Investment Analysis on Plantation Industry (15 Aug 2015)

Date:  Saturday, August 15 at 9:00am – 12:00pm
Location: Super Space, No. 1-2, Jalan PJS8/10, Dataran Mentari, Bandar Sunway,, 46150 Petaling Jaya
Course Outline: http://1drv.ms/1CInccU
Course Objectives:

  1. Life cycle, general structure and performance of CPO companies
  2. Important factors that influence CPO counters’ prices
  3. Key performance profiling and key metrics for assessing performance of CPO companies
  4. Case studies (more than 20 companies)
  5. Challenges in analysing diversified players
  6. Short demo of estimating EPS of a CPO counter.

Organizer: Wealth Creation Code
Speaker: L. C. Chong
Registration: Call 012-2681632 (Administrator of Wealth Creation Code)
Fee for WCC Member: Free
Fee for Public: RM300.00

Bank Balance Sheet

Today, The Busy Weekly published my comment about bank accounting. This is our of my expectation. Smile

 

Order of Liquidity

PBBANK – Fundamental Analysis (31 Jul 2015)

At the time of writing, I owned shares of PBBANK.
Changes:
  1. 31 Jul 2015 – First write up of PBBANK using new style, and covers FY15 Q2 results.

About PBBANK

The Bank is principally engaged in all aspects of commercial banking and the provision of related financial services. The Public Bank Group is one of the leading banking groups in Malaysia, with overseas market presence in Cambodia, Vietnam, Laos, Hong Kong, China and Sri Lanka. The Public Bank Group offers a comprehensive range of financial products and services covering, amongst others, personal banking, commercial banking, Islamic banking, investment banking, share broking, trustee services, nominee services, sales and management of unit trust funds, bancassurance and general insurance products.

The Group’s domestic business, which also includes Islamic banking business, is organised into the following key operating segments:

  1. Hire Purchase – The hire purchase operations focus on the provision of passenger vehicle financing to all levels of customers.
  2. Retail Operations – Retail operations focus on providing products and services to individual customers and small and medium enterprises. The products and services offered to customers include credit facilities (mortgages, trade and personal loans), credit cards, remittance services, deposit collection and investment products.
  3. Corporate Lending – The corporate lending operations cater to the funding needs of large corporate customers which are primarily public listed companies and their related corporations.
  4. Treasury and Capital Market Operations – The treasury and capital market operations are involved in proprietary trading in treasury related products and services such as foreign exchange, money market operations and securities trading.
  5. Investment Banking – The investment banking operations cater to the business needs of large corporate customers through the provision of financial solutions and direct lending. The services offered include structured financing, corporate advisory services, merger and acquisition, stock-broking and debt restructuring advisory services.
  6. Fund Management – The fund management operations consist of sale of trust units and the management of unit trust funds as conducted by the Bank’s wholly-owned subsidiary company, Public Mutual Berhad.
  7. Others – Others refer mainly to non-core operations such as property holding.

The Group’s overseas business operations are organised according to the following geographical locations:

  1. Hong Kong SAR – This includes all business operations conducted by the Group’s subsidiary companies in Hong Kong SAR and the People’s Republic of China, including retail and commercial banking and lending, wealth management services, stock-broking and other related financial services.
  2. Cambodia – This comprises all business operations conducted by the Group’s subsidiary companies in Cambodia, which includes mainly financing, deposit-taking, general insurance businesses and stock-broking.
  3. Other Countries – This refers to the Group’s banking business operations in the Socialist Republic of Vietnam, Lao People’s Democratic Republic and Sri Lanka.

Ownership

Main shareholders of PBBANK are Consolidated Teh Holdings and institutional funds. Besides, PBBANK is covered by a lot of local and foreign analysts. This provides quite a good liquidity to this shares.

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Economic Moats

Cost Advantage – Narrow

  • PBBANK enjoys extreme high net profit margin and FCF/Sales, and could be the highest among the banks in Malaysia
  • On the other hand, the banking sector is facing Net Interest Margin (NIM) compression
  • NIM compression will persist in the next few years.

Switching Costs – Wide

  • PBBANK’s wide networks, both local and also global reach
  • I don’t have statistics, but based on my observation, people tend to stick with PBBANK due to branding.
  • Another important is inertia. Many people don’t switch banks, even if they feel that they’re being nickeled and dimed by their current bank.
    • The inertia is weaker nowadays. Consumers can have few bank accounts in different bank, and change their preferred bank easily. Attractive refinancing offers provided by other banks.

Network Effect – Wide

  • Strong brand and leadership position in the domestic market.
  • Expected to continue with ETP investment momentum

Intangible Assets – Narrow

  • The abundant of experience and strong workforce
  • Widely known and well recognized by its unique brand name and its head logo.

Efficient Scale – Wide

  • Have characteristics of rational oligopolies
    • Can decide to lower its prices, change its output, expand into a new market, offer new services, or advertise. This will have powerful and consequential effects on the profitability of its competitors

Profitability

From FY10 to FY14, pre-provision operating income of PBBANK constantly increased 5.8% yearly. Nevertheless, its ROE decreased from 23.3% (FY11) to 16.1% (FY14) due to increase of tangible assets (such as loans and investment portfolio). We can clearly see this in the “Net Income % Tangible Assets” chart.

Using Moody’s rating system as benchmark, PBBANK’s profitability is rated as M+ (Medium+) for FY14. To help you gauge the rating, for FY11, PBBANK’s profitability is rated as S- (Strong-).

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Efficiency

To measure a bank’s efficiency and its ability to generate incremental profits with added revenue, I will use “Cost to Income” which is available in every bank’s financial report. The lower it is, the more profitable the bank will be.

In the past 5 financial years, PBBANK maintained its cost-to-income in the range of 29%-31%. Efficiency of PBBANK can be graded as A.

