December 2018

Dec 31

Daily Equities Bottom-Up: Larsen & Toubro (LT IN): Slowdown in New Orders Is Risk for 3Q, Markets Can’t Ignore It for Long and more

By Smartkarma Daily Briefs | Equity Bottom-Up

In this briefing:

Larsen & Toubro (LT IN): Slowdown in New Orders Is Risk for 3Q, Markets Can’t Ignore It for Long
Prabhat Dairy Ltd – Update: Revenues and Margins Continues to Increase in Line with Our Expectations
Alkem Laboratories – En Route to Recovery, Valuations Attractive
Swaraj Engines: Positive Outlook But Growth Is Slowing and Valuation Is Rich
Okinawa Cellular (9436 JP): Warm Tropical Breezes with KDDI

1. Larsen & Toubro (LT IN): Slowdown in New Orders Is Risk for 3Q, Markets Can’t Ignore It for Long

Larsen & Toubro (LT IN) has reported the new orders worth only Rs95 bn after 2Q FY19 results (reported on 31st October 2018). This is much lower run rate as compared to 2Q FY19 (Rs419 bn) or 1H FY19 (Rs781 bn). All these orders by Larsen & Toubro (LT IN) have been received from construction segment where margins are relatively poor e.g. the construction and infrastructure segment of Larsen & Toubro (LT IN) in 2H FY19 has reported 6.8% EBITDA margin, much lower than 11.8% for the company on an overall basis.

Unless new orders pick up in next few weeks, there is a strong likelihood that there could be a negative surprise in 3Q results on order inflow for Larsen & Toubro (LT IN) . This is despite the fact that overall number reported for a quarter for order inflow is a bit higher than the sum of individual orders announced and reported by the company. While the market has not noticed decline in new orders so far and may have been still hopeful about a recovery in order wins, it is highly unlikely that this will continue to get ignored by investors if the trend doesn’t change and get better in next couple of weeks.

2. Prabhat Dairy Ltd – Update: Revenues and Margins Continues to Increase in Line with Our Expectations

Farmer

Prabhat Dairy Ltd’s quarterly result is in line with our expectation. In Q2 FY19, the company registered a growth of 8.53% YoY, EBITDA margin was 9.4% improving by 119 bps since the same period last year, EBITDA grew by 24.2% YOY; the profit margin was at 2.95% improving by 60 bps YoY, Net Income grew by 35.86% YOY. For more details about the company, please refer to our initiation report Prabhat Dairy Ltd – An Emerging Star in the Indian Milky Way. B2B business contributed to 70% of revenue and the remaining 30% was driven by B2C business. Value Added Products contributed to 25% of revenue in Q2FY19.

The stock is trading at 16.3x its TTM EPS, 13.8x its FY19F EPS. Margins have improved over the past quarters due to lower cost of raw materials, we expect raw materials to continue to be lower than their historic average in short term. Lower cost of raw material along with the improving contribution from B2C will lead to higher margins in medium to long term. The company also wants to increase its B2C contribution aggressively from the current 30% to 50% by 2020.

We will monitor the stock closely to firm up our views further, albeit we remain positive on the long-term prospects of the company.

3. Alkem Laboratories – En Route to Recovery, Valuations Attractive

Alkem Laboratories (ALKEM IN) produces branded generics, generic drugs, active pharmaceutical ingredients and neutraceuticals, which it markets in India and over 50 countries internationally. With a portfolio of over 700 brands covering all the major therapeutic segments and a pan-India sales and distribution network, Alkem has been ranked amongst the top ten pharmaceutical companies in India by sales for the past 13 years.

We are optimistic about Alkem because-

Alkem continues to grow significantly ahead of the segment growth rate of ~16% in the chronic therapy areas of Cardiac, Antidiabetic, Neuro / Central nervous system (CNS) and Derma. Alkem continues grow in the acute therapy areas of Anti-infective, Gastro-intestinal, Pain/ Analgesic and Vitamins / Minerals /Nutrients.

We expect India revenues to grow at CAGR 13% (FY18-21E) to Rs 64,687 mn in FY21E from Rs 44,900 mn in FY18. We expect US revenues to grow at CAGR 31% (FY18-21E) to Rs 30,438 mn from Rs 13,667 mn in FY18 and other international business revenues to grow at CAGR 11% (FY18-21E) to Rs 6,443 mn in FY21E from Rs 4,670 mn in FY18.

We expect EBITDA to grow at CAGR 21% (FY18-21E) to Rs 18,638 mn in FY21E from Rs 10,566 mn in FY18 and EBITDA margins to expand by ~ 190 bps to 18.4% in FY21E from 16.5% in FY18. We expect PAT to grow at CAGR 27% (FY18-21E) to Rs. 12,979 mn in FY21E from Rs 6,289 mn in FY18 and we expect PAT margins to expand by ~ 300 bps to 12.8% in FY21E from 9.8% in FY18.

We expect RoE to expand by ~530 bps to 19.0% in FY21E from 13.7% in FY18 and RoCE to expand by ~390 bps to 21.1% in FY21E from 17.2% in FY18

We initiate coverage on Alkem with fair value of Rs. 2,260/- representing a potential upside of 21% in the next 12 months. We arrived at the fair value by applying 22x multiple to September 20E EPS of Rs 102. Currently, the stock trades at 21x and 17x its earnings estimates for FY20E and FY21E respectively. After a very volatile 2018, we believe Alkem share price may have smooth upwards move in 2019 driven by strong PAT growth in the next 3 quarters.

Particulars (Rs mn, Y/E March)	Net sales	EBITDA	PAT	EPS	ROE	ROCE	PE(x)
FY18	64,137	10,566	6,289	52.6	13.7%	17.2%	35
FY19E	74,075	12,406	8,130	68.0	16.0%	16.8%	27
FY20E	87,716	15,659	10,772	90.1	18.4%	20.4%	21
FY21E	1,01,568	18,638	12,979	108.6	19.0%	21.1%	17

Source- Alkem Annual Report FY18, Trivikram Consultants Research as on 27/12/2018

4. Swaraj Engines: Positive Outlook But Growth Is Slowing and Valuation Is Rich

Swaraj Engines (SWE IN) (SEL)is primarily manufacturing diesel engines for fitment into Swaraj tractors manufactured by Mahindra & Mahindra Ltd. (M&M). The Company is also supplying engine components to SML Isuzu Ltd used in the assembly of commercial vehicle engines. SEL was started as a joint venture between Punjab Tractor Ltd (now acquired by M&M Ltd) and Kirloskar Oil Engines Ltd. M&M holds 33.3% stake in SEL and is its key client.

We are positive about the business because:

SEL’s growth is correlated with M&M’s tractor business growth. SEL supplies engines to the Swaraj division of M&M. M&M expects tractor growth to be around 12% YoY in FY19E. We forecast SEL’s tractor engine volumes will grow at a CAGR of 12% for FY18-21E.
The growth of the company is dependent on the monsoon and rural sentiments. We expect the profitability to improve with normal rainfall and government initiatives towards the rural sector. We expect the revenue/ EBITDA/ PAT CAGR for FY18-21E to be 14%/ 15%/ 14% respectively.
SEL is debt free and a cash generating company. It has a healthy and stable ROCE and ROE. SEL has increased its capacity from 75,000 engines in FY16 to 120,000 engines in FY18. We expect the capacity utilisation to reach 97% by FY20E from 90% in 1HFY19. SEL funds its capex through internal accruals. We forecast a capex of Rs 600 mn for FY19E to FY21E considering the requirement of the additional capacity, R&D and testing costs for new and higher HP engines & for upgradation of engines according to the TREM IV emission norms for >50 HP engines.

We initiate coverage on SEL with a fair value objective of Rs 1,655/- over the next 12 months. This represents a potential upside of 15% from the closing price of Rs 1,435/- (as on 26-12-2018). We arrive at the fair value by applying PE multiple of 18x to EPS of Rs 87/- to the year ending December-20E and add cash of Rs 82/- per share. While the business outlook is good, we think the upside in the share price is limited due to rich valuation.

Particulars (Rs mn) (Y/E March)	FY18	FY19E	FY20E	FY21E
Revenue	7,712	9,210	10,478	11,525
PAT	801	906	1,063	1,190
EPS (Rs)	64.5	74.8	87.6	98.1
PE (x)	22.3	19.2	16.4	14.6

Source: SEL Annual Report FY18, Trivikram Consultants Research as on 26-12-2018

Note: E= Estimates

5. Okinawa Cellular (9436 JP): Warm Tropical Breezes with KDDI

Dps

As the colder winter weather is felt and the icy blast of industry tariff cuts continues to chill sentiment, we seek some respite (at least mentally) in the warmer climes of Okinawa. Okinawa Cellular is a unique company. It’s a small cap telecom network operator in Japan with a focus on the sub-tropical islands of Okinawa Prefecture. As part of the KDDI group, the company benefits from its parent’s economies of scale, but with its local presence, it also benefits from being the hometown hero.

Because the stock is relatively small, from an investment perspective it runs into liquidity constraints that the other telcos do not have, so it’s a different type of investment but one that we think is worth looking at. Over the past 12 months Okinawa Cellular’s stock has fallen by 12.3%, but over the past year the stock has delivered a return in the middle of its peer group and has outperformed the broad TOPIX by about 5.5%. Like most telcos, Okinawa Cellular is also ramping its dividend payments, and the current yield is about 3.5%.

