Rally loses steam; go back to defensives. In our July 1 strategy report, we had argued that the market is looking increasingly lethargic and we would not be surprised if the KLCI (now FBM KLCI) failed to reach our target of 1150 pts - the threshold where an outright sell call will be triggered. We reiterate our view that investors should gradually pare down their positions on cyclical stocks and high beta plays in favour of defensive picks as an imminent retracement in the market is a foregone conclusion. While the slew of liberalisation measures announced by PM Najib early this month were sentiment boosters, the market’s reception of the developments had been lukewarm, to say the least. The implementation of the new FBM KLCI index on July 6 was also largely treated as a non-event. We believe the interest in small caps will return when there are more meaningful signs of a sustained economic recovery in the months ahead, although their performance will take the cue from their bigger cap peers.
Oil & gas and steel stocks were clear winners. Steel and oil and gas stocks dominated the upper
quartile in terms of share price performance. Sino Hua-an and Lion Industries topped the gainers list with more than 100% returns. This is followed by CBS Technology, Alam Maritim, Petra Energy, Tanjong Offshore, Coastal Contracts, Leader Universal, Pantech Holdings and Naim Cendera, with returns ranging from 68% to 94%. The recovery in crude oil prices on the back of increasing conviction of green shoots emerging coupled with the weakening US dollar were the key catalysts driving the rerating in the oil and gas sector while steel companies had generally benefitted from their bombed-out valuations and the positive outlook arising from the collective fiscal spending globally.
Our oil and gas analyst, Jason Yap, remains bullish on the long-term prospects of the sector, with crude oil price looking to stabilise at above US$60 per barrel, thus spurring demand for deepwater and shallow water exploration. That said, he believes that risk-averse investors should take profit on the sector as a correction in oil & gas stocks in line with the anticipated retracement in the market is inevitable.
Our steel sector analyst, Ng Sem Guan, believes that much of the concerns surrounding the sector are fading, with a further re-rating spurred by improving pricing and demand dynamics as well as the impact of the stimulus measures kicking in. All in, our overweight recommendation for both sectors is maintained, with the top buys being ALAM (TP-RM1.95), PETRA (TP-RM3.50), KENCANA (TPRM2.14) and WAH SEONG (TP- RM2.58), LIONIND (TP- RM2.05), SOUTHERN STEEL (TP-RM1.93) and MASTEEL (TP-RM1.09). Despite the strong performance of their share prices to date, there is still upside based on the target prices ascribed.
Among the small caps, we continue to like
QL (BUY, TP-RM3.68),
As QL Resources is involved in the basic agri-food business which
is resilient in nature, we do not see any slowdown in its numbers
despite the weaker sentiment earlier this year. Its FY09 EBITDA
margins increased from 10.4% to 11.4%. QL will continue to grow in
2HCY09 as we see potential business from marine processing
manufacturing (MPM) as we gather that QL is moving into new
markets such as China for its surimi paste, as well as getting new
orders from the European Union after the lifting of a ban. The
expansion at its Hutan Melintang plant and regional expansion to
Surabaya, together with palm oil earnings in 2012, will definitely
boost its earnings going forward.
LIONIND (BUY, TP- RM2.05),
ALAM (BUY, TP-RM1.95),
The company announced very good 1QFY09 results that exceeded
industry expectations. The charter rates for its vessels remain
sustainable although it has experienced contract renewals for some
of its vessels. Going forward, management will continue to tap on its
business and financial JV strength to establish a more significant
presence in the O&G industry. We also expect the better industry
outlook to favour Alam, with more vessel contracts expected to be
awarded in 2H09. We maintain our BUY call with a TP of RM1.95
based on a PER of 10x FY10 earnings.
SINO (BUY, TP- RM0.66)
and
MUDAJAYA (BUY, TPRM2.13)
The EP contract for its Chhattisgarh IPP venture (RM3.4bn) will
drive FY09–11 earnings. Phase 1 is ongoing (>15% complete) while
contribution from Phase 2 will commence in 2H09. The PPA for both
phases has been signed and the project is expected to yield an IRR
of 16%–18%. Electricity sales are expected to begin by end-2010,
with all 4 plants fully operational by end-2011/early-2012. Upon full
commencement, the earnings contribution is estimated at
+RM100m. Another RM500m worth of local buildings and roadwork
jobs are in line for 2H09 while more Tune Hotel jobs are another
possibility. Its current O/B balance stands at > RM5bn. Maintain
BUY rating and a RM2.13 TP based on 10x mid-CY10 earnings.
The NPV of the IPP is not included in forecast and valuations. We
are projecting a 3-year CAGR of 40%.
given their respective stock catalysts. The more risk-averse investors should take comfort in our recommended dividend yielding names such as HAI-O (TP-RM5.20) and NTPM (TP-RM0.54).
The caveat for investing in small caps is to stick to familiar names and companies with strong management track records.
The caveat for investing in small caps is to stick to familiar names and companies with strong management track records.