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Asset Risk

A bank’s asset risk is fundamental to its creditworthiness because its high leverage implies that a small deterioration in the value of its assets has a large effect on solvency. These risks are captured, to a considerable degree, by a single financial ratio, problem loans/gross loans (which we term the problem loan ratio). As loan quality deteriorates, the problem loan ratio rises, signaling potential problems, credit losses and consequent pressure on solvency that disadvantages bondholders by reducing the earnings and equity capital buffers that protect them.

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As above, by Moody’s standard, PBBANK’s asset risk can be rated as VS+ (Very Strong+). This also indicates that PBBANK is very strict in loan approval.

Capital Adequacy

I use to two ratios to measure bank capitalization: “Tier 1 Ratio” and “Tangible Common Equity % RWA”. PBBANK increased regulatory capital, from 11.1% (FY13) to 12.8% (FY14). This is way above Bank Negara requirement.

To assess whether PBBANK increased the regulatory ratio with tangible assets, we can use “Tangible Common Equity % RWA” – 9.6% (FY13) to 12.2% (FY14). Again, by Moody’s standard, this is rated as M+ (Medium+).

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Funding Structure & Liquid Resources

A bank’s funding structure has a strong bearing on its potential need for assistance because some sources of funds are less reliable than others. This implies that a bank making significant use of an unreliable funding source – perhaps short-term in nature, from particularly risk-sensitive counterparties – is more likely to suffer periodic difficulties in refinancing its debt. All other variables being equal, this puts it at greater risk of needing support. The primary ratio is “market funds/tangible banking assets”. This ratio expresses the proportion of the balance sheet that credit-sensitive investors and counterparties fund; as such, it measures liability-side volatility and the resultant liquidity risk.

As of FY14, “market funds/tangible banking assets” of PBBANK is 10.0%, which is rated as S (Strong).

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An assessment of the liability-side structure of a bank has to be seen in the context of its asset side. A bank can reasonably borrow from credit-sensitive investors if it has corresponding assets in the form of high-quality liquid instruments that it can sell or repo for cash in response to its funding counterparts’ changing behaviour. The primary ratio is “liquid assets / tangible banking assets”. This provides an offset to the “market funding / tangible banking assets” ratio above. Moody’s study shows that banks with relatively low levels of liquid assets had a higher tendency to require support.

Since FY11, PBBANK has been working on improving liquid banking assets – 13.8% (FY11) to 22.7% (FY14). We can rate this as M (Medium).

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To measure whether a bank still has buffer to increase loans, the primary ratio is Loan-to-deposit ratio. This ratio is particularly useful to assess potential growth of a bank by measuring conversion rate of deposits to loans. If the ratio is too high, it means that banks might not have enough liquidity to cover any unforeseen fund requirements. If the ratio is too low, banks may not be earning as much as they could be. 75% to 90% can be considered as healthy range. Besides, we should also compare ratio of a bank with its peer.

The following chart shows loan-to-deposit for PBBANK, and the range is between 87% to 88%. We will compare this with other banks later.

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Market Risk Appetite

Market Risk Appetite aims at capturing the sensitivity of both the trading and non-trading books to major changes in key financial variables (including interest rates, FX, equity prices, credit spreads). In assessing a bank’s market risk appetite, our starting premise is that the fundamental relationship between risk and expected return indicates that the greater the risk, the higher the expected return. As expected return increases, the volatility of returns, and so the size of potential unexpected losses, increases. Conversely, as expected return decreases, the volatility of returns and so the size of potential unexpected losses decreases.

Market Risk Appetite of PBBANK is less than 10% where this can be rated as A.

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FY15 Q2 Results

2Q15 vs. 2Q14, QoQ

2QFY15 net profit of RM1.19b (+2.2% qoq, +13.3% yoy) led to a cumulative net profit of RM2.37b (+14.2% yoy). The improved earnings was mainly due to higher net interest income, higher net fee and commission income and higher investment income partially offset by higher other operating expenses.

NIM further contracted by 4bp qoq to 2.11% in 2QFY15. This was contributed by (MIDF 31 Jul 2015):

  1. Continuous rebalancing of its loan portfolio towards mortgage loans with lower financing rates and
  2. Higher COF from strong competition for deposits. Management has guided a NIM compression of up to 12bp for FY15 contributed largely by higher COF.
  3. Also contributing to the drop in NIM will be the decline in yield on the Group’s retail loans as a result of portfolio rebalancing as aforementioned.

However, the impact of portfolio rebalancing on NIM contraction will be smaller than that of the rise in COF and will gradually taper off, hence impacting NIM only by a few basis points moving into FY16.

1H15 vs. 1H14, YoY

Pre-provision operating profits in 1HFY15 was up by +11.0% yoy contributed by higher net income of +10.0% yoy with a rise in NII (+9.5% yoy) and NOII (+15.3% yoy). Net profit attributable to equity holders improved by RM295.0 million or 14.2% to RM2,368.3 million. The improved earnings was mainly due to higher net interest income of RM269.0 million (9.5%), higher net fee and commission income of RM88.9 million (13.3%), higher investment income of RM22.4 million (22.3%) and higher income from foreign exchange business of RM25.8 million (20.7%). These were partially offset by higher other operating expenses of RM103.1 million (7.8%) mainly due to higher personnel costs which were in tandem with the increased headcount to support business expansion.

Gross loans grew by RM26.6 billion or 11.5% to RM258.8 billion as at 30 June 2015 as compared to RM232.2 billion as at 30 June 2014, driven by growth in property financing, financing of passenger vehicles and lending to small and medium enterprises (“SMEs”). Total deposits from customers increased by 11.6% or RM30.8 billion to RM295.3 billion as at 30 June 2015 which partly contributed to the higher net interest income for the current period. PBBANK’s impaired loan ratio further improved to 0.54% as at 30 June 2015.

