Equity Bottom-Up

In this briefing:

1. Geo Energy (GERL SP): Recovery in Coal Price from 4Q18 Bottom; Continue to Wait for M&A Action
2. Meituan Dianping 4Q2018 Quick Read: Monetization Rate and Margins Disappointed
3. Nsk (6471) Conditions Have Deteriorated Significantly but Given Valuations, This Is Now in the Price
4. New J. Hutton Exploration Report (Weeks Ending 08/03/19)
5. NIO (NIO): NIO Is Essentially a Distributor, Not an OEM…3 Things to Keep in Mind at Lock-Up Expiry

1. Geo Energy (GERL SP): Recovery in Coal Price from 4Q18 Bottom; Continue to Wait for M&A Action

Geo Energy Resources (GERL SP) reported weak 4Q18 results late last month. The reason for the 5M USD net loss in 4Q18 was mainly due to Chinese import restrictions for Indonesian coal in November and December last year. With the import quota removed as of January ICI4 coal prices have rebounded from +/-30 USD/ton late 2018 to 40 USD/ton this week. 

Geo remains in deep value territory (3x EV/EBITDA) as the company still has over 200M USD+ in cash it raised from a 300M USD bond placing almost 18 months ago. While the CEO announced plans to organize a HK dual listing in 1H19 this cannot materialize unless management can execute on a significant acquisition opportunity it has been considering for the last twelve months. With Indonesian elections coming up next month the hope is that clarity on this potential transaction can be sorted by late 1H19.

While Europe is obsessed with Climate Change doomsday scenarios being shouted around by school-skipping teenagers, the reality is that three out of four of the most populated countries in the world (China, India and Indonesia) will remain heavy users of coal for decades to come. With cleaner coal technology being the key differentiator how much pollution is emitted.

My Fair Value estimate (Base case) remains 0.35 SGD or 89% upside.  Please recall, Macquarie paid 0.29 SGD for a 5% stake in November 2018 and had warrants issued to it at 0.33 SGD.

2. Meituan Dianping 4Q2018 Quick Read: Monetization Rate and Margins Disappointed

Meituan Dianping reported 4Q2018 numbers last night. As we covered the company’s IPO and lock-up expiry, we took a close look the company 4Q2018 results and listened in the conference call. While we are encouraged by the company’s strong transaction volume and revenue growth in 4Q2018, we are less bullish given the deceleration of monetization growth. We also note that the company trimmed down the details of reporting, in particular, the operation of its New Initiative segment and hence results were less transparent. 

3. Nsk (6471) Conditions Have Deteriorated Significantly but Given Valuations, This Is Now in the Price

Over the last 12 months, these shares have been a dreadful performer (as have the other ball bearing makers), both in absolute terms (-36%) and on a relative basis (underperformed TOPIX by 30%). Operating profits for the full year have recently been revised down (for the second time). The operating environment has deteriorated markedly into 4Q. It would appear to us that the market, and analysts, are aware of the current poor trading conditions. The question is when will conditions start to improve. The first half of next year will be very poor indeed with profits down perhaps 35% year-on-year. And it now appears that some analyst’s numbers do not assume recovery for any of next fiscal year, which we believe as too harsh.

Clearly the first half of next year (3/20) is going to show very poor year on year comparisons. This will be unavoidable given a good first half this year and business conditions now. The company itself is now forecasting a 4Q operating profit of Y16.7bn (-40%) having made Y24.8bn in 1Q, Y20.2bn in 2Q and Y21.3bn in 3Q. Assuming this level carries on into the first half of next year before starting a gradual recovery in the second half, then first half operating profit may well come in at about Y32-33bn, a 35% year-on-year fall. The consensus for the full year is currently about Y70bn with the lowest number being Y64bn. Sell recommendations have also begun to appear. To us this appear to be a bit after the event given where earnings are now and where the shares are trading.

The shares currently yield 4.2% and the pay-out ratio this year is 36%. Management’s target is for 30% but at the same time they are reluctant to cut the dividend going forward. This may well prove some support. Meanwhile the company owns 7% of itself and on our calculation is trading on an EV/ebitda of just under 4x. Finally, its book value (0.9x) relative to the market’s book value is now at a very depressed level (see chart below) which suggests to us that although there may be some short term down side risk, we would look to buy on a longer term.

4. New J. Hutton Exploration Report (Weeks Ending 08/03/19)

• Coverage now expanded to 730 mining companies
• Retain Peel Mining Ltd (PEX AU) as a Speculative Buy
• Current drilling infill only
• Est. A$4-4.5m cash with capital raising soon
• Very solid geological genetic model honing future extensional exploration efforts 
• Expect maiden Resource computation to commence after next three hole assays released
• Aeon Metals Ltd (AML AU), Blackearth Minerals NL (BEM AU), Boss Resources (BOE AU), Centaurus Metals (CTM AU), Catalyst Metals (CYL AU), Amur Minerals (AMC LN), Patagonia Gold (PGD LN), Tyranna Resources (TYX AU), Gladiator Resources (GLA AU), King River Resources (KRR AU), Vango Mining (VAN AU), Hummingbird Resources (HUM LN), Caravel Minerals (CVV AU), Lefroy Exploration Ltd (LEX AU), Millennium Minerals (MOY AU), Northern Minerals (NTU AU), Blackham Resources (BLK AU), Avz Minerals (AVZ AU), Orocobre Ltd (ORE AU), Serabi Gold plc (SRB LN), Paringa Resources (PNL AU), Artemis Resources (ARV AU), Centrex Metals (CXM AU), Great Boulder Resources Ltd (GBR AU), Superior Lake Resources (SUP AU), Cora Gold Ltd (CORA LN), European Metals Holdings Ltd (EMH LN), Savannah Resources PLC (SAV LN) , IronRidge Resources Ltd (IRR LN)

5. NIO (NIO): NIO Is Essentially a Distributor, Not an OEM…3 Things to Keep in Mind at Lock-Up Expiry

NIO’s 6-month Lock-up expires today and as of the time of this writing the stock is down by 6.6% from the closing price on Friday, March 8.  The stock’s share overhang issue have been well covered on the Smartkarma platform by other analysts (see NIO Post-CBS Rally Making TSLA Valuation a Grand Bargain (Price Target =$3) , NIO (NIO US): Lock-Up Expiry – This Could Get Messy) so while we do not see a need to rehash those details in this insight, here are 3 things that we believe every NIO investor and would-be investor should keep in mind about the company especially if one wants to play the Tesla vs. NIO scenario:

1. Licensing/Regulatory Risk – NIO has an autonomous driving testing license but no EV manufacturing license.  An EV manufacturing license issued by the NDRC is required for EV manufacturers to market and sell their products but a 100k unit scale is a main prerequisite.  This is a key reason why NIO entered into a 5-year outsourcing relationship with JAC.  While this relationship was assumed to be temporary, there could be many hurdles for NIO to actually obtain a license in the coming years should it decide to invest in production facilities again.
2. Core IP Held by Suppliers – Powertrain technology is held by CATL and the State-owned JAC is listed as the ES8’s manufacturer on the Ministry of Information and Technology website.  Continental AG designs NIO’s vehicle suspension and chassis.  It is also unclear how much actual development work other than exterior/cockpit design is done in-house at NIO based on publicly available information.  Without scale and IP we believe NIO’s bargaining position with its suppliers is weak and displays stronger characteristics of a distributor than a final assembler. 
3. Low ASP, low margins – NIO’s ASP on the ES8 from what we have seen was $64k per unit in 2018 and $63k per unit in 1Q19 while Tesla’s Model X ASP is about $100k per unit.  There is a reason why gross margin at NIO is razor thin and it has more to do with low price point than low volumes in our view.   

Given differences between the U.S. and China operating environment for EV makers, we believe Tesla is not a good equity valuation comp for NIO, which is basically a distributor in our view.  As such, long term value drivers would most likely come from aftermarket and service revenues, while short-mid term value drivers seem elusive especially in the aftermath of the company’s decision to scrap its production plant investment plans in Shanghai.

