Banks had struggled to maintain their NIMs during the QE years. About 60% of total income is from net interest income for the local banks.
“My theory is about cause and effect. As central banks downsize their balance sheets, we’re going to get an uplift in valuations for the banks. Valuations for the banks have been below their long-term average for a long time. But as the yield curve steepens, valuations for the banks could move towards the long-term average,” Koh says. He has a price target of $29.50 for DBS and $14.88 for OCBC.
The banks have other revaluation drivers. The new accounting standard FRS 109 was implemented on Jan 1 this year. Koh calculates that OCBC and United Overseas Bank could end up with excess capital as a result. Also, OCBC and UOB have lower payout ratios than DBS and they could raise dividends.
Four main themes
UOB Kay Hian has outlined four key themes that could underpin and drive stock prices. Mostly, a bottom-up stock-picking approach will be key.
The first theme is companies with multi-year growth drivers. Chief in this bucket is Venture Corp. “Venture has been an absolute outperformer. It could continue to surprise on the upside in the next one to two quarters. Dividends could see a potential upside,” Chow says.
Then, there are reflation plays. A theme that UOB Kay Hian has articulated a few times in 2H2017 is reflation play. More than $7 billion in en-bloc sales in FY2017 is likely to lead to a multiplier effect this year as developers pay for their purchases, creating instant millionaires, and start construction on their projects. This will spur loan and construction demand.
City Developments is the obvious big-cap reflation play, as it has the most inventory to launch among the big-caps. “Rather than speculate on physical property, which comes along with additional buyer’s stamp duty, consider CDL, which is trading at a discount to revalued net asset value [RNAV],” Chow says.
Keppel Corp has increasingly been driven by its property division. By UOB Kay Hian’s calculation, some 60% of Keppel Corp’s RNAV is from property. A more pure reflation play is Wing Tai Holdings, which is trading at a discount to book value and has a relatively unleveraged balance sheet. Unfortunately, it does not have a clear business strategy, except to hold prices at above $4,000 psf at Le Nouvel Ardmore.
A third theme is quality laggards. UOB Kay Hian has a “market weight” call on the telcos, but Singapore Telecommunications was a laggard last year and its dividend yield is around 5%. The other laggard is Raffles Medical Corp.
“Raffles Medical has been a very big underperformer, but it has a good brand name and has been investing in China, which will give it growth for the next 10 years. When I was talking to a lot of the funds, a number of insurance funds were interested in Raffles Medical because it’s a hedge for rising hospital and medical costs,” Chow says. However, he cautions that it is not a stock for the short term. “If you’re looking for near-term earnings, it may not be the stock for you.”
Investors should keep an eye out for stocks with earnings surprises. “My personal favourite is SATS, because the company has a presence in aviation hubs with strong growth profiles in China, India, Malaysia and Turkey. Even if the PER is not cheap, this is a stock you buy and [get to] sleep very well at night,” Chow says.
A couple of ‘sell’ calls
Chow’s top “sell” recommendation is local media giant Singapore Press Holdings. SPH’s share price fell 25% last year even as the STI rose almost 20%. SPH’s revenue and earnings have been declining for a couple of years because of the challenging media environment. Despite having a monopoly in Singapore, SPH has been unable to raise readership and advertising revenue. “SPH is more of a structural call. I see potential for it to cut dividend further since it’s spun off the REIT. If you like property, buy the REIT. There’s no point in holding SPH with falling dividend yields,” Chow says.
The other “sell” is CapitaLand Mall Trust. “We’re cautious on retail malls. We think there’s a structural downturn facing the industry because online will take offline market share,” Chow says. In addition, labour curbs make it a challenge for retailers who are tenants in the malls, and specifically for CMT, there is a large supply of malls in regional centres such as Jurong East and Tampines.
While UOB Kay Hian’s 3,460 target for the STI implies limited upside, valuations could stretch if the corporate reporting season now underway turns out to be a good one. “I see room for earnings revision if the February reporting season’s undertone is going to be very strong. I’ll be watching out for guidance and data points to see earnings upgrades. If I don’t see any, I will want to take some profit around the May-June-July period,” Chow says.
Mid-cap conviction picks
UOB Kay Hian likes Citic Envirotech a lot. In a nutshell, the stock is a proxy to China’s growing need for drinking and non-potable water, and the central government is committed to providing better-quality water for the people. “The Chinese government is increasing infrastructure spending at a rate of 5% to 7% a year. Of this, US$500 billion [$660 billion] is on water. The government is quietly resetting standards for water,” says Edison Chen, head of mid- and small-caps research at UOB Kay Hian.
Citic Envirotech treats 500 million litres of water a day and owns its membrane technology. This technology requires 20% less land than conventional water treatment plants and a lot less labour. “The company is looking at an internal rate of return of 12% to 15% versus the 6% to 8% of conventional treatment companies,” Chen says.
According to his earnings estimates, Citic Envirotech is trading at forward PERs of 10 times for this year, and eight times for 2019. This makes it cheaper than all the other water plays on the Singapore and Hong Kong exchanges. Chen points out that the company’s contract wins are very strong and it is likely to grow earnings by 15% a year for the next two years. “This is one of our conviction picks for the year,” he says.
Chen’s second conviction stock is traditional Chinese medicine company Tianjin Zhongxin Pharmaceutical Group Corp. The century-old, state-owned company owns 858 patents, including 461 for inventions, 60 for exclusive prescriptions and 41 for exclusive preparations. It also has 602 certificates of approval for preparations, and nine certificates of approval for crude drugs.
“In December, for the very first time, the company’s management invited investors to tour their site, and shared their new targets. They aim to double profit in three years,” Chen says. This is partly because the company will be able to raise prices following state-owned enterprise reform. In addition, Tianjin Zhongxin will benefit from China’s Belt and Road Initiative, as it will be encouraged to export Chinese drugs and traditional Chinese medicine to the Silk Road economies. As a kicker, Chen suggests that the company may eventually be delisted from the SGX. At its current price, Tianjin Zhongxin is trading at a dividend yield of 4%, and forward PERs of 8.9 times for this year and 7.5 times for FY2019. Chen has a target of US$1.52 versus its last traded price of 98.5 US cents.
Cityneon Holdings is Chen’s final conviction pick. The company owns three intellectual property rights — The Avengers S.T.A.T.I.O.N series from Disney, Transformers from Hasbro, and Jurassic Park — to run immersive exhibitions. Its relatively asset-light, fee-based model has significant growth prospects, Chen says. Stay tuned. We will give an update on Cityneon later this quarter.
