Tuesday, November 24, 2015

Be cautious of small caps run on Bursa

THE small to medium caps run on the stockmarket this round is not quite the same as previously when their share prices were ramped up as a result of speculation and “casino” like activities 

Selective small caps and penny stocks, to a certain extent, are in focus as their potential is uncovered based on fundamentals and improvement in their financials.

However, an element of speculation has crept especially into the ACE Market where prices have moved ahead of profits and companies have yet to show a track record.

These are likely to be impacted in the event of a pullback, the latest possibility resulting from the large volume last Thursday on Bursa Malaysia.

As for fundamentals, a compilation of listed companies’ results for the third quarter indicated that net profit jumped 64% year-on-year for the bottom 300 companies that were least profitable but not loss-making.

However, net profit was down 12.9% year-on-year for the top 300 listed companies; overall, net profit dropped 4.7% year-on-year for companies on Bursa Malaysia.

Small caps stock performance, as reflected by the FBM Feldging Index (FBMFL), is near its all time high at 16,600 points while the main index KLCI is down 12% from its peak in the third quarter of last year, said Pong Teng Siew, head of research, Inter-Pacific Securities, which did the compilation on net profit.

Among construction stocks, Pong has selected Gadang, a smallish construction player that is heavily involved in the Refinery and Petrochemicals Development (Rapid) project in Pengerang, Johor.

Because of its small size, the landing of a bigger chunk of contracts at Rapid makes the impact bigger for Gadang.

Due to a jump in its second quarter year-on-year earnings, Genetec’s half-year earnings per share (EPS) is at 2.2 sen and full year at 4 sen, putting its price earnings ratio at only 5-6 times.

Other penny stocks with potential are Rexit (online road tax and insurance renewals), Excel Force and N2N Connect (software provider for trading by broking houses).

“Penny stocks are in vogue, to a certain extent, due to better earnings performance,’’ said Pong. Many have retained their pricing power, these smaller manufacturers are not into commodities and their raw materials costs are down and they have new business lines.

Against the optimism in penny stocks and small to medium caps, investors have to keep a close eye on Wall Street for which direction seems undecided and the occasional large volumes on the KL stockmarket which often herald a pullback ahead.

In fact, last Thursday’s spike in volume on Bursa Malaysia may mark a short to intermediate peak in small/medium caps performance with a possible four-month drawdown (decline from peak to trough).

Looking at history, between the peak in the FBMFL index on Aug 14 last year and low on Dec 14, was a four-month long drawdown. The next peak to trough period was April 15 this year to Aug 15, which was again a four-month drawdown.

“This small/medium caps drawdown may possibly also last four months,’’ said Pong.

These are challenging times not just for senior management of banks but also for directors of banks who not only have to protect shareholder value but also help ensure the overall sound functioning and integrity of the financial system.

True, the banks have taken the pre-emptive measure of cutting costs but they also have to keep a lid on non-performing loans while delivering profits.

Slower world economic growth, lower commodity prices and rising US interest rate outlook are putting pressure on emerging economies.

Banks have to be on the lookout for any spiralling effect especially on their loan books; the directors have to ensure robust internal controls and risk management systems so as to weed out loans that could become problematic.

As part of the enhanced responsibilities of directors under the Financial Services Act 2013, it is their duty to oversee the performance of senior management and ensure that there is a transparent financial reporting process within the bank.

“Directors are personally responsible,’’ said Pong, adding that the next few years will be challenging for banks everywhere as capital requirements, responsibilities and costs are rising while revenue is declining.

The lending environment has also become less favourable with funding shortages; banks are fighting for deposits and interbank borrowings (the three-month KL Interbank Offered Rate has climbed further).

Non-performing loans (NPLs) are climbing in selected sectors especially those in commercial or non-residential real estate and some construction loans which tend to be lumpy.

NPLs in absolute amounts for non-residential real estate hit bottom in May last year and has been climbing steadily; NPLs in absolute amounts for residential real estate hit bottom in January this year.

“In absolute amounts, that is not worrisome but the trend especially for non-residential real estate is not too favourable,’’ said Pong.

Construction NPLs bear watching although an occasional spike up in a construction-related NPL gets cleared, indicating the flow of business and the ability of the company to rescue the NPL.

Construction NPLs spiked in July this year to RM3.1 billion; construction NPLs hit a bottom at RM1.7 billion in 2012 and had been higher since then, indicating not only the increased flow in business but also the risks.

Columnist Yap Leng Kuen sees the need for caution in regard to small/medium caps performance possibly over the next four months.


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