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Company warrant of MRCB

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Publish date: Mon, 25 Aug 2014, 09:11 AM
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Company warrant of MRCB

MRCB just released its 2014 second quarterly result ended 30 June 2014. It recorded cumulative revenue and net profit before tax of RM530.3m and 162.7m respectively as compared to the same period of RM447.8m and RM18.2m respectively in the preceding cumulative period. The earnings per share for the quarter is 7.11 sen. Thanks to the higher revenue contribution by the Q Sentral Office and the Sentral Residences projects, and the gain from the disposal of the Duke Highway.

Going forward, there appears to plenty of excitement with the achievement of several milestones; the resolution of the dispute with PKNS on P.J. Sentral, the entering of the Definitive Agreement with Kwasa Land for the development of MX-1 Land and the completion of the acquisition of the balance 51% equity interest in Penang Sentral Sdn Bhd, transportation hubs and others.

Hence it appears that there may be some excitements in investing in MRCB as there will be many ongoing as well as new projects in the near future. Rather than just looking at MRCB itself, why don’t we look at its warrants too?

Why invest in company warrant?

Company warrant is a derivative instrument, like a call option, which gives the holders the right, but not an obligation, to subscribe for new ordinary shares at a specified price during a specified period of time. Warrants have a maturity date (up to 10 years) after which they expire are worthless unless the holder had exercised to subscribe for the new shares before the maturity date.

Because the prices of warrants are low, and hence the relative much lower investment outlay, the leverage and gearing they offer is high. This means that there is a potential for larger capital gains. Warrants generally exaggerate share price movements in terms of percentage change, and hence a perfect security in a bull market.

Warrants also experience outsized declines in a falling market, or even a total loss when the warrant expires out-of-the-money. However, as the investment outlay is low, there is a limit of that loss.

A case of MRCB Wa

MRCB and its warrant, Wa closed at RM1.68 and 27.5 sen respectively on 22nd August 2014. The exercise price of Wa is RM2.30 and the expiry date is on 16 September 2018, or more than 4 years time. The warrant is hence way out-of-the-money with zero intrinsic value. The premium now is 53.3%.  Why do we invest in Wa when it is out-of-the-money and with a seemingly high premium of 53.3%? Why don’t we just invest in the underlying share?

 

The value of Wa is purely in its time value, a value which is considerable due to its long expiry date. If there is an increase in volatility and MRCB share price spikes up quickly, Wa will be in-the-money when MRCB share price goes up above RM2.30. MRCB share price has a time duration of 4 years to do that. Beyond that the sky is the limit for the return for Wa. The trick is in its relatively high gearing of 6.1 times which is very attractive. Hence Wa appears to be a good alternative investment if you are bullish about MRCB.

Black-Scholes Option Pricing

With the underlying share price at RM1.69, exercise price of RM2,30, 4 years to maturity, risk-free rate of 4% and a historical volatility of MRCB at 27%, the option value of Wa is 27 sen. This shows Wa at 27.5 sen, is apparently slightly overvalued. But why we want to buy it if it is overvalue?

The volatility as measured by the standard deviation of the return of MRCB for the last one year is a historical volatility. With the bright near term future outlook of MRCB as described above, the price of MRCB could spikes up quickly with much higher volatility. This can result in the increase in the warrant price quickly too, further amplified by its high gearing.

Payoff for MRCB warrant

Table 1 below shows the payoff for Wa for various price of MRCB before expiry of the warrant in four years time.

Table 1: Payoff

MRCB

2.00

2.30

2.50

2.60

3.30

4.00

MRCB

19.0%

36.9%

48.8%

54.8%

96.4%

138.1%

Wa

-100.0%

-100.0%

-27.3%

9.1%

263.6%

518.2%

If the price of the underlying share does not move above RM2.30, the exercise price, when Wa expires in 4 years time, it will be worthless. Your initial outlay is the limit of your total loss. However, if MRCB share price moves up by 55% to RM2.60 any time within this 4 years, Wa can be exercised for a gain of 9%, way below the return of the underlying share. However, from then on the rise of warrant will be very steep as shown in Figure 1 below.