The NIO ES8

In this briefing:

1. Meituan Dianping 4Q2018 Quick Read: Monetization Rate and Margins Disappointed
2. Nsk (6471) Conditions Have Deteriorated Significantly but Given Valuations, This Is Now in the Price
3. New J. Hutton Exploration Report (Weeks Ending 08/03/19)
4. NIO (NIO): NIO Is Essentially a Distributor, Not an OEM…3 Things to Keep in Mind at Lock-Up Expiry
5. REIT Discover: Sasseur Sizzles with 9% Yield

1. Meituan Dianping 4Q2018 Quick Read: Monetization Rate and Margins Disappointed

Meituan Dianping reported 4Q2018 numbers last night. As we covered the company’s IPO and lock-up expiry, we took a close look the company 4Q2018 results and listened in the conference call. While we are encouraged by the company’s strong transaction volume and revenue growth in 4Q2018, we are less bullish given the deceleration of monetization growth. We also note that the company trimmed down the details of reporting, in particular, the operation of its New Initiative segment and hence results were less transparent. 

2. Nsk (6471) Conditions Have Deteriorated Significantly but Given Valuations, This Is Now in the Price

Over the last 12 months, these shares have been a dreadful performer (as have the other ball bearing makers), both in absolute terms (-36%) and on a relative basis (underperformed TOPIX by 30%). Operating profits for the full year have recently been revised down (for the second time). The operating environment has deteriorated markedly into 4Q. It would appear to us that the market, and analysts, are aware of the current poor trading conditions. The question is when will conditions start to improve. The first half of next year will be very poor indeed with profits down perhaps 35% year-on-year. And it now appears that some analyst’s numbers do not assume recovery for any of next fiscal year, which we believe as too harsh.

Clearly the first half of next year (3/20) is going to show very poor year on year comparisons. This will be unavoidable given a good first half this year and business conditions now. The company itself is now forecasting a 4Q operating profit of Y16.7bn (-40%) having made Y24.8bn in 1Q, Y20.2bn in 2Q and Y21.3bn in 3Q. Assuming this level carries on into the first half of next year before starting a gradual recovery in the second half, then first half operating profit may well come in at about Y32-33bn, a 35% year-on-year fall. The consensus for the full year is currently about Y70bn with the lowest number being Y64bn. Sell recommendations have also begun to appear. To us this appear to be a bit after the event given where earnings are now and where the shares are trading.

The shares currently yield 4.2% and the pay-out ratio this year is 36%. Management’s target is for 30% but at the same time they are reluctant to cut the dividend going forward. This may well prove some support. Meanwhile the company owns 7% of itself and on our calculation is trading on an EV/ebitda of just under 4x. Finally, its book value (0.9x) relative to the market’s book value is now at a very depressed level (see chart below) which suggests to us that although there may be some short term down side risk, we would look to buy on a longer term.

3. New J. Hutton Exploration Report (Weeks Ending 08/03/19)

• Coverage now expanded to 730 mining companies
• Retain Peel Mining Ltd (PEX AU) as a Speculative Buy
• Current drilling infill only
• Est. A$4-4.5m cash with capital raising soon
• Very solid geological genetic model honing future extensional exploration efforts 
• Expect maiden Resource computation to commence after next three hole assays released
• Aeon Metals Ltd (AML AU), Blackearth Minerals NL (BEM AU), Boss Resources (BOE AU), Centaurus Metals (CTM AU), Catalyst Metals (CYL AU), Amur Minerals (AMC LN), Patagonia Gold (PGD LN), Tyranna Resources (TYX AU), Gladiator Resources (GLA AU), King River Resources (KRR AU), Vango Mining (VAN AU), Hummingbird Resources (HUM LN), Caravel Minerals (CVV AU), Lefroy Exploration Ltd (LEX AU), Millennium Minerals (MOY AU), Northern Minerals (NTU AU), Blackham Resources (BLK AU), Avz Minerals (AVZ AU), Orocobre Ltd (ORE AU), Serabi Gold plc (SRB LN), Paringa Resources (PNL AU), Artemis Resources (ARV AU), Centrex Metals (CXM AU), Great Boulder Resources Ltd (GBR AU), Superior Lake Resources (SUP AU), Cora Gold Ltd (CORA LN), European Metals Holdings Ltd (EMH LN), Savannah Resources PLC (SAV LN) , IronRidge Resources Ltd (IRR LN)

4. NIO (NIO): NIO Is Essentially a Distributor, Not an OEM…3 Things to Keep in Mind at Lock-Up Expiry

NIO’s 6-month Lock-up expires today and as of the time of this writing the stock is down by 6.6% from the closing price on Friday, March 8.  The stock’s share overhang issue have been well covered on the Smartkarma platform by other analysts (see NIO Post-CBS Rally Making TSLA Valuation a Grand Bargain (Price Target =$3) , NIO (NIO US): Lock-Up Expiry – This Could Get Messy) so while we do not see a need to rehash those details in this insight, here are 3 things that we believe every NIO investor and would-be investor should keep in mind about the company especially if one wants to play the Tesla vs. NIO scenario:

1. Licensing/Regulatory Risk – NIO has an autonomous driving testing license but no EV manufacturing license.  An EV manufacturing license issued by the NDRC is required for EV manufacturers to market and sell their products but a 100k unit scale is a main prerequisite.  This is a key reason why NIO entered into a 5-year outsourcing relationship with JAC.  While this relationship was assumed to be temporary, there could be many hurdles for NIO to actually obtain a license in the coming years should it decide to invest in production facilities again.
2. Core IP Held by Suppliers – Powertrain technology is held by CATL and the State-owned JAC is listed as the ES8’s manufacturer on the Ministry of Information and Technology website.  Continental AG designs NIO’s vehicle suspension and chassis.  It is also unclear how much actual development work other than exterior/cockpit design is done in-house at NIO based on publicly available information.  Without scale and IP we believe NIO’s bargaining position with its suppliers is weak and displays stronger characteristics of a distributor than a final assembler. 
3. Low ASP, low margins – NIO’s ASP on the ES8 from what we have seen was $64k per unit in 2018 and $63k per unit in 1Q19 while Tesla’s Model X ASP is about $100k per unit.  There is a reason why gross margin at NIO is razor thin and it has more to do with low price point than low volumes in our view.   

Given differences between the U.S. and China operating environment for EV makers, we believe Tesla is not a good equity valuation comp for NIO, which is basically a distributor in our view.  As such, long term value drivers would most likely come from aftermarket and service revenues, while short-mid term value drivers seem elusive especially in the aftermath of the company’s decision to scrap its production plant investment plans in Shanghai.

The NIO ES8

5. REIT Discover: Sasseur Sizzles with 9% Yield

REIT Discover is an insight series featuring under-researched and off-the-radar REITs in an attempt to identify hidden gems and gems in-the-making. In this issue, we follow up on the first China outlet mall REIT listed in Singapore, Sasseur Real Estate Investment (SASSR SP) , whose share price is down 7.5% from its IPO price of S$0.80 since its debut on 28 March 2018. Its distributable income exceeded its IPO forecast for FY2018. Annualized distribution per unit (DPU) yield for FY2018 was 9.1% based on current price. Moving forward, FY2019 DPU projection is S$0.06, translating into a DPU yield of 8.1% compared to FY2018. It is likely that the DPU for the projection years are conservative and the REIT manager will endeavour to beat the IPO forecast for FY2019 and even the annualized DPU for FY2018.

Sasseur REIT’s business model differs from other typical retail malls which lease out assets and receive rental income based on an agreed rental rate. Instead, it has structured a complex form of master lease, called the Entrusted Management Agreement (EMA), where it received a percentage of tenants’ sales turnover as the rental. As such, income generated its portfolio of properties are mainly sales-driven and hence may be unstable.

Essentially, the EMA encompasses a set of obligations that binds the sponsor to a two-year income support to Sasseur REIT in exchange for a long-term master lease which limits DPU upside. This is because a large chunk of the portfolio’s potential revenue growth will go to the sponsor. 

We are not saying this is all bad; the master lease under the EMA provides income stability to the REIT given that gross revenue is sales-driven. Rather, we acknowledge the resilience of the outlet mall business model as seen from the long and successful track record of Tanger Factory Outlet Centers Inc (SKT US) in the United States and strong growth of Bailian Group’s outlet business in China.  What is striking is China’s small outlet market size relatively to the mature regions despite the sheer size of its growing middle to upper-middle class population. This suggests that China’s outlet industry could grow significantly.