The growth in the PBBANK’s profit was driven by continued healthy loans and customer deposits growth coupled with sustained strong asset quality, as well as gains arising from foreign exchange fluctuation in respect of the PBBANK’s foreign operations.

Peer Comparison

Profitability

The following charts compare profitability of PBBANK with other local banks for FY14.

  1. In term of “Net Income % Tangible Assets”, from FY10 and FY13, PBBANK was the champion, but in FY14, AMMB took over the crown. AMMB managed to achieve this because they boosted the loan-to-deposit to 97%. This strategy is not sustainable in long term.
  2. For “Return on Equity”, from FY10 and FY13, PBBANK was the champion, but in FY14, BIMB took over the crown. in FY14, BIMB reduced substantial amount pay out to “Non-controlling Interests” – from 283,827 (FY13) to 54,575 (FY14).
  3. As for “Net Interest/Income Margin”, PBBANK is at the middle of the table. BIMB, CIMB and AMMB are the top 3, but later we will look into the quality of loans.

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Efficiency

As you can clearly see, cost-to-income of PBBANK obviously is the lowest in this industry. It means that PBBANK is the most efficient bank.

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Asset Risk

Quality of loans of PBBANK is obviously the best in the industry. Despite NIM of CIMB, AMMB and RHBCAP are higher than PBBANK, you can see quality of loans of the three banks are not good.

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Capital Adequacy

Regulatory capital of all banks already met Bank Negara’s requirements.

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Funding Structure & Liquid Resources

  1. Loan-to-Deposit – PBBANK is at the middle of the table. Compare MAYBANK and CIMB, PBBANK still has a small room to increase loans (if they want to).
  2. Market funds % Tangible Banking Assets – Compare to MAYBANK and CIMB, liability-side volatility and liquidity risks of PBBANK is quite low.
  3. Liquid Banking Assets % Tangible Banking Assets – Although PBBANK is at the middle of the table, compare to other banks, in the past 5 years, PBBANK has been increasing their liquid banking assets constantly.

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Market Risk Appetite

PBBANK is a very conservative bank in taking market risk. You can see how high market risk appetite of CIMB is, and what happened to CIMB performance now.

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Growth Drivers

  1. 25 Jul 2014 – To focus more on commercial property loans and loans to civil servants with higher yields. Moving ahead, price pressure on loans and funding pressure will continue but is likely to be partially mitigated by the repricing of loan rates following the recent 25bp rise in OPR. Management plans to focus more of lending to SMEs for purchase of commercial properties as well as grow the Group’s lending to civil servants with repayment through Angkasa’s direct salary deduction scheme. These financings will be higher in yields to defend its NIM. The lending to civil servant will the through its arrangement with an agency which already has access to the Angkasa code. The other plans to defend its NIM will be through expanding of CASA deposits as well as increasing the mix of retail CASA relative to its wholesale CASA.
  2. 25 Jul 2014 – After the completion of its acquisition of another 50% equity in VAD Public Bank (VPB) presently held by Joint Stock Commercial Bank for Investment and Development of Vietnam (BIDV), VPB will be converted into a 100% owned foreign bank. Management highlighted that VPB will focus on consumer/retail banking. The acquisition of another 50% equity will enable the Group to fully own VPB. This will allow it to accept savings deposits like other banks in Vietnam. In addition, it also allows the Group to operate VPB with its own business model.
  3. Internal growth drivers:
  1. 25 Jul 2014 – While PBBANK is expected to continue to have tight credit control, hence solid quality, the concerns of heightening credit cost remains due to higher living cost that would potentially impact borrowers’ affordability. Analysts have imputed in <20bps in credit cost. Note that before FY12, credit cost of PBBANK was ranging from 45bps to 60bps.
  2. 25 Jul 2014 – To maintain low CIR due to excellent cost control and operating efficiency, ie. CIR of ~30% for the next 2 years.
  • 6 Jul 2015 – Public Bank strengthens collaboration with Japan’s Resona Holdings
  • The business collaborations with Saitama Resona Bank and Kinki Osaka Bank will further facilitate Public Bank’s customers to benefit from the potential and established franchise in Saitama Resona Bank’s home market, Saitama Prefecture, and Kinki Osaka Bank’s home market at the Osaka Prefecture
  • The collaborations would allow the banks to leverage upon their respective strengths and expertise and enable them and their respective affiliates to establish and promote to their respective customers appropriate banking products and services in Malaysia and Japan.

Issues/Risks/Challenges

  1. ROE on declining trend and is set to decline further after the completion of right issue exercise. Analysts are expecting ROEs of 18.6% and 16.7% for FY14 and FY15 respectively.
  2. NIM compression
    1. Continuous rebalancing of its loan portfolio towards loans with lower financing rates
    2. The impact of higher COF from strong competition in particularly retail deposits due to implementation of LCR requirements on banks effective 1 June 2015
    3. 6 Feb 2015 – The impact on the rebalancing of loan portfolio towards the margin compression will still be significant in FY15 but the impact will gradually taper off over the next 3 years with smaller impact in the latter years. COF has risen with the increase in rates for retail and wholesale/corporate deposits. Management has guided for NIM to contract by 8-10bp in FY15.
  3. 6 Feb 2015 – Management highlighted that the slowdown in residential property loans was part of the Group’s strategy to be conservative and to avoid financing properties for speculation purposes and focus on the mass market for financing of affordable houses. Elsewhere, HP financing gained momentum slightly to a growth of 7.5%yoy. The Group remained as leader in domestic passenger vehicle financing with an improved market share of 28.1%.
  4. Other risks
  1. Tighter lending rules and slower loan growth – weaker-than-expected NIMs
  2. Slower than expected ETP projects rollouts
  3. Keener competitions and hence further margin squeeze
  4. sharp turn in NPLs hence higher credit charge
  5. Potential asset quality pressure arising from changing macroeconomic environment
  6. Competitive landscape to put further pressure on loan pricing & funding costs
  7. Deterioration in asset quality
  8. Adverse foreign exchange movements
  • 31 Jul 2015 – Slower loan momentum for Hong Kong and China and the other countries

Valuation

Historical EY%

  • Trailing:
  • FY14 (BPS: 7.674) – 19.90 (Uncertainty Risk: HIGH)
  • Current (BPS: 7.593) – 19.69 (Uncertainty Risk: HIGH)
  • Forward:
  • FY15 (BPS: 7.663 ± 5%) – From 18.88 to 20.87 (Uncertainty Risk: HIGH)
  • FY16 (BPS: 8.389 ± 5%) – From 20.67 to 22.84 (Uncertainty Risk: MEDIUM to HIGH)
  • BPS applied to reach the current stock price (18.98): 7.319

I think fair value of PBBANK is from 20.67 to 22.84.