Dec 31

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Daily Equities Bottom-Up: KRI (KRI MK): Continued Capacity Expansion to Meet Solid Demand and more

By Smartkarma Daily Briefs | Equity Bottom-Up

In this briefing:

KRI (KRI MK): Continued Capacity Expansion to Meet Solid Demand
Kalbe Farma (KLBF IJ): Navigating Through the New Pharma Dynamics
GMO Internet (9447 JP) – Grossly or Modestly Overrated?
58.com Inc. (NYSE: WUBA): Regulatory Pressure Has Long Term Implications
Tuan Sing: Beneficiary of Exuberant Demand for Prime Office Investment Properties

1. KRI (KRI MK): Continued Capacity Expansion to Meet Solid Demand

More attractive to analysts, low price-to-sales, and low correlation with Western stock markets relative to its sector
To meet strong demand, KRI recently commissioned Plant 17, which increased capacity by 1.5bn. Upcoming Plants 18 and 19 to commission in 2019 should add another 5.5bn or a 20% capacity increase
High barriers to entry for medical gloves due to stringent compliance to regulatory requirement aids KPI market shares
Trades above ASEAN Health Care at 19CE* 4.1x PB, in line with offering a better ROE
Risks: Sudden jump in raw materials prices

* Consensus Estimates

2. Kalbe Farma (KLBF IJ): Navigating Through the New Pharma Dynamics

The healthcare industry in Indonesia has undergone a massive change since the introduction of the National Health Insurance (JKN) in 2014. Although the program allows for better healthcare access for over 200mn Indonesians, the industry dynamics have shifted and Kalbe Farma (KLBF IJ) is one of the companies that has been on the losing side during this adjustment period.

With the Health and Social Security (BPJS) deficit forecast to grow to IDR16t by end of 2018, and with a continuing roll out of coverage to 250mn people by end of 2019, all parties in the healthcare industry are expected to continue subsidizing the program. Hospitals and drug manufacturers have had to cope with relatively flat pricing from the INA-CBG (reimbursement) tariff since 2014, despite cost pressures stemming from the currency depreciation and inflation. KLBF has reported declines in its overall pharmaceutical margin, as well as low growth rates for its licensed and OTC (over the counter) drugs over the past five years.

Our recent meeting with the company revealed that to mitigate the JKN impact, KLBF has launched several strategies, including expanding into niche specialty products such as oncology and biosimilar drugs, as well as preventive and herbal supplements. We are also at a tipping point where KLBF’s non-OTC consumer health and nutritionals revenues are finally larger than the pharmaceutical revenues for the first time. In this insight, we will discuss whether the worst is already behind us, and if it is now time to take another look at the stock.

3. GMO Internet (9447 JP) – Grossly or Modestly Overrated?

Gpa2

Source: Japan Analytics

THE GMO INTERNET (9449 JP) STORY – GMO internet (GMO-i) has attracted much attention in the last eighteen months from an unusual trinity of value, activist and ‘cryptocurrency’ equity investors.

VALUE– Many traditional, but mostly foreign, value investors have seen the persistent negative difference between GMO-i’s market capitalisation and the value of the company’s holdings in its eight listed consolidated subsidiaries as an opportunity to invest in GMO-i with a considerable ‘margin of safety’.
ACTIVIST – Since July 2017, the activist investor, Oasis, has waged a so-far-unsuccessful campaign with the aim of improving GMO’s corporate governance, removing takeover defences, addressing a ‘secularly undervalued stock price we are not able to tolerate’ (sic), and redefining the role and influence of the company’s Chairman, President, Representative Director and largest shareholder, Masatoshi Kumagai.
‘CRYPTO!’ – In December 2017, GMO-i committed to spending more than ¥35b or 10% of non-current assets. The aim was threefold: to set up a bitcoin ‘mining’ headquarters in Switzerland (with the ‘mining’ operations being carried out at an undisclosed location in Scandinavia), to develop proprietary state-of-the-art 7nm-node ‘mining chips’, and, in due course, to sell GMO-branded and developed ‘mining’ machines. The move was hailed in the ‘crypto’ fraternity as GMO-i became the largest non-Chinese and the first well-established Internet conglomerate to make a major investment in ‘cryptocurrency’ infrastructure.

OUTSTANDING – Following the December 2017 announcement, trading volumes spiked into ‘Overtraded’ territory – as measured by our Volume Score. Many investors saw GMO-i shares as a safer way of gaining exposure to ‘cryptocurrencies’, even as the price of bitcoin began to subside. By early June 2018, GMO-i’s shares had reached a closing price of ¥3,020: up 157% from the low of the prior year and outperforming TOPIX by 135%. Whatever the primary driver of this outstanding performance, each of our trio of investor groups no doubt felt vindicated in their approach to the stock.

CRYPTO CLOSURE – On December 25th 2018, GMO-i’s shares reached a new 52-week low of ¥1,325, a decline of 56% from the June high. Year to date, GMO-i shares have now declined by 31%, underperforming TOPIX by nine percentage points. On the same day, GMO-i announced that the company would post an extraordinary ¥35.5b loss for the fourth quarter, incurring an impairment loss of ¥11.5b in relation to the closure of the Swiss ‘mining’ headquarters and a loss of ¥24b to cover the closure of the ‘mining chip’ and ‘mining machine’ development, manufacturing and sales businesses. GMO-i will continue to ‘mine’ bitcoin from its Tokyo headquarters and intends to relocate the ‘mining’ centre from Scandinavia to (sic) ‘a region that will allow us to secure cleaner and less expensive power supply, but we have not yet decided the details’. Unlisted subsidiary GMO Coin’s ‘cryptocurrency’ exchange will also continue to operate, and the previously-announced plans to launch a ¥-based ‘stablecoin’ in 2019 will proceed. In the two trading days following this announcement, the shares have recovered 13% to ¥1,505.

RAIDING THE LISTCO PIGGY BANK – As we shall relate, this is the second time since listing that GMO-i has written off a significant new business venture which the company had commenced only a short time before. In both cases, the company was forced to sell stakes in its listed consolidated subsidiaries to offset the resulting losses. On this occasion, the sale of shares in GMO Financial (7177 JP) (GMO-F) on September 25 2018, and GMO Payment Gateway (3769 JP) (GMO-PG) on December 17 2018, raised a combined ¥55.6b and, after the deduction of the yet-to-be-determined tax on the realised gains, should more than offset the ‘crypto’ losses. According to CFO Yasuda, any surplus from this exercise will be used to pay down debt. Also discussed below and in keeping with this GMO-i ‘MO’, in 2015, the company twice sold shares in its listed subsidiaries to ‘smooth out’ less-than-desirable operating results.

In the DETAIL section below we will cover the following topics:-

I: THE GMO-i TRACK RECORD – TOP-DOWN v. BOTTOM UP

BOTTOM LINE No. 1: NET INCOME
BOTTOM LINE No.2 – COMPREHENSIVE INCOME

II: THE GMO-i BUSINESS MODEL – THROWING JELLY AT THE WALL

III: THE GMO-i BALANCE SHEET – NOT SO HAPPY RETURNS

IV: THE GMO-i CASH FLOW – DEBT-FUNDED CASH PILE

V: THE GMO-i VALUATION – TWO METHODS > SAME RESULT

VALUATION METHOD No.1 – THE ‘LISTCO DISCOUNT’
VALUATION METHOD No.2 – RESIDUAL INCOME

CONCLUSION – For those unable or unwilling to read further, we conclude that GMO-i ‘rump’ is a grossly-overrated business. Despite having started and spun off several valuable GMO Group entities, CEO Kumagai bears responsibility for two decades of serial and very poorly-timed ‘mal-investments’. As a result, the stock market has, except for the ‘cryptocurrency’-induced frenzy of the first six months of 2018, historically not accorded GMO-i any premium for future growth, and has correctly looked beyond the ‘siren song’ of the ‘HoldCo discount’. According to the two valuation methodologies described below, the company is, however, fairly valued at the current share price of ¥1,460. Investors looking for a return to the market-implied 3% perpetual growth rate of mid–2018 are likely to be as disappointed as those wishing for BTC to triple from here.

4. 58.com Inc. (NYSE: WUBA): Regulatory Pressure Has Long Term Implications

● We notice that Anjuke’s Oct.-Nov. traffic declined. We attribute this decline to the tightening of registration requirement in various cities, which will reduce the number of housing leads on WUBA platform;

● We, however, believe new home business will deliver strong revenue for WUBA this year, contributing Rmb2bn in revenues by our estimate;

● We rate the stock Buy and cut TP from US$84 to US$79.

5. Tuan Sing: Beneficiary of Exuberant Demand for Prime Office Investment Properties

Gaw Capital is said to be paying a CLSA-managed fund S$710 mn for 77 Robinson, which is just 3 minutes’ walk away from Tuan Sing-owned prime freehold office building, Robinson Point. This works out to around S$2,300 psf based on NLA. 77 Robinson has a balance lease of 74 years.

Evidently, institutional buying interest in Singapore’s prime commercial buildings remains strong as the Singapore office market is now still a “landlords’ market”. Grade A CBD office rents are expected to continue their upward growth trajectory into 2019. Tuan Sing is a beneficiary of the strong office rental upturn as its prime freehold commercial assets in Singapore – 18 Robinson, Robinson Point, and 896 Dunearn – make up more than two-third of its total property portfolio value. Tuan Sing’s share price is down 17% in the last six months and lately, the company has been busy buying back its own shares at around S$0.33-0.345/share.

Dec 31

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Daily Equities Bottom-Up: TRACKING TRAFFIC/Chinese Express & Logistics: Parcel Pricing Weak, Again and more

By Smartkarma Daily Briefs | Equity Bottom-Up

In this briefing:

TRACKING TRAFFIC/Chinese Express & Logistics: Parcel Pricing Weak, Again
Elastic: Why Is It Outperforming In Recent Tech Carnage?
Horiba (6856 JP): Bad News Largely Discounted
FBN Holdings: A Contrarian Call from Behind the Hydrocarbon Clouds and Shadows

1. TRACKING TRAFFIC/Chinese Express & Logistics: Parcel Pricing Weak, Again

Tracking Traffic/Chinese Express & Logistics is the hub for our research on China’s express parcels and logistics sectors. Tracking Traffic/Chinese Express & Logistics features analysis of monthly Chinese express and logistics data, notes from our conversations with industry players, and links to company and thematic notes.