At 29% gearing ratio, Sasseur REIT has additional debt headroom of S$283mn to tap on its right-of-first-refusal (ROFR) pipeline of assets to grow its S$1.5bn initial portfolio. Even without inorganic growth, two of its properties, representing 43% of total portfolio valuation, are relatively new assets in their third year of operation, suggesting strong potential for growth. Sasseur REIT looks promising based its results in the last three quarters. Sasseur REIT’s premium P/NAV of 1.03x at the point of listing was surprisingly expensive given that its properties are non-prime outlet malls in China’s Tier-Two cities. P/NAV has since fallen to an attractive 0.8x.  

In this briefing:

1. New J. Hutton Exploration Report (Weeks Ending 08/03/19)
2. NIO (NIO): NIO Is Essentially a Distributor, Not an OEM…3 Things to Keep in Mind at Lock-Up Expiry
3. REIT Discover: Sasseur Sizzles with 9% Yield
4. HK Connect Discovery Weekly: PICC, Xinyi Solar (2019-03-08)
5. Japan Tobacco: No Dire Consequences Despite Late Entry to Heated Tobacco

1. New J. Hutton Exploration Report (Weeks Ending 08/03/19)

• Coverage now expanded to 730 mining companies
• Retain Peel Mining Ltd (PEX AU) as a Speculative Buy
• Current drilling infill only
• Est. A$4-4.5m cash with capital raising soon
• Very solid geological genetic model honing future extensional exploration efforts 
• Expect maiden Resource computation to commence after next three hole assays released
• Aeon Metals Ltd (AML AU), Blackearth Minerals NL (BEM AU), Boss Resources (BOE AU), Centaurus Metals (CTM AU), Catalyst Metals (CYL AU), Amur Minerals (AMC LN), Patagonia Gold (PGD LN), Tyranna Resources (TYX AU), Gladiator Resources (GLA AU), King River Resources (KRR AU), Vango Mining (VAN AU), Hummingbird Resources (HUM LN), Caravel Minerals (CVV AU), Lefroy Exploration Ltd (LEX AU), Millennium Minerals (MOY AU), Northern Minerals (NTU AU), Blackham Resources (BLK AU), Avz Minerals (AVZ AU), Orocobre Ltd (ORE AU), Serabi Gold plc (SRB LN), Paringa Resources (PNL AU), Artemis Resources (ARV AU), Centrex Metals (CXM AU), Great Boulder Resources Ltd (GBR AU), Superior Lake Resources (SUP AU), Cora Gold Ltd (CORA LN), European Metals Holdings Ltd (EMH LN), Savannah Resources PLC (SAV LN) , IronRidge Resources Ltd (IRR LN)

2. NIO (NIO): NIO Is Essentially a Distributor, Not an OEM…3 Things to Keep in Mind at Lock-Up Expiry

NIO’s 6-month Lock-up expires today and as of the time of this writing the stock is down by 6.6% from the closing price on Friday, March 8.  The stock’s share overhang issue have been well covered on the Smartkarma platform by other analysts (see NIO Post-CBS Rally Making TSLA Valuation a Grand Bargain (Price Target =$3) , NIO (NIO US): Lock-Up Expiry – This Could Get Messy) so while we do not see a need to rehash those details in this insight, here are 3 things that we believe every NIO investor and would-be investor should keep in mind about the company especially if one wants to play the Tesla vs. NIO scenario:

1. Licensing/Regulatory Risk – NIO has an autonomous driving testing license but no EV manufacturing license.  An EV manufacturing license issued by the NDRC is required for EV manufacturers to market and sell their products but a 100k unit scale is a main prerequisite.  This is a key reason why NIO entered into a 5-year outsourcing relationship with JAC.  While this relationship was assumed to be temporary, there could be many hurdles for NIO to actually obtain a license in the coming years should it decide to invest in production facilities again.
2. Core IP Held by Suppliers – Powertrain technology is held by CATL and the State-owned JAC is listed as the ES8’s manufacturer on the Ministry of Information and Technology website.  Continental AG designs NIO’s vehicle suspension and chassis.  It is also unclear how much actual development work other than exterior/cockpit design is done in-house at NIO based on publicly available information.  Without scale and IP we believe NIO’s bargaining position with its suppliers is weak and displays stronger characteristics of a distributor than a final assembler. 
3. Low ASP, low margins – NIO’s ASP on the ES8 from what we have seen was $64k per unit in 2018 and $63k per unit in 1Q19 while Tesla’s Model X ASP is about $100k per unit.  There is a reason why gross margin at NIO is razor thin and it has more to do with low price point than low volumes in our view.   

Given differences between the U.S. and China operating environment for EV makers, we believe Tesla is not a good equity valuation comp for NIO, which is basically a distributor in our view.  As such, long term value drivers would most likely come from aftermarket and service revenues, while short-mid term value drivers seem elusive especially in the aftermath of the company’s decision to scrap its production plant investment plans in Shanghai.

The NIO ES8

3. REIT Discover: Sasseur Sizzles with 9% Yield

REIT Discover is an insight series featuring under-researched and off-the-radar REITs in an attempt to identify hidden gems and gems in-the-making. In this issue, we follow up on the first China outlet mall REIT listed in Singapore, Sasseur Real Estate Investment (SASSR SP) , whose share price is down 7.5% from its IPO price of S$0.80 since its debut on 28 March 2018. Its distributable income exceeded its IPO forecast for FY2018. Annualized distribution per unit (DPU) yield for FY2018 was 9.1% based on current price. Moving forward, FY2019 DPU projection is S$0.06, translating into a DPU yield of 8.1% compared to FY2018. It is likely that the DPU for the projection years are conservative and the REIT manager will endeavour to beat the IPO forecast for FY2019 and even the annualized DPU for FY2018.

Sasseur REIT’s business model differs from other typical retail malls which lease out assets and receive rental income based on an agreed rental rate. Instead, it has structured a complex form of master lease, called the Entrusted Management Agreement (EMA), where it received a percentage of tenants’ sales turnover as the rental. As such, income generated its portfolio of properties are mainly sales-driven and hence may be unstable.

Essentially, the EMA encompasses a set of obligations that binds the sponsor to a two-year income support to Sasseur REIT in exchange for a long-term master lease which limits DPU upside. This is because a large chunk of the portfolio’s potential revenue growth will go to the sponsor. 

We are not saying this is all bad; the master lease under the EMA provides income stability to the REIT given that gross revenue is sales-driven. Rather, we acknowledge the resilience of the outlet mall business model as seen from the long and successful track record of Tanger Factory Outlet Centers Inc (SKT US) in the United States and strong growth of Bailian Group’s outlet business in China.  What is striking is China’s small outlet market size relatively to the mature regions despite the sheer size of its growing middle to upper-middle class population. This suggests that China’s outlet industry could grow significantly.

At 29% gearing ratio, Sasseur REIT has additional debt headroom of S$283mn to tap on its right-of-first-refusal (ROFR) pipeline of assets to grow its S$1.5bn initial portfolio. Even without inorganic growth, two of its properties, representing 43% of total portfolio valuation, are relatively new assets in their third year of operation, suggesting strong potential for growth. Sasseur REIT looks promising based its results in the last three quarters. Sasseur REIT’s premium P/NAV of 1.03x at the point of listing was surprisingly expensive given that its properties are non-prime outlet malls in China’s Tier-Two cities. P/NAV has since fallen to an attractive 0.8x.  

4. HK Connect Discovery Weekly: PICC, Xinyi Solar (2019-03-08)

In our Discover HK Connect series, we aim to help our investors understand the flow of southbound trades via the Hong Kong Connect, as analyzed by our proprietary data engine. We will discuss the stocks that experienced the most inflow and outflow by mainland investors in the past seven days.

We split the stocks eligible for the Hong Kong Connect trade into three groups: component stocks in the HSCEI index, stocks with a market capitalization between USD 1 billion and USD 5 billion, and stocks with a market capitalization between USD 500 million and USD 1 billion.