Returns to Shareholders

To maintain capital adequacy, in general, banks unlikely to maintain high dividend payout.

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Going Forward

Despite unexpected good results of PBBANK in Q2FY15, moving forward, I believe that PBBANK result will be stable or a bit slow down. This is because loan applications will continue to be slow marginally and NIM compression will be higher in the future.

I will continue to hold this share, and accumulate it when there is a dip in the price.

Resources

Excel – http://1drv.ms/1MWTr8a

Notes – http://tinyurl.com/popzxf3

2Q15 Quarterly Report – http://www.bursamalaysia.com/market/listed-companies/company-announcements/4814941

RSS Feed for The Edge Malaysia

If you want to subscribe RSS Feed of The Edge Malaysia, you can do the following RSS to your news reader. My favourite news reader is Feedly.

  1. http://www.theedgemarkets.com/en/content/subscribe-rss – You can manually add every RSS to your news reader. The issue doing this is your news reader will download duplicate articles.
  2. http://www.feedcombine.com/rss/5184/the-edge-malaysia.xml – You can add this RSS instead where this aggregates all RSS above. Thus, you won’t see duplicate articles.

Book – Equity Valuation for Analysts and Investors

I just finished this book recently: Equity Valuation for Analysts and Investors. If you want to build a model for earnings estimation, this is a good book.

In my opinion, certain parts of this book can be simplified by using more illustrations.

It is not advisable to buy the electronic version of this book because many illustrations show an excel worksheet with too many columns. You will have difficulty to see the illustration with your Tablet.

DIGI – Fundamental Analysis (21 Jul 2015)

About DIGI

This company is involved in the establishment, maintenance and provision of mobile telecommunication services and its related products in Malaysia.

Ownership

Main shareholders of DIGI are Telenor ASA and institutional funds. Besides, DIGI is covered by a lot of local and foreign analysts. This provides quite a good liquidity to this shares.

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Economic Moats

Cost Advantage Moat: Narrow

  • Lower ARPU if compare to MAXIS and CELCOM. However, DIGI got the highest net profit margin.
Switching Costs Moat: None

  • Nowadays, changing Telco is piece of cake. However, good coverage service will retain subscribers longer.
  • DIGI coverage is still not as good as MAXIS and CELCOM, but DIGI makes great efforts to improve their network.
  • Since Jun 2013 (after they upgraded few thousands of stations) , I have much better experience in using their data services, and I am no longer experience call drop while driving.
Network Effect Moat: Narrow

  • DiGi has established an integrated distribution approach across all its owned shops, exclusive stores, dealers and alternate channels. This in-depth cluster performance management structure will assist DiGi in driving prepaid while strengthening its postpaid and broadband.
  • With the stronger organisational capabilities, DiGi is well-placed to further maximise revenue and optimise its infrastructure use. Furthermore, this will provide greater opportunity for DiGi to address dedicated and segmented offerings to customers as well as design dedicated below-the-line (BTL) campaigns and engagements.
  • Statistics shows that DIGI subscribers are increasing over the years. Still got room of improvement.
Intangible Assets Moat: Wide

  • DiGi placed significant importance on sustainable operational efficiencies to support its growth and to deliver the best customer experience.
  • Cost of goods sold (COGS) and operational expenditure (Opex) were managed prudently, driven by strong cost management discipline throughout the organisation, with visible efficiencies obtained from the recently completed network modernisation exercise.
  • High ROIC and CROIC above 15% in the past 9 years – This is a proof of excellent operational efficiency in DIGI.
Efficient Scale Moat: None

The following chart shows ROIC and CROIC of DIGI in the past 10 years. By MorningStar’s definition of economic moats, DIGI enjoys very wide economic moats in Malaysia.

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Profitability

From FY10 to FY14, DIGI’s revenue has been growing 6.4% annually in average, and DIGI was able to maintain EBITDA margin more than 40%. Nevertheless, in FY13 and FY14, DIGI’s EBITDA margin declined slightly because

  1. Higher capex in modernized its network
    1. 6 Mar 2014 – DIGI is committed to invest up to RM900 million in capital expenditure (capex) spending to capitalise on its recently modernised network to generate more growth in data. Although this will involve more capex (FY14 capex/sales ratio will be higher than FY13’s 11%), this is the right approach, as it will enable the telco to better monetise data by serving areas that are currently underserved, as well as close the gap with its peers and increase scale. By year-end, DIGI expects its 3G coverage to reach 86% (from 80% currently versus peers’ more than 85%) and roll out 1,000 long-term evolution sites.
    2. 13 Jul 2015 – DIGI strategically invested another RM200 million in capex to boost its data network coverage and quality with extensive 4G-LTE coverage available in all its key market centres.
  2. Higher marketing costs
  3. Higher customer acquisition costs (via heavy handset’s subsidies)
  4. Based on Moody’s standard, DIGI’s EBITDA margin is rated as Aa.

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Leverage & Cash Flow

In the past few years, in order to modernizing its network and increasing its market share, DIGI has been taking some gearing.

