Friday, September 17, 2010

Beware Of Share Buybacks

UNDER normal circumstances, investors should get excited when companies buy back their own shares. In theory, this action implies the management views the best available investment opportunity for the utilisation of excess cash is to invest in its own company rather than buy into some other companies.

This is because when a company buys back its own shares, it will reduce the firm’s outstanding shares and enhance the company’s earnings per share (EPS).

Due to information asymmetry, the management is in the best position to determine that the company is being undervalued at the current price and, thus, it is to the best interest of the shareholders to buy back the company’s shares.

Hence, in general, we can conclude share buybacks usually convey a positive signal that implies the stock of a company is underpriced.

However, lately in Malaysia there was one listed company, Company K – we prefer to call it Company K than to reveal its real name – which showed unusual buying-back activities over an extended period up to May 17, 2010.

Here is an analysis of the Company K’s stock-price movement over this period. The price chart shows Company K had been hovering at around 80 to 90 sen until May 25, 2010. In fact, the company’s stock was being traded above 80 sen despite the recent financial crisis.

During the 2008-2009 market crashes, while the majority of companies were facing drops of 50% or more in their prices, Company K’s share price remained stable at above 80 sen.

Based on our observation of stock exchange filings, the stability of this company’s share price at around 80–85 sen appeared to be supported by its share buyback activities.

The company stopped buying its own shares since May 17. The last tranche of its share repurchase was on May 17 and the total number of shares bought were 36,000. As a result, since May 25, the stock prices started to plunge.

The main reasons for the sharp drop were because Company K defaulted on loans repayments and a few of the company’s key owners had left the company as well as the country.

As mentioned earlier, finance text books say when companies buy back their own shares, it implies the companies are undervalued.

However, in this case, Company K reported on June 7 RM146.5mil of losses for its fiscal fourth quarter ended March 31, 2010. Table 1 shows the company continued to buy back its own shares during the fourth quarter of FY10 and first quarter of FY11, even though the company was incurring huge losses during the periods. This seem to be against what we have learned from financial theory.

Investors may be wondering whether they are able to sell before the sharp plunge in share prices. Based on our observation, the company only announced the default in loans repayments on May 31, 2010 and the share prices immediately tumbled to a low of 10 sen.

By the time the company announced its fourth-quarter results on June 7, its share price remained low at 14.5 sen.

An interesting point to note from Table 1 is that coincidentally, Company K’s key owner, Mr JH, sold most of his holdings by the time the results were announced. He sold 39.2 million shares (53.4 million minus 14.2 million) from April 7 to June 7, 2010.

At the moment, due to the delay in submitting audited financial statements for the period ended March 31, 2010, shares in the company have been suspended from trading at 6.5 sen. The company is currently facing a winding-up petition and the appointment of provisional liquidators.

In short, share buybacks do not imply companies are undervalued. Investors need to be careful as some companies may use these activities to support their share prices.

Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting

Monday, September 13, 2010

Bursa Malaysia May Enter 'Golden Era'

Philippine and Malaysian stock markets may soon end 16 years of stagnation and enter a “golden era,” according to CLSA Asia-Pacific Markets technical analysts.

The Philippine Stock Exchange Index is testing its record high reached on Oct. 8, 2007, after fluctuating between support at 975 to 1,075 and resistance at 3,447 to 3,896 since 1993, CLSA analysts led by Laurence Balanco said.

The FTSE Bursa Malaysia KLCI Index is also poised for a breakout after it “drifted net-sideways” below the 1,332 to 1,524 range since 1994, the analysts wrote in a report.

The “secular bear markets” in the two Southeast Asian countries may be similar to ones in South Korea from 1989 to 2005, Indonesia from 1990 to 2004, India from 1992 to 2004, Singapore from 1994 to 2006, and the US from 1966 to 1982, according to CLSA. Since then, benchmark indexes in the five countries have rallied at least 51 per cent and posted gains of as much as 282 per cent, the analysts said.

“If the PSE index and the KLCI are to adhere to these common secular bear market patterns, then both markets are on the cusp of entering a new long-term bull market phase,” the analysts wrote.

A “conclusive” breakout above 3,896 could take the Philippine gauge to 6,752 “in the years to come,” according to the analysts. Still, they said the market may yet pause as it approaches the resistance zone and as the benchmark index completes a five-wave sequence from the October 2008 low.

The Philippine index lost 0.6 per cent to 3,723.45 at 11:14 am local time.

Cyclical Correction

“A partial retracement from the 3,447 to 3,896 resistance zone will mark the end of a 16-year secular bear market,” they wrote. “We would look at accumulating stocks during this cyclical correction.”

Resistance refers to the upper boundary of a trading range, where sell orders may be clustered, while support is where there may be buy orders. Elliott Wave Theory, created by US market analyst Ralph Elliott in 1938, concludes that market swings, or waves, follow a predictable, five-stage structure of three steps forward and two steps back.

In Malaysia, a breakout may suggest a long-term minimum target of 2,610 for the KLCI index, according to the analysts, who didn’t specify a time frame. The gauge was little changed at 1,433.68.