In this insight, we will highlight PICC and Xinyi Solar.

5. Japan Tobacco: No Dire Consequences Despite Late Entry to Heated Tobacco

• Late entry to Japanese heated tobacco market resulted in Japan Tobacco (2914 JP) losing market share to peers
• New product launches to give Japan Tobacco a fighting chance against IQOS
• Early maturity of heated tobacco in Japan: a blessing in disguise for Japan Tobacco
• Pricing power is expected to be back on track in future
• PloomTECH will soon be ready to compete with IQOS at a global level
• More product offerings targeting different customer needs in reduced risk products category
• International segment volume growth driven by global flagship brands and acquisitions
• Market unjustly penalising Japan Tobacco for the early maturity of heated tobacco segment
• Transformation of dividend yield from industry worst to industry best
• Undervalued at 10.09x EV/Forward EBIT: DCF target price yields 21.8% upside

In this briefing:

1. NIO (NIO): NIO Is Essentially a Distributor, Not an OEM…3 Things to Keep in Mind at Lock-Up Expiry
2. REIT Discover: Sasseur Sizzles with 9% Yield
3. HK Connect Discovery Weekly: PICC, Xinyi Solar (2019-03-08)
4. Japan Tobacco: No Dire Consequences Despite Late Entry to Heated Tobacco
5. Hitachi High Tech’s Ace in the Hole

1. NIO (NIO): NIO Is Essentially a Distributor, Not an OEM…3 Things to Keep in Mind at Lock-Up Expiry

NIO’s 6-month Lock-up expires today and as of the time of this writing the stock is down by 6.6% from the closing price on Friday, March 8.  The stock’s share overhang issue have been well covered on the Smartkarma platform by other analysts (see NIO Post-CBS Rally Making TSLA Valuation a Grand Bargain (Price Target =$3) , NIO (NIO US): Lock-Up Expiry – This Could Get Messy) so while we do not see a need to rehash those details in this insight, here are 3 things that we believe every NIO investor and would-be investor should keep in mind about the company especially if one wants to play the Tesla vs. NIO scenario:

1. Licensing/Regulatory Risk – NIO has an autonomous driving testing license but no EV manufacturing license.  An EV manufacturing license issued by the NDRC is required for EV manufacturers to market and sell their products but a 100k unit scale is a main prerequisite.  This is a key reason why NIO entered into a 5-year outsourcing relationship with JAC.  While this relationship was assumed to be temporary, there could be many hurdles for NIO to actually obtain a license in the coming years should it decide to invest in production facilities again.
2. Core IP Held by Suppliers – Powertrain technology is held by CATL and the State-owned JAC is listed as the ES8’s manufacturer on the Ministry of Information and Technology website.  Continental AG designs NIO’s vehicle suspension and chassis.  It is also unclear how much actual development work other than exterior/cockpit design is done in-house at NIO based on publicly available information.  Without scale and IP we believe NIO’s bargaining position with its suppliers is weak and displays stronger characteristics of a distributor than a final assembler. 
3. Low ASP, low margins – NIO’s ASP on the ES8 from what we have seen was $64k per unit in 2018 and $63k per unit in 1Q19 while Tesla’s Model X ASP is about $100k per unit.  There is a reason why gross margin at NIO is razor thin and it has more to do with low price point than low volumes in our view.   

Given differences between the U.S. and China operating environment for EV makers, we believe Tesla is not a good equity valuation comp for NIO, which is basically a distributor in our view.  As such, long term value drivers would most likely come from aftermarket and service revenues, while short-mid term value drivers seem elusive especially in the aftermath of the company’s decision to scrap its production plant investment plans in Shanghai.

The NIO ES8

2. REIT Discover: Sasseur Sizzles with 9% Yield

REIT Discover is an insight series featuring under-researched and off-the-radar REITs in an attempt to identify hidden gems and gems in-the-making. In this issue, we follow up on the first China outlet mall REIT listed in Singapore, Sasseur Real Estate Investment (SASSR SP) , whose share price is down 7.5% from its IPO price of S$0.80 since its debut on 28 March 2018. Its distributable income exceeded its IPO forecast for FY2018. Annualized distribution per unit (DPU) yield for FY2018 was 9.1% based on current price. Moving forward, FY2019 DPU projection is S$0.06, translating into a DPU yield of 8.1% compared to FY2018. It is likely that the DPU for the projection years are conservative and the REIT manager will endeavour to beat the IPO forecast for FY2019 and even the annualized DPU for FY2018.

Sasseur REIT’s business model differs from other typical retail malls which lease out assets and receive rental income based on an agreed rental rate. Instead, it has structured a complex form of master lease, called the Entrusted Management Agreement (EMA), where it received a percentage of tenants’ sales turnover as the rental. As such, income generated its portfolio of properties are mainly sales-driven and hence may be unstable.

Essentially, the EMA encompasses a set of obligations that binds the sponsor to a two-year income support to Sasseur REIT in exchange for a long-term master lease which limits DPU upside. This is because a large chunk of the portfolio’s potential revenue growth will go to the sponsor. 

We are not saying this is all bad; the master lease under the EMA provides income stability to the REIT given that gross revenue is sales-driven. Rather, we acknowledge the resilience of the outlet mall business model as seen from the long and successful track record of Tanger Factory Outlet Centers Inc (SKT US) in the United States and strong growth of Bailian Group’s outlet business in China.  What is striking is China’s small outlet market size relatively to the mature regions despite the sheer size of its growing middle to upper-middle class population. This suggests that China’s outlet industry could grow significantly.

At 29% gearing ratio, Sasseur REIT has additional debt headroom of S$283mn to tap on its right-of-first-refusal (ROFR) pipeline of assets to grow its S$1.5bn initial portfolio. Even without inorganic growth, two of its properties, representing 43% of total portfolio valuation, are relatively new assets in their third year of operation, suggesting strong potential for growth. Sasseur REIT looks promising based its results in the last three quarters. Sasseur REIT’s premium P/NAV of 1.03x at the point of listing was surprisingly expensive given that its properties are non-prime outlet malls in China’s Tier-Two cities. P/NAV has since fallen to an attractive 0.8x.  

3. HK Connect Discovery Weekly: PICC, Xinyi Solar (2019-03-08)

In our Discover HK Connect series, we aim to help our investors understand the flow of southbound trades via the Hong Kong Connect, as analyzed by our proprietary data engine. We will discuss the stocks that experienced the most inflow and outflow by mainland investors in the past seven days.

We split the stocks eligible for the Hong Kong Connect trade into three groups: component stocks in the HSCEI index, stocks with a market capitalization between USD 1 billion and USD 5 billion, and stocks with a market capitalization between USD 500 million and USD 1 billion.

In this insight, we will highlight PICC and Xinyi Solar.

4. Japan Tobacco: No Dire Consequences Despite Late Entry to Heated Tobacco

• Late entry to Japanese heated tobacco market resulted in Japan Tobacco (2914 JP) losing market share to peers
• New product launches to give Japan Tobacco a fighting chance against IQOS
• Early maturity of heated tobacco in Japan: a blessing in disguise for Japan Tobacco
• Pricing power is expected to be back on track in future
• PloomTECH will soon be ready to compete with IQOS at a global level
• More product offerings targeting different customer needs in reduced risk products category
• International segment volume growth driven by global flagship brands and acquisitions
• Market unjustly penalising Japan Tobacco for the early maturity of heated tobacco segment
• Transformation of dividend yield from industry worst to industry best
• Undervalued at 10.09x EV/Forward EBIT: DCF target price yields 21.8% upside

5. Hitachi High Tech’s Ace in the Hole

Last Friday, Hitachi (6501) was reported to be considering selling Hitachi Chemical (4217), according to media sources over the weekend. This has sent Hitachi Chemical and its parent into a frenzy with Hitachi Chemical ADR up 13% last Friday. We believe this news is relevant for Hitachi High Tech because both subsidiaries are 51-52% consolidated by the parent Hitachi, and both have arguably businesses with little synergy with the parent. We believe that Hitachi High Tech is also rumored to be on the block for sale or spin-off.  Media sources say that Hitachi is considering a sale of Hitachi Chemical and would reap Y300bn.  The current value of their 51% ownership in Hitachi Chemical is Y211bn, and thus there is 42% implied upside if the Y300bn figure is achieved.