  1. FY14’s Debt/EBITDA – 0.33x (Aaa)
  2. FY14’s RCF/Debt – 125% (Aaa)
  3. FY14’s FCFF/Debt – 182% (Aaa)

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Coverage

For Telco, there are two important ratios to assess coverage:

  1. (EBITDA-CAPEX)/ Int. Exp. – This ratio considers the ability of a telco to cover interest expenses after it has made the necessary re-investments into it core operations. The concept represents the need to maintain/sustain operating cash flow, while servicing ongoing interest payments. It is important in the telecommunications industry as substantial investments in evolving and existing technology are required.
  2. (FFO+Int. Exp.)/ Int. Exp. – This ratio provides a measure of a telco’s ability to fund interest expenses from operational cash flow prior to payment of dividends, working capital movements, and capital expenditure investment.

By Moody’s standard, DIGI’s coverage is rated as Aaa. This is extremely healthy.

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FY15 Q2 Results

2Q15 vs. 2Q14, QoQ

2Q15 revenue was lower by 3.8% due mainly to lower device & other revenue while its service revenue remains relatively stable at RM1.59b (+0.1%). EBITDA improved by 1.7% to RM788m with margin enhanced to 45.7% (vs. 43.3% in 1Q15).

1H15 vs. 1H14, YoY

EBITDA margin improved as a flow through from lower device sales. However, absolute EBITDA declined 0.9% year-on-year due to the compounding effects from GST implementation, margins pressure from intensified price competition in the market and weaker MYR currency development.

Profit after tax (PAT) ended lower at RM464 million this quarter on the back of progressively higher depreciation and amortisation charges as well as higher tax expenses.

DIGI’s service revenue grew +1.3%yoy to RM1,589m from RM1,568m in 2Q14, driven by higher internet revenue growth of +24%yoy to RM507m. Total customer base increased 124k to 11.8m while internet subscribers gained further traction to 6.8m forming 57.9% of total subscribers from 49.4% in 2Q14. DIGI’s 1H15 cumulative earnings amounted to RM943.6m – in-line with ours and consensus expectations. This accounts for 45.4% and 45.5% of ours and consensus full year earnings estimates respectively.

Postpaid segment

imageSource: 2Q15 Quarterly Report In 2Q15, postpaid service revenue grew 3.5% YoY and 3.2% QoQ as a flow through from encouraging smartphone bundles commitments secured in the preceding quarter. Its subscriber base grew by 75k year-over-year to 1,771k in 2Q15, while the proportion of active internet subscribers increased to 76.3% of total postpaid subscribers. Average Revenue per User (ARPU) remained stable at RM82.

Prepaid

imageSource: 2Q15 Quarterly Report Prepaid service revenue remained steady with marginal growth of 0.5% year-on-year although sequentially lowered by 1.1% as a result of the recent changes in the prepaid market. DIGI continued to strengthen its stronghold with additional 111,000 subscribers and sealed the quarter with a total of 10.0 million prepaid subscribers.Both prepaid service revenue growth and ARPU were adversely impacted from competition intensity especially in IDD services and aggressive prepaid sim pack offers in the market. This was further compounded by effects from post GST implementation confusion and challenges which slowed down operational momentum significantly in 2Q 2015.

Blended

imageSource: 2Q15 Quarterly Report DIGI effectively challenged industry dynamics and secured service revenue growth of 1.3% year-on-year and halted negative sequential growth seen in 1Q 2015.DIGI added 124,000 more subscribers into its network, most of which are active internet users.

Internet subscribers rose to more than 6.8 million, representing 57.9% of the total subscriber base whilst smartphone penetration also reached a new level at 57.1%, a marked improvement from 41.9%, a year ago.

Internet revenue remained a strong catalyst for service revenue growth with an encouraging growth of 24.0% year-on-year.

Sequential internet revenue growth of 5.2% seen in 1Q 2015 was reduced to 0.4% in 2Q 2015 due to interim weaker spending post GST among the prepaid subscribers although demand for mobile internet remained strong.

Blended ARPU stayed resilient although moderated slightly to RM45 over an increasing subscriber base.

Total Cost Trend

imageSource: 2Q15 Quarterly Report Cost of Goods Sold (COGS) trimmed 8.2% year-on-year and 12.7% quarter-on-quarter mainly as a flow through from lower device cost consequential from higher mix of affordable smartphone bundles sold.The depreciation of MYR currency resulted in relatively higher IDD traffic cost while price competition intensity weighed in at the expense of revenue and margin.

Nonetheless, opex to service revenue ratio remained fairly resilient at 29.1%, consistent level as the last two quarters amid competition intensity and rapid expansion of data network.

Peer Comparison

Compare to others, subscriber base of DIGI increased constantly in the past 5 years.

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For postpaid segment, in overall, ARPU of three Telcos are stagnant, and DIGI ranked the 3rd position. For prepaid segment, DIGI ARPU can be considered the highest one, but its ARPU has been declining from 41 to 38.

Prepaid service ARPU of DIGI were adversely impacted from competition intensity especially in IDD services and aggressive prepaid sim pack offers in the market. This was further compounded by effects from post GST implementation confusion and challenges which slowed down operational momentum significantly in 2Q 2015.

Surprisingly, MAXIS prepaid ARPU increased from 34 to 38.

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In terms of EBITDA Margin, compare to MAXIS and AXIATA, DIGI maintains the 2nd position. Nevertheless, three of them enjoy very good margin so far.

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In terms of CROIC and ROIC, DIGI is obviously the most efficient company in generating revenue and cash flow. Despite MAXIS having some unfair competitive advantages in network infrastructure, DIGI is still able to achieve outstanding operational excellence in building very wide economic moats.

