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Friday, February 26, 2010

EU Debt Crisis: Overhyped!! Not too concerned


The recent debt debacle in Greece has partly triggered the recent correction which saw markets worldwide declining by as much as 10%, besides other causes such as the increased regulations proposed on US banks and China's tightening measures. The worst performing markets are EU & Taiwan currently. DJ Stoxx 600 declined 11% from its high in mid Jan 2010 followed by TWSE decline of 10%. KLCI, as expected, was rather sheltered from the onslaught by dropping a mere 3.7%. In addition, EUR has dropped against major currencies such as USD and Yen by 5.9% and 9.5% YTD.
Is the Greek crisis a major cause for concern at the moment for the equity markets? I believe the market has hyped up this issue too much and the correction seen now is overdone and should be temporary. Here, we'll just take a closer look at the debt concerns in EU.

Greek crisis:
Greece debt levels came to the limelight owing to its high debt levels revealed after the government revised its fiscal deficit for 2008, raising questions on the transparency and accuracy of its accounts. By 2010, its fiscal deficit and debt/GDP levels will reach 12.7% and 113% respectively, much higher compared to the EU's SGP (Stability and Growth Pact) standards which requires EU members to adhere to its fiscal deficit and debt/GDP limits of 3% and 60% respectively. Its debt/GDP level is also the highest in Eurozone and 2nd highest in terms of fiscal deficit after Ireland (Eurozone's fiscal deficit and debt/GDP at 6.9% and 84% respectively in 2010). In addition, its economy is expected to remain in the negative in 2010 before turning a small positive in 2011, raising concerns over the sustainability of its economy and its ability to repay its debts. About EUR 17 billion worth of Greek bonds will be maturing mostly in 1H 2010 and whether Greece will be able to pay the loans is in question.

Small impact apparently: Nonetheless, note that Greek economy is just a very small portion of the EU, accounting for just 2.7% of Eurozone's GDP. On top of this, Eurozone's overall debt levels are relatively lower as compared to US (Fiscal Deficit: 11.6%; Debt/GDP: 93.6%) and Japan (Fiscal Deficit: 7.1%; Debt/GDP: 227% - Massive!!).


Possible Outcomes:

1. Greece exit from Eurozone:
This will be a precursor to the destruction of the single EU currency which they have taken years of painstaking efforts to unite. It would be more costly for Greece to exit from EU as it will have to fend for itself without the EU umbrella. Its currency will be devalued, alleviating its foreign debt even higher while at the same time borrowings will be extremely costly for Greece.

2. Own fiscal consolidation efforts:
Rather hopeless apparently. Its plans for budget cuts were met with strong opposition with strikes across most sectors and public unrest on the streets. Corruption is too deeply entrenched in the system and there is too much political baggage to head off any fiscal consolidation efforts.

3. Help from EU:
This will be the most likely outcome. EU member representatives have pledged to step in to provide financial aid to Greece should the need arises, likely in the form of guarantee for Greek bonds and extending low-cost lifeline to banks with Greek exposure especially Greek banks. Nonetheless, European commission (EC) authorities will have to assume a supervisory role over Greek's economy by imposition of conditions on Greece to regularize its economy. Greek's financial autonomy has to be diluted.

Furthermore, Greece could be the 'Lehman Brothers' of Europe where Greek's debt risks will cascade through the financial systems of other EU members. Greek government bonds are widely held by Greek banks which are used as collateral for loans from ECB and German banks are known to have substantial holdings in Greek bonds and bank debts. Should Greek economy collapses, the domino effect could be severe throughout EU. EU cannot afford to have this kind of crisis to occur.

4. Help from IMF:
Greece is still under the Eurozone. Any crisis that happen within the Eurozone, EC is obligated to solve it and not having authorities outside of EU to assist. IMF's financial aid package could be costlier at the same time.