To recap Q3 results for Hitachi High Tech from January 31, 2019, the numbers were decent with earnings above consensus forecasts by 33% for Q3 (Y15.8bn OP versus Y13.8bn forecast). The profit rise was due to improved margins in medical and continued strength in process semiconductor equipment. The shares are up 20% year-to-date, outperforming the Nikkei by 15%. Some of the fears of a sharp slowdown in semiconductor have been nullified by the continued strength in logic chip investments as well as the improved profitability in medical clinical analyzers. Medical profits soared 46% YoY in Q3 to Y7.6bn on a 13% YoY increase in revenues. OP margin improved from 12.3% to 15.8% YoY.

In this briefing:

1. REIT Discover: Sasseur Sizzles with 9% Yield
2. HK Connect Discovery Weekly: PICC, Xinyi Solar (2019-03-08)
3. Japan Tobacco: No Dire Consequences Despite Late Entry to Heated Tobacco
4. Hitachi High Tech’s Ace in the Hole
5. Bank Alfalah: Metrics Point to Falāh

1. REIT Discover: Sasseur Sizzles with 9% Yield

REIT Discover is an insight series featuring under-researched and off-the-radar REITs in an attempt to identify hidden gems and gems in-the-making. In this issue, we follow up on the first China outlet mall REIT listed in Singapore, Sasseur Real Estate Investment (SASSR SP) , whose share price is down 7.5% from its IPO price of S$0.80 since its debut on 28 March 2018. Its distributable income exceeded its IPO forecast for FY2018. Annualized distribution per unit (DPU) yield for FY2018 was 9.1% based on current price. Moving forward, FY2019 DPU projection is S$0.06, translating into a DPU yield of 8.1% compared to FY2018. It is likely that the DPU for the projection years are conservative and the REIT manager will endeavour to beat the IPO forecast for FY2019 and even the annualized DPU for FY2018.

Sasseur REIT’s business model differs from other typical retail malls which lease out assets and receive rental income based on an agreed rental rate. Instead, it has structured a complex form of master lease, called the Entrusted Management Agreement (EMA), where it received a percentage of tenants’ sales turnover as the rental. As such, income generated its portfolio of properties are mainly sales-driven and hence may be unstable.

Essentially, the EMA encompasses a set of obligations that binds the sponsor to a two-year income support to Sasseur REIT in exchange for a long-term master lease which limits DPU upside. This is because a large chunk of the portfolio’s potential revenue growth will go to the sponsor. 

We are not saying this is all bad; the master lease under the EMA provides income stability to the REIT given that gross revenue is sales-driven. Rather, we acknowledge the resilience of the outlet mall business model as seen from the long and successful track record of Tanger Factory Outlet Centers Inc (SKT US) in the United States and strong growth of Bailian Group’s outlet business in China.  What is striking is China’s small outlet market size relatively to the mature regions despite the sheer size of its growing middle to upper-middle class population. This suggests that China’s outlet industry could grow significantly.

At 29% gearing ratio, Sasseur REIT has additional debt headroom of S$283mn to tap on its right-of-first-refusal (ROFR) pipeline of assets to grow its S$1.5bn initial portfolio. Even without inorganic growth, two of its properties, representing 43% of total portfolio valuation, are relatively new assets in their third year of operation, suggesting strong potential for growth. Sasseur REIT looks promising based its results in the last three quarters. Sasseur REIT’s premium P/NAV of 1.03x at the point of listing was surprisingly expensive given that its properties are non-prime outlet malls in China’s Tier-Two cities. P/NAV has since fallen to an attractive 0.8x.  

2. HK Connect Discovery Weekly: PICC, Xinyi Solar (2019-03-08)

In our Discover HK Connect series, we aim to help our investors understand the flow of southbound trades via the Hong Kong Connect, as analyzed by our proprietary data engine. We will discuss the stocks that experienced the most inflow and outflow by mainland investors in the past seven days.

We split the stocks eligible for the Hong Kong Connect trade into three groups: component stocks in the HSCEI index, stocks with a market capitalization between USD 1 billion and USD 5 billion, and stocks with a market capitalization between USD 500 million and USD 1 billion.

In this insight, we will highlight PICC and Xinyi Solar.

3. Japan Tobacco: No Dire Consequences Despite Late Entry to Heated Tobacco

• Late entry to Japanese heated tobacco market resulted in Japan Tobacco (2914 JP) losing market share to peers
• New product launches to give Japan Tobacco a fighting chance against IQOS
• Early maturity of heated tobacco in Japan: a blessing in disguise for Japan Tobacco
• Pricing power is expected to be back on track in future
• PloomTECH will soon be ready to compete with IQOS at a global level
• More product offerings targeting different customer needs in reduced risk products category
• International segment volume growth driven by global flagship brands and acquisitions
• Market unjustly penalising Japan Tobacco for the early maturity of heated tobacco segment
• Transformation of dividend yield from industry worst to industry best
• Undervalued at 10.09x EV/Forward EBIT: DCF target price yields 21.8% upside

4. Hitachi High Tech’s Ace in the Hole

Last Friday, Hitachi (6501) was reported to be considering selling Hitachi Chemical (4217), according to media sources over the weekend. This has sent Hitachi Chemical and its parent into a frenzy with Hitachi Chemical ADR up 13% last Friday. We believe this news is relevant for Hitachi High Tech because both subsidiaries are 51-52% consolidated by the parent Hitachi, and both have arguably businesses with little synergy with the parent. We believe that Hitachi High Tech is also rumored to be on the block for sale or spin-off.  Media sources say that Hitachi is considering a sale of Hitachi Chemical and would reap Y300bn.  The current value of their 51% ownership in Hitachi Chemical is Y211bn, and thus there is 42% implied upside if the Y300bn figure is achieved.

To recap Q3 results for Hitachi High Tech from January 31, 2019, the numbers were decent with earnings above consensus forecasts by 33% for Q3 (Y15.8bn OP versus Y13.8bn forecast). The profit rise was due to improved margins in medical and continued strength in process semiconductor equipment. The shares are up 20% year-to-date, outperforming the Nikkei by 15%. Some of the fears of a sharp slowdown in semiconductor have been nullified by the continued strength in logic chip investments as well as the improved profitability in medical clinical analyzers. Medical profits soared 46% YoY in Q3 to Y7.6bn on a 13% YoY increase in revenues. OP margin improved from 12.3% to 15.8% YoY.

5. Bank Alfalah: Metrics Point to Falāh

Bank Alfalah (BAFL PA) is heading in the right direction as testified by its metric progression, embodied in its quintile 1 PH Score™.

Valuations are not stretched – especially the Total return Ratio of 1.8x and an Earnings Yield of 14.5%.

Combining the fundamental momentum signals (PH Score™) with franchise valuation, and a low RSI, places BAFL PA in the top decile of bank opportunities globally.

In this briefing:

1. HK Connect Discovery Weekly: PICC, Xinyi Solar (2019-03-08)
2. Japan Tobacco: No Dire Consequences Despite Late Entry to Heated Tobacco
3. Hitachi High Tech’s Ace in the Hole
4. Bank Alfalah: Metrics Point to Falāh
5. SMC (6273 JP): Profit Decline Accelerates

1. HK Connect Discovery Weekly: PICC, Xinyi Solar (2019-03-08)

In our Discover HK Connect series, we aim to help our investors understand the flow of southbound trades via the Hong Kong Connect, as analyzed by our proprietary data engine. We will discuss the stocks that experienced the most inflow and outflow by mainland investors in the past seven days.

We split the stocks eligible for the Hong Kong Connect trade into three groups: component stocks in the HSCEI index, stocks with a market capitalization between USD 1 billion and USD 5 billion, and stocks with a market capitalization between USD 500 million and USD 1 billion.

In this insight, we will highlight PICC and Xinyi Solar.

