Yes, the concession still have about another decade to go. There is also the possibility of new projects before concession ends.

However even an investor with a short holding period of say 3 years still can't ignore the finite concession period. The institutional investors value the company based on discounted cash flow. They will not pay a premium for retail investors to exit 3 years from now by assuming company dividends can grow into perpetuity.

@pjseow, FY21 and FY22 profits not distributed as dividends will be retained, primarily to fund future investments. If analysts have done their earnings projection properly, this retained earnings would have been responsible for their projected FY23 earning, which in turn is used to calculate the share price by applying a PE multiple.

Therefore adding the undistributed FY21 and FY22 profits will be like double counting. It’s for the same reason that in the typical PE valuation, the retained earning from last year is not added to the PE valuation.

Hi Ben, thanks for sharing the article by Pankaj C Kumar. This is a very good article.

I actually read the article three times to make sure I fully understand his points. I’m not concerned about the (mis)statement on earning downgrade. What I found useful is Prakaj has pointed out common valuation mistakes committed by analysts. More importantly, he has also provided a valuation approach which I will work out here.

Pankaj’s valuation approach is simple and yet practical. Basically he assumes by FY23 earnings will revert to normal. He therefore applies the historical mean PE of 20 times to FY23 forecasted EPS. After that, by adding expected dividend for FY21 and FY22 to the earlier value, we get the current "fair value" for Top Glove.

I try to improve on his approach by adding two modification.

First, I assume the HK listing will be completed by May-Jun as expected by Top Glove, thereby adding additional shares of 1,495 million to existing 8,015 million, making a total of 9,510 million shares. For simplicity, I shall assume dividend and earning dilution to kick in only from FY22. (Note: the HK IPO is expected to raise RM7.77 billion based on RM5.2 IPO price used by Top Glove for illustration purpose. However, I expect the extra capital raised will have little contribution to FY23 revenue as existing cash flow is more than sufficient to support expansion until then.)

Second, I will convert FY22 dividend and FY23 PE to present value by using the 8.5% cost of equity assumed by Prakaj. I agree with him that it will be cheaper to use debt capital which only costs 3% plus. However by raising a lot of cash in HK, the resulting cash balance will be sufficient to cover at least the RM10 billion Capex planned until FY25. Hence the assumption of of 100% equity capital and the higher discount rate at 8.5%.

With the above modifications, the components of Top Glove value will be
(A) Dividend per share for remaining of FY21.
Expected FY21 net profit = RM10,695 million
Expected FY21 EPS = RM10,695 million/ 8,015 million shares = RM1.334
Expected FY21 DPS = 70% * RM1.334 = RM0.934
Remaining FY21 DPS to be paid = RM0.934 – RM0.165 = RM0.769

(B) Dividend per share for FY22
Expected FY22 net profit = RM4,145 million
Expected FY22 EPS = RM4,145 million/ 9,510 million shares = RM0.436
Expected FY22 DPS = 50% * RM0.436 = RM0.218
Present Value of FY21 DPS = RM0.218 / 1.085 = RM0.201

(C) Value based on 20 times of FY23 Earning
Expected FY23 net profit = RM2,496 million
Expected FY23 EPS = RM2,496 million/ 9,510 million shares = RM0.262
“Fair Value” based on 20 times historical mean PE = 20 * RM0.262 = RM5.249
Present value = RM5.249 / (1.085)^2 = RM4.459

Summing up the three components, the current value = A + B + C = RM0.769 + RM0.201 + RM4.459 = RM5.43. I'm a bit surprise to find the result is quite close to current share price at RM5.20

Of course, the above valuation changes as assumptions change. For example, if vaccine resistant virus is established and gain dominance in the coming months, a PE multiplier higher than the historical mean of 20 times will be warranted.

On the other hand, we also have to watch for sign of looming competition and its impact on margin, especially due to Chinese competition. Currently analysts assume FY23 net margin is about 20% (= RM2,496m net profit/ RM12,524m revenue). This is actually much higher than the 6% to 12% net margin achieved between FY11 to FY19. In a price war scenario, the net margin could easily revert to say 10%. Even if PE remains at 20 times, the PV for FY23 share value will be halved to RM2.237. Adding back the dividends, the present value is only RM3.21.

This might not be a valid outcome. However I like to consider all possible valuation approach and assumptions out there to make sure all considerations are covered.

Hi Yuwei, I got your point. I too agree that a buisness with safe and steadily growing profitability offers a more sound investment. As an outsider I'm just mystified by how Berkshire did it. Thanks for your sharing!

Hi Ben, thanks for another great contribution. I agree with your criticisms on the analysts' work.

I actually made a similar comment in your article on Supermax last week. The question then was why Supermax price continued to slide despite most analysts’ buy calls. I postulated that the market dominated by institutions simply doesn’t trust analyst inputs.

https://klse.i3investor.com/blogs/bursainvestments/2021-03-02-story-h1541975241-Supermax_Trading_at_Forward_PE_of_3_3_While_Sitting_on_RM3_56_Billion_C.jsp

Sell side analysts are known for adjusting their TPs to stay not far off from the current market price. If the market price has dropped by say 20% since the last quarterly report, they may adjust their TP down by roughly 20% in the current quarter while still maintaining their buy/ hold calls.

The valuation assumptions and calculations are reversed engineered accordingly. It happened last year when the price was on the way up, and it happened this year again when the price was on the way down.

Moreover, analysts also need the “safety in number”. Not only their TPs are usually not far off from market price, but also not far off from one another. There is no reward for being a hero. The odd one out is usually hammered. As you've commented, Affin Hwang analyst was ridiculed in July last year when it put up a TP of around RM60 (RM20 after split-adjusted), and a bull case of RM110 (RM37 split-adjusted)!

https://www.theedgemarkets.com/article/top-gloves-fair-value-could-surpass-rm110-affin-hwang-says

If the Affin analyst was forgiven, the same cannot be said of the JP Morgan analyst who went the other extreme by assigning the infamous RM3.50 target price in Dec last year.

https://www.theedgemarkets.com/article/jp-morgan-pegs-these-glove-makers-fair-value-half-their-market-price-says-supernormal-cycle

With such experiences, the analysts have good (personal) reasons to maintain buy calls with TP’s just a few notches higher than the market price. What they did not do well is to cover their tracks in their valuation work, as you’ve rightly highlighted. But such a mistake is common in the rush for time. Analysts often have to churn out multiple reports overnight during reporting seasons.

However, their valuation mistakes cut both ways. I’ll take the RHB report you highlighted as an example.

You’ve rightly pointed out that the analyst overlooked 2 quarters of earnings for FY21. Given the cash flow for FY21 was estimated at around RM10 billion, it means he missed out about RM5 billion for Top Glove. Divided by about 8 billion shares, an extra 60+ sens should have been added to the latest TP of RM6.8, making the TP close to RM7.5.

However if you look at the DCF valuation table, the analyst assumed only an annual CAPEX of RM500 million. But Top Glove press release has stated that it “has earmarked RM10 billion for CAPEX over the next 5 years from FY2021 to FY2025”.

In other words, between FY2021 to FY2025, the analyst has underestimated an investment cost of close to RM 7 billion. Converting to present value that was about RM6 billion or about 75 sen per share. These two errors that roughly cancel out one another. The "corrected" TP ends up about 10 sen lower or RM6.7.

But I won’t blame the sell side analysts. This is the industry norm. The is also not restricted to Malaysia. The reason that sell side analysts exist is for brokerages to get their clients to do more trading and generate more commission revenue.

Wonder why the number of buy calls always far outweigh the number of sell call? Besides not offending their investment banking clients (i.e. companies under coverage like Top Glove here), it’s far easier to get more people to trade with buy recommendation than sell recommendation.

That’s why I am cautious when quoting/ using analyst figures when doing my own valuation.

Hi Yuwei. GEICO is often hailed as the success story in auto insurance according to the folklore of value investing.

Are there any lessons that Malaysian motor insurers especially Allianz can learn from GEICO, though we may be constrained by a smaller market size?

@freedomfund, thank you for taking the time to share your thoughts. Your inputs have given me a fresh and useful perspective when I read those company reports. I've truly benefited!

@freedomfund, thanks for your valuable inputs. I've learned a lot from you!

Considering the business fundamentals, management quality and valuations of the different insurers listed in different markets, which insurance stocks would you accumulate, besides the AIA stock you already own in HKEX?

Do you feel that insurance stocks are under/ over/ fairly valued as compared to the general market or financial sector stocks?