Other highly indebted countries:
Spain, Ireland and Portugal are countries which are put in the spotlight as well over its ballooning debts. However, the conditions of these countries are not as severe as Greece. Spain and Ireland, though having a high fiscal deficit of 10.1% and 14.7% respectively, are stronger in their fiscal position as their debt/GDP for 2010 will just be at 66.3% and 83% respectively, therefore allowing more fiscal flexibility to boost up their economy.

On the other hand, Portugal's economy is much smaller which contributes about 1.8% to Eurozone's GDP. Its bonds maturing in 2010 are expected to amount EUR 5.9 billion while fiscal deficit and debt/GDP will be 8% and 85% respectively. In other words, its small economy is easier to be handled.

Recent bond issuances have been successful nonetheless:
13th Jan 2010: Spain 10-Year bonds worth EUR 5 billion at interest rate 0.63% above German Bunds' only
26th Jan 2010: Greek 5-Year bonds worth EUR 8 billion at interest rate of 6.2%
16th Feb 2010: Spain 15-Year bonds worth EUR 5 billion at interest rate of 4.7%
Sometime in end Feb 2010: Greek planning a 10-Year bond issuance worth EUR 3-5 billion at unknown interest rate

(The success of the planned Greek bond issuance anytime now will determine whether Greece will need any financial aid. The dilemma faced by Greece is that the bond issuance might need a high premium on interest rate to justify the risks of investors buying Greek bonds and Greece won't be able to service the debt. But Greece will need the money to refinance its maturing debts at the same time. Have to see how this will unfold)

Conclusion:
EU will come to the rescue if Greek economy fails. Might not even need assistance in the short term if bond issuances are proved successful. Nonetheless, Greece will need to regularize its economy by imposing austere budgets to ensure its economic sustainability. However, the country is plagued by public backlash, massive corruption and structural weakness, rendering its efforts to steer the economy out of recession toothless.

There have been talks of severe contagion effects of sovereign defaults on EU economies and the moral hazards arising from financial aid given to Greece. However, I think these two risks will be low. Firstly, EC cannot afford this crisis to blow out of control and therefore will help its troubled members. Secondly, if financial aids are given out, EC will be imposing strict controls on Greece and the country's financial autonomy has to go. If the members wish to exercise their autonomy, they will have to put their house in order. Moral hazards will happen only if members are not disciplined for creating such chaos.

Overall, valuations of EU are cheap, trading at PE of 12x and 10x for 2010 and 2011 respectively. Corporate earnings growth will be 25% and 20% for 2010 and 2011 respectively. Investors will steer their attention back to earnings which will be key driver of markets once the debt concerns subside. Investors might consider buying into European equity funds to take advantage of the current correction.

Disclaimer: The above article does not represent an investment advisory service as no subscription or management fees are charged. The contents of the article are provided as general information only and should not be taken as investment advice or as a recommendation to buy or sell any security or financial instrument. Any investment decisions carried out based on information, analysis, or commentary provided above is solely your responsibility. You should consult your investment adviser before making any investment decisions.

Thursday, February 25, 2010

Faber Group (RM1.66): Fantastic Results, Still Cheap!!

Faber just released its 4Q 09 results which is nothing short of fantastic. Revenue for 4Q09 rose 105.7% y-o-y to RM303.9 mil while net profit increased 138.3% y-o-y, bringing the full year net profit of RM82.7 mil or EPS 22.9 sen. This far exceeded my expectations of RM60mil and has already reached near my expectations of RM85 mil for 2010.

Backed by its recurrent IFM business coupled with improving property outlook, net earnings will continue to improve. Valuations are still very cheap at historical PE of just 7.3x (I'm talking of historical PE, not even forward PE) and earnings will continue to grow on the back of higher contribution from Mid East and property sales. Balance sheets remain healthy with net cash of about RM120 mil.

For previous post on Faber, click here.

Disclaimer: The above article does not represent an investment advisory service as no subscription or management fees are charged. The contents of the article are provided as general information only and should not be taken as investment advice or as a recommendation to buy or sell any security or financial instrument. Any investment decisions carried out based on information, analysis, or commentary provided above is solely your responsibility. You should consult your investment adviser before making any investment decisions.

