Singapore Market Monitor (Sector View) - Maybank Kim Eng 2016-12-13: Secular over cyclical growth

SGinvestors.io

Singapore Market Sector Outlook

Singapore Market Monitor - Secular over cyclical growth

• Against the backdrop of our view on a sluggish economy, weak earnings growth, external policy uncertainties and only modestly attractive market valuations, on a 1-year view we have a bias towards steady, relatively high cash flow resilience sectors, ones with low or declining capex requirements and ones that benefit from some secular growth trends.
• Admittedly, macro factors of a modest recovery in commodity prices plus rising rate expectations suggest cyclicals may outperform, but in our opinion this will likely be a short-term tactical relief recovery (after a prolonged period of underperformance). There is little to suggest that final demand for cyclicals has materially changed for the better.

Rotation stagnation will likely continue 

• We also have a preference for bottom-up stock picking over sector-driven picks as performance of broader sector indices appear to have settled into a range bound -/+ c8% range over the past half a year given the lack of visibility over growth drivers — the three visible exceptions to this have been:
  1. The tech sector (small weighting in the market has materially underperformed)
  2. The consumer sector has materially outperformed, the biggest driver of which was Thai Beverage, an FSSTI component with a significant weighting, which witnessed stellar price performance
  3. The telco sector that saw a sharp rerating, albeit for a brief period of c2 months, on media reports that there was a possibility a fourth player in the market would not materialize. However most of these gains were lost post Oct-2016.
• The reason for our preference for bottom-up stock picking is because almost a third of our stocks under coverage (15/48 stocks) have outperformed FSTAS delivering c14-50% returns YTD without any apparent sector bias and driven more by company-specific dynamics.
• That said, for sector-driven portfolios, our preference would be overweighting Property REITS, Healthcare, underweighting Financials, Consumer & Gaming and maintaining a neutral stance on Property Developers, TMT, Industrials and Commodities. 

Sector views 

Financials: Rising NPA risks 

• We believe more provisions are likely to be set aside by the banks amid the turning credit cycle and lackluster economic outlook, especially in O&G, commodities and SME sectors. On average, we assume credit costs of 44bps and 41bps respectively for FY17-18E across the banks. Our estimates for provisions are currently 14-24% and 8-20% above consensus estimates for FY17 and FY18 respectively across the banks. 
• We estimate that if we lower FY17-18E credit costs by 10bps for each bank, FY17-18E net profit will increase by c.6-7%, ceteris paribus. We believe asset quality deterioration has not fully run its course. 
• Operating outlook will remain challenging for 2017. We estimate loan growth will be in the low single digits given that: 
  1. the lending environment is likely to remain lackluster; and 
  2. banks may be unwilling to take on higher risks. 
• As of Sep 2016, Singapore banks have been lending out faster than the system domestically, where system’s loan growth was -5% YoY vs. the banks’ loan growth at 4-5% YoY. Therefore, we think banks are likely to compromise on loan pricing. 
• A normalised interest rate environment can help to offset the fall in customer spreads, although it remains to be seen if customer spreads may be under pressure from competitive loan pricing and lack of repricing for credit spreads.

Property: Stability trumps growth in 2017 

• With another challenging year ahead for the physical market, we struggle to turn more positive on property counters despite cheap valuations. 
• In a risk adverse environment, we opt for exposure to stable platforms over trading portfolios which drives our preference for Office REITs over Developers.

Office REITs: Trading below replacement costs? 

• We will position in Office REITs ahead of a potential bottom in early 2018. Low supply of prime office space in 2018-20 should give the market ample time to absorb excess space in the market. Valuations are supportive with Office REITs trading at a significant discount to their underlying assets. This is despite strong institutional interest in office buildings. Furthermore, strong bids seen at the recent Central Boulevard land tender suggest high replacement cost for offices.
• CCT (BUY, TP SGD1.81) and KREIT (BUY, TP SGD1.21) are our preferred sector exposure as they are well-placed to ride through the storm with their strong WALEs and low lease expiry profile in the near term.

Property Developers: Defensive positioning 

• All developers will not meet their cost of capital in the year ahead and the market is rightly bearish in pricing them below book. Operating environment remains challenging as intense competition for land could weigh on margins. In this environment, we believe developers with stable streams of recurring income and good development earnings visibility could outperform. 
• UOL (BUY, TP SGD7.37) is our top sector pick.