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Growth Drivers

  • 13 Jul 2015 – DIGI strategically invested another RM200 million in capex to boost its data network coverage and quality with extensive 4G-LTE coverage available in all its key market centres.
  • 9 Apr 2015 – TM and DIGI will tap each other’s customer base through a collaboration involving TM’s Internet Protocol television (IPTV).
    • TM will provide entertainment, sports and video on demand on its HyppTV to DiGi customers through mobile app “HyppTV Everywhere”.
    • IPTV revenue from the consumer segment continued to increase with higher number of buys for premium channels and Video on Demand
    • TM’s planned collaboration with DiGi comes at a time when TM needs to increase Internet, multimedia, and data-based revenue. This is crucial to mitigate the decline in voice and non-telecommunication related services income.
  • 27 Apr 2015 – Data traffic volume has increased to 19,900 terabytes (TB) against the previous years’ 9,900TB. With long-term evolution (LTE) network coverage rapidly expanding to more than 33% of the population, there will be increased data growth opportunity especially when the LTE network is now made available to prepaid subscribers.

Issues/Risks/Challenges

  • Potential irrational competition, especially in the prepaid segment, from U Mobile, MVNOs and OTT players.
  • Potential margins pressure as a result of the higher customer acquisition costs (via heavy handset’s subsidies)
  • Higher marketing costs to retain market share which may further pressure profitability
  • Regulatory risks – regulation of tariffs
  • FOREX – The weakening of MYR has also resulted in higher IDD traffic cost
  • Unable to monetize data
    • weaker than expected net adds
  • worse than expected voice tariffs
  • Dumb pipes – Operators like DIGI and Maxis cannot offer their traditional services (such as downloads of wallpapers, ringtones, games, applications, etc.) as Apple controls the total iPhone user experience.
  • The sudden change in chief executive officer (CEO) may dampen market perception of DiGi.Com’s leadership stability
    • DiGi.Com announced the appointment of Murty as its new CEO with effect from April 1.
    • The change in CEO was unexpected and it is unusual for DiGi.Com to change CEO within a year (previous CEOs: Henrik Clausen was there for four years, Johan Dennelind [two years] and Morten Lundal [four years]).
    • Nevertheless, Murty has been COO at DiGi.Com for more than a year and has worked in the company for more than 12 years, which enables significant cultural and operational familiarity with the group.
    • In addition, DiGi.Com’s effective management team and organisational process will ensure operational and business continuity despite the unexpected change in leadership.

Valuation

Historical EY%

  • Trailing:
    • FY14 (EPS: 0.261) – 6.16 (Uncertainty Risk: MEDIUM)
    • R4Q (EPS: 0.256) – 6.04 (Uncertainty Risk: MEDIUM)
  • Forward:
    • FY15 (EPS: 0.262 ± 5%) – From 5.88 to 6.50 (Uncertainty Risk: MEDIUM)
    • FY16 (EPS: 0.275 ± 5%) – From 6.17 to 6.82 (Uncertainty Risk: LOW to MEDIUM)
  • EPS applied to reach the current stock price (5.37): 0.228

Industrial Avg. EY%

  • Trailing:
    • FY14 (EPS: 0.261) – 6.44 (Uncertainty Risk: MEDIUM)
    • R4Q (EPS: 0.256) – 6.32 (Uncertainty Risk: MEDIUM)
  • Forward:
    • FY15 (EPS: 0.262 ± 5%) – From 6.15 to 6.80 (Uncertainty Risk: LOW to MEDIUM)
    • FY16 (EPS: 0.275 ± 5%) – From 6.46 to 7.13 (Uncertainty Risk: LOW to MEDIUM)

5-Y DCF

  • Good Scenario (9.0% – 11.0%): From 6.27 to 6.74 (Uncertainty Risk: MEDIUM)
  • Base Scenario (7.0%): 5.82 (Uncertainty Risk: MEDIUM)
  • Bad Scenario (3.0% – 5.0%): From 5.02 to 5.41 (Uncertainty Risk: HIGH to VERY HIGH)
  • Ugly Scenario (-1.0% – 1.0%): From 4.31 to 4.65 (Uncertainty Risk: VERY HIGH)
  • At current price (5.37), based on RDCF, assumption of FCFF growth rate in the next 5 years is 5%.

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Based on the above football field chart, I think fair value of DIGI is from 6.2 to 6.8.

Returns to Shareholders

In the past 10 years, DIGI maintains more than 100% dividend payout. High dividend payout makes DIGI a defensive stock.

4 Mar 2015 – DIGI plan to set up a business trust to increase the telecommunications giant’s capital efficiency and return excess cash to shareholders remains “on track”. DiGi first announced its plan to set up a business trust in April 2013, but not much has been said about it since. DIGI is still engaging stakeholders and regulators on setting up the business trust. A business trust is a trust that runs and operates a business enterprise. Registered business trusts must have a trustee-manager, whose role is to safeguard the interests of beneficiaries or unit-holders of the trust and to manage the business of the trust. It is still a relatively new framework in Malaysia and Norling had previously said back in 2013 that because of the newness of the framework, DiGi needed time to fully understand the implications of setting up the trust, and the benefits as well as the limitations that would come with it.

Going Forward

All in all, Digi delivered a resilient performance in 1H 2015, with service revenue growth of 1.8% at 45% EBITDA margin on the back of competition intensity and GST implementation challenges. Digi believes growth momentum will improve in the second half of 2015 alongside with stronger consumer sentiments after a period of adjustment post GST and continuous strong demand for quality mobile internet services.

The 2015 guidance remained intact as follows:

  • Low to mid single digit service revenue growth
  • Sustain EBITDA margin and Capex similar to 2014 level

I will continue to hold and accumulate DIGI.