@untong, thanks for your clarification and the relevant links. Yes, the AGM Q&A will be a good source of information. I'll read up first. Much appreciate!

Yes, Takaful Malaysia management has a long record of disposing their shares granted, which does not send a good signal to shareholders.

@freedomfund, I believe Takaful Malaysia high PB ratio has to be compared against its high ROE at over 20% currently (used to be above 30% a few years ago). While Public Bank is priced at "only" PB 1.8X, its ROE is just above 10%. The ROE for banks has been declining for years given they need to hold more capital under Basel III.

Since you’ve been in the insurance industry for many years, can I seek your opinion on how the competitiveness and profitability of life insurers in Malaysia, in particular Allianz Malaysia which is also listed. How does it compare against AIA and others?

I read that AIA has done very well in recent years because mainland China clients sign up with AIA Hong Kong as a means to transfer wealth out of the mainland. The other stellar performer in HKEX is Ping An Insurance. Wonder if you have any view on them too?

Hi untong and yuwei, thank both of you for the explanation.

Can anyone elaborate on why insurers prefer motor insurance on the basis of cash flow? My personal experience is I pay up front premium for both motor and fire insurances on annual basis. Won't the cash flow for both types of insurance be quite similar to the GI?

I also looked up the ISM Insurance Services Malaysia 2019 Yearbook. I wonder why fire insurance has a much lower net claimed incurred ratio at 27.6% than motor at 70.1% (page 18). Does it mean fire insurance offers better margin? Or does fire insurance incur higher expenses in commission and management fee?

Building on papayashot’s question, I also wonder in the long run will Allianz be stuck in the low growth conventional insurance business. According to the ISM yearbook, general takaful GWP grew 18.8% in 2019 (albeit from a low base), but general insurance shrunk by 0.8% (refer page 15 and 21). New business contribution of Family Takaful grew 25% in 2019 (page 11).

Will the greater growth prospect compensate for the limitation on takaful players as highlighted earlier? How easy and likely for Allianz to apply for a takaful license?

Hi Yu Wei. Thanks for your reply.

It’s good that you highlighted that NPAR/ ILP policy acquisition cost is front loaded. Will IFRS 17 require the cost to be apportioned over the policy lifetime, like how profit recognition has to be distributed?

You’ve also highlighted that Allianz Life Insurance has grown its New Business Value by 250% from 2015 to 2019. I’ve crossed check the annual reports. Allianz first published NBV in 2015. The NBV over the 5 years amounts to about RM900 million.

Even factoring in policy surrender, could I say that conservatively there is still an embedded value of say RM800 million from just last 5 years alone? That is like RM 800m / (177m + 169m) = RM2.3 value per share created by life insurance over the period?

Is there a way to estimate the existing capital level of an insurance company, so that we can determine how much it is above the 130% minimum Capital Adequacy Ratio? And from there determine much new business it could write without increasing its retained earnings?

I still don’t understand why LPI has RM 2,075m of equity for RM 2,168m of contract liabilities, which means RM1 of equity for RM1 of contract liabilities. At the other extreme, STMB has RM1,542m equity for RM9,224m contract liabilities, or RM1 of equity for RM6 of contract liabilities.

What does this discrepancy tell us about their differences?

As a comparison, the capital ratio of Malaysian banks are closer to one another. For example, the CET1 ratio of Malaysian banks only differ by a few percentage points only.

Why do insurance companies have a larger discrepancy? What does it imply in term of their future growth potential, dividend payout, risk and other considerations?

Thank you.

Both STMB and MNRB are takaful insurers. Yet they have different levels of equity. For each amount of contract liabilities, MNRB has more equity than Allianz. But STMB has less equity. What could be the reasons?

LPI and Tune Protect have more equity to support each dollar of contract liabilities. Do general insurers need more equity? What could be the reasons.

Besides, LPI also seems to be very conservative. RM1 of equity supports only RM1 to RM1.3 of contract liabilities. Can this mean LPI has more room to declare higher dividend payout in the future?

I find a large discrepancy of this ratio among the insurers.

Allianz - between 3.7 and 4.0 (2014 to 2020)
STMB - declining from 9.7 to 6.0 (2014 to 2020)
MNRB - declining from 3.6 to 2.6 (2016 to 2020)
Manulife - increasing from 4.4 to 5.0 (2015 to 2020)
LPI - between 1.0 to 1.3 (2015 to 2020)
Tune Protect - between 2.2 and 2.9 (2015 to 2020)

I will now cut my original message down into a few summarized comments, and try post again. Basically, after reading your input, I have worked out the ratio of contract liabilities to equity for different insurers (data extracted from the Balance Sheet).

I assume contract liabilities represent size of business. I want to know how much equity will be needed to support a certain size of insurance business.

Hi Yu Wei. I want to continue above conversation. However, this i3 forum system does not accept my posting beyond a few sentences long. I've sent a message to your i3 Messenger. Please kindly take a look. Thanks.

Hi Ben, thank you for your reply.

Actually I just wanted to make a general comment on the sentiment in this forum, where people assume that by listing in “advanced” markets the Malaysian glove stocks could enjoy better valuation. I know given your knowledge you won’t fall for such simplistic assumptions.

This brings me to another sentiment in the forum. Some people believe that glove stock price is down because Bursa has been “manipulated”. My gut feeling is given RSS is limited to only 4%, short selling forces alone and whatever “propaganda machine” they have could not possibly have "pressed" the market down by so much and for so long. Timing wise, RSS only resumed on 1 Jan 2021, but the glove stock price downtrend has already started in Oct 2020.

In fact “downward manipulation” forces, if exist, are far weaker than the “upward manipulation” forces. Almost every analyst, except one or two odd fellows, has issued and maintained buy calls since last year. To me, if the advocacy to sell is manipulation, the advocacy to buy should also be seen as manipulation. Right now the buy calls still far outweigh the sell or even hold calls.

Just to be clear, I know you didn’t say it’s manipulated (just that the market price seems irrational). My opinion above is actually directed against some voices in this forum who blame the decline on manipulative forces.

This leads me to your central idea that given the huge cash pile, the multiple buy calls, the consensus view on the enormous profit for at least in 2021, the market valuation at a forward PE of 3.3X seems ridiculous.

While I don’t have a firm opinion on this, I would interpret this as in aggregate, the market (which is dominated by institutions instead of retail investors) doesn’t trust the analysts. After all, it’s well known that analysts often behave like a dog wagging its tail. Analysts adjust their TPs so that they don’t stray too far from the market price. The proof is while almost all analysts still maintain their buy calls, they have gradually slashed their TPs as stock prices decline. Most just make sure their TPs are 20% to 30% higher than current market prices. If analysts adjust their TPs in order to suit the market price trend, then their inputs to those TPs (projected revenue, margin ...) will be under suspect too.

The same kind of skepticism could be extended to Frost & Sullivan research, including the ASP projection we referred to in Top Glove valuation. After all, Frost & Sullivan is often engaged by companies seeking IPO, and I’ve never read an industry projection from them that undermines the IPO exercise.

Therefore, while the forward PE is at a seemingly ridiculous 3.3X, the market (again, driven by institution fund managers) has heavily discounted it. It doesn’t mean I believe the market is right. It is just how I see the market operates right now.

However, as I always believe, if one is a long-term value investor, and if one believes the company is really undervalued, one should actually welcome any irrational market prices. Over time, the market price will follow the company's earnings growth and dividends.

So, if one is confident that own valuation is right and the market is wrong, just sit back and wait for a few more quarters. The coming quarters will deliver the verdict.

Ben, thanks for your info. I would like to digest your numbers when I have time.

I just want to highlight that the Hong Kong stock market, where TG wants to list, doesn’t necessarily give a higher valuation, especially after IPO sentiment has receded. There are more than a hundred companies listed in both mainland China (A share) and Hong Kong (H share). Every single one of them is sold at a discount in HK. Many of them at half the price or even less. Big-name companies like Sinopec and SMIC are traded in HK at only 1/3 of their prices in mainland China!

http://www.aastocks.com/en/stocks/market/ah.aspx?sort=5&order=1&filter=3

Such deep discounts are not only restricted to mainland Chinese companies. I know profitable, dividend-paying companies with reasonable management being valued at close to their net cash level. The intuitional investors in Hong Kong could be very demanding and ruthless.

I also want to respond to MrInvestorOr’s comment. Many established exchanges are also manipulated, in fact even worse than Bursa.