This month’s issue covers the following topics:

November express parcel pricing remained weak. Average pricing per express parcel fell by 7.8% Y/Y to just 11.06 RMB per piece. November’s average price represents a new all-time low for the industry, and November’s Y/Y decline was the steepest monthly decline in over two years (excluding Lunar New Year months, which tend to be distorted by the timing of the holiday).
Express parcel revenue growth dipped below 15% last month. Weak per-parcel pricing pulled express sector Y/Y revenue growth down to just 14.6% in November, the worst on record (again excluding distorted Lunar New Year comparisons). Chinese e-commerce demand has slowed and we suspect ‘O2O’ initiatives, under which online purchases are fulfilled via local stores, are also undermining express demand growth.
Intra-city pricing (ie, local delivery) remains firm relative to inter-city. Relative to weak inter-city express pricing (where ZTO Express (ZTO US) and the other listed express companies compete), pricing for local, intra-city express deliveries remained firm. In the first 11 months of 2018, express pricing rose 1.7% Y/Y versus a -2.9% decline in inter-city shipments (international pricing fell sharply, -14.5% Y/Y). Relatively firm pricing on local shipments may make it hard for local food delivery companies like Meituan Dianping (3690 HK) and Alibaba Group Holding (BABA US) ‘s ele.me to beat down unit operating costs.
Underlying domestic transport demand held up well again in November. Although demand for speedy, relatively expensive express service (and air freight) appears to be moderating, demand for rail and highway freight transport has held up well. The relative strength of rail and water transport (slow, cheap, industry-facing) versus express and air freight (fast, expensive, consumer-oriented) suggests a couple of things: a) upstream industrial activity is stronger than downstream retail activity and b) the people in charge of paying freight are shifting to cheaper modes of transport when possible.

We retain a negative view of China’s express industry’s fundamentals: demand growth is slowing and pricing appears to be falling faster than costs can be cut. Overall domestic transportation demand, however, remains solid and shows no signs of slowing.

2. Elastic: Why Is It Outperforming In Recent Tech Carnage?

Db 1

Elastic NV (ESTC US) has been one of the best tech IPOs globally in 2018. Its current price is $62.53, up 74% from its IPO price of $36. Elastic’s share price has been holding up very nicely since its IPO on October 5th, 2018. Meanwhile, from October 5th to December 21st 2018, many tech stocks have experienced brutal declines. Elastic’s ability to outperform the top US tech stocks in a very difficult environment for the stock market sets the stage for a continued out-performance once the stock market starts to stabilize.
Since the IPO, the company reported better than expected second quarter results (quarter ending October 31, 2018) on December 4th. The company’s adjusted net loss in FY2Q19 was $0.38 per share, beating analysts’ consensus estimate by 9 cents. It generated revenue of $63.6 million, up 72% YoY. Calculated billings were also strong at $88.5 million, up 73% YoY.
The company’s guidance for FY3Q19 (quarter ending January 31, 2019) is to generate revenue in the range of $64 million to $66 million, representing a 56% YoY growth rate at the midpoint of the guidance. It expects to generate operating margin of negative 28% to negative 30% in FY3Q19.
A combination of major investors shifting their assets away from FAANG and semiconductor stocks has resulted in some improved performance of many software related stocks in recent months relative to other major tech stocks. In general, these stocks face less negative impact from a prolonged trade war between China and the US. Plus, they are not as exposed to the higher cycle volatility as the semiconductor related stocks. In many respects, Elastic shares many business similarities with these software driven companies, and thus has been more immune from the decline in the stock prices since early October. We remain positive on Elastic NV (ESTC US).

3. Horiba (6856 JP): Bad News Largely Discounted

Horiba combines high gearing to semiconductor capital spending with a large and growing automotive test business characterized by upward trending but uneven profitability. At ¥4,545 (Friday, December 21, closing price), its share price has dropped by 53% from an all-time high of ¥9,590 reached last May. Falling demand for semiconductor production equipment and a downward revision to FY Dec-18 sales and profit guidance announced in November appear to be largely in the price.

The downward revision, which cut projected full-year operating profit growth from 15.5% to 2.5%, followed a 22.2% year-on-year decline in operating profit in 3Q and implies a similar rate of decline in 4Q. The weakness is concentrated in Semiconductor Equipment and Automotive Test, the former due to a cyclical downturn in overall demand, the latter due to M&A-related and other one-time expenses. New Automotive Test orders continued to outpace sales, leading to a 9.5% increase in the order backlog during 3Q.

Automotive Test sales and profits should rise next year, while semiconductor equipment sales and profits seem likely to bottom out. In a report issued on December 17, SEMI (the semiconductor equipment and materials industry organization) forecasts a further decline in wafer fab equipment sales in 1H of 2019, followed by recovery in 2H. Other industry sources we talked to before the report was issued had similar views.

This scenario could fall apart due to general economic weakness, American attempts to stifle China’s semiconductor industry, or both. On December 21, Reuters reported that Foxconn “…is in the final stages of talks with the local government of the Chinese city of Zhuhai to build a chip plant there with a total investment of about $9 billion… most of which would be shouldered by the Zhuhai government through subsidies and tax breaks…” This looks like a perfect target for the Americans, but whether or not they will notice or care remains to be seen.

Horiba is now selling at 9.6x our EPS estimate for this fiscal year, 13.4x our estimate for next year and 12.1x our estimate for FY Dec-20. These and other projected valuations are near the bottom of their 5-year historical ranges. If the Semiconductor Equipment division does not recover in 2H of 2019, historical data suggest that its operating profit could drop by 70% rather than the 47% we are now forecasting, resulting in a P/E ratio of 17x. Nevertheless, it is time to start considering when and at what price to buy Horiba.

Horiba is a diversified Japanese maker of precision and analytical devices and systems with a significant presence in the global markets for automotive test, industrial process and environmental analysis, hematology, semiconductor production equipment and scientific instruments. It is by far the world’s leading producer of automotive emission measurement systems (EMS), having supplied about 80% of the installed base worldwide, and also the world’s top manufacturer of mass flow controllers for the semiconductor industry, with an estimated global market share of nearly 60%.

4. FBN Holdings: A Contrarian Call from Behind the Hydrocarbon Clouds and Shadows

FBN Holdings Plc (FBNH NL) is the oldest and second-largest bank in Nigeria with a market share of 14% of domestic loans.

FBN’s solid franchise provides robust revenue generation capacity (especially in e-business and insurance) plus a solid and cheap funding base complemented by a strong liquidity profile. The Group’s solid funding base of low cost retail deposits, mainly CASA, underpins one of the most competitive in the sector.

Under new management, FBN is focused on a legacy asset quality clean-up and enhancing risk controls. The franchise has exhibited resilience in the face of system-wide asset quality problems, related to some extent to the concentration of oil/gas exposures. Moving forward, profitability can strengthen with improving asset quality though the recent plunge in oil prices represents a threat to this de-risking process. A plus point is the vibrant income streams from e-business and insurance growth drivers.

The operating environment in Nigerian remains challenging: while the country has emerged from a recession, vulnerabilities remain. Lower oil prices, tighter external market conditions, heightened security issues, and delayed policy responses are the main downside risks. The recent fall in oil prices is a concern given Nigeria’s dependency on the commodity and its knock-on effect to the hydrocarbon-exposed Banking System. Although access to foreign currency has eased, due to FX reforms, many borrowers retain limited capacity to service obligations and there are modest opportunities for banks to grow their loan portfolios.

FBN is thus somewhat of a contrarian call given the weakness in the oil market. But one should buy a hydrocarbon “play” when prices are low, not high. Shares trade at a 60% discount to Book Value and stand on a low Mkt Cap./Deposits rating of 8%, far below the global and EM median. FBN commands a dividend-adjusted PEG of 1.3x. Dividend and earnings yields are 3.3% and 15%, respectively. A quintile 1 PH Score™ of 7.7 captures the valuation dynamic while metric change is satisfactory. Combining franchise valuation and PH Score™, FBN stands in the top quintile of opportunity globally. The asset quality position and interrelated lower profitability vis-a-vis peers is a reason behind FBN’s lower credit rating and relatively low valuation. We are somewhat sceptical that FBN’s underlying creditworthiness and valuation are efficiently evaluated versus more popular counterparts.

Dec 31

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Daily Energy: 2019: Five Key Elements to Watch for in the Oil Market and more

By Smartkarma Daily Briefs | Energy & Materials Sector

In this briefing:

2019: Five Key Elements to Watch for in the Oil Market

1. 2019: Five Key Elements to Watch for in the Oil Market

As we turn the page into 2019, uncertainties over the world’s economic environment are stacked so high, that it would be presumptuous to try and read the fortunes of the oil market in great detail.

We expect plenty of volatility and surprises in a very event- and sentiment-driven environment for the oil market next year.

In this year-ender, we cast our eye over the first half of 2019, which promises to be action-packed, with major deadlines and signposts that could set the tone for the rest of the year.

We have identified the following five key elements that will shape the oil market:

Economic sentiment to remain in the driver’s seat
OPEC/non-OPEC compliance will be strong
Demand growth rather than oversupply will be key
Prices could rebound by end of Q1
Wild cards: Iran sanctions, US recession

Dec 31

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Daily Finance: Reality Check 2019: What Premium Does Thanachart Deserve from TMB’s Takeover? and more

By Smartkarma Daily Briefs | Financials

In this briefing:

Reality Check 2019: What Premium Does Thanachart Deserve from TMB’s Takeover?
Last Week in Event SPACE: Harbin Electric, MYOB, TMB Bank, Halla Holdings
Okinawa Cellular (9436 JP): Warm Tropical Breezes with KDDI
GMO Internet (9447 JP) – Grossly or Modestly Overrated?
LIC Housing Finance Ltd. – Builder Loans and LAP to Drive Growth in Loan Book

1. Reality Check 2019: What Premium Does Thanachart Deserve from TMB’s Takeover?

Tmb

As the merger between TMB and Thanachart gets a nudge from the Ministry of Finance and could be finalized this month, we try to answer a few questions in this review:

Takeover premium. Based on our estimates, the potential improvements in ROE from the merger and potential divestment of MBK, we think it justifies an Bt11.1/sh premium for Thanachart. The new best case price target for Thanachart stands at Bt64.25/sh, implying a 29% premium over current share price.
Negotiations will play a key role in the actual takeover price. We provide a table of how much money is left on the table for TMB if they acquire TCAP at lower than what we expect.
Benefits. Thanachart has a higher ROE than TMB and appears smaller but better managed. The merger would allow TMB to re-enter the securities business (more cross-selling), enlarge its asset management franchise, and scale up deposit base for both banks…more so on the Thanachart side.
Size. Even after the merger, the combined bank would still have a much smaller headcount than BAY, smallest of the five largest Thai banks. However, it would have more branches than BAY and just 11% less branches than KBANK.