Resources

Excel – http://1drv.ms/1KiQaj9

Notes – http://tinyurl.com/q7hrudm

2Q15 Quarterly Report – http://www.bursamalaysia.com/market/listed-companies/company-announcements/4800865

BURSA – Fundamental Analysis (20 Jul 2015)

About BURSA

The Company is an exchange holding company, whose principal activities are treasury management and the provision of management and administrative services to its subsidiaries. BURSA operates and regulates a fully-integrated exchange, offering a range of exchange-related facilities including listing, trading, clearing, settlement and depository services. The Group offers its products covering equities, derivatives, offshore listings and services and bonds and Islamic offerings.

The four major market segments of the Group are as follows:

  1. The securities market mainly comprises the provision and operation of the listing, trading, clearing, depository services and provision and dissemination of information relating to equity securities quoted on exchanges for the securities market.
  2. The derivatives market mainly comprises the provision and operation of the trading, clearing, depository services and provision and dissemination of information relating to derivative products quoted on exchanges for the derivatives market.
  3. The exchange holding business refers to the operation of the Company which functions as an investment holding company.
  4. Others mainly comprises the provision of a Shari’ah compliant commodity trading platform, a reporting platform for bond traders and the provision of an offshore market.

Ownership

Obviously, BURSA is a government linked company because Capital Market Development Fund and Ministry of Finance are the major shareholders. They owned 43.6% of shares of BURSA.

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BURSA issued  ordinary shares to employees every year, and also there are potential ordinary shares which may arise from the SGP grants. Dilution of EPS is not significant

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Economic Moats

Cost Advantage
    Moat: Wide
  • BURSA is the one and only stock exchange in Malaysia. Its net profit margin throughout the years are consistently above 30%.
Switching Costs
    Moat: Wide
  • The sole fully-integrated exchange in Malaysia.
    Network Effect
      Moat: Wide
    • The sole fully-integrated exchange in Malaysia.
    • It has a niche in Islamic investment products
    • It has the largest derivatives exchange dealing palm oil contracts.
      Intangible Assets
        Moat: Wide
      • The sole fully-integrated exchange in Malaysia.
      Efficient Scale
        Moat: Wide
      • The sole fully-integrated exchange in Malaysia.
      • It has a niche in Islamic investment products
      • It has the largest derivatives exchange dealing palm oil contracts.

      The wide economic moats are further proven with high ROIC and CROIC.

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      Profitability

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      From FY11 to FY14, BURSA’s pre-tax income grew 12% in CAGR. This is mainly attributed to

      1. Higher participation from local/foreign institutional funds and retails.
      2. Bullish market where FBMKLCI index increased from 1,200 level to 1,800 level.

      In the past 10 years, BURSA has been enjoying very high pre-tax margin, and the margin increased dramatically from FY10 onwards.

      BURSA has very high dependency on market sentiment. Bearish market sentiment reduces participation of trading/investing in market. This is clearly shown from FY08 to FY10.

      By the way, I have adjusted FY09 pre-tax income by deducting one-time income from disposal of a subsidiary (FY09: RM75,975 mln)

      The following chart shows revenue by operating revenue. Securities market is the main revenue contributor, but revenue contribution from derivatives market has been improving over the years. Evidently, we see 65% YoY (FY14: 10,514 mln; FY13: 6,371 mln) growth of revenue in Syariah compliant commodity trading platform and the reporting platform.

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      FY15 Q2 Results

      2Q15 vs. 2Q14, QoQ

      Pre-tax income 2Q15 was RM69.5 million, an increase of 5.6% from RM65.8 million in 2Q14. Operating expenses reduced –5%, but the performance was capped by flat operating revenue. Operating revenue was lethargic given weak trading revenue from the derivatives market (-5%); daily average trading volume for CPO futures fell 17%. Total segment profit for 2Q15 was RM84.2 million, an increase of 4.0 per cent from RM81.0 million in 2Q14. The movements in the segment profits are depicted in the graph below:

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      Source: 2Q15 Quarterly Report

      1H15 vs. 1H14, YoY

      Pre-tax income for 1H15 was RM136.3 million, an increase of 5.9 per cent from RM128.7 million in 1H14. The 4% increase in operating revenue came on the back of higher trading revenue from the derivatives market (+20%); daily average trading volume for index and CPO futures rose 6% and 24% respectively. Total segment profit for 1H15 was RM166.4 million, an increase of 4.5 per cent from RM159.3 million in 1H14. The movements in the segment profits are depicted in the graph below:

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      Source: 2Q15 Quarterly Report

      Revenue was also supported by increases in:

      1. Depository fees mainly due to higher CDS fees and SBL fees
      2. Fees from market data due to higher number of subscriptions.

      Key Operating Drivers in the Securities Market by Quarters

      The following table shows the trend of key operating drivers in the securities market by quarters.

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      Source: BURSA’s quarterly reports

      Derivatives trading revenue improved due to higher average daily contracts (ADC) traded of 55,314 contracts compared to 46,966 in 1H2014. Of this, 81% of total trades were in crude palm oil futures and 19% in FBMKLCI futures. By participation, foreign institutions traded 56% and 33% of the FLKI and FCPO.

      On the Islamic market trading activity front, the Bursa Suq Al-Sila’ (BSAS) ADV continued to show exceptional growth as:

      1. The number of trading participants broaden to 106 (1H2014: 83)
      2. The number of sukuk listed widened to 21 from 20 a year ago. However, market capitalization of Shari’ah compliant stocks slipped to RM1,023mn (1H2014: RM1,088mn) in tandem with weak overall market sentiments. Bursa Suq Al-ila’ (BSAS) continues to benefit from the conversion of deposits to Murabaha and the introduction of Tenor Based Pricing.

      In my opinion, the market pulse and activities are still high, but I do have few minor concerns:

      1. Looks like number of IPO in 2015 will be lower than last 2-3 years.
      2. Number of new structured warrant listings decreased in 2015.
      3. Daily average futures contracts traded decreased in 2Q15 (1Q15: 60,335; 2Q15: 50,612)

      Liquidity

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      Growth rate of FCF for 5 years and 10 years is 7.8% and 8.9% respectively. This is one of the reasons BURSA can give high dividend payout.