Just to give some examples. In the US there is this perfectly legal scam called mini-tender offers. Syndicates would initiate offers that are received by blue-chip company shareholders through their brokers. Unsuspecting shareholders may accept the offers without reading the fine prints. Shareholders from Boeing, P&G, GE would have come across such scams before. The practice has continued for years without the US authorities cracking down.

https://www.businesswire.com/news/home/20200717005255/en/PG-Recommends-Stockholders-Reject-Mini-Tender-Offer-From-Mason-Bell-LLC

Hong Kong is even worse. Many stocks are manipulated by syndicates through repeated cycles of consolidation and splits. The below articles detail one of the more famous manipulation uncovered by an activist investor. The HK regulator only acted after being shamed into it.

https://www.businessinsider.com/activist-investor-david-webbs-enigma-network-causes-stock-fall-2017-6

https://webb-site.com/articles/enigma.asp


In HK the interest of intuitions (stock brokerages, IB, fund houses) always comes first. Retail investors are at a distant second. Despite the shortcoming of Bursa, the local stock exchange and regulator are much better in investor protection.

LDP concession ends in 2030 and SPRINT shortly after that. Rightfully they should look for and inject new projects so that the listed status doesn't go wasted. When asked during AGM the management said there was no plan yet. Perhaps they just wait and take orders from their largest shareholder Gamuda.

https://www.litrak.com.my/wp-content/uploads/2020/10/25th-AGM-Questions-Answers.pdf

Hi YuWei. Thank you for sharing. I learn something useful every time I visit this page!

We learn that Warren Buffett is successful not only because of his investment acumen, but also because he takes advantage of Berkshire Hathaway's free float. Could this not happen in Malaysia because the regulator is too restrictive?

I look up the Allianz analyst presentation you shared. 76.5% of the GI portfolio is in bonds and deposits. The life portfolio is even more conservative where equity accounts for just 8.6%. This seems to go against the maturity matching principle. Given that the liabilities of life policies lie far into the future, I thought there should be a higher weight of risk assets like equity. While equity is volatile in the short term, it offers better growth and inflation protection in the long term. Any idea why Allianz is so conservative (besides the need to meet the minimal regulatory requirements)?

Given that ROE might not be a reliable performance indicator, what are the say 3 to 5 key indicators that you will look at when measuring life insurers and general insurers?

Hi Ben, thanks for your reply again. I too would like to believe Tan Sri Lim is sincere he has bought a large number of shares with his own money. Perhaps he just miscalculated in the early euphoria when Top Glove almost overtook Maybank's top spot in KLCI, something I wish he had never said in the public. Anyway, this incident has cast doubt on my view of the company (as compared to say Harta)

Let’s get back to your DCF calculation. I’ve reproduced it and have a few comments.

You’ve basically adopted a Free Cash Flow to Firm method, but using projected profit to replace the projected cash flow. I too think this rough estimate is good enough to get an approximate value.

By using the assumed capacity, ASP and net margin from various sources, you’ve calculated the net profit as
CY2021: RM 12,503 million
CY2022: RM 5,943 million
CY2023: RM 3,097 million
CY2024: RM RM2,319 million
CY2025: RM 1,572 million
(I) The total net profit for first five years = RM25,434 million

I believe you’ve estimated the terminal value from Year 6 onwards as follow:
(II) Terminal value
= Year 5 net profit / (cost of capital – perpetual growth rate)
= RM1,572 million/ (7% - 5%)
= RM78,578 million

(III) Current net cash = RM 1,210 million

Enterprise value = (I) + (II) + (III) = RM 25,434m + RM 78,578m + RM 1,210m = RM 105,222 million (note: slightly different from yours by half a percent)
Divided by the share base of 8,015.659 million, the value per share = RM13.10
(I ignore the dilution effect of HK listing, which could have lowered the value).

However, there are a few points I want to highlight. First, the above calculation has missed the step of converting calculated values in (I) and (II) to present value by dividing them with the chosen cost of capital at 7% per annum.

Adding back the step, net present value (PV) of the first five years are
CY2021: RM 12,503 million/ (1 + 0.07) = RM 11,685 million
CY2022: RM 5,943 million/ (1 + 0.07)^2 = RM 5,191 million
CY2023: RM 3,097 million/ (1 + 0.07)^3 = RM 2,528 million
CY2024: RM 2,319 million/ (1 + 0.07)^4 = RM 1,769 million
CY2025: RM 1,572 million/ (1 + 0.07)^5 = RM 1,121 million
(I) The PV of net profit for the first five years = RM22,294 million

(II) Terminal value
= Year 6 net profit / (cost of capital – perpetual growth rate)
= Year 5 net profit * (1 + growth rate) / (cost of capital – perpetual growth rate)
= RM1,572 million * (1 + 5%) / (7% - 5%)
= RM82,507 million

The PV of terminal value = RM82,507 million/ (1 + 0.07)^5 = RM58,826 million.

By enterprise value = (I) + (II) + (III) = RM22,294m + RM58,826m + RM1,210m = RM82,330 million.
Value per share = RM10.3

The second point is terminal value is very sensitive to the cost of capital and perpetual growth rate used. In the above calculation, more than 70% of the value comes from the terminal value, which is determined by RM1,572 million * 1.05 / 2%.

If the denominator (cost of capital – perpetual growth rate) is 3% instead of 2%, the enterprise value will be RM60,550 million, and the per share value is RM7.6

If the denominator is even higher at 4% (instead of 2%), the enterprise value will be RM49,551 million, and per share value RM6.2.

Moreover, the chosen terminal growth rate of 5% is too high. It's a weakness in DCF calculation that it assumes growth into infinity. Therefore as a rule of thumb, the growth rate cannot be larger than the overall economic growth rate. Otherwise, the company will grow into a size larger than the overall economy, which is absurd.

A more reasonable approach is to assume after Year 5 (CY2025), Top Glove will enjoy another 5 years of high growth at 10% a year, and after that a perpetual growth of 3% (which is considered high; usually analysts only give 3% if they want to “bump” up their TP!)

Using this approach, the PV for the next 10 years is RM28,386 million. Adding the PV of terminal value RM33,131 million and net cash RM1,210 million, enterprise value is RM62,727 million. The value per share is RM7.8.

Even this value is highly sensitive to various other assumptions. By changing the cost of capital assumption especially we could get a vastly different result.

Ben, thank you for your response. I forgot to say earlier that I appreciate your effort in pulling the various information together for the benefit of readers. The info is useful, even though we seem to draw different conclusions on the merits of Top Glove management.

I agree the HK IPO price has not been settled. The investment bankers need to touch base with potential investors to work out a mutually acceptable price. There is always the happy possibility that TG share price in Bursa rebounds sharply above RM8 and somehow Top Glove successfully raises capital in HK close to that valuation.

However, based on Top Glove announcement to Bursa on 26 Feb, the company proposes “issuance of up to 1,495,000,000 new Top Glove Shares raising up to HKD14.95 billion (equivalent to approximately up to RM7.77 billion)”

https://www.bursamalaysia.com/market_information/announcements/company_announcement/announcement_details?ann_id=3133602

In other words, even if the market price remains sluggish around RM5, the management still plans to go ahead with the HK IPO at a price up to ~RM7,770m/ 1,495m = RM5.2. That is the stated price in their announcement. After spending a lot of money on the IPO, I doubt the management will abandon the IPO if they can get their stated price (unless they don't receive the necessary approvals)

As such, the management needs to answer why they spent up to RM1.4 billion of shareholder funds to buy back shares at higher prices earlier; and now issue billions of new shares at a lower price, grossly diluting their existing shareholders? Why buy high and sell low?

Of course, I understand the logic that a listing at HKEX could raise the company profile and facilitate future fundraising. But Top Glove management could still have gone for the HK IPO without the preceding drama of the most aggressive SBB in Bursa history, done at a much higher price. How does it benefit Top Glove long-term shareholders? I also fail to see how the high price drama earlier would impress future HK investors.

Now with hindsight, this entire exercise resembles a movement of funds. I’m not sure whether this is by plan or by accident. If it’s by plan, it means the Top Glove management has not been entirely truthful in the past since their aggressive SBB actions have created the impression of stock being undervalued. Only now they say they are willing to list at a much lower price. What is the message to new shareholders who bought at RM7, 8 or above based on management past SBB action?

If it’s by accident, Top Glove will need to brush up on its financial management skill.

Ben, I view the decision by Top Glove to list in HK as full of self-contradiction!

Top Glove bought back its share at a price up to RM8 in Sep last year. The signal sent by management then was Top Glove was undervalued at RM8.

