Retracement of earlier gains. While logistics counters saw a sector-wide price rally earlier in the year following positive trading sentiments from the launching of the Digital Free Trade Zone, the last quarter of 3QCY17 saw many of them erasing some earlier gains amid an underwhelming round of quarterly earnings. Overall, logistics counters declined an average of 5% over the last quarter, with the notable ones, including CENTURY (-16%), XINHWA (-11%), TNLOGIS (-10%), and NATWIDE (-6%). Comparatively, our sector’s coverage had also underperformed against the broader market during the quarter with an average 3% decline, while the FBMKLCI gained 0.4% QoQ. (Take note that our strategy’s cut-off date is at 21-Sep-2017)

Weakness in earnings growth persists. We view the recent round of poor results among logistics players to be a larger indication of underlying weakness in earnings growth. Within our coverage, notable ones include GDEX (UP, TP: RM0.45), which had just posted its first ever negative quarterly results (down 12% YoY) due to lower margins, despite having a strong history of consistent earnings growth. TNLOGIS (MP, TP: RM1.60) also posted shockingly poor results (down 55% YoY) due to higher expenses coupled with weakness from its property development segment. Outside our coverage, CENTURY (Not Rated) posted notably poor results (down 45% YoY), citing lower logistics activity due to the festive season. Moving forward, we expect the weakness in earnings growth among industry players to continue for the next 1-2 years, mainly underpinned by: (i) increased competition within the industry, leading to margins suppressions, coupled with (ii) higher running costs arising from expansions and new ventures, with most industry players currently having expansion plans or new ventures in their pipelines. With that said, main drivers towards a recovery in earnings growth for logistics players are mainly: (i) consolidation activities within the industry, resulting in dampened competitiveness among players, (ii) strong growth in domestic economy to drive volume growth, and (iii) expansions and new ventures to grow beyond current infancy phases to potentially turn earnings-accretive. Elsewhere, port operators are also expected to see weaker earnings for the remainder of the year, with WPRTS (MP, TP: RM3.70) suffering from throughput decline from reshuffling of global shipping alliances. BIPORT (MP, TP: RM6.05) is also expected to see a weaker 2H17 due to increased costs from the commencement of Samalaju Port, while MMCCORP (OP, TP: RM2.85) is also expected to show weaker FY17 earnings due substantial completion of KVMRT Line 1 coupled with absence of land sale in Senai Airport Free Industrial Zone.

Lofty valuations on established parcel delivery players. Volume growth continued to be positive for established parcel delivery players, mainly underpinned by the growing e-commerce. In the last quarter, established parcel delivery players POS (UP, RM4.00) and GDEX recorded healthy growth of 11% and 10% YoY, respectively, in parcel delivery revenue. However, while top-line is expected to continue growing, we believe that the sub-sector could see suppressed margins going forward, due to increased competition within the industry. As such, top-line growth may not entirely cascade into bottom-line growth moving forward. Many of the competitions consist of smaller start-ups and non-listed players, often positioning themselves competitively in-terms of pricing in order to gain market share from established players. From our understanding, POS and GDEX still hold the top-two positions in terms of market share, despite continuous pricing pressures. Of the two, we still believe GDEX to be the better earnings proxy for e-commerce, given its pure-play parcel delivery business model, while POS’ earnings will continue to be dragged by its declining postal mail and retail businesses for the foreseeable future. However, we are opting to stay sidelined from this sub-sector for now due to lofty valuations, with GDEX and POS currently trading at forward PERs of 102x and 35x, respectively.

Ports throughput expected to see mild recovery from 2018 onwards. Of the two main container transhipment ports in the country, WPRTS was the most adversely affected from the reshuffling of global shipping alliances, with its 2Q17 throughput deteriorating a staggering 11% YoY, while Port of Tanjung Pelepas (PTP) remains flattish. Comparatively, Singapore’s container throughput continued its trend of positive growth, recording 9% higher TEUs YoY. This was also partially due to volumes shift from WPRTS to Singapore, as an aftermath of: (i) CMA CGM’s decision to use Singapore as its main transhipment hub within the region, thus moving containers away from WPRTS, coupled with (ii) UASC’s completed merger with Hapag-Lloyd. As a result, we are expecting container throughput to record a c.10% drop in FY17. However, with that being said, we believe that FY17 shall serve as a new base for organic growth. As such, we are expecting to see some recovery in throughput in FY18 and beyond, underpinned by: (i) expected growth in gateway volumes, (ii) gradual recovery of transhipment as post-reshuffling business environment stabilises, and (ii) overall domestic economic growth.

Expecting seasonal improvement in 4Q17 for shipping rates. The Hurricane Harvey has caused a short-lived gain in charter rates in September, but such hikes are not bound to be sustainable. Overall, tanker rates are still on a declining trend dragged by higher tanker fleet growth and sluggish tonnage demand. Having said that, stepping into 4Q17, rates improvement is expected from 2017 low with seasonal pick-up as the winter season kicks in. Thus far, VLCC, Suezmax and Aframax average spot rates in September have fallen almost by half YoY, and such, weakness could persist if OPEC extends its production cut beyond March 2018, which will likely be concluded by the next regular OPEC meeting in November this year. On the flip side, LNG spot rates have rebounded c.50% from its 2017 low, strongly underpinned by improving flow of volumes, especially from Australia and US to countries such as China, Taiwan and South Korea. Overall, we see limited catalyst in our sole shipping coverage, MISC (MP, TP: RM8.04) in the near term but its balance sheet remains healthy with net gearing of 0.2x, allowing it to seek opportunistic brown field replacement projects, shallow-water assets requirement in the region as well as to grow its fleet size upon weakness in asset value.

Maintain NEUTRAL. Being the sole OUTPERFORM call within our sector’s coverage universe, MMCCORP emerged as the preferred pick within our sector. While near-term earnings are expected to show some weakness due to: (i) substantial completion of KVMRT Line 1, and (ii) absence of land sale in Senai Airport Free Industrial Zone, we believe MMCCORP is a solid SoP-valuation play, with the upcoming listing of its ports operations as a potential rerating catalyst. Likewise, a successful conclusion to talks for a stake in Sabah Ports would further bolster the group’s current profile as the largest ports operator in the country. Conversely, despite being widely regarded as earnings proxy for the growth of e-commerce within the country, we opt to stay side-lined from established parcel delivery players POS and GDEX, given their lofty valuations. GDEX had already gained +48% since our initiation with an OUTPERFORM call, and thus, we believe that foreseeable positives are well priced-in at current levels. We maintain our call for the rest of our sector, with MARKET PERFORM on BIPORT, MISC, TNLOGIS and WPRTS.

Source: Kenanga Research - 6 Oct 2017