Wednesday, February 10, 2010

Snippets of outlook on Malaysia

Thanks to this recent correction in the markets, this time will be a good buying opportunity again. I still believe markets are going to continue moving upwards and the recent concerns that caused this correction is more hyped-up than a real threat to the economic recovery. Time to buy again as markets might surge after CNY as investors are withdrawing money ahead of the CNY holidays where China markets will be closed for the whole next week and pump in again after CNY.

Anyway, I'll just share a gist of the Malaysian market outlook here, the things we can look out for in 2010.

Catalysts:

New Economic Policies:
This year, we will be seeing a clearer picture of the economic policies to be pursued by the Government over the next few years, to be unveiled in the new economic model by the National Economic Advisory Council (MPEN) in Mar 2010 (Delayed again) and the 10th Malaysia Plan in June 2010 . More favorable economic policies are expected, which is in line with Malaysian Prime Minister’s intention to navigate Malaysia from a middle income to a high income economy. Since Dato Seri Najib Tun Razak’s ascension to the Prime Minister’s office, the Government has laid down more investor-friendly policies, including liberalization of 27 services sector and financial sectors, review of minimum wage for selected industries to attract talents from overseas and improving ties with regional economies like Singapore, India and China via high level visits which could bring in more investments from these regions.

External Trade:
Exports which consist of 107% of total GDP, continue to remain bright in outlook driven by exports of E&E products and commodity related products. E&E products which is 43% of total exports continue to experience growth on the back of strong global demand, especially from Asia Pacific Countries. Global chip sales continue to surge to US$22.6 bil in Nov 09 since bottoming out in Feb 2009 which was near its high of US$22.9bil in Sept 2008. On top of that, manufacturers around the world cut its capacity and investments sharply in 2009 which could create a supply glut sometime in mid 2010. This will raise the prospects of higher selling prices and acceleration in semiconductor equipment investments. On the other hand, commodity exports which consist of 21% of total exports will be driven by global demand growth especially from developing economies and supported by increasing oil supply costs and resulted from declining supply of 'cheap oil'.
Electricity sector (Something to look out for if you doubt the economic recovery) continued to post strong gains in Dec 2009 at 14.1% y-o-y which was the seventh consecutive month of y-o-y increase. This would be one of the strong indicators of economic recovery as most if not all economic activities utilize electricity and it is almost impossible to function without it. I just ran some numbers of GDP and electricity output which showed Malaysia GDP growth has a strong correlation of 80% with electricity consumption.

Retail and Corporate Sector Growth:
Private expenditure, which consists of 54% of GDP, is expected to take the lead in driving Malaysian economy, backed by more pro-business policies, low interest rates and higher corporate earnings. Corporations emerge stronger from the recession enjoy greater efficiency and healthy balance sheets and cash flows.

Newsflow of major projects:
Construction industry expected to thrive this year. Major construction projects like Interstate Water Transfer Scheme (RM8.8 billion), LRT extension (RM7 billion), new LCCT terminal (RM2 billion) and Gemas-Johor Bahru Double Tracking Project (RM5 billion) are expected to roll out over 6-12 months (Please don't delay anymore!!). Construction industry is known to have high multiplier effects on the overall economy via construction output, income generation, employment and imports. It also generates extensive backward and forward linkages with different sectors such as manufacturing industries and service type sectors, of which both constitute a majority portion of total GDP.
Firmer commodity prices: Malaysian economy is very much intertwined with commodities. About 40% of Government’s revenue comes from oil related industries while about 22% of the FBM KLCI constituents consisting of commodity related companies. According to my computation, surprisingly KLCI has an 80% correlation with crude oil price over the past 10 years. Firmer commodity prices lead to improved fiscal position of the Government, enabling higher fiscal spending or lower fiscal deficit of which both are favorable to the economy. Higher corporate earnings among commodity-related companies could also lift up the local bourse.