Later Top Glove announced special dividends of up to 70% of profit, which means it will return billions of cash to shareholders. The signal sent by management is they are flush with cash and more cash is on the way in the coming quarters. The signal sent is, even after their RM10 billion Capex plan, they still have so much cash on hand that they decide tp return to shareholders.

Now they have finally submitted for HK Listing, right on the heel of Intco Medical. The news report that Top Glove plans wants to issue 1.5 billion new shares and raises up to RM7.7 billion. This works out to be a listing price up to roughly 7.7/1.5 = RM5.13 per share.

https://www.theedgemarkets.com/article/top-glove-plans-float-shares-hong-kong-raise-rm77-billion

Contradiction #1 – If RM8 is undervalued in Sep, why raise a massive amount of equity capital at RM5.13 less than 6 months later, and dilute the existing shareholders in the process?

Has the business fundamental turned so bad in 6 months such that what's worth more than RM8 in Sep last year worths less 2/3 now?

The impact is not confined to Top Glove shareholders. Recall last year, the Tropicana board, where Tan Sri Lim was the chairman and substantial shareholder, also bought Top Glove shares at a much higher price then (although Tan Sri abstained from the vote). Should Tropicana shareholders now wish that their board should have just applied for the HK IPO at a cheaper price?

Contradiction #2 – If Top Gloves could afford to pay back billions of special dividends to its Malaysian shareholders, why the decision to raise RM7.7 billion in HK? The net effect is while paying RM1 or so special dividend to Malaysian shareholders, at the same time dilute their equity by another 15% to 20%. Picking the left pocket to give to the right pocket?

To me this feels like either management incompetence, or lack of sincerity, or both!

At least the gung ho Intco Medical is very consistent with their message. They think they can become number 1 and they go all out for it by raising as much capital and expanding as fast as they can. Their shareholders who buy into them cannot complain later as they have been warned.

Closer to home, the no drama Hartalega management has provided a much better example of good corporate governance – no dramatic SBB or special dividends or foreign listing; just focus on the business and deliver results.

This incident has illustrated again why Top Glove suffers from a valuation discount while Hartalega enjoys a premium!

Thanks YuWei.

Does it mean that, due to the higher front-loading of profits and the lack of long-term risk surplus sharing, takaful operators' profits could be more volatile from year to year? My reasoning is during the good time when there is a lot of new business, profits may soar. However during the bad time, like during the Covid-19 lockdown, new business dries up yet takaful operators cannot derive much profit from existing policies. Is this the right reasoning?

But given takaful is based on risk/ surplus sharing, can I say takaful operators face a lower risk of blow-up due to underpricing? I'm not sure whether underpricing is a problem for the Malaysian insurance sector. I recalled reading GEICO nearly went bankrupt in the 1970s as the management then underestimated risks and underpriced products. Rightly or wrongly, this story has given me the impression that insurance is a black box business. Wrong actuarial assumptions could set off a time bomb for the future. Do you think such risk is present in Malaysian life or GI?

I'm also puzzled by the large disparity in ROE among the few listed insurers. Since 2012 STMB has managed to achieve ROE above 20% every year. ROE reached 32% - 33% in 2018-19. However, Allianz Malaysia is in the range of only 11% to 15%. LPI, which only offers GI, is just a few points higher. In your view, does STMB sustain its high ROE mostly because of the heavier front-loading of profits? Are there other reasons for the seeming outperformance?

@limyuwei, if you don't mind I would like to get your view on an earlier issue involving Allianz.

Earlier the Malaysian Competition Committee (MyCC) has ruled against the agreement between PIAM and the Automobile Workshop Owners' Association of Malaysia (FAWOAM) on the discount rate for motor parts prices and labour rate.

Interestingly Bank Negara Malaysia supports the agreement. The two government bodies are in open conflict over this matter. What is your view on that, especially the implication on general insurance companies?

https://www.nst.com.my/business/2020/10/628794/bank-negara-regrets-mycc-decision-over-piam-workshop-owners-deal

There is also the incident of Motor Vehicles Workshop Owners Association from 7 states calling for boycott on Allianz Malaysia. It seems that they are unhappy over Allianz General Insurance's initiative to revamp its panels.

https://www.allianz.com.my/allianz-general-revamp-allianz-authorised-repairers-panel

Is Allianz GI's initiative a direct response to MyCC's ruling? What are the effects of the boycott? Any idea what is the latest development and responses from other GI companies?

@limyuwei, thank you for your valuable explanation. Until you pointed out, I wasn't aware that IFRS17 has a disproportionate impact on Takaful operators. This is a very important piece of information.

To better understand, may I further clarify with a few more questions? Take your example of MRTA where the premium is paid as a lump sum upfront. Do you mean currently STMB books the profit derived from their Wakalah Fee in Year 1, however under IFRS17 the same profit will have to be apportioned over the life of the protection?

Don't conventional insurance companies also follow the same practice (of booking the profits in Year 1)?

Could it be the impact is greater for Takaful operators like STMB because they have a higher reliance on one-time premium products like MRTA? Besides MRTA, what other products also have such features of single premium for protection over a number of years?

Do you have an estimate of the level of reliance (and therefore the level of IFRS17 impacts) across different insurance companies?

Besides the above, any other factors that may cause Takaful operators to fare worse (reporting wise) under IFRS17?

@Multibagger, I read your blog. I share the same sentiment.

https://m-bagger.blogspot.com/2020/11/hong-leong-industries-what-is-plan.html

Sometimes I feel a stock may appear undervalued for a good reason. The cash cow is only a cash cow to the controlling shareholder if they have no ambition to let their cash works harder, or return this excess cash to all shareholders. Worse, as you've highlighted in your blog, one day they may privatize as the same controlling shareholder has done it before elsewhere.

However, given many minority shareholders are long-term shareholders, I suppose the majority of them will not accept any lousy offer after holding it for a long time and forgoing other opportunities.

The results have just been announced. Quarterly revenue, operating profit, profit before tax have all returned or even slightly exceeded the previous level. I hope MCO 2.0 will not affect its next quarterly performance too much.

It's also reassuring to see the share of profit from its associate continues to increase.

The only problem is the management keeps accumulating the cash without spending them on meaningful projects or returning it to shareholders. At this rate, they will soon run out of place to store their cash!

https://www.bursamalaysia.com/market_information/announcements/company_announcement/announcement_details?ann_id=3134170

@limyuwei,
Thanks for your explanation. I agree with kywoo. Your contribution is indeed very valuable to us who find the financial statements of insurance companies too technical.

I wonder if you follow Syarikat Takaful. The combined ratio of its general insurance business is much lower at 65% to 70% range (latest quarter 58%) as compared to Allianz at 85% to 95% (latest quarter 84%). Any idea why such a large discrepancy could persist in a competitive market?

The other question is whether we can find the embedded value of Allianz life insurance business? The latest report from RHB put the estimate at RM3 billion. But it’s unclear how they arrived the figure.

@kywoo,
The basic EPS = Leftover profit after paying off the preference share divided by the number of ordinary shares.

Since preference share dividends are paid out in Q4, there is a lump sum deduction that only occurs in Q4. Hence the low basic EPS.

You can find the calculation in the quarterly results. It's under Part B, Note 12a, page 31.

This brings me to the next subject on the world economy.

You’ve raised an interesting point about declining velocity of money. I don’t have the world figure, but this phenomenon has been observed in the US for quite some time already. The velocity of M1 has declined since 2008, and velocity of M2 has actually last peaked in 1997! But their relationship with the economic health is complicated. US economy was rather good during most of the period of declining money velocity. This 2015 article discusses about the phenomenon.

https://seekingalpha.com/article/3066146-why-money-velocity-continues-...

Actually, the world economy has faced many threats over the last decade. But most of the risks, except the China-US trade conflict, have receded before 2020. At the start of 2020, the US economy was in a very good health with unemployment at a record low level. US corporation were making great profits. The main source of concern during 2018-20 was the US-China trade war. But the threat is no bigger than some of the earlier threats:

(1) Weak banking sector
Some banks, especially in Europe, has not fully recovered from 2008 crisis. However the banks have become a lot safer nowadays after being forced to take on massive equity in accordance to Basel 3. Todays banks, including Malaysian banks, are generally robust and could take on a lot of stress.