Still, an “extreme” reading for the gauge’s 14-day relative strength index may be a warning sign of a pullback in the near term, the analysts said. The KLCI’s RSI, tracking how rapidly prices advanced or declined, was at 77.6 today, higher than the 70-level seen by some analysts as a signal that prices are poised to fall. -- Bloomberg

Wednesday, September 08, 2010

Foreign Direct Investments Vs Domestic Investments

THE domestic debate on whether a country should focus on foreign direct investments (FDIs) or direct domestic investments (DDIs) is gaining traction as Malaysia moves towards increasing private investment under the 10th Malaysia Plan. Questions are being raised on the impact and contribution of FDIs versus domestic investments on the economy.

Before I go any further, some definitions are in order. What is FDI? What is direct investment abroad and what is domestic investment? FDI is defined as a long-term investment in a foreign country. It has three components, namely equity capital, reinvested earnings and intra-company loans. Domestic investment is investment by local companies in the domestic market.

Cases where Malaysian conglomerates invest overseas are known as direct investments abroad.The labs initiated by PEMANDU have identified 131 projects, also referred to as Entry Point Projects. These are projects which will be launched in the next five years. It is hoped that the implementation of these projects will help stimulate private investment.

By definition, Entry Point Projects are just the beginning, and going forward, there will be other investments which might result from their implementation. What is interesting is the following:

*That a large proportion is private investment, i.e. 92 per cent, with projects requiring public sector funding amounting to only 8 per cent; and

* About 80 per cent of these projects are domestic investments with the remainder coming from FDIs.Looking at these numbers, questions may be asked as to whether FDIs are necessary. Or can we ignore FDIs completely and depend only on domestic investments?

Let us begin by looking at the role of FDIs in Malaysia's economic development. Malacca had been a leading centre of commerce and trade between the 14th to the 19th centuries. Its strategic location in the Straits of Malacca made it a coveted settlement. Traders from China, India, the Middle East and neighbouring regions converged into the thriving port for trade and commerce. As early as the 14th century, Malacca had attracted FDIs in services.

Later in our history, we had the British coming to Malaya to invest in rubber and tin. British investments in these two commodities resulted in the laying of railway tracks and the construction of roads to transport commodities to the markets. This in turn opened up the country for development. We also earned valuable foreign exchange for these exports and a significant cross-section of "Malayans" benefitted in the form of higher income. Kuala Lumpur, Ipoh and Penang grew as a result of booming trade in these commodities. This is a very simple illustration of the benefit of foreign investments.

In the 1970s and 1980s, Malaysia began to attract investments in the electronics sector. We have a growing population and the farms and tin mines can no longer absorb the surplus labour from the rural areas. Fortunately, the factories in Penang, Shah Alam and Johor were able to provide job opportunities for our young people. Without FDIs, our unemployment rate would have jumped to more than 20 per cent. The young boys and girls who worked in these factories were able to send money home, thus providing income support to their families.

We also have been attracting investments in the services industry. Foreign banks opened up branches in Penang and Kuala Lumpur. There were also investments in transport and logistics. All these have provided job and business opportunities for our people.

Of course there are also downsides to FDIs. There was not much linkage with the domestic economy. In the early stages, there was little value-added as components were mainly imported. In the 1970s and 1980s, many FDIs were only in assembly-type operations. We became more dependent on foreign labour, and remittance abroad kept on growing. Large multinational corporations became complacent as the government was quite generous in approving applications for foreign labour. In a way, this has created a vicious cycle of dependence on foreign labour which is extremely difficult to break.

All told, FDIs on balance have played an important role in our country's development. We liberalised foreign equity requirements in 1988 which further stimulated FDI flows. We were considered as one of the tiger economies, and this status was achieved partly because Malaysia was one of the major destinations for FDIs.Questions have been raised as to whether FDIs continue to be relevant. These questions have been asked because of the following:

* The lack of linkages with the local economy;
* In some cases, imported components remain high;
* Dependence on foreign labour has increased;
* Dependence on foreign labour has increased;
* Domestic wages have been depressed;
* Our failure to effectively move up the value chain;
* The volatile nature of FDIs especially in the earlier days, some FDIs were footloose in nature;
* Greater competition from China and some neighbouring countries; and
* The apparent neglect of domestic investments.

Our position is that Malaysia will continue to need foreign investments. But FDIs of a different kind. We have been talking about quality FDIs. But, what are quality FDIs?Quality FDIs are those which generate more benefits and spin-offs to the local economy. They will have to possess the following features:

* Strong linkages to the domestic economy including SMEs in terms of local sourcing;
* Investments which are more capital-intensive which will not require too much foreign labour; and
* Investments which are knowledge-intensive, which will pay higher wages.

This will be our focus going forward. In other words, we have to be selective because our wages are higher compared with those in neighbouring countries. We have decided to attract these kind of industries to the country. Some might say that we have also failed to attract quality investments. This is not entirely true.

Going forward, we are going to focus more and more on domestic investment. I am not saying that FDIs are no longer relevant. They continue to be important, but given the competitive environment and our large domestic savings, we need to motivate our own people to put more money into the country.

