Thursday, February 3, 2011

2010 Jewels - A good sheen

Extracts of a report by OSK Research

OSK Research said 2010 proved to be a decent year for its Small Cap Jewels although their performance was eclipsed by the liquidity-infused rally, which benefited the bigger caps, particularly from 2H2010.

Of the 50 stocks profiled in our handbook, half posted absolute returns in excess of 20%, with 49% outperforming the FBM Small Cap and FBM KLCI indices.

While the smaller caps are expected to bask in the glory their larger cap peers in 2011, investors should not ignore names with good longer term potential that are trading at attractive valuations.

We like small caps in the construction, property, oil & gas and consumer sectors as beneficiaries of the ETP, elections and earnings themes.

Our current top small cap buy ideas are Kimlun (TP: RM2.34), Plentiude (TP: RM2.78) and CI Holdings (TP: RM4.37).

A fair play. In 2010, we attempted to balance the risks and rewards when selecting the stocks to be included in our OSK Jewels handbook given the anticipated market volatility.

We were comforted in that our selection garnered a hit rate of 74% (defined as stocks with positive returns).

Although this was below the 92% achieved in our 2009 edition – arguably the best year in terms of overall performance for this publication since inception – more than half (52%) of our picks actually outperformed the FBM KLCI (64% in 2009 edition).

The major winners were from the consumer and construction sectors, which dominated the upper quartile in terms of ranked returns. The performance of our top 10 picks was mixed, with 8 of the 10 companies eking out positive returns.

CI Holdings was the star performer (among our Top 5 picks) as its share price more than doubled in 2010. The other notable winners in the 2010 edition (in no particular order) were Sunway Holdings, Mamee, Zhulian, Delloyd, HELP and Handal.

Aside from HELP, the other five stocks were featured for the first time in the handbook. Investors who bought into our top 5 picks would have chalked up an average return of 30% in 2010, a respectable gain and trumping the performance of both the FBM KLCI and FBM Small Cap indices.

More than mere gems. The devoted followers of our handbook would know that two particular companies, QL Resources and KPJ Healthcare, continued to be heavily promoted with the latter being among the top 10 stocks in the 2010 edition.

The commendable gains they notched up in 2009 extended into 2010 as more investors warmed up to their strong longer-term prospects and better coverage by the investment community.

Both stocks were first included in our 2005 and 2006 editions, with their market capitalisation soaring above RM2bn from under RM500m when they were first selected as our jewels.

These two companies continue to be our choice picks for exposure to the consumer and healthcare sectors.

Every dog has its day. While we strove to pick winners within the 18 sectors profiled in the book, there was no guarantee that our stock picks would not disappoint.

There were two disappointments last year, the first being Hai-O, a multi level marketing company which saw its share price nosedive after it dished out an earnings surprise in 2Q10.

The other was Notion VTec, one of the few technology companies well liked for its exposure to the hard drive industry.

In the case of Hai-O, more stringent recruitment policies imposed by the authorities affected the growth of its agency force, resulting in the poor earnings while Notion VTec’s operations were impacted by issues affecting its 2.5” base plate designs.

Subsequent to the findings, we took the unpopular decision to downgrade both the stocks to sells.

In retrospect, it would not have been possible for us to predict the outcomes (the entire market was wrong) as both companies had fairly decent track records and were leaders in their respective industry segments.

Hai-O was for a long time a preferred pick of OSK with a near-flawless record of consistently outperforming OSK and street estimates.

The other stocks that saw their share prices fall were hit by a combination of sector-wide de-rating, poor demand outlook and stock specific challenges.

Small caps to bask in the glory of their larger peers in 2011. While we expect the bigger cap companies to naturally be the winners of the liquidity infused rally, there remain investment opportunities within the small cap space as indirect and cheaper proxies which present good alpha strategies for investors.

The selection of stocks to be included in the 2011 edition will be guided by our broader themes of Earnings, Elections and Easing (3Es), which form the basis of our 2011 investment strategy.