2. Japan Tobacco: No Dire Consequences Despite Late Entry to Heated Tobacco

• Late entry to Japanese heated tobacco market resulted in Japan Tobacco (2914 JP) losing market share to peers
• New product launches to give Japan Tobacco a fighting chance against IQOS
• Early maturity of heated tobacco in Japan: a blessing in disguise for Japan Tobacco
• Pricing power is expected to be back on track in future
• PloomTECH will soon be ready to compete with IQOS at a global level
• More product offerings targeting different customer needs in reduced risk products category
• International segment volume growth driven by global flagship brands and acquisitions
• Market unjustly penalising Japan Tobacco for the early maturity of heated tobacco segment
• Transformation of dividend yield from industry worst to industry best
• Undervalued at 10.09x EV/Forward EBIT: DCF target price yields 21.8% upside

3. Hitachi High Tech’s Ace in the Hole

Last Friday, Hitachi (6501) was reported to be considering selling Hitachi Chemical (4217), according to media sources over the weekend. This has sent Hitachi Chemical and its parent into a frenzy with Hitachi Chemical ADR up 13% last Friday. We believe this news is relevant for Hitachi High Tech because both subsidiaries are 51-52% consolidated by the parent Hitachi, and both have arguably businesses with little synergy with the parent. We believe that Hitachi High Tech is also rumored to be on the block for sale or spin-off.  Media sources say that Hitachi is considering a sale of Hitachi Chemical and would reap Y300bn.  The current value of their 51% ownership in Hitachi Chemical is Y211bn, and thus there is 42% implied upside if the Y300bn figure is achieved.

To recap Q3 results for Hitachi High Tech from January 31, 2019, the numbers were decent with earnings above consensus forecasts by 33% for Q3 (Y15.8bn OP versus Y13.8bn forecast). The profit rise was due to improved margins in medical and continued strength in process semiconductor equipment. The shares are up 20% year-to-date, outperforming the Nikkei by 15%. Some of the fears of a sharp slowdown in semiconductor have been nullified by the continued strength in logic chip investments as well as the improved profitability in medical clinical analyzers. Medical profits soared 46% YoY in Q3 to Y7.6bn on a 13% YoY increase in revenues. OP margin improved from 12.3% to 15.8% YoY.

4. Bank Alfalah: Metrics Point to Falāh

Bank Alfalah (BAFL PA) is heading in the right direction as testified by its metric progression, embodied in its quintile 1 PH Score™.

Valuations are not stretched – especially the Total return Ratio of 1.8x and an Earnings Yield of 14.5%.

Combining the fundamental momentum signals (PH Score™) with franchise valuation, and a low RSI, places BAFL PA in the top decile of bank opportunities globally.

5. SMC (6273 JP): Profit Decline Accelerates

Downturns in the semiconductor, auto and other user industries have caught up with SMC. Sales were down 4.0% year-on-year in the three months to December (the first decline in more than two years) and the decline in profits accelerated, with gross profit down 5.4%, operating profit down 10.6% and net profit down 18.8%. Year-on-year comparisons are likely to remain difficult for at least another two quarters.

In December, we wrote: “Management reports that semiconductor-related demand is down in all markets and that auto-related demand is down in the U.S. Auto sales are also declining in China.” (SMC (6273 JP): Profits Start to Decline ) Last week, WSTS reported the first decline in semiconductor sales in 30 months and the Nikkei newspaper reported that “Japanese chipmaker Renesas Electronics will temporarily halt work at 13 of the company’s 14 production facilities, including all nine domestic plants, due to high inventory levels and possible impact as Chinese demand for automotive and machinery tools plummets.” On Friday, March 8, SMC’s share price dropped by 3%. 

SMC has left FY Mar-19 guidance unchanged, implying a 4.1% decline in sales and a 2.9% decline in operating profit in 4Q. In view of current trends, this looks over-optimistic. The shares are now selling at 17.8x our EPS estimate for FY Mar-19 and 18.6x our estimate for FY Mar-20. These multiples compare with a 5-year historical P/E range of 13.8x – 28.5x. 

In this briefing:

1. Japan Tobacco: No Dire Consequences Despite Late Entry to Heated Tobacco
2. Hitachi High Tech’s Ace in the Hole
3. Bank Alfalah: Metrics Point to Falāh
4. SMC (6273 JP): Profit Decline Accelerates
5. M: Trimmed 2019-20E Earnings Forecast by 12% and 19%

1. Japan Tobacco: No Dire Consequences Despite Late Entry to Heated Tobacco

• Late entry to Japanese heated tobacco market resulted in Japan Tobacco (2914 JP) losing market share to peers
• New product launches to give Japan Tobacco a fighting chance against IQOS
• Early maturity of heated tobacco in Japan: a blessing in disguise for Japan Tobacco
• Pricing power is expected to be back on track in future
• PloomTECH will soon be ready to compete with IQOS at a global level
• More product offerings targeting different customer needs in reduced risk products category
• International segment volume growth driven by global flagship brands and acquisitions
• Market unjustly penalising Japan Tobacco for the early maturity of heated tobacco segment
• Transformation of dividend yield from industry worst to industry best
• Undervalued at 10.09x EV/Forward EBIT: DCF target price yields 21.8% upside

2. Hitachi High Tech’s Ace in the Hole

Last Friday, Hitachi (6501) was reported to be considering selling Hitachi Chemical (4217), according to media sources over the weekend. This has sent Hitachi Chemical and its parent into a frenzy with Hitachi Chemical ADR up 13% last Friday. We believe this news is relevant for Hitachi High Tech because both subsidiaries are 51-52% consolidated by the parent Hitachi, and both have arguably businesses with little synergy with the parent. We believe that Hitachi High Tech is also rumored to be on the block for sale or spin-off.  Media sources say that Hitachi is considering a sale of Hitachi Chemical and would reap Y300bn.  The current value of their 51% ownership in Hitachi Chemical is Y211bn, and thus there is 42% implied upside if the Y300bn figure is achieved.

To recap Q3 results for Hitachi High Tech from January 31, 2019, the numbers were decent with earnings above consensus forecasts by 33% for Q3 (Y15.8bn OP versus Y13.8bn forecast). The profit rise was due to improved margins in medical and continued strength in process semiconductor equipment. The shares are up 20% year-to-date, outperforming the Nikkei by 15%. Some of the fears of a sharp slowdown in semiconductor have been nullified by the continued strength in logic chip investments as well as the improved profitability in medical clinical analyzers. Medical profits soared 46% YoY in Q3 to Y7.6bn on a 13% YoY increase in revenues. OP margin improved from 12.3% to 15.8% YoY.

3. Bank Alfalah: Metrics Point to Falāh

Bank Alfalah (BAFL PA) is heading in the right direction as testified by its metric progression, embodied in its quintile 1 PH Score™.

Valuations are not stretched – especially the Total return Ratio of 1.8x and an Earnings Yield of 14.5%.

Combining the fundamental momentum signals (PH Score™) with franchise valuation, and a low RSI, places BAFL PA in the top decile of bank opportunities globally.

4. SMC (6273 JP): Profit Decline Accelerates

Downturns in the semiconductor, auto and other user industries have caught up with SMC. Sales were down 4.0% year-on-year in the three months to December (the first decline in more than two years) and the decline in profits accelerated, with gross profit down 5.4%, operating profit down 10.6% and net profit down 18.8%. Year-on-year comparisons are likely to remain difficult for at least another two quarters.

In December, we wrote: “Management reports that semiconductor-related demand is down in all markets and that auto-related demand is down in the U.S. Auto sales are also declining in China.” (SMC (6273 JP): Profits Start to Decline ) Last week, WSTS reported the first decline in semiconductor sales in 30 months and the Nikkei newspaper reported that “Japanese chipmaker Renesas Electronics will temporarily halt work at 13 of the company’s 14 production facilities, including all nine domestic plants, due to high inventory levels and possible impact as Chinese demand for automotive and machinery tools plummets.” On Friday, March 8, SMC’s share price dropped by 3%. 

SMC has left FY Mar-19 guidance unchanged, implying a 4.1% decline in sales and a 2.9% decline in operating profit in 4Q. In view of current trends, this looks over-optimistic. The shares are now selling at 17.8x our EPS estimate for FY Mar-19 and 18.6x our estimate for FY Mar-20. These multiples compare with a 5-year historical P/E range of 13.8x – 28.5x. 