(2) Debt crisis in developed countries
You’re right that debt to GDP ratio has gone up a lot, creating doubt on sustainability and impending debt crisis. There has been concern since 2008/09 on how developed countries could get themselves out of their debt situation. And for Japan, that concern has persisted for at least two decades. But so far no major crisis has occurred, except for Greece, which is a small country. The absence of debt crisis has now triggered a rethink among many economists whether sustainable debt levels are a lot higher than they have assumed, especially for countries that issue debts in their own currencies.

(3) Breakup of EU
There were periodic crisis since 2008 starting with the Greece debt crisis, which later evolved into non-confidence in PIGS countries, and was followed by emergence of Eurosceptic populist parties of AfD, National Front, Five Star Movement and eventually Brexit. But somehow the EU and the monetary union muddled on. In fact the outlook has turned much better today. Brexit has already happened without major impacts, except some managable problems for UK. Covid-19 has forced the EU to take the first step toward a fiscal union by setting up a 750 billion Euro recovery fund to assist countries in need. The risk of an EU implosion is now very low.

(4) China hard landing
Again there have been several rounds of scares. A few years ago it was doubtful whether the total debt to GDP ratio at 270% can sustain. But somehow through many intervention the Chinese government has stabilized the debt level and has also engineered a soft-landing in its overheated property market. Instead of capital outflow the past year has seen foreign capital inflow especially to China bond market, pushing up the RMB exchange rate.

Of course the US-China rivalry remains a source of instability. But under Biden's administration the risk of an escalating trade war between US and China, and in fact between US and other major economies, have greatly subsided.

If there is any worry, the worry has shifted away from a weak economy to an overheated economy. The growing appetitie of China and the expectation of Biden's USD1.9 trillion stimulus package has already sent commodity price rising. But central banks would welcome a temporary pick up in inflation as it will lift the economy out of deflation risks.

So while the future is not cast in stone, the general consensus including from IMF and World Bank is growth will pick up in 2021 and 22. While we can't rule out black swans, the outlook seems on balance on the positive side for me. Of course, the world stock market valuation is another matter as valuation may have run too far ahead due to easy liquidity.

Hi Ben. It’s always nice to read your opinion on such matters. From your reply, it’s clear that you’ve done a lot of readings and given a lot of thought to them.

Yes, we have some differences in opinions in terms of the threat posed by continuous virus evolution and the impact on the world economy. But it is a difference in degree rather than direction.

First the virus. I believe most developed countries should be able to vaccinate a very large segment of their population by the second half of this year. As mentioned earlier, that means they have to make progress on the unwilling population and children. Yesterday the WHO European Director said he believes the pandemic will end by early 2022. So there is hope that the pandemic will turn into an endemic by then.

But you’re rightly concerned about the speed and uncertainty around the virus mutation. However, countries especially developed countries are much better prepared now. mRNA technology has already been proven. Pfizer boss has also claimed that the technology could be retooled to target new variants in 6 weeks. Production and logistic facilities are already in place to support boosters should it become necessary.

However, I agree the future will be rather bleak for many poor countries, especially war-torn countries where public healthcare systems have collapsed. But from the economic point of view, the poor countries have a smaller contribution to the world economy. The OECD countries are responsible for about half of the world GDP (measured on PPP). Adding in China the weight is close to 2/3. They alone absorb most of the export from Malaysia.

Hi Ben. Thank you for taking the time to explain. Very informative!

Yes, it’s good that the Malaysian government has secured diverse sources of vaccines. The diversity will reduce the risk of a single point of failure.

After reading your reply, I found that I had misinterpreted vaccination does per 100 people with vaccination rate per 100 people. However, the number cannot simply be divided by two. For example, UK has delayed the second dose from 3-4 weeks to 12 weeks. Therefore the coverage is not 25.73 doses per 100 = 12.86% coverage as you've assumed.

Two days ago BBC put the latest number as “more than 16 million have received at least one does”. That is close to 24% of the UK population at 68 million.

https://www.bbc.com/news/health-55274833

Meanwhile, as of Feb 16, the Israel media reports that the country has vaccinated 4 million or 44% of their population, representing 2/3 of the eligible people.

https://www.timesofisrael.com/two-thirds-of-eligible-israelis-have-received-at-least-1-dose-of-covid-vaccine/

The article also contains hints on how other governments may deal with vaccine hesitancy. It reports that after a recent slowdown, Israel vaccination rate has ticked up again because the government has approved reopening venues and events to only those who have been vaccinated (or previously contracted the virus). Its government also considers mandating workers with high public exposure to be either vaccinated or have a virus test every 2 days. In Malaysia, the government has just announced giving out “vaccine passport”, which could serve as a powerful incentive for students/ workers/ business people who need to travel. In other words, faced with a health and economic emergency, every government is going to roll out all the carrots and sticks to get their people vaccinated.

Furthermore, the share of the unwilling population is a changing number. A key reason for not taking up the jabs is due to the concern of side effects. But when the people around like relatives, friends and colleagues have been vaccinated without apparent ill effects, such vaccine hesitancy will decline. There could also be social or workplace pressure to vaccinate.

The next question is how to deal with children. Last week a trial has started in the UK for children as young as 6 years old. There is a strong motivation to get children vaccinated and get them back to school. Remote schooling has not only been disruptive to learning but has also widened social inequality as children from poorer families suffer disproportionately.

https://www.theguardian.com/world/2021/feb/13/oxford-astrazeneca-covid-vaccine-to-be-tested-on-children-as-young-as-six

In fact close to a hundred Israeli children with pre-existing conditions like diabetes, lung and heart diseases, cancer have already been vaccinated. No side effects have been reported. The Israel findings will be closely watched by other countries.

https://www.theguardian.com/world/2021/feb/13/oxford-astrazeneca-covid-vaccine-to-be-tested-on-children-as-young-as-six

Therefore I believe the challenges presented by these two groups are not insurmountable. As vaccines get progressively rolled out to the larger population, attention will shift to these groups. Sticks, carrots and emergency use will be applied.

Having said that, I agree with you that many industries will not return to the 2019 level soon. Commercial airlines, cruise, hotels, outdoor entertainment are among them. This is not only due to fear of traveling but also the new way of working. Business travel will stay low which is bad news for full-service airlines.

Nonetheless, human society and the economy as a whole will soon learn to live with the virus, which no doubt will keep on mutating as viruses did in the past billion years. We have lived through such experiences. Washington Post has carried an article describing what happened after the 1918 Spanish Flu.

“All those pandemics that have happened since — 1957, 1968, 2009 — all those pandemics are derivatives of the 1918 flu … The flu viruses that people get this year, or last year, are all still directly related to the 1918 ancestor.”

https://www.washingtonpost.com/history/2020/09/01/1918-flu-pandemic-end/

It is likely that Covid-19 could evolve into something like seasonal flu, which kills many elderly in every season but is hardly noticed by the general public.

Hi Ben. I understand your points. I think your assessment of government actions is fair and balanced. As compared to most developing countries and even some developed ones, Malaysia is doing OK. However just like every boss tends to be demanding, sometimes unreasonably so, I hope Malaysian politicians will feel the heat from citizens demanding the best from them. Such pressure is necessary for the country to progress.

If I read your blog correctly, you seem to favor another one-time, longer, stricter lockdown to bring the cases down to near zero or really low level before reopening. One-time pain is better than prolonging the limbo state, which is the danger of premature relaxation.

This in fact is the China approach. Whenever there is a small outbreak of maybe just a few cases, the whole neighborhood will be under strict lockdown and the entire city population is tested within days. As a result, Chinese citizens could confidently carry out their normal activities despite their vaccination rate of only 3% of the population. So long as they continue to shut their borders, they are fine.

Unfortunately, I don’t think Malaysia could adopt this model even if the strict MCO 1.0 version is imposed for another 2 months. Unlike Mar last year, the virus has taken root in every corner. There are too many asymptomatic carriers that which is like a hidden fire burning underground of peatland. They could not possibly be flushed out without a Chinese-style whole of the city kind of mass testing. Malaysian simply does not have the manpower, organization and political will to deliver that. Outside of China, the only near success I read is Slovakia which tested 3.6 million out of 4 million population in last Oct. But even their mass testing only served to halve daily cases from 2K to 1K before bouncing back the next month.

Even if Malaysia could successfully carry out the mass testing and flush out every carrier (not an easy feat given there could be false negatives in testing), the viruses could soon make come back through the porous borders as you’ve mentioned. If unchecked, the strict nationwide lockdown earlier could simply go wasted, easily at the cost of another 5% or so GDP contraction.