      Returns to Shareholders

      The board is recommending an interim dividend of 16.5 per share. This is slightly higher than 16 sen paid in 1H2014 but note the absence of a 20 sen special dividend this year to maintain healthy capital and regulatory buffers. Nevertheless, DPS announced YTD translates to an attractive dividend payout of 91%.

      The current R4Q-DY% is4.7%.

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      Growth Drivers

      1. 17 Jun 2014 – For the derivatives market, a new USD denominated Refined Palm Olein Futures Contract (FPOL) was launched. Bursa also inked an MoU with the Saudi Stock Exchange (Tadawul) to develop cross border activities in capital market development. A new Environmental, Social and Governance Index, to be launched in end-2014, targets Socially Responsible Investments funds estimated at USD3.4tr.
      2. 17 Jul 2014 – For the derivatives market, Bursa introduced the new participantship structure for trading and associate participants – to increase the number of licensed traders and expand the distribution channel.
      3. 17 Jul 2014 – More ETFs (exchange traded funds) – a form of passive investment fund that offers investors benefits of diversification – are also in the works including for equities, commodities and indices for other stock exchanges. In 1Q14, the MyETF MSCI Malaysia Islamic Dividend was introduced.
      4. 21 Oct 2014 – Higher revenue is expected from the Islamic market unit, where Bursa Suq Al-Sila’ (BSAS) recorded higher utilization of its commodity trading platform by both local and foreign participants.
        • The Islamic capital market continues to register positive growth. The need for Shariah compliant products is expected to increase further due to the demand from Islamic funds as well as those funds dedicated to ethical investments. Wider usage of Murabahah contracts is expected to spur greater utilisation of our commodity trading platform, Bursa Suq Al-Sila’ (BSAS).

      Issues/Risks/Challenges

      1. 8 May 2015 – The number of public listed companies on the local bourse has been on a downward trend. From 957 companies in 2010, it shrank to 906 last year.
        • Similarly, the number of new listings have decreased — there were 29 new listings in 2010 compared with 28 in 2011, 17 in 2012, 18 in 2013 and 14 in 2014.
        • In contrast, the total funds raised rose to RM24.3 billion in 2014 from RM22.5 billion in 2013. A total of RM32 billion was raised in 2012 compared with RM15 billion in 2011 and RM33 billion in 2010.
        • Bursa is not the only stock exchange that is seeing a slowdown in IPO exercises this year. As at end-March, Singapore only had one IPO listing. Meanwhile, the Stock Exchange of Thailand saw five listings in the first quarter of this year while the Indonesia Stock Exchange had two.
      2. The participation of retail investors in Bursa remains weak. In 2013, despite the strong post-election rally across the board, the opening of CDS accounts fell to its lowest in seven years. This could mean the rally failed to attract new investors, particularly the younger ones. Between 2009 and 2013, the number of CDS accounts only grew from 4 million to 4.4 million.
        • However, retail investors’ trading interest is not the only the factor that can lift market velocity
        • At Wall Street, retail participation is minimal in the US, but there is a big pool of hedge funds that help churn trading volume.
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      3. Deferment of key IPOs in 2015 – The slowdown in initial public offering (IPO) activity raises concerns about the vibrancy of the local bourse, which may affect Bursa’s earnings and, in turn, its dividend payments.
      4. Debt crisis at Greece, meltdown of China’s stock market as well as lingering domestic issues should continue to cast a long shadow over market sentiment. Hence, the current choppy market environment is likely to stay, driving investors to the sideline or to exit. Overall, lackluster trading activities is expected in the securities market over the short-term.

      Valuation

      Historical EY%:

      • Trailing:
        • FY14 (EPS: 0.37) – 10.49 (Uncertainty Risk: LOW)
        • R4Q (EPS: 0.378) – 10.71 (Uncertainty Risk: LOW)
      • Forward:
        • FY15 (EPS: 0.354 ± 5%) – From 9.53 to 10.53 (Uncertainty Risk: LOW to MEDIUM)
        • FY16 (EPS: 0.389 ± 5%) – From 10.45 to 11.55 (Uncertainty Risk: LOW)
      • EPS applied to reach the current stock price (8.1): 0.286

      5-Y DCF

      • Good Scenario (10.0% – 12.0%): From 10.28 to 11.40 (Uncertainty Risk: LOW)
      • Base Scenario (8.0%): 9.28 (Uncertainty Risk: MEDIUM)
      • Bad Scenario (4.0% – 6.0%): From 7.56 to 8.37 (Uncertainty Risk: HIGH to VERY HIGH)
      • Ugly Scenario (0.0% – 2.0%): From 6.18 to 6.83 (Uncertainty Risk: VERY HIGH to EXTREME)
      • At current price (8.1), based on RDCF, assumption of FCFF growth rate in the next 10 years is 5%.

      Softer trading activities is expected in the near term as sentiments remain depressed by broad macro uncertainties and concerns over potential outflow in foreign funds in the 2H. On the other hand, I think BURSA still has room to grow in long term, and it is protected by expected excess of 90% dividend payout. I believe that BURSA fair value worth from 10.3 to 11.40.

      Going Forward

      This financial year will remain challenging in view of expected softer trading activities in the near term as sentiments remain depressed by broad macro uncertainties (debt crisis at Greece, meltdown of China’s stock market as well as lingering domestic issues) and concerns over potential outflow in foreign funds in the 2H.

      BURSA’s attractive dividend will the main catalyst for the stock.

      I will continue to hold and accumulate BURSA as I believe that BURSA has the ability to overcome the challenges ahead.

      Resources

      Excel – http://1drv.ms/1Gv2IPA

      Notes – http://tinyurl.com/q7hls3r

      2Q15 Quarterly Report – http://www.bursamalaysia.com/market/listed-companies/company-announcements/4803485