Appreciation of RM over USD:
In view of the large fiscal deficit of the US resulted from its stimulus measures to curtail one of the worst financial crisis faced by US, US$ is expected to depreciate against RM. This is further backed by Malaysian Government’s efforts to rein in fiscal deficit via cuts in operating (hopefully they can implement that without having too much political pressure to do otherwise) and development expenditure, lowering of fuel subsidies coupled with broadening Government’s revenue base such as review of GST and disposal of government assets, all of which could strengthen the ringgit and enhance Malaysia’s attractiveness as an investment destination. Consequently, Malaysia’s fiscal deficit is expected to decrease to 5.6% of GDP (I'm following Government's guidance) in 2010 from 7.6% in 2009 .

Foreign Fund Flow:
Foreign fund shareholdings in Malaysia declined drastically since March 2008, triggered by the General Election in Mar 2008 which sparked a huge sell down by foreigners. As a result, foreign shareholding in Malaysia plunged to about 21% currently from 27% in Mar 2008. Nonetheless, we are seeing foreign funds slowly returning to the market albeit in a moderate way. Having said that, foreign investors still have reservations about the Malaysian market such as the willpower to execute Government’s planned reforms coupled with political and social security concerns. Nonetheless, with State Elections in Sarawak and the General Election approaching in 2011 and 2012 respectively, it will be crucial for the Government to ensure that its planned reforms be executed to regain the lost votes from the previous General Election. Foreign investors’ interest could revive again, backed by clearer picture of Malaysia’s economic growth plan over the next few years coupled with anticipated execution of Government reform policies and further liberalization of its economy, which could lend support to the uptrend of FBM KLCI. Intersesting to note that FBM KLCI has been resilient in its uptrend over the past year, despite the lack of foreign investors’ support, meaning the market is very much domestic-driven.
Concerns:
Doubts remain over the execution of economic reforms though the Government openly expressed intentions to navigate Malaysia from middle-income to a high-income economy. Investors still have reservations over Government’s willpower to undertake structural reforms as the Government has failed to implement them in the past.

Uncertainty in the political arena arises as Oppositions are making inroads, as seen in the General Election in Mar 2008 which denied BN two-thirds majority in the Parliament. The race in the coming Sarawak State Election and General Election in 2011 and 2012 respectively are expected to be fierce. The recent judgments on high profile cases, scandals and squabbling continue to undermine investor confidence. Further exacerbating the situation including the escalation of inter-race and inter-religious quarrels which led to the desecration and burning of places of worship.

Bye bye, FDI: Domestic and foreign investments in Malaysia are on a declining trend, dropping by about 55% y-o-y in 2009. About 45% of total investments are still being channeled to manufacturing sector which contribute about 30% to the economy while less than 30% find its way to the services sector which contribute about 55% to the economy. This is a hindrance to Malaysia’s intention to direct services sector to lead the economic growth and move up the economic ladder. Infrastructure, political risks, structural cracks and productivity remain key concerns among investors. Malaysia’s net outflow in investments to overseas are increasing significantly, raising concerns over lack of capital investments locally. If Government does not get its act together, we will be losing way behind emerging economies like Thailand, Indonesia and Vietnam.

Valuation:

Where are we now? KLCI still trading at forward PE of 14x, below its 10-year average of 16x. There is still upside in Malaysia equity market in the short term but will not be spectacular, probably about 15% upside. Nonetheless, without FDI support, economy is going to hurt in the long term while foreign funds will continue to ignore Malaysia if we keep on harping on race/religious dominance and undermine the independence of judiciary, police etc.

I think policies and politics are going to be one of the main determinants of the direction of the market this year.

Disclaimer: The above article does not represent an investment advisory service as no subscription or management fees are charged. The contents of the article are provided as general information only and should not be taken as investment advice or as a recommendation to buy or sell any security or financial instrument. Any investment decisions carried out based on information, analysis, or commentary provided above is solely your responsibility. You should consult your investment adviser before making any investment decisions.

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