The repeated flare-up is also the experience for advanced East Asian economies. Korea, Japan, Taiwan and Hong Kong all have seen the periodic resurgence of cases. So Malaysia has no choice but to make a fine balance between opening up and containing the pandemic. Without the Chinese advantage, it has to follow the Western approach of rapid vaccination rollout strategy. The latest vaccination progress chart I read (as of Feb 16) shows Israel at close to 80%, Britain above 20% and US at 17%. Large scale study in Israel has shown the vaccines has made a significant positive impact. Daily cases are declining fast in UK. Can Malaysia learn something from these countries on how to roll out their program faster and effectively?

Put all focus and resources into a successful vaccination rollout. Up the budget if necessary. Even assumed at RM 500 per person (an average dose probably costs only USD20 or RM80), it will cost the nation merely 33 million * RM500 = RM16.5 billion, which is just about 1% of 2020 nominal GDP at RM1,341 billion. The cost-benefit equation is a no-brainer.

While vaccines may not fully protect individuals from contracting Covid-19, they can significantly reduce severe cases. By driving up vaccination to a rate of say at least 80% in the next 3 quarters, it would have restored a lot of confidence, the necessary foundation for many economic activities.

The 1918 Spanish flu killed at least 50 million (some said 100 million) but it subsided in 2-3 year time without substantial economic damages. That was achieved purely based on natural herd immunity. There is no reason that with much better scientific understanding, medical help and resources at our disposal today, we cannot organize ourselves and do a better job than in 1918.

Guys, check out The Edge today. Just as we debated the merits of RCE, their weekly edition published an article "RCE Capital shines in adversity".

Hi Ben. I see that your analysis has brought you to the Malaysian Covid-19 situation. Thumb up for you! I also happen to have a few opinions on this matter. Let me put forward my 2 cents.

IMHO, the Malaysian government has a mixed record. The right things are like the quick imposition of a draconian lockdown during the MCO 1.0 (started in Mar 2020). The rollout of a bold stimulus package to sustain livelihood and businesses in the face of soaring debts. Taking the Covid-19 threat seriously and listening to health experts instead of dismissing it as flu as Donald Trump did.

Now the bads.

First, Malaysian leaders are slow learners during a crisis (or they’re too consumed by politics?). I can understand a sledgehammer MCO 1.0 (Mar 2020), as most of the world governments also had no clues how best to respond. But MCO 1.0 was extended several times up to 2 months with no finetuning or modification across different states and districts. Surely some flexibility could have been injected at the later part of MCO 2.0 with some experimental gradual openings at green zones.

The rigid MCO approach, such as allowing breweries to operate and then U-turn at the last minute, has caused unnecessary economic contractions. The sharp fall in GDP during MCO 1.0 would later come back to haunt ministers like Azmin Ali, arguing against another lockdown when cases soared by citing unaffordable economic damage. The economy was damaged in the first place because the cabinet only knew how to operate in two-mode – either ON or OFF, but not in between!

Second, the government does not learn from other country lessons. Singapore experienced a mass outbreak at their foreign worker dormitories in Apr 2020 with 4 digit daily cases. Given Malaysia has more foreign workers, and many are in fact undocumented, what have the relevant authorities learned and done between April to Nov when mass contagion first came to light starting with Top Gloves factories at Klang? Why the highly publicized raids by Human Ministry were only conducted in Nov and Dec? As Workplace clusters have now become a norm and dropping out from media headlines, are the authorities still keeping up with their efforts?

Third, leaders not walking the talk. While the Sabah state election had to go on, why the health authorities did not impose quarantine demand on West Malaysia politicians returning from campaigning in Sabah, with the full knowledge that an outbreak was happening at Sabah then? Returnees from Sabah were key contributors to the Covid-19 spread in West Malaysia starting in the Klang Valley. The lax attitude made a mockery of the unnecessary strict MCO 1.0 just a few months earlier. And now certain ministers only need to quarantine for 3 days after returning from selected foreign destinations. I wonder do politicians have higher immunity.

Fourth, the lack of coordination at the middle and lower levels of the government machinery. One year into Covid-19 we still hear different standars during enforcement. Isn’t there an internal review and dissemination process to ensure uniform standards? I’m also perplexed by the ill-defined line separating essential versus non-essential businesses. For example, selling shoes was not allowed during MCO 2.0 but selling televisions (I’ve seen in malls) was OK. When apparel shops were reopened, customers were required to wear gloves. But everywhere I go I don’t see eateries kitchen staff or waiters wearing gloves (higher-end restaurants might be the exception). Do people get Covid by touching contaminated clothes but not when they swallow contaminated food?

The list of grievances could go on but that will risk turning an investment discussion into a political discussion.

Nonetheless, I’m always optimistic that this difficult time shall pass soon given human ingenuity. We and our earlier generations have faced far greater challenges in the past but still bounce back from them.

Mr kywoo, thanks for sharing. I see you are very confident with a concentrated portfolio as you’ve studied each one in depth. As I hold more stocks, I experience the challenge you mentioned.

Like you Nestle used to be my favorite holding, and I was reluctant to part even as valuation became very expensive. But I completely sold it in March to switch to many other bargains and never look back since.

Let me also put forward my 2 cents on how I would allocate between HLIND, Allianz and RCE if they are the only choices. If I start from a clean slate today, I will probably be 1/2 Allianz, 1/3 HLIND and 1/6 RCE.

Putting valuation aside, I have more confidence for Allianz to maintain good governance and capital discipline over the long term as this will be demanded by its parent. Today HLIND will be a recovery play for me. The net cash is also a potential positive wild card. As for RCE, even though I believe its valuation is only fair at the current level, my approach is usually to take a foothold when I come across a good company and observe it over time. Besides Buffett once advised buying good companies at fair prices.

Of course, this is just hypothetical. As I’ve started with them much earlier, I also own them in roughly equal proportion, besides a range of other stocks.

Mr kywoo, thanks for sharing your investment decision. Not sure why my earlier comment disappeared. I deleted and reposted after correcting typos. I just found the reposted message missing.

*****

Mr. Kywoo! It’s nice to see you joining. You’re a very knowledgeable and focused investor. It’s a real pleasure to have you sharing your opinion and pointing out where I went wrong. If you don’t mind I'd like to take this opportunity to dwell into those points further details just to clear some doubts.

On point 1, yes I’ve overlooked it. It makes more sense now. Using Loanstreet flat to effective rate calculator, a 4.99% fixed rate over a 10-year tenure works out to have an effective rate of 8.67%.

4.99% fixed rate demands taking a takaful. Without takaful, it is 5.85%, equivalent to an effective rate of 9.99%.

The only fee mentioned is a stamp duty of 0.5% of total financing. The product disclosure sheet states that no collateral is required although a guarantor is needed.
https://www.bankrakyat.com.my/c/personal/financing_i/personal_financin...

So if the above calculation is correct, the effective rate is slightly under 10%. But not reaching 12% as in your experience. It’s still lower than 13% to 14% by RCE that I read somewhere. But that was quite a while back and RCE might have adjusted its rate down too as borrowing cost reduces.

Back to the question that prompts me to raise this example in the first place. Are Bank Rakyat, Bank Islam, BSN etc have the means and incentives to lower pricing and/or lending standards among public sector employees? How could RCE defend its profitability and market share, although it certainly helps that RCE has good management and pride itself for speedy loan approval.

On Point 3, you’ve misquoted me when you wrote “You have said that RCECap has enjoyed a PE of 6.5 in the past years and you are quite happy with that”.

What I wrote was “the past 5 year average PE was only 6.5X”. From the chart I saw, the forward PE over the last 5 years went as high as 9 to 10 times and as low as below 5. The average forward PE is 6.5X. (Median forward PE would tell a better story but I don’t have the data).

As I’ve commented back on Jan 1 and again today, I deemed current forward PE that is close to 9X as fair. Fair means I’m happy to hold, but not topping up or selling. If for no fundamental reason the share price is back to around 6.5X forward PE (which is RM0.33 * 6.5 = RM2.14), I personally will feel it’s undervalued and will top up.

So our difference is at 9X to 10X is undervalued for you and fair for me. But that is our personal opinions. The market price considers factors besides what retail value investors think, such as liquidity. Yes, the market could be “wrong” in the last 5 years. By 2026 we shall see in the new PE chart of the preceding 5 years whether the average PE gets “corrected”.

This brings me to a very practical question. Mr. Kywoo, not sure if you still remember that we’ve once discussed Allianz and HLIND, the two other companies that you’ve viewed as grossly undervalued. I also happen to like both companies, except HLIND management due to its cash hoarding.