5. M: Trimmed 2019-20E Earnings Forecast by 12% and 19%

M had 4Q18 net profit of Bt606m (+11%YoY, -10%QoQ). The 2018 earnings was 10% lower than our forecast but in line with our expectation.

• Excluding impairment cost from employee benefit, 4Q18 core earnings grew 26.4%YoY to Bt690m. Meanwhile, gross margin remains flat at 68.3%, close to past four quarters level.
• The 2018 earnings increases 6% driven by gross profit margin expansion to 68.4% from 67.8% in 2017 and 4.3% growth in sales to Bt16bn due mainly to branches expansion and lower raw material costs respectively.
• We maintain our positive view toward its 2019-2020 outlook backed by SSSG recovery and branch expansion plan. However, we cut our 2019-20E earnings forecast by 12% and 19% respectively to factor in weak sales and margin than our previous expectation.

We maintain our BUY rating based on a new target price of Bt88 (27.4xPE’19) or down 8% from our previous target to follow earnings cut.

In this briefing:

1. Hitachi High Tech’s Ace in the Hole
2. Bank Alfalah: Metrics Point to Falāh
3. SMC (6273 JP): Profit Decline Accelerates
4. M: Trimmed 2019-20E Earnings Forecast by 12% and 19%
5. UUUM (3990) Phenomenal Growth but at a Price.

1. Hitachi High Tech’s Ace in the Hole

Last Friday, Hitachi (6501) was reported to be considering selling Hitachi Chemical (4217), according to media sources over the weekend. This has sent Hitachi Chemical and its parent into a frenzy with Hitachi Chemical ADR up 13% last Friday. We believe this news is relevant for Hitachi High Tech because both subsidiaries are 51-52% consolidated by the parent Hitachi, and both have arguably businesses with little synergy with the parent. We believe that Hitachi High Tech is also rumored to be on the block for sale or spin-off.  Media sources say that Hitachi is considering a sale of Hitachi Chemical and would reap Y300bn.  The current value of their 51% ownership in Hitachi Chemical is Y211bn, and thus there is 42% implied upside if the Y300bn figure is achieved.

To recap Q3 results for Hitachi High Tech from January 31, 2019, the numbers were decent with earnings above consensus forecasts by 33% for Q3 (Y15.8bn OP versus Y13.8bn forecast). The profit rise was due to improved margins in medical and continued strength in process semiconductor equipment. The shares are up 20% year-to-date, outperforming the Nikkei by 15%. Some of the fears of a sharp slowdown in semiconductor have been nullified by the continued strength in logic chip investments as well as the improved profitability in medical clinical analyzers. Medical profits soared 46% YoY in Q3 to Y7.6bn on a 13% YoY increase in revenues. OP margin improved from 12.3% to 15.8% YoY.

2. Bank Alfalah: Metrics Point to Falāh

Bank Alfalah (BAFL PA) is heading in the right direction as testified by its metric progression, embodied in its quintile 1 PH Score™.

Valuations are not stretched – especially the Total return Ratio of 1.8x and an Earnings Yield of 14.5%.

Combining the fundamental momentum signals (PH Score™) with franchise valuation, and a low RSI, places BAFL PA in the top decile of bank opportunities globally.

3. SMC (6273 JP): Profit Decline Accelerates

Downturns in the semiconductor, auto and other user industries have caught up with SMC. Sales were down 4.0% year-on-year in the three months to December (the first decline in more than two years) and the decline in profits accelerated, with gross profit down 5.4%, operating profit down 10.6% and net profit down 18.8%. Year-on-year comparisons are likely to remain difficult for at least another two quarters.

In December, we wrote: “Management reports that semiconductor-related demand is down in all markets and that auto-related demand is down in the U.S. Auto sales are also declining in China.” (SMC (6273 JP): Profits Start to Decline ) Last week, WSTS reported the first decline in semiconductor sales in 30 months and the Nikkei newspaper reported that “Japanese chipmaker Renesas Electronics will temporarily halt work at 13 of the company’s 14 production facilities, including all nine domestic plants, due to high inventory levels and possible impact as Chinese demand for automotive and machinery tools plummets.” On Friday, March 8, SMC’s share price dropped by 3%. 

SMC has left FY Mar-19 guidance unchanged, implying a 4.1% decline in sales and a 2.9% decline in operating profit in 4Q. In view of current trends, this looks over-optimistic. The shares are now selling at 17.8x our EPS estimate for FY Mar-19 and 18.6x our estimate for FY Mar-20. These multiples compare with a 5-year historical P/E range of 13.8x – 28.5x. 

4. M: Trimmed 2019-20E Earnings Forecast by 12% and 19%

M had 4Q18 net profit of Bt606m (+11%YoY, -10%QoQ). The 2018 earnings was 10% lower than our forecast but in line with our expectation.

• Excluding impairment cost from employee benefit, 4Q18 core earnings grew 26.4%YoY to Bt690m. Meanwhile, gross margin remains flat at 68.3%, close to past four quarters level.
• The 2018 earnings increases 6% driven by gross profit margin expansion to 68.4% from 67.8% in 2017 and 4.3% growth in sales to Bt16bn due mainly to branches expansion and lower raw material costs respectively.
• We maintain our positive view toward its 2019-2020 outlook backed by SSSG recovery and branch expansion plan. However, we cut our 2019-20E earnings forecast by 12% and 19% respectively to factor in weak sales and margin than our previous expectation.

We maintain our BUY rating based on a new target price of Bt88 (27.4xPE’19) or down 8% from our previous target to follow earnings cut.

5. UUUM (3990) Phenomenal Growth but at a Price.

This has been a fantastic performer. Since our buy note one year ago, the shares are up just over 3 times. Earnings growth has been very strong, and much better than we had anticipated. The story is even better now than it was then. Unfortunately, the valuations are not! The company is very focussed on growing revenue for the time being. If one is happy to buy a very fast growing new business, then this is still worth looking at.

In this briefing:

1. India Generic Drugs: “Antitrust Unredacted”
2. Speedcast: Back on Track
3. King’s Town: “The Night Seems to Fade, but the Moonlight Lingers On”
4. Dabur IN
5. Dabur IN

1. India Generic Drugs: “Antitrust Unredacted”

New information in the government’s investigation into antitrust violations by generic drug companies continues to surface. An unredacted version of the Attorneys General complaint was published recently by a health care trade publication. The unredacted portions of the document paint an incriminating picture of the industry, increasing the pressure to settle. The timetable for the process remains open-ended, and manufacturers will be reluctant to raise prices absent documentable product shortages. Among the Indian companies, Sun Pharmaceutical Indus (SUNP IN), Dr. Reddy’S Laboratories (DRRD IN), and Aurobindo Pharma (ARBP IN) feature prominently in the court filings.

2. Speedcast: Back on Track

Speedcast International (SDA AU) recently reported FY18 (Dec YE) results which showed a solid recovery in 2H. That has allowed the stock to start to recover from a torrid 1H18 performance which saw targets missed. The strong recovery in operating performance in 2H18 has allowed Ian Martin to reset forecasts and he now looks for the EBITDA margin to increase steadily as acquisitions are bedded down. By FY20, we expect Speedcast to be in a much stronger position as rising cash flow leads to lower debts. We have a new 12m target price of A$4.40 based on 11.7x FY20F EPS. We expect SpeedCast to be in a materially better operating position as it moves into FY20, and good cash flow will be used to reduce debt through the year. Operating execution in 1H19 is crucial.

3. King’s Town: “The Night Seems to Fade, but the Moonlight Lingers On”

King’S Town Bank (2809 TT) flags up some amber signals with the growth of funding and credit costs, huge asset writedowns on financial assets, and a shrinking bottom line that barely resembles Comprehensive Income.

This all may signal a management team getting to grips with some asset problems and navigating the ship into calmer waters. Or is the bank being cleaned up for sale? The bank was rumoured to be interested in Entie Commercial Bank (2849 TT).

Our PH Score™ (our fundamental trend and value-quality indicator) though is subpar at 2.5 (bottom quintile globally) and the RSI (14 day) is high at 77. We would prefer to see an elevated PH Score™ and a low RSI. “If a business does well, the stock will follow”. We are intrigued.