2. Last Week in Event SPACE: Harbin Electric, MYOB, TMB Bank, Halla Holdings

Last Week in Event SPACE …

Just how will Harbin Electric Co Ltd H (1133 HK)‘s independent directors justify recommending an Offer to shareholders at a price which gave cash less cavalier than cash?
MYOB Group Ltd (MYO AU)‘s directors grudgingly yet understandably enter an agreed deal with KKR.
A TMB Bank PCL (TMB TB) / Thanachart Capital (TCAP TB) courtship is a possibility after an earlier Krung Thai Bank Pub (KTB TB) /TMB alliance failed.

(This insight covers specific insights & comments involving Stubs, Pairs, Arbitrage, share Classification and Events – or SPACE – in the past week)

M&A – ASIA-PAC

Harbin Electric Co Ltd H (1133 HK) (Mkt Cap: $546mn; Liquidity: $0.4mn)

As previously discussed in Harbin Electric Expected To Be Privatised, Harbin Electric (HE) has now announced a privatisation Offer from parent and 60.41%-shareholder Harbin Electric Corporation (“HEC”) by way of a merger by absorption. The Offer price of $4.56/share, an 82.4% premium to last close, is bang in line with that paid by HEC in January this year for new domestic shares. The Offer price has been declared final.

Of note, the Offer price is a 37% discount to HE’s net cash of $7.27/share as at 30 June 2018. Should the privatisation be successful, this Offer will cost HEC ~HK$3.08bn, following which it can pocket the remaining net cash of $9.3bn PLUS the power generation equipment manufacturer business thrown in for free.
On pricing, “fair” to me would be something like the distribution of net cash to zero then taking over the company on a PER with respect to peers. That is not happening. It will be difficult to see how independent directors (and the IFA) can justify recommending an Offer to shareholders at any price below the net cash/share, especially when the underlying business is profit-generating.
Dissension rights are available, however, there is no administrative guidance on the substantive as well as procedural rules as to how the “fair price” will be determined under PRC and HK Law.
Trading at a gross/annualised spread of 15%/28% assuming end-July completion, based on the average timeline for merger by absorption precedents. As HEC is only waiting for approval from independent H-shareholders suggests this transaction may complete earlier than precedents.

(link to my insight: Harbin Electric: The Price Is Not Right)

MYOB Group Ltd (MYO AU) (Mkt Cap: $1.2bn; Liquidity: $7mn)

KKR and MYOB entered into Scheme Implementation Agreement (SIA) at $3.40/share, valuing MYOB, on a market cap basis, at A$2bn. MYOB’s board unanimously recommends shareholders to vote in favour of the Offer, in the absence of a superior proposal. The Offer price assumes no full-year dividend is paid.

On balance, MYOB’s board has made the right decision to accept KKR’s reduced Offer. The argument that MYOB is a “known turnaround story” is challenged as cloud-based accounting software providers Xero Ltd (XRO AU) and Intuit Inc (INTU US) grab market share. This is also reflected in MYOB’s forecast 7% revenue growth in FY18 and follows a 10% decline in first-half profit, despite a 61% jump in online subscribers.
And there is justification for KKR’s lowering the Offer price: the ASX is down 10% since KKR’s initial tilt, the ASX technology index is off by ~14%, a basket of listed Aussie peers are down 17%, while Xero, the most comparable peer, is down ~20%. The Scheme Offer is at a ~27% premium to the estimated adjusted (for the ASX index) downside price of $2.68/share.
Bain was okay selling at $3.15/share to KKR and will be fine selling its remaining ~6.5% stake at $3.40. Presumably, MYOB sounded out the other major shareholders such as Fidelity, Yarra Funds Management, Vanguard etc as to their read on the revised $3.40 offer, before agreeing to the SIA with KKR.
If the markets avoid further declines, this deal will probably get up. If the markets rebound, the outcome is less assured. This Tuesday marks the beginning of a new year and a renewed mandate for investors to take risk, especially an agreed deal; but the current 5.3% annualised spread is tight.

(link to my insight: MYOB Caves And Agrees To KKR’s Reduced Offer)

TMB Bank PCL (TMB TB) (Mkt Cap: $1.2bn; Liquidity: $7mn)

The Ministry of Finance, the major shareholder of TMB, confirmed that both Krung Thai Bank Pub (KTB TB) and Thanachart Capital (TCAP TB) had engaged in merger talks with TMB. Considering an earlier KTB/TMB courtship failed, it is more likely, but by no means guaranteed, that the deal with Thanachart will happen. Bloomberg is also reporting that Thanachart and TMB want to do a deal before the next elections, which is less than two months away.

TMB is much bigger than Thanachart and therefore it may boil down to whether TMB wants to be the target or acquirer. In Athaporn Arayasantiparb, CFA‘s view, a deal with Thanachart would leave TMB as the acquirer rather than the target. But Thanachart’s management has a better track record than TMB.
Both banks have undergone extensive deals before this one: 1) TMB acquired DBS Thai Danu and IFCT; and 2) Thanachart engineered an acquisition of the much bigger, but struggling, SCIB.
A merger between the two would still leave them smaller than Bank Of Ayudhya (BAY TB) and would not change the bank rankings; but it would give TMB a bigger presence in asset management, hire-purchase finance and a re-entry into the securities business.

(link to Athaporn’s insight: Sathorn Series M: TMB-Thanachart Courtship)

STUBS/HOLDCOS

Halla Holdings (060980 KS) / Mando Corp (204320 KS)

Mando accounts for 45% of Halla’s NAV, which is currently trading at a 50% discount. Sanghyun Park believes the recent narrowing in the discount may be due to the hype attached to Mando-Hella Elec, which he believes is overdone; and recommends a short Holdco and long Mando. Using Sanghyun’s figures, I see the discount to NAV at 51%, 2STD above the 12-month average of ~47%.

(link to Sanghyun’s insight: Halla Holdings Stub Trade: Downwardly Mean Reversion in Favor of Mando)

SHARE CLASSIFICATIONS

LG Chem Ltd (051910 KS)‘s 1P is now at a 44.20% discount to Common. The dividend will be the same as last year of ₩6,000 despite lower earnings. The dividend yield for Common will be 1.68%, and 3.03% for 1P or a dividend yield difference of 1.35%, a four-year high. (link to Sanghyun’s insight: LG Chem Share Class: Another Pref to Watch as Div Yield Gap at 4Y High)

OTHER M&A UPDATES

Glow Energy Pcl (GLOW TB). In a strange twist to the tale, the ERC agrees to approve Global Power Synergy Company Ltd (GPSC TB)‘s takeover of Glow under a revised plan in which they have to: 1) sell Glow SPP1, a power plant with 124MW capacity and 90 tons/hr of steam; and 2) allow clients such as Pa Daeng to change providers. This will reduce Glow’s market share within the MapTaPhut area, but Athaporn Arayasantiparb, CFA thinks the purchase price (Bt139bn according to Bangkok Post) will have to be revised downwards too. For more on the original deal, see Deal Alert! GPSC Goes For the Jugular! and Anti-Trust Should Be A Non-Issue In The GPSC/Glow Deal.
Unisem (M) (UNI MK). The Offer is now unconditional and will remain open to acceptances until the 7 January 2019.
Stanmore Coal (SMR AU). The offer has been extended until the 22 January 2019.

CCASS

My ongoing series flags large moves (~10%) in CCASS holdings over the past week or so, moves which are often outside normal market transactions. These may be indicative of share pledges. Or potential takeovers. Or simply help understand volume swings.

Often these moves can easily be explained – the placement of new shares, rights issue, movements subsequent to a takeover, amongst others. For those mentioned below, I could not find an obvious reason for the CCASS move.

Name	% change	Into	Out of	Comment
Putian Communication (1720 HK)	69.75%	Shanghai Pudong	Outside CCASS
Chu Kong Shipping Enterprises(Grp) (560 HK)	37.68%	China Industrial	Outside CCASS
C-Mer Eye Care Holdings Limited (3309 HK)	16.23%	HSBC	Outside CCASS

Source: HKEx

3. Okinawa Cellular (9436 JP): Warm Tropical Breezes with KDDI

Dps

As the colder winter weather is felt and the icy blast of industry tariff cuts continues to chill sentiment, we seek some respite (at least mentally) in the warmer climes of Okinawa. Okinawa Cellular is a unique company. It’s a small cap telecom network operator in Japan with a focus on the sub-tropical islands of Okinawa Prefecture. As part of the KDDI group, the company benefits from its parent’s economies of scale, but with its local presence, it also benefits from being the hometown hero.

Because the stock is relatively small, from an investment perspective it runs into liquidity constraints that the other telcos do not have, so it’s a different type of investment but one that we think is worth looking at. Over the past 12 months Okinawa Cellular’s stock has fallen by 12.3%, but over the past year the stock has delivered a return in the middle of its peer group and has outperformed the broad TOPIX by about 5.5%. Like most telcos, Okinawa Cellular is also ramping its dividend payments, and the current yield is about 3.5%.

4. GMO Internet (9447 JP) – Grossly or Modestly Overrated?

Gpa2

Source: Japan Analytics

THE GMO INTERNET (9449 JP) STORY – GMO internet (GMO-i) has attracted much attention in the last eighteen months from an unusual trinity of value, activist and ‘cryptocurrency’ equity investors.

VALUE– Many traditional, but mostly foreign, value investors have seen the persistent negative difference between GMO-i’s market capitalisation and the value of the company’s holdings in its eight listed consolidated subsidiaries as an opportunity to invest in GMO-i with a considerable ‘margin of safety’.
ACTIVIST – Since July 2017, the activist investor, Oasis, has waged a so-far-unsuccessful campaign with the aim of improving GMO’s corporate governance, removing takeover defences, addressing a ‘secularly undervalued stock price we are not able to tolerate’ (sic), and redefining the role and influence of the company’s Chairman, President, Representative Director and largest shareholder, Masatoshi Kumagai.
‘CRYPTO!’ – In December 2017, GMO-i committed to spending more than ¥35b or 10% of non-current assets. The aim was threefold: to set up a bitcoin ‘mining’ headquarters in Switzerland (with the ‘mining’ operations being carried out at an undisclosed location in Scandinavia), to develop proprietary state-of-the-art 7nm-node ‘mining chips’, and, in due course, to sell GMO-branded and developed ‘mining’ machines. The move was hailed in the ‘crypto’ fraternity as GMO-i became the largest non-Chinese and the first well-established Internet conglomerate to make a major investment in ‘cryptocurrency’ infrastructure.