Comparing these three companies as of today:
HLIND: share price RM8.15, TTM PE 17X (was 10X pre-Covid), ROE 9% (was 20% pre-Covid), dividend yield 5.2% (42 cents), net cash RM4.27 per share.
Allianz PA: share price RM13.90, TTM PE 9X (after dilution), PB 1.1X (after dilution), ROE 13%, dividend yield 5.0% (69.6 cents)
RCE Capital: share price RM2.78, TTM PE 9X, PB 1.4X, ROE 16%, dividend yield 4.3% (12 cents)

Assuming you have not held these stocks earlier, given a sum of capital, how many percent would you allocate into each of them?

This is a sincere question. I asked because eventually, stock investment is not carried out in isolation without relative comparison. Besides we both like these three companies. The allocation decision will reflect relative preferences.

Thanks for the inputs. This is becoming a lively discussion. I like reading differences in opinion and throwing up challenges so that the forum doesn’t become an echo chamber.

Checking back my records, in the 2013 Chairman’s Statement, Azman Hashim explained revenue dropped almost 30% due to intense competition. In that same year, impairment jumped almost 150% from a year earlier. The BNM’s guideline to lower loan tenure to 10 years was only mentioned in the 2014 Chairman’s Statement.

Actually, the government sector is not small given Malaysia has a bloated civil service with 1.6 million civil servants. In fact, when asked about how could RCE grow by just focusing on the public sector employees, the CEO explained that RCE only has about 5% of the market (his measure is based on headcounts where RCE has about 80,000 users). So other players are active too.

As I’ve read before, Bank Rakyat is the largest share in the personal financing space (in total, i.e. not limited to government servants). You can find the terms offered by Bank Rakyat. Borrowers who opt for a salary deduction scheme can get a fixed-rate at 4.99% for financings of 3 to 10 years tenure. Note 4.99% is within the range of RCE borrowing cost at 3% to 5.8% as reported in the last quarterly report.

https://www.bankrakyat.com.my/c/personal/financing_i/personal_financing_i_public_sector-4/personal

I can’t find RCE loan terms on its website. But I’ve read analyst reports citing it charges as high as 13% to 14%. If that’s true the situation could not sustain. In fact, last quarterly report Note 13 mentions the group benefits from higher early settlement income, which means some customers have refinanced given better terms elsewhere. This is why I’ve raised the possibility of increased competition.

As for RCE and AmBank relations, as revealed in Annual Reports, in some years the related party transactions with the AmBank group of companies measured over 10 million or more. Granted they have to be conducted according to the arm’s length principle. I also have no doubt the transactions are mutually beneficial. In the finance business trust and reputation are crucial. The association with AmBank group benefit RCE when they go to the market to raise fund and potentially lowering the funding cost. Note I raised this point earlier as a plus for RCE.

RCE Capital dividend guidance is 20% to 40% payout ratio. So 40% is actually the upper limit. In FY19 and FY20 they were 33% and 35% respectively. The trend is increasing. I check the consensus EPS for FY21 and FY22 is 33 and 35 cents. Assuming a maximum payout of 40%, 33 cents * 40% = 13.2 cent dividend, and 35 cents * 40% = 14 cents. In the past several years the dividend history is 3+3, 4+4, 5+5 and 6+6. If the pattern continues, the next one could be 7+7 =14 cents by 2022 if not 2021.

As I’ve mentioned before, despite RCE being a good company I would hesitate to extrapolate its good results too far too fast. REC has benefited from several onetime factors. The higher early settlement income is one. Another is borrowing cost has become lower and lower. But the Sukuk funding is determined by the government bond yield + a spread. Can it go lower? After falling so much, 10Y MGS has gone up. It started touching 3% in the last few days.

https://www.bnm.gov.my/government-securities-yield?p_p_id=my_gov_bnm_yield_display_portlet&p_p_lifecycle=0&p_p_state=normal&p_p_mode=view&_my_gov_bnm_yield_display_portlet_tradingDateTxt=2021-02-15

But last let me say this. I'm not here to challenge anyone or prove something. I want to list the concerns as I see and I hope to get answers from people who have thought about them. The better I know about the company (for goods and bad), the more confident I'm in holding on to the shares.

@Learner King. Thanks for taking 2 hours to respond to me!

In summary, your answer is all answers are already in the quarterly reports and google. Thanks for telling me that! Apparently your English is very good despite your repeated claim of otherwise. I’ve read the same quarterly and annual reports every quarter and every year. Yet I’ve missed the answers. Perhaps I lack the intelligence or expertise to read through the obscure risk management policies and processes to translate into simple English on how they work out for the specific risks I care.

But one thing I’m certain of is while RCE and AmBank are two independent companies, they have close connections as I've commented. That is clearly stated in their Annual Report. They share key shareholders and board members and the AmBank group of companies are even listed in the Annual Report related party disclosures. Even though related parties are required to deal at arm's length, at least I know how it works in practice. For that, I can read beyond the English text.

BTW I’m no analyst nor even remotely connected to the finance and stock market industry beyond just a small potato investor. Lastly, I wish you prosperity through this company as that also brings continuous dividends as my pocket money too. Cheers!

@moolala, Aeon Credit 5Y average forward PE is 10-11X. It's during this bad time that its forward PE goes up to 16X as expected earning drops faster than the share price. But forward PE is based on FY21. As earning normalizes post FY21, PE could go lower even as share price recovers.

RCE at 15X forward PE will be RM4.80 or about 2.4 times Price to Book. That is about 40% more valuable than today Public Bank which is1.7X PB. That is possible if more funds start to prefer RCE than the time tested grandfather stock.

@x3mg33, not sure if your good suggestion is partly directed at me. But I ain’t any sifu. However I’m happy to give a prediction since you’ve asked for one. I predict with 99% confidence that by year end the price will be different from today. And I’m not shy to say that my past predictions have outperformed many analysts!

@Learner King. Thanks for your explanation. Since you pointed out, now I got your point.

Just to set the context right, refer to my comment on Jan 1. My view then was at RM2.75 in Jan 1 (quite similar to today price), at a forward PE of 8.7X, the price was fair for me. Just no longer undervalued. But still too early to sell. Just that I stopped topping up after many quarters of accumulation.

But there is no contradiction to also warn that the past 5 year average PE was only 6.5X. My personal risk appetite is different from the general market risk appetite. I’m undisturbed even if the price retreats to the previous RM1.5 – RM1.7 range, as long as it’s due to market sentiment reversal not deterioration in fundamentals. But the same cannot be said for people who don’t study the company and are advised to get in at RM2.80.

Besides my “fair PE” can be very different from the collective market “fair PE”. The market price is determined by the collective power of funds willing to take liquidity risk to invest in this small-cap niche business, where the float is only 40% (the Azman family controls the remaining 60%). So the average 6.5X in the last 5 years partly reflects this liquidity discount. If that’s the market verdict I’m happy to stay at 6.5 times for years to come while collecting dividends. But my circumstances may be different from another person.

Not to mention I suspect the break-out since Nov is not due to the RCE factor alone. While the past 2 quarter results are good, they are not spectacular. I notice Nov 2020 coincided with the start of recovery play. Even laggard like CIMB stock price rebounded from below 3 to over 4.X. Looking further say the tech sector. While I might still top up MPI at RM20 in Nov, I would be edgy with a price near RM40 and PE approaching 50X now. People in such a position, who may want to take some chips off the table yet hate to leave the party, may decide to switch some money into good quality and relatively cheaper counters like RCE. In this way in a market euphoria is like water that flows everywhere and lifts all boats. Even Air Asia is currently up 60% from its low in Nov. But has Air Asia fundamentals improved that much in the last 3 months?

Anyway, this is just my view. I’ve been in the market long enough to be proven wrong with enough times that the future is a range of possibilities.

But if you don’t mind, since you’ve been following this company for several years, I would like to get your view on two questions that I’ve come across. One is since earlier years RCE has relied on Yayasan Dewan Perniagaan Melayu Perlis and Yayasan Ihsan Raykay to reach end customers. The dependence has declined over the years, but any idea of the current proportion? More importantly, how does RCE manage the credit risk if these intermediaries were to default?

The other question concerns how to avoid a repeat of the difficult period in 2013-14. Stiff competitions then from Bank Rakyat and the like resulted in lax credit standard and subsequent rise in impairment. It took BNM’s intervention to limit loan tenure to not more than 10 years to prevent the race to the bottom. RCE management has turned conservative after that lesson. But what stops other banks from encroaching into RCE market share as a source of their growth? While RCE may enjoy its connection with the AmBank, other banks could tap into equally or even much lower funding sources.