If the bank was trading on a Franchise Valuation of 8% (Asia Pacific median including Japan), shares might be more compelling. But Market Cap./Deposits stands at 20%. The median P/Book in the region (including Japan) stands at 0.8x versus 1.1x at King’s Town.

4. Dabur IN

Either Dabur India Ltd (DABUR IN) should change the crystal ball or those responsible for gazing at it. Going by its trajectory of strategies in the recent past, the narrative that emerges is that of confusion. Confusion has been a constant about whom Dabur perceived its competitors, its perception of the market while the disruptors reigned and what is and what should be its core strengths.

In this summary insight, we find Dabur heading to hibernation in summers. We believe this confused state of mind at Dabur will lead to lower than expected growth rates and an impact on margins. Our arguments are based on in-depth analysis of over 3 years of conference calls, past 5 year financial statements, competitors balance sheets and primary research covering different parts of the country. Our base case FY 21 EPS is 21% lower than consensus estimates and a potential aggressive case EPS is 26% lower than consensus. We argue for a 35x forward multiple giving us a target price of INR 322 for the base case and an aggressive case target price of INR 305 indicating a potential 26% & 30% downside from the latest close price of INR 437.

A Detailed Insight that includes our detailed arguments and financial forecasts can be found elsewhere here on Smartkarma using the company’s ticker.

5. Dabur IN

Either Dabur India Ltd (DABUR IN) should change the crystal ball or those responsible for gazing at it. Going by its trajectory of strategies in the recent past, the narrative that emerges is that of confusion. Confusion has been a constant about whom Dabur perceived its competitors, its perception of the market while the disruptors reigned and what is and what should be its core strengths.

In this insight, we find Dabur heading to hibernation in summers. We believe this confused state of mind at Dabur will lead to lower than expected growth rates and an impact on margins. Our arguments are based on in-depth analysis of over 3 years of conference calls, past 5 year financial statements, competitors balance sheets and primary research covering different parts of the country. Our base case FY 21 EPS is 21% lower than consensus estimates and a potential aggressive case EPS is 26% lower than consensus. We argue for a 35x forward multiple giving us a target price of INR 322 for the base case and an aggressive case target price of INR 305 indicating a potential 26% & 30% downside from the latest close price of INR 437.

In this briefing:

1. Brazil Banks Outlook; Pension Reform, the Big Recession Hangover Cure?
2. SIS: 4Q18 Result Broke the Record
3. OCBC – Difficult to Square
4. Renesas: Factory Stoppage Announcement Should Correct Premature Rebound Expectations
5. Matahari Department Store (LPPF IJ) – A Retail Conundrum

1. Brazil Banks Outlook; Pension Reform, the Big Recession Hangover Cure?

• Despite its challenges, the pension reform outlook in Brazil remains constructive, in our view; successful pension reform would create solid foundations for GDP growth, lowering fiscal account and inflationary pressures and lead to sustainably lower benchmark rates
• A no or very limited reform scenario would leave Brazil stuck in the GDP growth slow lane, which would imply a growing fiscal deficit and rising public sector debt burden, with a need for higher benchmark rates. We believe that meaningful pension reform will be approved in 2019; but the possibility of a heavily diluted version of reforms is still a potential risk
• The BCB’s January bank sector data indicates a solid start to 2019, especially in seasonally adjusted new loan grantings driven by corporates, and in better yoy comparisons in NPL ratio and NPL coverage
• We believe that successful pension reform should be positive for the bank sector, driving loan growth potential, as well as structural improvement in credit quality and sustainable lower benchmark interest rates. In conjunction, we see these factors as supportive for bank sector returns, with, over the medium term, the negative effect of lower credit spreads more than offset by the positive, structurally lower cost of risk from lower NPL ratios
• The successful pension reform scenario implies further bank stock re-ratings, driven by multiple expansion. Our top pick in large cap banks is Banco Do Brasil Sa (BBAS3 BZ), where the PBV discount to the private sector remains excessive; versus Itau Unibanco Holding Sa (ITUB4 BZ), the PBV discount is 42% and versus Banco Bradesco Sa (BBDC4 BZ) the PBV discount is 39%

2. SIS: 4Q18 Result Broke the Record

SIS’s 4Q18 net profit was Bt149m (+77%YoY, +16%QoQ), a record high level. The impressive 2018 result was much better than our forecast and accounts for 131% of our full-year forecast.

• A YoY and QoQ earnings growth were backed by an all-time high level of gross margin at 6.7% mainly driven by higher sales contribution from data center related products and others (security and surveillance) segments. 2018 net profit was at Bt468 (+58%YoY), buoyed by a record high sales and margin
• We maintain a positive outlook toward its 2019-20E earnings driven by 1) solid growth for high margin segments: enterprise, security and surveillance on the back of strong outlook for IT investment by private sector along the mega-trend of digitalization.
• Announced Bt0.55 of dividend payment or equivalent to 4.7% yield (XD on 3th May 2019

We maintain a BUY rating for SIS with our new target price of Bt15.0 derived from 10xPE’19E, its average trading range in the past five years or a 30% discount to the Thai Info Tech sector.

3. OCBC – Difficult to Square

The data and text from Oversea Chinese Banking Corp. (OCBC SP) is difficult to square. It talks about improved credit quality, but its NPLs are up both YoY and QoQ.  In the bank’s Pillar 3 disclosure it notes that ‘risk-weighted assets (RWA) were largely stable in the quarter primarily due to improving asset quality.’ In its financial supplement it reports NPLs of S$3,938m compared with S$3,594m, in 4Q18 and 3Q18. This is nearly 10% higher QoQ.  The reality is that OCBC ramped up credit costs in 4Q18 to nearly 3x its full 9M18 charge and despite this, its NPL cover is now down to 57% from 78% a year ago. To us this appears like marked deterioration.  And even QoQ, where NPL cover was 65% in 3Q18. The risk now is that credit costs during the current year are more like 4Q18 or higher, rather than the paltry figures seen during full year 2018. We do not believe the market is expecting this. 

4. Renesas: Factory Stoppage Announcement Should Correct Premature Rebound Expectations

We commented previously on 13 Dec 2018 that:

We visited Renesas Electronics (6723 JP) this week to discuss progress on inventory reduction and its likely ramp of utilisation rates/wafer throughput, as well as to gather further details on the IDT acquisition and its long -term strategy. On the whole, we continue to like the long-term picture, consider the stock to be undervalued and believe investors with long time horizons should be looking at the stock on the long side. However, our discussions suggested to us that while production cuts to reduce inventory should be completed this month or at worst in 1Q2019, a ramp in utilisation rates could take longer than is implied by consensus.

Following this comment Renesas Electronics (6723 JP) traded directionally with the market though in very volatile fashion, first dropping 17% before rebounding 69%. Now, with Nikkei reporting that the company would halt production at most facilities during the year and for as much as two months in some cases, the stock is once again giving up its gains and is limit down -14%.  This leaves it just 10% above where we previously commented on the stock and as it approaches the ¥500 level again we feel it is becoming interesting again. We examine the potential financial impact from the production halts below.

5. Matahari Department Store (LPPF IJ) – A Retail Conundrum

Pt Matahari Department Store (LPPF IJ)‘s FY18 results call was an interesting combination of kitchen sinking, a cautious outlook, combined with some more optimistic strategies on specialty stores with new brands and smaller format stores for regional expansion. The big question is whether these strategies will win out or will the company continue to underwhelm on its growth prospects? 

Pt Matahari Department Store (LPPF IJ) remains a market leader in its space with 159 departments stores across Indonesia selling affordable fashion to the middle classes but it has underwhelmed on a few occasions on its growth and guidance. It is reducing its dividend payout to facilitate the build-out of specialty stores with new brands on board. 

Valuations do now look interesting with the company trading on 6.0x FY19E PER and 5.4x FY20E PER. It generates a forecast ROE of 70% and ROE of 30%, which is extremely high for a retailer. The question is how much analysts will downgrade and whether investors will look through its Lippo connection. After another 9% fall in the share price today after 22% yesterday, a lot does seem to have been factored in already.