OUTSTANDING – Following the December 2017 announcement, trading volumes spiked into ‘Overtraded’ territory – as measured by our Volume Score. Many investors saw GMO-i shares as a safer way of gaining exposure to ‘cryptocurrencies’, even as the price of bitcoin began to subside. By early June 2018, GMO-i’s shares had reached a closing price of ¥3,020: up 157% from the low of the prior year and outperforming TOPIX by 135%. Whatever the primary driver of this outstanding performance, each of our trio of investor groups no doubt felt vindicated in their approach to the stock.

CRYPTO CLOSURE – On December 25th 2018, GMO-i’s shares reached a new 52-week low of ¥1,325, a decline of 56% from the June high. Year to date, GMO-i shares have now declined by 31%, underperforming TOPIX by nine percentage points. On the same day, GMO-i announced that the company would post an extraordinary ¥35.5b loss for the fourth quarter, incurring an impairment loss of ¥11.5b in relation to the closure of the Swiss ‘mining’ headquarters and a loss of ¥24b to cover the closure of the ‘mining chip’ and ‘mining machine’ development, manufacturing and sales businesses. GMO-i will continue to ‘mine’ bitcoin from its Tokyo headquarters and intends to relocate the ‘mining’ centre from Scandinavia to (sic) ‘a region that will allow us to secure cleaner and less expensive power supply, but we have not yet decided the details’. Unlisted subsidiary GMO Coin’s ‘cryptocurrency’ exchange will also continue to operate, and the previously-announced plans to launch a ¥-based ‘stablecoin’ in 2019 will proceed. In the two trading days following this announcement, the shares have recovered 13% to ¥1,505.

RAIDING THE LISTCO PIGGY BANK – As we shall relate, this is the second time since listing that GMO-i has written off a significant new business venture which the company had commenced only a short time before. In both cases, the company was forced to sell stakes in its listed consolidated subsidiaries to offset the resulting losses. On this occasion, the sale of shares in GMO Financial (7177 JP) (GMO-F) on September 25 2018, and GMO Payment Gateway (3769 JP) (GMO-PG) on December 17 2018, raised a combined ¥55.6b and, after the deduction of the yet-to-be-determined tax on the realised gains, should more than offset the ‘crypto’ losses. According to CFO Yasuda, any surplus from this exercise will be used to pay down debt. Also discussed below and in keeping with this GMO-i ‘MO’, in 2015, the company twice sold shares in its listed subsidiaries to ‘smooth out’ less-than-desirable operating results.

In the DETAIL section below we will cover the following topics:-

I: THE GMO-i TRACK RECORD – TOP-DOWN v. BOTTOM UP

BOTTOM LINE No. 1: NET INCOME
BOTTOM LINE No.2 – COMPREHENSIVE INCOME

II: THE GMO-i BUSINESS MODEL – THROWING JELLY AT THE WALL

III: THE GMO-i BALANCE SHEET – NOT SO HAPPY RETURNS

IV: THE GMO-i CASH FLOW – DEBT-FUNDED CASH PILE

V: THE GMO-i VALUATION – TWO METHODS > SAME RESULT

VALUATION METHOD No.1 – THE ‘LISTCO DISCOUNT’
VALUATION METHOD No.2 – RESIDUAL INCOME

CONCLUSION – For those unable or unwilling to read further, we conclude that GMO-i ‘rump’ is a grossly-overrated business. Despite having started and spun off several valuable GMO Group entities, CEO Kumagai bears responsibility for two decades of serial and very poorly-timed ‘mal-investments’. As a result, the stock market has, except for the ‘cryptocurrency’-induced frenzy of the first six months of 2018, historically not accorded GMO-i any premium for future growth, and has correctly looked beyond the ‘siren song’ of the ‘HoldCo discount’. According to the two valuation methodologies described below, the company is, however, fairly valued at the current share price of ¥1,460. Investors looking for a return to the market-implied 3% perpetual growth rate of mid–2018 are likely to be as disappointed as those wishing for BTC to triple from here.

5. LIC Housing Finance Ltd. – Builder Loans and LAP to Drive Growth in Loan Book

Lichf

Lic Housing Finance (LICHF IN), founded by Life Insurance Corporation of India, is the 2^nd largest Housing Finance Company (HFC) in India with a total outstanding loan book portfolio of Rs 1,759 bn as of 2QFY19. 94% of the company’s loans were to retail customers as home loans & Loan Against Properties (LAP) and the balance 6% were to project developers as of 2QFY19.

We like the business of LICHF for following reasons:

LICHF focuses on the salaried segment. 86% of the customers as of 2QFY19 were from the salaried class. This provides the company with stability in earnings and better asset quality. We expect the NIMs & Spreads to be stable at 2.4% & 1.2% respectively for the period of FY18-21E.
We expect LICHF’s total loan book to grow at a CAGR of 16% over the period of FY18-21E. This growth will be supported by LAP and Developer loans. We expect the retail home loan portfolio to grow at a CAGR of 11% over the same period.
As the company focuses on LAP & developer segment to grow the total loan book, we expect this to affect the asset quality adversely. We expect the Gross Non-Performing Assets (GNPA) & Net Non-Performing Assets (NNPA) to increase to 1.3% (from 1.2% as of Sept-18) & 0.5% (from 0.4% as of Sept-18) respectively.

We initiate coverage on LICHF with a fair value estimate of Rs 570/- over the next 12 months. This implies a potential upside of 19% from the closing market price of Rs 481 as on 20^th December 2018. This is arrived by applying P/ABV (Price to Adjusted Book Value) multiple of 1.7X to our Adjusted Book Value Estimate of Rs 337 per share for the period ending Sept-20E.

Particulars	FY18	FY19E	FY20E	FY21E
P/ABV (X)	2.1	1.7	1.5	1.3
ROE (%)	17.3	15.5	14.5	15.1
ROA (%)	1.3	1.2	1.2	1.2

Source: Trivikram Consultants Research as of 20^th December 2018

Note: E= Estimates

Dec 31

0

Daily TMT & Internet: Tesla Motors Inc: Come Hell or High Water and more

By Smartkarma Daily Briefs | TMT/Internet

In this briefing:

Tesla Motors Inc: Come Hell or High Water
Nintendo: Is the Hype Surrounding the Switch Slowly Dying Down?
Hyosung Holdings: 10%p Drop in Discount to NAV Should Be Reverted Soon
Recruit Holdings Down 30% From October; Still Not Cheap
Uber IPO: Its Sprawling Empire And Battle Lines (Part 3)

1. Tesla Motors Inc: Come Hell or High Water

It is our view, that come hell or high-water, in 2019, Tesla Motors (TSLA US) will establish itself as the pre-eminent large-cap growth stock. Those that are short would cover the position at a loss and those that are long are looking at another Apple Inc (AAPL US) or Amazon.com Inc (AMZN US) in the making. The ride may be volatile, but will be worth it.

2. Nintendo: Is the Hype Surrounding the Switch Slowly Dying Down?

Nintendo reported their 2QFY03/19 in October with results showing growth at both the top line and bottom line albeit not living up to consensus expectations. Top line grew by 4.0% YoY to JPY388.9bn in 1H03/19 while OP grew by 53.9% YoY to JPY61.4bn. OP in the last quarter (2QFY03/19) was the second highest the company has experienced over the last five years. This growth has been mainly driven by the sales of Nintendo Switch hardware which sold just over 5m units in 1HFY03/19. However, YoY growth remained at 3.4% compared to 4.9m units sold in 1HFY03/18. This has left investors worried about Nintendo’s aggressive target of selling 20m units of the Switch for FY03/19. Of this target, the company has managed to achieve only around 25.0% in 1H. Nintendo’s financial performance follows a seasonal trend with the December quarter showing stronger performance due to increased sales during Christmas. While the company’s current quarter is likely to show strong results, we remain skeptical about the company reaching the aforementioned target for FY03/19.

Switch Sales Have Caused an Improvement in Nintendo’s OP….

Source: Capital IQ

….Despite a Slowdown in the Growth of Units Sales

Source: Nintendo website

Nintendo’s Last Quarter Has Also Failed to Live Up To Consensus Expectations

Source: Capital IQ

Source: Capital IQ

3. Hyosung Holdings: 10%p Drop in Discount to NAV Should Be Reverted Soon

Hyosung Corporation (004800 KS) had fallen 16% just in two days. Holdco is now at a 50% discount to NAV. This is a 10%p drop from 10 days ago (Dec 19). Holdco price must have been overly corrected. The ongoing police investigation on Cho Hyun-joon’s alleged crime won’t lead to a delisting. 10%p drop in discount to NAV must be a price divergence, not a sensible price correction.
Trade volume remained steady. Local hedge funds led the selling on Dec 27. Even they changed their position the following day. No short selling spike has been seen either. Hyosung is one of the highest yielding div holdco stocks. Hyosung Capital liquidation and Anyang Plant revaluation would be another short-term plus.
I’d exploit this price divergence. It would soon revert to the Dec 19 discount level. It should at least stay at the peer average.

4. Recruit Holdings Down 30% From October; Still Not Cheap

Capture

The share price of Recruit Holdings (6098 JP) has fallen by around 30% over the past three months from an all-time high of JPY3,826 (on 1^st October 2018) to JPY2,705 on 24^th December 2018. Prior to this, Recruit’s share price saw a strong upward rally during May-September following the company’s announcement that it would acquire Glassdoor Inc. (the company which operates the employment information website glassdoor.com).

We expect Recruit’s consolidated revenue to grow 7.7% and 6.5% YoY in FY03/19E and FY03/20E respectively, driven by the acquisition of Glassdoor and steady growth in Japanese staffing operations, partially offset by a likely slowdown in global labour market activity. We also expect Recruit’s consolidated EBITDA margin to improve by around 50bps due to higher margin from Glassdoor.