@ Learner King. Sorry if my writing has taken up too much space on your screen. Unfortunately, this is my way of thinking about stocks. I’m a long term fundamentalist and have no talent for momentum. I stay on what I know best.

Given your emphasis on speed, I suppose you’re a momentum follower. But since you’ve professed to hold it since 2016, I wonder if you started on momentum before turning into fundamentalist and recently back to momentum again? Or your momentum timescale is measured in years? :)

BTW I don’t necessarily own stocks that I comment on, and I haven’t commented on many stocks that I own. But what we have in common is I too like this company. RCE has been a favorite before I even registered an account with this forum. Cheers!

@Xxxting.

If I were you, I wouldn’t rely on buy/sell recommendations by others without doing my own homework. Even if the buy advice is right, I may panic into selling at a loss during a market shakedown if I don’t understand the fundamentals of the company.

I don’t even trust analyst recommendations. But just FYI the current analyst consensus is 1 strong buy, 1 buy and 1 hold.
https://www.bursamarketplace.com/mkt/themarket/stock/REDI/analystconsensus

Actually RCE Capital is one of my favorite stocks. It has good management and good business fundamentals. The question is whether the current price is right. During the past two quarters, the stock price has run up a lot faster than its good results. It may mean the market has “discovered” and re-rated it upwards. Another reason could be with its several quarters of steady performance, there is a chance of higher dividend from current 12 cents to 13 or even 14 cents.

But don't be misled by the seemingly low forward PE of 8 to 9 times. Current forward PE should be compared against the past 5 year average of only 6.5 times.

On another valuation measure Price to Book. At a closing price of RM2.89 today, the PB is 1.4 based on the latest book value per share at RM2.05. This corresponds to a respectable ROE of 16% to 17%. As a comparison, Malaysian largest bank Maybank has a lower PB ratio of 1.1, though an even lower ROE at 8% to 9%.

But RCE should have a discount against Maybank. RCE is in the lucrative but higher risk personal loan business targeting civil servants only. Maybank, on the other hand, is in a safer integrated bank business and a must-have in the portfolios of many fund managers. Besides the small size of RCE means it could experience larger business volatility, such as if a large bank decides to compete aggressively in its niche.

Personally, if I were to discover this stock only by now, I will still buy a small slice first, while further study it in depth to decide whether I should add or exit.

Sorry. Borrow this space to respond to a glove question.

@Bao2Lai. You can find my calculation on the operating profit of Intco vs Harta & Top Glove in my comment to Ben Tan’s blog. Timestamp 07/02/2021 2:58 PM.

https://klse.i3investor.com/blogs/bursainvestments/2021-02-06-story-h1540340424-Top_Glove_Hartalega_Supermax_The_US_Demand_for_Gloves_and_Homeland_Prod.jsp

In summary, for the first three quarters of 2020, the operating margin of Intco was 19%, 59% and 69%. Top Glove 12%, 26%, 46%. Harta 18%, 30%, 51%.

I’ve also worked out the Capex required for new capacity expansion. It takes Top Glove about USD25 for every 1,000 pieces of new capacity. Capex for Intco is only about USD17. See my calculation in another comment in the link below. Timestamp 16/02/2021 11:29 PM

https://klse.i3investor.com/blogs/bursainvestments/2021-02-16-story-h1541112319-Glove_Supply_and_the_Supply_Demand_Disequilibrium_Top_Glove_Supermax_Ha.jsp

The current blended ASP of USD70, if sustainable, means it takes only 4 months to breakeven for new production investment. That explains why Intco is rushing for a second listing in HK to fund its explosive growth. Its capacity by the end of 2019 was 19 billion pieces; end of 2020 36 billion; now already 45 billion. It has announced at least another 190 billion.

I also don’t think Intco needs to worry about US protectionism or even outright ban, despite US being a key market currently. Even though Intco annual capacity has already increased to 45 billion, that is still a fraction of its announced additional capacity of 190 billion. If the management senses the risk of over concentration in US, it could aggressively future capacities to non-US market.

Glove impose little switching cost on customers. I doubt customer loyalty on branded gloves, not to mention many producers are OEM. To prise open new markets outside US, Intco just needs to lower price sufficiently given it’s already a low cost producer.

If I’m in Mr Liu’s shoes, I will be more concerned on how fast I could seize the opportunity to raise the multibillion necessary to support aggressive expansion. Luck will play a role here. One is the sentiment of Hong Kong IPO market, which currently is piping hot. The other is whether ASP can stay high for the next few quarters so that their investment bankers can sell a good story to fetch a lofty valuation. Afterall the IPO market is mostly about sentiment where participants are motivated by quick money.

Therefore, although current consensus is glove ASP will remain elevated at least until end of 2021, it might not be a bad thing if ASP normalize sooner. It will at least pour cold water on Intco’s second listing and deter it from raising the necessary fund to launch a race to the bottom.

Hi Ben! Thanks for your view again.

I agree we can never know fully how the dynamic will develop in the future. What we can however do is to look into past records for guidance.

I too believe the secular growth of gloves far into the future. In the past, the leading Malaysian glove makers have shown remarkable collective restraint in their capacity expansion. They scale back expansion when market demand didn’t grow as fast. Such “cooperation” has ensured all efficient players could maintain profitability. But such implicit understanding might be more difficult when foreign big players like Sri Trang and Chinese start appearing.

Looking back into past financial data, excluding the bumper year of 2020, in the decade since 2010 operating profit margin for Top Glove was 7% to 13%, Supermax 9% to 16%, Kossan 11% to 17%, while Harta was at a different level of 20% to 33%.

Such good, but not excessively high margin, is one reason why Malaysian glove leaders continued to dominate the market until now. The moderate operating margin did not provide adequate incentive for new challengers to take on incumbents that already have the economy of scales.

This also explains why the long-term trend of ASP is actually downward. I’ve tracked Hartalega blended ASP year by year. Until 2019 its annual reports would display a chart showing annual nitrile glove shipment. A rough estimate of its ASP can be derived by dividing annual revenue with shipment quantity and converting it to USD based on the exchange rate at that time.

Over the 2011-19 period (where it was almost a pure nitrile glove producer with 90% to 95%), ASP gradually declined from around USD40 to USD25 per 1,000 pieces, representing a compounded annual decline rate of about -5% to -6%. It’s clear that the law of economy would drive down ASP, even during a period of high demand growth. This is why I’m skeptical that the long-term ASP could settle at a higher level. There seem no convincing economic reasons to support a higher plateau for long term ASP.

In a more likely scenario, if all key players including the Thai and Chinese could “cooperate”, long term ASP should revert to a cost-plus basis where leading players continue to enjoy an operating profit margin of say 10% to 15%, or even 20% for an innovator like Harta. After tax, the net margin may be around 10%, plus or minus a few percent, as achieved by key players in the last decade (again excluding 2020). However, this will imply a reversion to ASP below USD20+, i.e. the bear case scenario in RHB valuation I mentioned in the earlier comment.

Yes, in that case, Intco shareholders who are new to the party will be proven too optimistic. Having said that, Intco forward PE (the only relative valuation measure I can find) is at 11 times, while higher than Top Glove it’s lower than Harta.

But note Intco’s valuation is not solely based on the high ASP assumption. I’ve read those Chinese analyst reports, news articles and investor blogs. The sentiment is clearly based on Intco aggressive expansion for market shares. It seems to prioritize market dominance first and high profitability can wait.

Besides, even if minority shareholders may abhor the idea of destructive competition, the controlling shareholder can have a different calculation. Right now Intco controlling shareholder Mr. Liu merely sits on his paper wealth consisting of 40% company shares. Mr. Liu couldn’t cash out by selling his stake without bringing the price down. From his perspective, therefore, it could be better to exploit the current high valuation to attract more capital. Hence the Hong Kong listing on the premise of rapid expansion and long-term growth. Intco current valuation expects it behaves like a growth company. Rapid market share and revenue growth come first. Lower profitability could be tolerated during the growth period.

Actually, the pursuit of market share at all costs is not new in China. China shareholders should have gotten used to it. Not just solar PV panel and steel coils. During the bike sharing craze a few years ago, Ofo, Mobike and other aspiring unicorns competed to burn cash, rolling out free bikes for users while still figuring out their business models. When the dust settled they already burned more than USD5 billion and 25 million bikes ended up in “bicycle graveyard”. At least the glove sector would have a more benign competition. Players can still make a profit even despite slashing prices.