That said, the overall selection process will continue to be based on our qualitative and quantitative benchmarks of good fundamental and operational standing.

The key sectors that encapsulate these themes are construction, oil and gas, property and consumer.

We had earlier included a teaser in our January monthly strategy report issued on 2 Jan entitled: “Of Black Swans and Hidden Jewels”, in which we highlighted some new small cap names that could potentially be included in the 2011 edition.

Construction and oil & gas remain key themes: Kimlun our top pick With the economic transformation program (ETP) shifting to higher gear, we continue to see more goodies going the way of the local construction players.

The Government recently announced 19 more entry point projects (EPP) valued at RM67bn, adding to the list of 18 projects announced earlier.

The most ambitious of the projects unveiled to date is the RM36bn KL Mass Rapid Transit (MRT) development, for which Gamuda has been the appointed the project delivery partner (PDP).

While bigger cap contractors are natural beneficiaries of large scale infrastructure projects, small cap contractors with good execution track records and that have relevant expertise are also winners as they will also benefit from sub-contract works under the private finance initiatives (PFIs).

Our top pick for small cap construction exposure is Kimlun (BUY, TP: RM2.34). We favour Sarawak construction players such as Naim (BUY, TP: RM5.10) and Hock Seng Lee (BUY, TP: RM2.32) which will be buoyed by the impending state election to be held by July.

The oil and gas sector, which saw a paucity of contracts over the last two years, is also seeing a resurgence of interest due to new investments by major oil majors, which will indirectly benefit the likes of service providers, platform fabricators and ancillary vessel operators.

Our preferred exposure for the small cap oil and gas space remain Alam (BUY, TP: RM1.50), Petra Energy(BUY, TP:RM2.16) and Coastal (BUY, TP: RM4.41).

Consumer names still figure prominently: CI Holdings our top pick

The consumer sector was featured most prominently in our handbook given that the sector had been relatively defensive in the face of the downturn in 2009 and performed well for most part of 2010 on the back of the improving consumer sentiment. With the strong spending propensity of Malaysians supported by the wealth effect from an rising stock market, the retailers generally performed better in 2010 on the back of a steady expansion in their toplines.

The food companies, on the other hand, have generally benefited from a stronger Ringgit and various cost-down initiatives, with indications of a better showing in FY11. For 2011, we see the Government’s indirect efforts to promote consumption spending via the abolishment of import duties on goods announced during Budget 2011 being one of the indirect sweeteners for the sector.

As the impact of reduced subsidies on flour and sugar has proven to be insignificant for most food companies under our coverage, we also see F&B companies faring reasonably well this year.

The increasing number of consumer companies undertaking corporate proposals such as bonus issues, share splits (Padini, QL Resources) suggests that their managements are positive on the outlook of the economy and see further value creation from such exercises. This should boost sentiment in the sector.

Our top pick consumer food and beverage (F&B) exposure remains CI Holdings (BUY, TP: RM4.37) as there is room for the F&B segment in Malaysia to expand further.

The other top pick within our small cap consumer universe is Bonia, as the company will benefit from stronger consumption spending and earnings accretion from the previous acquisition of Jeco.

Property sector in the spotlight: Plenitude our top pick The property sector is back in the limelight, thanks to a flurry of positive news of late, in particular the mergers of UEM Land-Sunrise, MRCB-IJM Land (later aborted) and Sunway-SunCity, which will create key property groups with sizeable market capitalization, and the strong market liquidity fuelling appetite for mid to high end landed properties.

We see the strong demand for landed properties to continue in 2011, thus bolstering the earnings of developers. While the larger cap players typically benefit first from the sector- wide rerating due to their exposure to good and strategic landbank, we think it is only a matter of time when the smaller property outfits catch up due to their cheaper valuations. We see good value in a few small cap property stocks such as

Plenitude (BUY, TP: RM2.78) and Bandar Raya Developments (BUY, TP: RM3.00), which stand to benefit from the current upcycle in the sector.

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