Telecommunications: Fourth player threat but yields attractive 

• Singapore is facing an all-but-certain entry of a new competitor. With two companies, MyRepublic and TPG Telecom qualified to press forward, the next step is for the regulator, Infocomm Media Development Authority (IMDA), to hold two spectrum auctions, with the first new entrant auction to be held before the end of this year and the second incumbent auction to be started in 1Q17. Our money is on TPG Telecom winning the coveted spectrum, given the deep pockets of its Australia-listed parent. 
• We believe entry of a fourth operator will pave the way for a price war that will impact the incumbents’ revenue and margins, especially M1. As a pure mobile operator, it has no other levers to defend its subscriber base other than pricing, unlike StarHub or Singtel which can bundle other services such as Pay TV, broadband to keep subscribers sticky. Its reliance on the consumer market also makes its earnings particularly vulnerable, unlike the other two that have a bigger corporate business balance.
• M1 and StarHub both offer 6%+ dividend yields even after a 20% cut to historical dividends while Singtel will offer c.4.5%. In the case of M1, the historical DPS of 15.3 cts has already been reduced by 20% by the company. 
• Despite the relatively attractive valuations however, we do not think the market will be ready to take a constructive view on Singapore telco stocks. After all, even before the entry of a new telco, the incumbents’ mobile business has already been affected, going by recent trends on mobile revenue and ARPUs. We have a SELL on M1 and HOLDs on Singtel and StarHub. Singtel is preferred for exposure.

Industrials: No inflection point across segments just yet 

Offshore & Marine 

• The OPEC production cut has been driving a sentiment rally. But we think that business wise, 2017 may still not be an easy year. The Singapore oil services sector is dominated by shipyards and OSV owners, which is plagued by severe asset oversupply. In our view, utilisation improvements (if any) from better oil price sentiment may not be fast enough before some players run out of cash.
• We do not rule out more failures of weak players as banks turn more stringent in granting new and even extending existing credit. Access to bond and equity markets for capital are likely shut for most given the repercussions from the bond defaults seen in 2016. This means that players that cannot generate self-sustaining cashflows face the risk of going down like Swiber and Swissco. But this would more distinctively separate the wheat from the chaff, meaning that there are long-short opportunities.
• We envisage another round of provisions when companies report FY16 results from mid-Jan to end-Feb next year, which could be an overhang on stock prices till then. Any asset sales by the judicial managers of Swiber and Swissco could provide price discoveries on asset values and that is likely to be below companies’ expectations.
• But beyond this and on the assumption of a more stable oil price environment in 2017 where oil demand-supply mismatches will continue to balance out, we advocate positioning in financially strong asset owners that would be early beneficiaries (EZI SP, BUY, TP SGD0.42) from increases in oilfield activities. We are less optimistic of shipyards (KEP SP, SELL, TP SGD4.47 | SMM SP, SELL, TP SGD1.00) as we view them as late cyclicals, with oversupplied drilling rigs and OSVs, plus competition from yards in Korea and China. A change to a more neutral stance may be warranted in 2H17 if cancellation risks fade but we still see some time before orders return for the shipyards.
• The consolation is that valuations are depressed with many asset owners now trading at 0.3-0.4x P/BV, indicating that the market has already discounted asset values by 60- 70%. We think this sets the stage for stronger players that can demonstrate improvements in free-cash flows and balance-sheet strength to outperform.

Aerospace, aviation & services 

• For Airlines, the outlook for the Singapore aviation sector is challenging given its overwhelming reliance on long-haul and transit passengers, a segment that is experiencing severe overcapacity and competitive strain for full service carriers.
• The regional low cost carrier segment has slightly better growth dynamics. Fuel prices are at comfortable levels but the USDSGD volatility is offsetting some of the benefit on the cost and revenue front. With a tough business outlook for full service airlines, aviation support services too face pricing pressure in addition to stiff competition. As a result companies such as SATS are banking on growth from diversification in non-airline sectors. 
• Aerospace services gave modest growth prospects: near-term cyclical softness in MRO for engines and heavy maintenance due to the number of regional carriers undergoing fleet upgrades is balanced by conversion opportunities for ageing aircraft families like A330 facing a replacement cycle.

Land transport 

• We are neutral on Land Transport player ComfortDelGro (HOLD, TP SGD2.63) as valuations are fair considering its current earnings prospects and business outlook. However, we could turn more positive on three events. 
• Firstly, a successful bid to operate the Thomson-East Coast Line may be earnings accretive in the medium term and valuations may expand to reflect a stronger outlook. We are confident that the successful bidder will achieve healthy profitability as competition is less intense (only the two incumbents are invited to this tender) and the government is assuming majority of the financial risks (asset-light, fare-independent).
• Secondly, better-than-expected taxi earnings will give us more confidence in its ability to fend off competitive threats from new entrants. We have factored in a 5% decline in taxi EBIT for 2017. Lastly, delivering profitability that is above our current 10% margin assumption for its Singapore bus business could lead to upwards revision to earnings.

