Mid-Cap Stocks Strategy - UOB Kay Hian 2018-09-14: Safety First

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CSE GLOBAL LTD SGX:544 PROPNEX LIMITED SGX:OYY SUNNINGDALE TECH LTD SGX:BHQ TIANJIN ZHONG XIN PHARM GROUP SGX:T14 VALUETRONICS HOLDINGS LIMITED SGX:BN2

Mid-Cap Stocks Strategy - Safety First

• Given the external uncertainties, we would adopt a defensive stance, and within the small/mid caps, visible earnings and sustainable dividend yields are preferred.
• Our key picks include CSE, Valuetronics and PropNex.

WHAT’S NEW

Risk aversion leading to sharp decline in small caps.

• On a YTD basis, the small-cap sector, represented by FTSE ST Small Cap Index declined 13.4% and underperformed the FSSTI’s YTD decline of 8.0%. This is not surprising given the general risk aversion in view of the external concerns over rising trade tensions, uncertainties over the US mid-term elections as well as higher interest rates.
• Following this, small and mid-cap stocks, particularly il-liquid stocks, have borne the brunt of the selldown. This report highlights our key picks in the mid-cap space in view of these developments.

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Cautious stance.

• Given the near-term uncertainties, we continue to be relatively defensive, particularly on mid-caps stocks that do not offer visible earnings or those without strong operating cashflows to support a decent dividend yield. 
• Within our mid-caps coverage, stocks that have outperformed offers a combination of visible earnings recovery and decent dividend yield include CSE Global and Tianjin ZhongXin Pharmaceutical.

Sustainability of dividend is key.

• We analyse the high-yielding mid-caps to assess stocks that could see potential upside surprise to dividends, and conclude that companies that can afford to and could raise its dividend payout include Valuetronics and Sunningdale. 
• As for CSE, whilst we think the group has the capacity to raise dividends given its improving operating cashflow, the group tends to adopt an absolute DPS payout and has been maintaining this at 2.75 S cents/share since 2014.

Cash is king.

• With rising interest rates and general risk aversion, we believe that investors should pay more attention to stocks with high net cash and strong free cashflow yield.
• Our screen within the mid cap space indicates that Valuetronics, CSE Global and PropNex look attractive on the FCF yield benchmark (with 2018 FCF yield of 11-21%).
• In addition, stocks with a high level of net cash as a percentage of its market cap are also preferred, and these stocks include Valuetronics and PropNex with net cash/market cap of 47% and 38% each respectively.

Potential near-term earnings upside.

• In terms of near-term catalysts, we would zoom in on stocks that could offer earnings upside surprise in the upcoming 3Q2018 results. In our view, CSE and Valuetronics could see some upside in their upcoming 3Q18 results.
• CSE could surprise from delivery of higher-margin small oil & gas contracts whereas Valuetronics may see consensus upgrades from recovery of smart lighting product.
• In addition, Valuetronics could continue to enjoy healthy growth in the industrial and commercial electronics (ICE) segment, from better demand for connectivity modules used in the automotive industry.

Andrew Chow CFA UOB Kay Hian Research | Singapore Research Team UOB Kay Hian | https://research.uobkayhian.com/ 2018-09-14

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