However, it is acknowledged that domestic investments cannot create as much impact as FDIs for the following reasons:

* Our people do not possess sophisticated technology as the Japanese and Germans;
* Our domestic companies do not have extensive overseas marketing network;
* We do not have many regional and global companies; and
* Our domestic market is relatively small.

Notwithstanding the above, we have examples of Malaysian companies investing overseas with high level of technology. But we do not have enough of them.

Despite these constraints, we believe there is potential to boost domestic investments. These will be in the area of infrastructure development, resource-based industries and in property development. Some of our investors are beginning to develop capabilities in the area of manufacturing.

How do we get our entrepreneurs to invest more in the country? We know that a number of our large corporations including government-linked companies have invested large sums both locally and overseas. Khazanah, CIMB Bank, Maybank, YTL, Genting, Petronas, Sime Darby are among some of our companies which have sought opportunities abroad.

While we are not preventing them from going abroad, we have to further improve the domestic investment climate, to motivate them to invest more locally. We have to continue reducing red tape and bureaucracy and making government rules and procedures more transparent. But above all, we have to create more opportunities for them to invest in the domestic economy.

Monday, September 06, 2010

Analysts See New High For Bursa Malaysia Index

PETALING JAYA: With four months to go before 2010 ends, a number of brokerages have unveiled their 2011 year-end targets for FTSE Bursa Malaysia KL Composite Index (FBM KLCI).

Quite a few predicted the benchmark index will reach a new high in 2011.

“Theoretically, the FBM KLCI could reach 1,578 to 1,691 by the end of 2011 purely based on our corporate earnings growth forecasts and by applying mid-cycle forward price/earnings (PE) targets of 14 to 15 times,’’ UOB Kay Hian Research said in its report yesterday.

“This assessment explicitly assumes that investors are no longer concerned over global economic and financial systemic risks,’’ it added.

The brokerage preferred to “err on the cautious side” and pegged a tentative target at 1,580 level.

The FBM KLCI reached a record 1,516.22 points on Jan 11, 2008, months before the credit crisis erupted in the United States and wreaked financial havoc across the globe.

As at Thursday, FBM KLCI closed at 1,441 points. The index was up 13.2% for the year. It is the fourth-best performing index in Asia, trailing behind Thailand, Indonesia and Phillipines.

The big markets in Japan and China are down for the year, as well as those in Europe and the United States.

It may seem that investors have ignored “warning signals” coming from developed worlds, which are struggling to revive their ailing economies.

The region’s outperformance “was partly caused by inflows of portfolio funds into emerging markets as investors switched out of developed markets,’’ RHB Research Institute said yesterday.

This, the firm said, was not a sustainable trend. “We continue to believe that the equity market may move into a phase of greater volatility in the months ahead,’’ it said.

Although it foresees a market correction, if it happens, it will not be “sharp given the ample liquidity and sustainable economic and earnings growth’’.

RHB sees a potential for the market to trade up to 1,450 points by the year-end, which is higher than its previous forecast of 1,400 points.

The research house also has the most aggressive 2011 year-end target for the index at 1,640 points – based on an estimated market value of 15 times its one-year forward projected earnings for 2012.

Local listed companies, mainly big banks, churned out a predictably strong earnings in the April-to-June quarter. Banking stocks, led by Malayan Banking Bhd and CIMB Group Holdings Bhd, accounted for a major chunk of the FBM KLCI basket.

With banking stocks’ earnings outlook upgraded at HwangDBS Vickers Research, the firm yesterday raised its current year-end target for the index to 1,500 points from 1,448 points previously.

It sees “intermittent” profit taking on the back of the FBM KLCI 14% climb since May, but believes that the index’s longer-term uptrend is intact.

But the just-ended results season may not have impressed everyone, especially those at CIMB Research and OSK Research.

Save for the banking and gaming stocks, CIMB said the August earnings season was generally below expectation and lacked “excitement”.

Propelled by rising profits at banks and gaming firms, CIMB projected that this year’s corporate profit growth would reach 30%, up from 24% it predicted three months ago.

It said banks and gaming stocks’ rapid profit increases had more than made up for the shortfalls at telecommunications, industrial, as well as oil and gas sectors.

This year’s blistering growth rate will be the fastest in the region. CIMB forecasts the pace will slow down to 13% next year.

Despite the strong recovery in earnings, CIMB kept its year-end target for the FBM KLCI at 1,450 points, and expects the index to go up to 1,520 points in 2011.

Over at OSK, the mood is equally sombre. The research house has revised its 2010 earnings growth forecast to 26% from 22% previously. However, it maintained a year-end target of 1,465 points after ascribing to a lower PE ratio of 15 times versus 16 times previously.

Given the weakening earnings trend across the board, OSK cautioned that the third quarter may see “more downgrades than upgrades’’.

However, this may be a “temporary situation” until the Government rolls out so-called mega projects that will provide the lift in the construction, steel and banking sectors.

Despite its cautious view, OSK’s 2011 year-end target for the FBM KLCI is at 1,580 points.