Consumer & Gaming: Tightening belts and falling out of favour 

Consumer 

• The consumer sector (F&B and retail) in Singapore is struggling with keen competition and consumer belt-tightening that make it difficult to lift revenue, while margins are continually being squeezed by high business costs. However, overseas expansion is no panacea either. 
• Many companies have tried to beat the home market doldrums by expanding overseas (eg Breadtalk, Sakae Sushi) but have run into issues with market acceptance of their product and service offerings, keen local competition and a simple lack of differentiation. Basically, their products were seen to be more of the same by the locals and could not sufficiently stand out to realise a superior return on investment.
• In our view, the sustainable differentiators are a strong brand name and a highly recognisable product that help to make them “default” choices for customers. For example, when one mentions chili crab, the name Jumbo immediately springs to mind. In addition, a strong local track record and the successful startup of three profitable China restaurants so far now position it well to attract partners keen to help it accelerate its overseas push. 
• Companies with defensive earnings but limited growth such as Sheng Siong have been pushed to aggressive valuations and are unlikely to outperform. Jumbo is our top BUY for its combination of a resilient home base, successful overseas thrust that should provide catalysts to outperform and best of all, valuations that do not yet price in the expected catalysts.

Gaming 

• Singapore is increasingly less favoured by Chinese VIPs. Singapore VIP volumes have continued to fall YoY and have not mirrored the Macau VIP volumes recovery despite having done so in the past. Philippines and Saipan have had some success in wresting Chinese VIPs from Singapore. The tax amnesty in Indonesia is also sending Indonesian VIPs away and the weakening MYR against the SGD is also deterring Malaysian VIPs from gambling in Singapore. 
• We estimate that Singapore VIP volume will fall 10% YoY in 2017. Furthermore, there is more downward pressure from recently imposed capital outflow controls in China.
• The high margin mass market is also deteriorating. We estimate that mass market contributes 60-70% to group EBITDA for both Marina Bay Sands and Resorts World Sentosa. Singaporean citizens and permanent residents (SCPRs) account for ~75% of the mass market and this is under pressure from employment concerns. Additionally, the weakening MYR against the SGD is also deterring Malaysian mass market gamblers from gambling in Singapore. 
• We estimate that Singapore mass market gross gaming revenue (GGR) will ease 3% YoY in 2017.

Commodities (Softs): A year of two halves 

• While La Nina has not been established, the region has enjoyed largely normal to above normal rainfall in 2H16. For CPO, this will set the stage for a strong YoY recovery in FFB yield as yield is anticipated to normalize from 2Q17. 
• In Malaysia, 10M16 output declined 16% YoY over the corresponding period following one of the strongest El Nino on record in 2015-16 which have a more pronounced impact on the older oil palm trees. As for Indonesia, absolute output growth was potentially flattish-to-marginally lower YoY as young and new areas coming to maturity offset declining yields.
• Nonetheless, the low FFB output was compensated by higher CPO price which rose to MYR3,090/t (+40% YTD) by 30 Nov 2016 as the market had previously underestimated the severity of the supply crunch. Malaysia’s MPOB Oct 2016 stockpile was low at 1.57m MT (-44% YoY). And as the industry enters into seasonally declining monthly output trend going into 1Q17, the lofty CPO price is likely to stay high into 1Q17.
• However, once FFB yield normalizes from 2Q17 (especially during the peak production months of Aug-Oct 2017), we anticipate CPO price will correct sharply from the current high CPO price. Comparisons can be observed from the equally strong 1997-98 El Nino which led to a sharp CPO price correction in 1999 when output recovered that year (see charts below). Hence, we are maintaining our CPO ASP forecasts of MYR2,400/t for 2017 (2016: ~MYR2,600/t).
• Risk to our view: 
  1. Weather anomalies remain the biggest threat to both palm oil (perennial crop) and competing annual crops like soybean, corn and rapeseed, 
  2. crude oil price unexpectedly jumps back above USD80/bbl to stimulate demand for biofuel, and 
  3. MYR continues to weaken from current level of 4.40 ex-rate resulting in higher CPO price in MYR terms.

Healthcare: Growing from structural demand factors 

• We remain positive on the medium to long term growth potential of the healthcare sector where we expect fundamental performance to remain resilient driven by various expansion plans of the hospitals and service providers.
• There are multiple positive structural growth factors for the Singapore companies. The demand for quality private healthcare is rising because of i) rising affluence; ii) an aging population; and iii) sustainable niche in medical tourism demand in the region.
• While admittedly there are execution risks in expanding capacity and/or venturing overseas, the cost of expansion is supported by very strong cashflow generation that can tide out start-up time for the new ventures plus healthy balance sheets that have headroom for leveraging up. 
• Our top sector pick is Raffles Medical.

Neel Sinha Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2016-12-13