Despite the recent dip in share price and steady topline and bottom line growth over the forecast period, at a FY2 EV/EBITDA multiple of 14.0x, Recruit doesn’t look particularly attractive to us. Recruit’s internet advertising business and employment business peers, Yahoo Japan (4689 JP) and Persol Holdings (2181 JP) are trading at FY2 EV/EBITDAs of 7.7x and 9.6x respectively.

Key Financials FY03/18-20E

	FY03/18	FY03/19E	FY03/20E
Consolidated Revenue (JPYbn)	2,171	2,338	2,490
YoY Growth %	11.9%	7.7%	6.5%
Consolidated EBITDA (JPYbn)	258	288	312
EBITDA Margin %	11.9%	12.3%	12.5%

Source: Company Disclosures/LSR Estimates

5. Uber IPO: Its Sprawling Empire And Battle Lines (Part 3)

Although Uber aims to be an Amazon for transport, we will focus on the ride-hailing market in part 3 of this series. Here, we try to answer the following questions:

What are the indicative ride-hailing market shares of Uber vs Lyft in North America?
What is Uber’s share in other key countries?
What are the lawsuits investors should watch out for?
How do Uber’s revenue drivers compare with Lyft’s?
What are the timelines and key figures for both companies’ IPOs?

This is the third note in a series about the expected 2019 IPO of global ride-hailing giant Uber Technologies (0084207D US) and Lyft. Please read the earlier two pieces in the series for better contexts:

Uber IPO Preview: Its Sprawling Empire and Battle Lines (Part 1) written by me.

Uber IPO Preview: Fast-Growing Uber Eats Has Become a Material Part of Uber (Part 2) written by Daniel Hellberg

Dec 31

0

Daily Finance: SPX Tactical Reversal Level for Bounce with Asia/EM’s the Perform and more

By Smartkarma Daily Briefs | Financials

In this briefing:

SPX Tactical Reversal Level for Bounce with Asia/EM’s the Perform
Sathorn Series M: TMB-Thanachart Courtship
FBN Holdings: A Contrarian Call from Behind the Hydrocarbon Clouds and Shadows

1. SPX Tactical Reversal Level for Bounce with Asia/EM’s the Perform

Short press below S&P 2,600 working well but the pace of the decline warns of a bigger macro bear cycle ahead in 2019.

Near term we are moving into oversold territory in core sectors featured in this webcast as the S&P approaches our first key target near 2,350. Given risk of a bounce post Christmas we are placing a tactical reversal target above this level.

Support levels to work into are outlined as well as tactical bounce targets. Given key support breaks that macro picture continues to favor shorting rally attempts as our cycle work suggests we see more pain after the New Year.

EEM outperform versus the S&P is gaining traction and with a USD roll would see additional fuel.

MSCI Asia x Japan perform call over US equities is also taking shape. Buy support targets outlined. If one intends to trade a year-end would licking bounce then Asia/EM’s is the space to participate.

2. Sathorn Series M: TMB-Thanachart Courtship

Right before Christmas, the Ministry of Finance confirms that both Thanachart and KTB were in talks to merge with TMB. We note that:

Considering that KTB’s earlier courtship failed once, it is more likely, but by no means guaranteed, for the deal with Thanachart to happen.
A deal with Thanachart would leave TMB as the acquirer rather than the target. Thanachart’s management has better track record than TMB.
Both banks have undergone extensive deals before this one: 1) TMB acquired DBS Thai Danu and IFCT; and 2) Thanachart engineered an acquisition of the much bigger, but struggling, SCIB.
A merger between the two would still leave them smaller than BAY and not really change the bank rankings, but it would give TMB a bigger presence in asset management and hire-purchase finance and an re-entry into the securities business.

3. FBN Holdings: A Contrarian Call from Behind the Hydrocarbon Clouds and Shadows

FBN Holdings Plc (FBNH NL) is the oldest and second-largest bank in Nigeria with a market share of 14% of domestic loans.

FBN’s solid franchise provides robust revenue generation capacity (especially in e-business and insurance) plus a solid and cheap funding base complemented by a strong liquidity profile. The Group’s solid funding base of low cost retail deposits, mainly CASA, underpins one of the most competitive in the sector.

Under new management, FBN is focused on a legacy asset quality clean-up and enhancing risk controls. The franchise has exhibited resilience in the face of system-wide asset quality problems, related to some extent to the concentration of oil/gas exposures. Moving forward, profitability can strengthen with improving asset quality though the recent plunge in oil prices represents a threat to this de-risking process. A plus point is the vibrant income streams from e-business and insurance growth drivers.

The operating environment in Nigerian remains challenging: while the country has emerged from a recession, vulnerabilities remain. Lower oil prices, tighter external market conditions, heightened security issues, and delayed policy responses are the main downside risks. The recent fall in oil prices is a concern given Nigeria’s dependency on the commodity and its knock-on effect to the hydrocarbon-exposed Banking System. Although access to foreign currency has eased, due to FX reforms, many borrowers retain limited capacity to service obligations and there are modest opportunities for banks to grow their loan portfolios.

FBN is thus somewhat of a contrarian call given the weakness in the oil market. But one should buy a hydrocarbon “play” when prices are low, not high. Shares trade at a 60% discount to Book Value and stand on a low Mkt Cap./Deposits rating of 8%, far below the global and EM median. FBN commands a dividend-adjusted PEG of 1.3x. Dividend and earnings yields are 3.3% and 15%, respectively. A quintile 1 PH Score™ of 7.7 captures the valuation dynamic while metric change is satisfactory. Combining franchise valuation and PH Score™, FBN stands in the top quintile of opportunity globally. The asset quality position and interrelated lower profitability vis-a-vis peers is a reason behind FBN’s lower credit rating and relatively low valuation. We are somewhat sceptical that FBN’s underlying creditworthiness and valuation are efficiently evaluated versus more popular counterparts.

Dec 31

0

Daily TMT & Internet: Okinawa Cellular (9436 JP): Warm Tropical Breezes with KDDI and more

By Smartkarma Daily Briefs | TMT/Internet

In this briefing:

Okinawa Cellular (9436 JP): Warm Tropical Breezes with KDDI
GMO Internet (9447 JP) – Grossly or Modestly Overrated?
58.com Inc. (NYSE: WUBA): Regulatory Pressure Has Long Term Implications
MYOB (MYO AU): Shareholders Are Caught Between a Rock and a Hard Place
Infosys Ltd (INFO IN): Another Buyback Coming? Not a Bad Idea, but How Much It Can Really Help?

1. Okinawa Cellular (9436 JP): Warm Tropical Breezes with KDDI

Dps

As the colder winter weather is felt and the icy blast of industry tariff cuts continues to chill sentiment, we seek some respite (at least mentally) in the warmer climes of Okinawa. Okinawa Cellular is a unique company. It’s a small cap telecom network operator in Japan with a focus on the sub-tropical islands of Okinawa Prefecture. As part of the KDDI group, the company benefits from its parent’s economies of scale, but with its local presence, it also benefits from being the hometown hero.

Because the stock is relatively small, from an investment perspective it runs into liquidity constraints that the other telcos do not have, so it’s a different type of investment but one that we think is worth looking at. Over the past 12 months Okinawa Cellular’s stock has fallen by 12.3%, but over the past year the stock has delivered a return in the middle of its peer group and has outperformed the broad TOPIX by about 5.5%. Like most telcos, Okinawa Cellular is also ramping its dividend payments, and the current yield is about 3.5%.

2. GMO Internet (9447 JP) – Grossly or Modestly Overrated?

Gpa2

Source: Japan Analytics

THE GMO INTERNET (9449 JP) STORY – GMO internet (GMO-i) has attracted much attention in the last eighteen months from an unusual trinity of value, activist and ‘cryptocurrency’ equity investors.

VALUE– Many traditional, but mostly foreign, value investors have seen the persistent negative difference between GMO-i’s market capitalisation and the value of the company’s holdings in its eight listed consolidated subsidiaries as an opportunity to invest in GMO-i with a considerable ‘margin of safety’.
ACTIVIST – Since July 2017, the activist investor, Oasis, has waged a so-far-unsuccessful campaign with the aim of improving GMO’s corporate governance, removing takeover defences, addressing a ‘secularly undervalued stock price we are not able to tolerate’ (sic), and redefining the role and influence of the company’s Chairman, President, Representative Director and largest shareholder, Masatoshi Kumagai.
‘CRYPTO!’ – In December 2017, GMO-i committed to spending more than ¥35b or 10% of non-current assets. The aim was threefold: to set up a bitcoin ‘mining’ headquarters in Switzerland (with the ‘mining’ operations being carried out at an undisclosed location in Scandinavia), to develop proprietary state-of-the-art 7nm-node ‘mining chips’, and, in due course, to sell GMO-branded and developed ‘mining’ machines. The move was hailed in the ‘crypto’ fraternity as GMO-i became the largest non-Chinese and the first well-established Internet conglomerate to make a major investment in ‘cryptocurrency’ infrastructure.

OUTSTANDING – Following the December 2017 announcement, trading volumes spiked into ‘Overtraded’ territory – as measured by our Volume Score. Many investors saw GMO-i shares as a safer way of gaining exposure to ‘cryptocurrencies’, even as the price of bitcoin began to subside. By early June 2018, GMO-i’s shares had reached a closing price of ¥3,020: up 157% from the low of the prior year and outperforming TOPIX by 135%. Whatever the primary driver of this outstanding performance, each of our trio of investor groups no doubt felt vindicated in their approach to the stock.

CRYPTO CLOSURE – On December 25th 2018, GMO-i’s shares reached a new 52-week low of ¥1,325, a decline of 56% from the June high. Year to date, GMO-i shares have now declined by 31%, underperforming TOPIX by nine percentage points. On the same day, GMO-i announced that the company would post an extraordinary ¥35.5b loss for the fourth quarter, incurring an impairment loss of ¥11.5b in relation to the closure of the Swiss ‘mining’ headquarters and a loss of ¥24b to cover the closure of the ‘mining chip’ and ‘mining machine’ development, manufacturing and sales businesses. GMO-i will continue to ‘mine’ bitcoin from its Tokyo headquarters and intends to relocate the ‘mining’ centre from Scandinavia to (sic) ‘a region that will allow us to secure cleaner and less expensive power supply, but we have not yet decided the details’. Unlisted subsidiary GMO Coin’s ‘cryptocurrency’ exchange will also continue to operate, and the previously-announced plans to launch a ¥-based ‘stablecoin’ in 2019 will proceed. In the two trading days following this announcement, the shares have recovered 13% to ¥1,505.