Figure 1: Payoff for underlying share and warrant of MRCB

If MRCB share price rises up by 138% to RM4.00, you can exercise the warrant and make a gain of 518%, , about 4 times more than the gain in the underlying share. Figure 1 above depicts the payoff at different price of MRCB. It can be seen from the figure that when the share price of MRCB goes above RM2.60, Wa will provide very handsome return.

 

Conclusion

MRCB Wa, with quite a long time to expiry of four years,  is trading at an undemanding valuation in terms of premium of 53.3%. Furthermore, it has a high gearing of 6.1 times which would greatly amplify the gain if the underlying share price spikes up before the expiry date.  Hence, if you believe in a company like MRCB as an investment with its various high profile projects, Wa is definitely a good alternative buy.

 

K C Chong (23/8/14)

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3 people like this. Showing 11 of 11 comments

calvintaneng

YES! WARRANT IS INSTRUMENT OF BULL MARKET! IN BULL MARKET WARRANT AMPLIFIES GAIN BUT IN BEAR MARKET WARRANT EXACERBATES LOSSES!

IN MRCB CASE THE UPSIDE IS MORE THAN DOWNSIDE

2014-08-25 10:28

Angel_Investor

Wellsay Kcchongnz!

2014-08-25 12:26

lcwin

Hope newbies read this with a bowl of salt. Warrant are great for its leverage but it will sent you to poor house many time faster if you make the wrong buy. I am not disputing Kchongnz article here. I just want to add this buy warrant only on very good stocks. Speculative and crony infested stock with questionable intergity is best avoided. When the market turns south you will see all your hard earn money burned doubly fast. Overvalued warrant is another case to avoided. Just look at the active warrant stock being traded at stupid price now.I will not name any as it will not be fair to the investor concern so buyer beware.
Be very selective when you play warrants and the reward will be spectacular. Before you want to tell me "what do you know advising others". I specialise on Warrants play and I never touch anything if it is not very sound and undervalued with spectacular result. Anyway I will once in a while leaves tip for investors willing to listen to help them make wiser decision.

2014-08-26 21:21

adriansim

Any advice for newbie like me? WA with premium < 10% can consider as undervalue?

2014-08-26 22:49

lcwin

Hi Adian Simple, First and second step make sure stock is good then ONLY you look at the warrant,then as long as premium is not over 20 to 25% with at least 2 year life. Warrant below 1 years life preferable with little or no premium. Leverage if less then 30% I wouldn't bother buying. This is just a general guideline for warrant investment.
Market now in liquidity bullrun so you see pigs flying.Becareful as I don't see much opportunity to make big gains. If you follow my rule of thumb in stock investing, buy only if the stock have at least 50% upside and 15% downside risk. Sorry no reccomendation for stock as I am unloading slowly. HaHaHa.....

2014-08-27 10:33

adriansim

Thx,Icwin. I am now learning to understand more about WA. Pmetal WA premiuim is -2%. Then,can consider cheap? Is it correct to buy a WA when mother share price up but WA drop?

2014-08-27 22:08

lcwin

buy only if you think mother share is good. As long as premium and life is within acceptable limits it is not important. Read again what I said earlier. I think I shouldn't comment about Pmetal as I missed it due to high absolute price compare with what I was playing. If you still think it still can make 50% or more from now then it should good.

2014-08-28 14:47

adriansim

How to know at least 50% upside and 15% downside risk?

2014-09-05 21:52

lcwin

Yes this is where you do your homework. Research the company report see broker report then get a rough estimate of target price likely possible. Downside look at how well they manage the company historically and assets if any will be a plus.Companies with Lots of cash usually will think of ways to waste it so beware. Anyway generally hot stock and stocks played by instituition are best avoided. Crony and milk cow stock used for fixed deposit usually held by politician trustees. So you end up with only about 20% stock worth looking at. Trust me 2% is more than enough to make good money. Been there made my cash many times over. But I can't give any tip at the moment as I am unloading my stocks as I find market overvalued. If possible trade through a broker and get some advice as it cost you slightly more but if he is good you got yourself a finacial consultant for peanuts!

2014-09-08 20:09

dragonking

buy warrant only if you think mother is going up, with lots of margin of safety (MOS).

2014-09-08 20:54

adriansim

Will dividend affect WA price?

2014-09-10 22:13

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