SG Market 2016 - OCBC Investment 2016-11-28: A lackluster year...

SG Market 2016 - OCBC Investment 2016-11-28: A lackluster year... Singapore Market 2016

SG Market 2016 - A lackluster year...

Investors were on the sidelines...

  • Since 2013, the average daily traded value has averaged just slightly above S$1b on the local exchange and together with the uncertainty in the market this year, investors opted for defensive or yield-providing assets. 
  • Equities were largely sidelined and this was acutely felt in Singapore as the Straits Times Index (STI) is down about 1.4% this year versus double-digit gains for the SET and JCI. However, most of the other regional markets were also down so far this year including China and Japan.
  • Volatility for the STI (30-day) hit a high of 25.3 in Feb 2016 when the sharp plunge in oil prices dragged equity markets lower. This was a 5- year high. Since then, it has corrected and has stabilized at around 10.0. 
  • Going forward, we expect market expectation of higher interest rates could be one of the triggers for market volatility as it could impact property, REIT and some of the high dividend yielding stocks, although it is likely to be positive for banks.

REITs outperformed the rest of the sectors in 2016 S-REITs enjoyed good gains in 2016...

  • Aside from the sharp drop in Feb, the benchmark Straits Times Index (STI) was trading within a narrow band of 2700-2960 for most of 2016. 
  • There was a lack of key price drivers or themes to push the index above the 2900 level. Market actions were largely dictated by external events including Brexit and oil prices. With the cautious stance, stock price movements were rather limited and most of the sub-indices also saw modest movements up/down YTD. 
  • The REIT sector was one of the key star performers, rising as much as 17% from the year’s trough to the year’s peak (+12% YTD then). With the recent expectation of higher rates post the US Presidential election, REITs have corrected, but are still up some +2.1% YTD.

STI’s valuations are reasonable 

Dividend yield of almost 4% 

  • Currently, the STI is trading at price-earnings ratio of 13.8x for this year and will drop to 13.2x for next year. On a price/book basis, the current ratio of 1.1x is still below the level seen during the European debt crisis period of 1.2-1.4x and just slightly higher than the lows seen during the Global Financial Crisis (GFC) of <1.0x. 
  • With a sustainable and still healthy dividend yield of 3.8%, which is higher than most of the regional market, we believe that valuations in the Singapore market, especially for the STI stocks, are fairly attractive, especially for longer term investors looking for sustainable dividend payouts.

SG Banks: Hurt by impairment charges, but boosted by higher rates ahead 

Expectation of higher rates ahead...

  • 2016 was marked by higher impairment charges and higher non-performing loans (NPLs) for the local banks. With the beleaguered O&G sector hurting the local banks, the market focused on swelling NPLs and the possibility of further defaults. This took a sharp turn for the better following Trump’s election as US President as local banks moved up sharply higher, in tandem with US banks on expectation of higher rates ahead. 
  • While the probability of higher rates ahead is high, we expect the operating environment in Asia to remain challenging. While impairment charges could ease off a bit in 2017, we do not expect bottomline earnings growth to pick up as quickly. 
  • Overall, we are more moderate in our earnings projections and expect low-to-mid single digit earnings growth in 2017. 

Commodity and Oil & Gas: Still challenging

Reversed losses from year’s low

  • Having hit a low in Feb 2016, the Thomson Reuters Core Commodity Index (CRY) has erased most of the losses and is up about 3.5% by Nov 2016. This trend was similarly seen for oil prices. 
  • Oil touched a low in February of about US$26 per barrel before recovering to hover between US$40-50 for the larger part of 2016. 

Outlook remains cloudy

  • While prices have recovered from the low, the outlook for the local Oil & Gas (O&G) sector remains dim. Most are embroiled in trying to re- finance their bonds and the industry looks in dire need of a strong helpline. With oil at current levels, we do not see any pick up in orders for a long while. 
  • The current restructuring will continue and weak players will likely be forced to exit the market, streamline their operations or seek alternative new businesses. It remains a tough environment and while the trough in oil price appears to be over, there are still no clear signs of a pick -up in orders for local oil and gas players. 

Recent privatizations in this space

  • Recently, there were privatization offers for two locally listed O&G companies. Valuations have fallen sharply and based on the FTSE Oil & Gas Index, which is down some 20% for this year, the PER is about 11.1x for 2016 and this drops to 9.5x in 2017. 
  • In addition, the price to book is currently at about 0.7x. However, stripping off the big-cap companies, we estimate that the PER could be lower at closer to 7x. 
  • Some of the small-to-mid cap O&G companies could potentially either become takeover targets or exit the market, and we expect this trend to continue into 2017.

Privatizations & Acquisitions: Current pace reflects under-valuation

Pace of privatization signals inexpensive values

  • The pace of privatization continued unabated this year and several established names were taken off the market including SMRT, NOL and OSIM. 
  • With the exception of Eu Yan Sang, premiums of offer prices over last traded prices ranged from 6% to 39%. This signaled the under- valuation in the market, as offerers took these companies private, to take advantage of the current low valuations to either have a new growth stream or enjoy better operational synergies and efficiencies. 

More privatizations to come...

  • Valuations in the Singapore market are one of the lowest in the region. In addition, valuations are also at one of the lowest levels in about 10 years. The STI is hovering at a tight band, and this range-bound trading over the past six months is an indication of the current lackluster trading environment. 
  • On the upper end, there are limited price drivers to take the index higher. On the lower end, the STI is well supported due to undemanding valuations. We expect this range-bound trading to continue. With many investors staying on the sidelines, share price outperformance is unlikely for the short-to-medium term. Under this scenario, companies or individuals with cash are likely to consider taking over or privatizing some of the under-valued stocks. 

Especially in the mid-cap space

  • We believe that there are several likely candidates in the mid-cap space, especially in the beleaguered oil and gas sector as well as the property sector (which has been in the doldrums for several years). 

IPOs were mainly smaller cap companies

Lack of big-cap IPOs

  • Of the IPOs in 2016, most were in the small-to-mid cap space. The largest IPO, Frasers Logistics & Industrial Trust was only one out of two in the > S$1b segment. 
  • The lack of new, big and interesting IPOs coupled with the on-going privatizations will mean that there are gradually going to be fewer listed stocks and will also weigh on current somber market sentiment. 

Funds flow into bonds

  • Bonds were the primary beneficiaries of global fund flow in 2016, diverting funds away from equities.

Carmen Lee OCBC Investment | http://www.ocbcresearch.com/ 2016-11-28