RAIDING THE LISTCO PIGGY BANK – As we shall relate, this is the second time since listing that GMO-i has written off a significant new business venture which the company had commenced only a short time before. In both cases, the company was forced to sell stakes in its listed consolidated subsidiaries to offset the resulting losses. On this occasion, the sale of shares in GMO Financial (7177 JP) (GMO-F) on September 25 2018, and GMO Payment Gateway (3769 JP) (GMO-PG) on December 17 2018, raised a combined ¥55.6b and, after the deduction of the yet-to-be-determined tax on the realised gains, should more than offset the ‘crypto’ losses. According to CFO Yasuda, any surplus from this exercise will be used to pay down debt. Also discussed below and in keeping with this GMO-i ‘MO’, in 2015, the company twice sold shares in its listed subsidiaries to ‘smooth out’ less-than-desirable operating results.

In the DETAIL section below we will cover the following topics:-

I: THE GMO-i TRACK RECORD – TOP-DOWN v. BOTTOM UP

BOTTOM LINE No. 1: NET INCOME
BOTTOM LINE No.2 – COMPREHENSIVE INCOME

II: THE GMO-i BUSINESS MODEL – THROWING JELLY AT THE WALL

III: THE GMO-i BALANCE SHEET – NOT SO HAPPY RETURNS

IV: THE GMO-i CASH FLOW – DEBT-FUNDED CASH PILE

V: THE GMO-i VALUATION – TWO METHODS > SAME RESULT

VALUATION METHOD No.1 – THE ‘LISTCO DISCOUNT’
VALUATION METHOD No.2 – RESIDUAL INCOME

CONCLUSION – For those unable or unwilling to read further, we conclude that GMO-i ‘rump’ is a grossly-overrated business. Despite having started and spun off several valuable GMO Group entities, CEO Kumagai bears responsibility for two decades of serial and very poorly-timed ‘mal-investments’. As a result, the stock market has, except for the ‘cryptocurrency’-induced frenzy of the first six months of 2018, historically not accorded GMO-i any premium for future growth, and has correctly looked beyond the ‘siren song’ of the ‘HoldCo discount’. According to the two valuation methodologies described below, the company is, however, fairly valued at the current share price of ¥1,460. Investors looking for a return to the market-implied 3% perpetual growth rate of mid–2018 are likely to be as disappointed as those wishing for BTC to triple from here.

3. 58.com Inc. (NYSE: WUBA): Regulatory Pressure Has Long Term Implications

● We notice that Anjuke’s Oct.-Nov. traffic declined. We attribute this decline to the tightening of registration requirement in various cities, which will reduce the number of housing leads on WUBA platform;

● We, however, believe new home business will deliver strong revenue for WUBA this year, contributing Rmb2bn in revenues by our estimate;

● We rate the stock Buy and cut TP from US$84 to US$79.

4. MYOB (MYO AU): Shareholders Are Caught Between a Rock and a Hard Place

On 24 December, MYOB Group Ltd (MYO AU) announced that it entered into a scheme implementation agreement under which KKR will acquire MYOB at $3.40 per share, which is 10% lower than 2 November offer price of A$3.77. MYOB claims its decision to recommend KKR’s lower offer was based on current market uncertainty, long-term nature of its strategic growth plans and the go-shop provisions of the deal.

We believe that KKR’s revised offer is opportunistic, but MYOB’s shareholders are caught between a rock and a hard place. Shareholders can take a short-term view and grudgingly accept the revised offer. Alternatively, shareholders can take a long-term view by rejecting the offer and hope MYOB’s strategic growth plans and a market recovery can reverse the inevitable share price collapse.

5. Infosys Ltd (INFO IN): Another Buyback Coming? Not a Bad Idea, but How Much It Can Really Help?

As per reports, Infosys Ltd (INFO IN) may consider a proposal for a share buyback of $1.60 billion very soon. The buyback announcement is likely to be made on January 11 when the company board meets to consider the 3Q FY19 results. Before this, in November 2017, Infosys Ltd (INFO IN) had announced a buyback and spent Rs130 bn to buy a total of 113mn equity shares. This fresh buyback could be an important development and could be an important support for the stock, it is also sensible for other reasons.

There are no major acquisitions in recent times by Infosys Ltd (INFO IN) and if this is likely to be the trend for near future, share buyback is not a bad idea. The company is still struggling with some of the legacy issues and the priority as of now is to streamline the organic growth. We think Infosys Ltd (INFO IN) is also cautious with inorganic growth opportunities as the company had serious issues with acquisitions in the past. What could be another key driver behind this is that in valuation terms, Infosys Ltd (INFO IN) is not very expensive.

Dec 31

0

Daily TMT & Internet: SoftBank Corp (9434 JP) & Arteria Networks (4423 JP): A Tale of Two IPOs and more

By Smartkarma Daily Briefs | TMT/Internet

In this briefing:

SoftBank Corp (9434 JP) & Arteria Networks (4423 JP): A Tale of Two IPOs
MYOB Caves And Agrees To KKR’s Reduced Offer
COM7 (COM7 TB): Acquisition to Support Aggressive Expansion
TRACKING TRAFFIC/Chinese Express & Logistics: Parcel Pricing Weak, Again
Elastic: Why Is It Outperforming In Recent Tech Carnage?

1. SoftBank Corp (9434 JP) & Arteria Networks (4423 JP): A Tale of Two IPOs

During the second half of December 2018, Japan saw two telecom companies list on the Tokyo Stock Exchange: Softbank Corp (9434 JP) and ARTERIA Networks (4423 JP). After years of industry consolidation, which saw several stocks delist, this felt like a Christmas miracle (at least for those watching the sector’s stocks).

It would be hard to find two companies in the same industry that are so different – both in their business models as well as in how their IPOs were positioned to investors. One stock is 100 times larger than the other, but this is not a story of David and Goliath. It is two unique stories in parallel.

While each company took a very different approach to selling its stock, both have suffered from the subsequent broader market weakness, irrespective of company specifics. We can’t say it has been the worst of times, but it certainly has been a tough time with SoftBank Corp down 13% and Arteria down 20% from their IPO prices.

In this Insight we explore how each company approached its IPO and how each has fared since.

2. MYOB Caves And Agrees To KKR’s Reduced Offer

Chart

It could have gone either way.

After securing a 19.9% stake from Bain in early October and initially pitching A$3.70/share, in a textbook bear hug, KKR (marginally) bumped its indicative offer to A$3.77/share to a get a look under the hood, then following seven weeks of due diligence, backtracked with a lower price of A$3.40/share, citing adverse market conditions.

MYOB Board’s response last week to the reduced offer was to inform KKR that it is not in a position to recommend the revised proposal, however, “it remains in discussions with KKR regarding its proposal”, leaving the door open for ongoing negotiations. KKR for its part, said there were no landmines following the DD process. The price action last Friday suggested the outcome was a coin toss.

Today, KKR and MYOB entered into Scheme Implementation Agreement (SIA) at $3.40/share, valuing MYOB, on a market cap basis, at A$2bn. MYOB’s board unanimously recommends shareholders to vote in favour of the Offer, in the absence of a superior proposal and subject to an independent expert concluding the Offer is in the best interest of shareholders. The Offer price assumes no full-year dividend is paid.

The agreement provides a “go shop” provision until the 22 February 2019 – when MYOB is expected to release its FY18 results – to solicit competing proposals.

The Offer appears reasonable when compared to peers and with regards to the 14% decline in the ASX technology index; but conversely, could be construed as being opportunistic.

A Scheme Booklet is expected to be dispatched mid-March with an estimated implementation date of 3 May. Currently trading at a 3.8%/11% gross/annualised spread. 1 January makes a new year and there will be investors who would want to take an agreed deal at 11%.

3. COM7 (COM7 TB): Acquisition to Support Aggressive Expansion

Improving asset turnover, good risk adjusted price momentum, and relatively strong analyst recommendations relative to its sector
Larger distribution channel through acquisition of DNA Retail Link to add 95 more stores to current 518 stores
New mobile product launches in 4Q18 and COM7’s focus on high margin products, such as Android smartphones, should support high earnings growth which was up 56% YoY in 3Q18
Attractive at a 19CE* PEG of 0.9 versus ASEAN sector at a PEG of 2.7
Risks: Lower-than-expected demand for new IT products, slower-than-expected store expansions

* Consensus Estimates

4. TRACKING TRAFFIC/Chinese Express & Logistics: Parcel Pricing Weak, Again

Tracking Traffic/Chinese Express & Logistics is the hub for our research on China’s express parcels and logistics sectors. Tracking Traffic/Chinese Express & Logistics features analysis of monthly Chinese express and logistics data, notes from our conversations with industry players, and links to company and thematic notes.

This month’s issue covers the following topics:

November express parcel pricing remained weak. Average pricing per express parcel fell by 7.8% Y/Y to just 11.06 RMB per piece. November’s average price represents a new all-time low for the industry, and November’s Y/Y decline was the steepest monthly decline in over two years (excluding Lunar New Year months, which tend to be distorted by the timing of the holiday).
Express parcel revenue growth dipped below 15% last month. Weak per-parcel pricing pulled express sector Y/Y revenue growth down to just 14.6% in November, the worst on record (again excluding distorted Lunar New Year comparisons). Chinese e-commerce demand has slowed and we suspect ‘O2O’ initiatives, under which online purchases are fulfilled via local stores, are also undermining express demand growth.
Intra-city pricing (ie, local delivery) remains firm relative to inter-city. Relative to weak inter-city express pricing (where ZTO Express (ZTO US) and the other listed express companies compete), pricing for local, intra-city express deliveries remained firm. In the first 11 months of 2018, express pricing rose 1.7% Y/Y versus a -2.9% decline in inter-city shipments (international pricing fell sharply, -14.5% Y/Y). Relatively firm pricing on local shipments may make it hard for local food delivery companies like Meituan Dianping (3690 HK) and Alibaba Group Holding (BABA US) ‘s ele.me to beat down unit operating costs.
Underlying domestic transport demand held up well again in November. Although demand for speedy, relatively expensive express service (and air freight) appears to be moderating, demand for rail and highway freight transport has held up well. The relative strength of rail and water transport (slow, cheap, industry-facing) versus express and air freight (fast, expensive, consumer-oriented) suggests a couple of things: a) upstream industrial activity is stronger than downstream retail activity and b) the people in charge of paying freight are shifting to cheaper modes of transport when possible.

We retain a negative view of China’s express industry’s fundamentals: demand growth is slowing and pricing appears to be falling faster than costs can be cut. Overall domestic transportation demand, however, remains solid and shows no signs of slowing.

5. Elastic: Why Is It Outperforming In Recent Tech Carnage?

Db 1

Elastic NV (ESTC US) has been one of the best tech IPOs globally in 2018. Its current price is $62.53, up 74% from its IPO price of $36. Elastic’s share price has been holding up very nicely since its IPO on October 5th, 2018. Meanwhile, from October 5th to December 21st 2018, many tech stocks have experienced brutal declines. Elastic’s ability to outperform the top US tech stocks in a very difficult environment for the stock market sets the stage for a continued out-performance once the stock market starts to stabilize.
Since the IPO, the company reported better than expected second quarter results (quarter ending October 31, 2018) on December 4th. The company’s adjusted net loss in FY2Q19 was $0.38 per share, beating analysts’ consensus estimate by 9 cents. It generated revenue of $63.6 million, up 72% YoY. Calculated billings were also strong at $88.5 million, up 73% YoY.
The company’s guidance for FY3Q19 (quarter ending January 31, 2019) is to generate revenue in the range of $64 million to $66 million, representing a 56% YoY growth rate at the midpoint of the guidance. It expects to generate operating margin of negative 28% to negative 30% in FY3Q19.
A combination of major investors shifting their assets away from FAANG and semiconductor stocks has resulted in some improved performance of many software related stocks in recent months relative to other major tech stocks. In general, these stocks face less negative impact from a prolonged trade war between China and the US. Plus, they are not as exposed to the higher cycle volatility as the semiconductor related stocks. In many respects, Elastic shares many business similarities with these software driven companies, and thus has been more immune from the decline in the stock prices since early October. We remain positive on Elastic NV (ESTC US).

Dec 31

0

Daily Industrials: Daelim Industrial Share Class: One of Prefs to Arb Trade on Div Payout Record Date and more

By Smartkarma Daily Briefs | Industrials

In this briefing:

Daelim Industrial Share Class: One of Prefs to Arb Trade on Div Payout Record Date
TRACKING TRAFFIC/Containers & Air Cargo: Container Rates Up
TRACKING TRAFFIC/Chinese Express & Logistics: Parcel Pricing Weak, Again
Horiba (6856 JP): Bad News Largely Discounted

1. Daelim Industrial Share Class: One of Prefs to Arb Trade on Div Payout Record Date

Daelim Industrial (000210 KS) is one of the main targets of local activist movement. This makes a setting for higher dividends. Common div yield to 1.58% and Pref to 4.18%. Difference is 2.59%p. This is the widest gap in many years.
Pref is currently at a 60.89% discount to Common. Among those > ₩100bil MC prefs, it is the second highest discounted pref, only behind CJ Cheiljedang 1P (097955 KS). Local street expects at least ₩1,600 div per share. This should be a conservative estimate. On a 20D MA, Pref is above +1 σ.
Dec 26 is record date of dividend payout. I expect a price catchup movement tomorrow in favor of Pref. I’d go long Pref and short Common as early in the morning as possible.

2. TRACKING TRAFFIC/Containers & Air Cargo: Container Rates Up

Tracking Traffic/Containers & Air Cargo is the hub for all of our research on container shipping and air cargo, featuring analysis of monthly industry data, notes from our conversations with industry participants, and links to recent company and thematic pieces.

Tracking Traffic/Containers & Air Cargo aims to highlight changes to existing trends, relationships, and views affecting the leading Asian companies in these two sectors. This month’s note includes data from about twenty different sources.

In this issue readers will find:

An analysis of November container shipping rates, which our index suggests increased by over 20% Y/Y. We concede that our index skews toward volatile spot rates rather than contract rates, but we suspect higher average container rates in Q418, combined with moderating fuel prices, will result in surprisingly strong earnings for the quarter.
A look at November air cargo activity and air cargo pricing, which diverged. The volume of air cargo handled by the five airlines we track declined slightly (-0.1% Y/Y) but some of those carriers reported sharply higher yields (circa +10% Y/Y), due to limited capacity expansion in the region.
Some good news: fuel prices have continued to moderate. Bunker climbed by just 5.1% Y/Y as of mid-December, and jet fuel prices have fallen about 11% Y/Y. Given firm container rates and air cargo pricing, the drop in fuel prices bodes well for Q418 margins, though it’s unclear whether such gains are sustainable.

Although slowing demand growth is unlikely to generate impressive top-line improvements, firmer pricing combined with lower fuel costs should support an ongoing improvement in profitability for container carriers and air cargo operations in the near-term. We believe many investors remain too pessimistic regarding near-term earnings for container carriers and airlines.

3. TRACKING TRAFFIC/Chinese Express & Logistics: Parcel Pricing Weak, Again

Tracking Traffic/Chinese Express & Logistics is the hub for our research on China’s express parcels and logistics sectors. Tracking Traffic/Chinese Express & Logistics features analysis of monthly Chinese express and logistics data, notes from our conversations with industry players, and links to company and thematic notes.

This month’s issue covers the following topics:

November express parcel pricing remained weak. Average pricing per express parcel fell by 7.8% Y/Y to just 11.06 RMB per piece. November’s average price represents a new all-time low for the industry, and November’s Y/Y decline was the steepest monthly decline in over two years (excluding Lunar New Year months, which tend to be distorted by the timing of the holiday).
Express parcel revenue growth dipped below 15% last month. Weak per-parcel pricing pulled express sector Y/Y revenue growth down to just 14.6% in November, the worst on record (again excluding distorted Lunar New Year comparisons). Chinese e-commerce demand has slowed and we suspect ‘O2O’ initiatives, under which online purchases are fulfilled via local stores, are also undermining express demand growth.
Intra-city pricing (ie, local delivery) remains firm relative to inter-city. Relative to weak inter-city express pricing (where ZTO Express (ZTO US) and the other listed express companies compete), pricing for local, intra-city express deliveries remained firm. In the first 11 months of 2018, express pricing rose 1.7% Y/Y versus a -2.9% decline in inter-city shipments (international pricing fell sharply, -14.5% Y/Y). Relatively firm pricing on local shipments may make it hard for local food delivery companies like Meituan Dianping (3690 HK) and Alibaba Group Holding (BABA US) ‘s ele.me to beat down unit operating costs.
Underlying domestic transport demand held up well again in November. Although demand for speedy, relatively expensive express service (and air freight) appears to be moderating, demand for rail and highway freight transport has held up well. The relative strength of rail and water transport (slow, cheap, industry-facing) versus express and air freight (fast, expensive, consumer-oriented) suggests a couple of things: a) upstream industrial activity is stronger than downstream retail activity and b) the people in charge of paying freight are shifting to cheaper modes of transport when possible.

We retain a negative view of China’s express industry’s fundamentals: demand growth is slowing and pricing appears to be falling faster than costs can be cut. Overall domestic transportation demand, however, remains solid and shows no signs of slowing.

4. Horiba (6856 JP): Bad News Largely Discounted

Horiba combines high gearing to semiconductor capital spending with a large and growing automotive test business characterized by upward trending but uneven profitability. At ¥4,545 (Friday, December 21, closing price), its share price has dropped by 53% from an all-time high of ¥9,590 reached last May. Falling demand for semiconductor production equipment and a downward revision to FY Dec-18 sales and profit guidance announced in November appear to be largely in the price.

The downward revision, which cut projected full-year operating profit growth from 15.5% to 2.5%, followed a 22.2% year-on-year decline in operating profit in 3Q and implies a similar rate of decline in 4Q. The weakness is concentrated in Semiconductor Equipment and Automotive Test, the former due to a cyclical downturn in overall demand, the latter due to M&A-related and other one-time expenses. New Automotive Test orders continued to outpace sales, leading to a 9.5% increase in the order backlog during 3Q.

Automotive Test sales and profits should rise next year, while semiconductor equipment sales and profits seem likely to bottom out. In a report issued on December 17, SEMI (the semiconductor equipment and materials industry organization) forecasts a further decline in wafer fab equipment sales in 1H of 2019, followed by recovery in 2H. Other industry sources we talked to before the report was issued had similar views.

This scenario could fall apart due to general economic weakness, American attempts to stifle China’s semiconductor industry, or both. On December 21, Reuters reported that Foxconn “…is in the final stages of talks with the local government of the Chinese city of Zhuhai to build a chip plant there with a total investment of about $9 billion… most of which would be shouldered by the Zhuhai government through subsidies and tax breaks…” This looks like a perfect target for the Americans, but whether or not they will notice or care remains to be seen.

Horiba is now selling at 9.6x our EPS estimate for this fiscal year, 13.4x our estimate for next year and 12.1x our estimate for FY Dec-20. These and other projected valuations are near the bottom of their 5-year historical ranges. If the Semiconductor Equipment division does not recover in 2H of 2019, historical data suggest that its operating profit could drop by 70% rather than the 47% we are now forecasting, resulting in a P/E ratio of 17x. Nevertheless, it is time to start considering when and at what price to buy Horiba.

Horiba is a diversified Japanese maker of precision and analytical devices and systems with a significant presence in the global markets for automotive test, industrial process and environmental analysis, hematology, semiconductor production equipment and scientific instruments. It is by far the world’s leading producer of automotive emission measurement systems (EMS), having supplied about 80% of the installed base worldwide, and also the world’s top manufacturer of mass flow controllers for the semiconductor industry, with an estimated global market share of nearly 60%.

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