SINGAPORE (Oct 28): Our Malaysia portfolio has been fairly defensive since April as local and global market conditions turn more uncertain. For much of 2017 and 2018, our portfolio was 70% to 90% invested, with cash holding of 10% to 30%. This year, we have been more proactively managing our asset allocation, with our cash holding fluctuating between 2% and 56% (see Chart 1).
With the FBM KLCI currently trading near multi-year lows, we think it is time to put more cash to work. Earlier this month, we halved our cash holding from 40% to 20%, and added Power Root and Public Bank to the portfolio. This week, we elaborate on why we like the two stocks.
Power Root
In the current market environment, consumer stocks offer defensive qualities. Bursa Malaysia, however, does not have many listed consumer stocks. The major ones, such as Nestlé, Dutch Lady and the breweries, are mostly multinationals and trade at very high price-to-earnings multiples of 26 to 50 times. The local players are mainly in confectionery, and are often small or illiquid.
Power Root is a home-grown beverage company that produces coffee, tea, chocolate malt drinks and energy drinks. Coffee is the group’s main product, contributing 80% of total revenue in 1QFY2020 ended March 31, 2019, followed by tea (9%), energy drinks (7%) and chocolate (3%). The company derives 50% of sales from Malaysia and 50% from exports, mainly to the Middle East.
We like Power Root for its undemanding valuations relative to the sector and growth, its portfolio of strong consumer brands and attractive dividend yields. Based on AbsolutelyStocks methodology, the company has a Fundamental Score of 2.1/3.0 and a Valuation Score of 1.7/3.0.
Some of the popular brands owned by Power Root are Alicafe, Per’l Café, Ah Huat White Coffee, Ah Huat Coco, Per’l Coco, Alitea, Oligo and Extra Power Root. Alicafe, which houses products such as the Tongkat Ali Ginseng Premix Coffee, is the market leader in the functional coffee segment in Malaysia. Alicafe contributed 60% of the group’s revenue in FY2019.
Power Root’s key differentiating factor is the infusion of the Tongkat Ali herb in its products. Tongkat Ali is a local herb believed to have health and aphrodisiac benefits. It is the only home-grown company to rank among the top five in Malaysian retail sales of ready-to-drink coffee, alongside units of Nestlé and Asahi, according to Euromonitor International.
Strong brands, rebounding profits
Power Root’s financials turned around in FY2019, after a disappointing performance in FY2018, owing partly to impairments on assets and inventory. Net profit, which had averaged RM45 million to RM47 million a year from FY2015 to FY2017, fell to RM9.7 million in FY2018 and rebounded to RM28.1 million ($9.1 million) in FY2019.
Earnings are set to recover further, helped by top-line growth, lower raw material costs and better cost controls. Under a new leadership in place since February 2018, various initiatives have been undertaken to tighten internal controls, monitor sales and inventory, cut down wastage and channel resources towards long-term strategic planning.
The company also restructured its overseas distribution networks to achieve higher growth. For example, in the United Arab Emirates, management switched to a larger distributor, having outgrown its previous partner. In China, Power Root switched focus to online channels and refined its sales strategy, in view of customers’ preference for purchasing through e-commerce.
Power Root is targeting double-digit growth in the medium term, driven by new product launches in untapped categories. For instance, it recently launched a new range of Alicafe called Warung, for customers who prefer non-functional beverages.
The stock is reasonably priced at 20 to 22 times estimated earnings, relative to the broader consumer sector. Dividends totalled eight cents a share in FY2019, or a decent yield of 3.7%. With expectations of improved profits, coupled with net cash of RM47 million as at June 30, we could see higher dividends this year.
Beneficiary of lower coffee bean prices
Power Root will also benefit from lower raw material costs. Coffee bean prices have been trending down since end-2016 (see Chart 2). Power Root did not benefit from this previously, as management hedged coffee input costs at high levels. On the positive side, it is starting to gain from lower prices early this year and has hedged prices for the next two years.
Lower coffee bean prices, coupled with higher operating efficiencies, have gradually improved Power Root’s profit margins. The company’s earnings before interest, taxes, depreciation and amortisation (Ebitda) margin (adjusted for forex gains/losses, impairments and write-offs) reversed from -3% in 4QFY2018 to 15% in 1QFY2020 and is expected to remain at the current levels.
Public Bank
Unlike Power Root, Public Bank needs no introduction. Well recognised as Malaysia’s best-managed bank, Public Bank is well known for being prudent and cost-efficient, with the industry’s lowest non-performing loans (NPLs) and cost-to-income ratios — key criteria essential to earnings and balance sheet strength as the economic headwinds increase.
As a result, Public Bank has a stellar track record of delivering strong earnings and dividends to shareholders over the long haul. With a strong capital base, it distributes almost half its earnings annually as dividends. The bank has an excellent track record of wading through economic uncertainties and downturns well. Its NPL ratio is just 0.5%, well below the industry’s 2.1% average, while the cost-to-income ratio is 34% versus the industry’s 48% average.
To be sure, there are many challenges ahead for the bank. Its net interest margins were squeezed in 2QFY2019, owing to a cut in the overnight policy rate (OPR) in May. Banks had earlier aggressively locked in long-term higher funding costs and about 20% of Public Bank’s loans are on fixed rates. Any further OPR cut at the next Bank Negara meeting in November could trim margins further, but we believe most banks have since restructured their deposit profile.
Public Bank’s loan growth is expected at 4% to 5% this year, driven by its core loan base of households and small and medium- sized enterprises, which enjoy better credit risks. Although loan demand growth is slow, Public Bank has been able to gain market share in residential loans, which grew an annualised 7.4% in 1HFY2019 versus the industry’s 6.7% average. On the cost front, it is also investing more in IT to upgrade its systems.
While everyone acknowledges Public Bank to be a solid long-term investment, it is also traditionally the most expensive banking stock in Malaysia. It is more attractive now, after a major sell-off this year, owing to a combination of its high foreign shareholding and recent flattish quarterly results. Despite an aversion towards banking stocks, as the economy slows, we believe Public Bank has defensive qualities, with relatively resilient earnings and dividends.
Public Bank’s shares have fallen 21.1% this year — from almost RM25 to a twoyear low of just above RM19. This is far worse than the FBM KLCI’s 9.4% fall and two to three times the rate of decline for its peers Malayan Banking (down 6.5%) and CIMB Group Holdings (down 11.4%). As such, the premium valuation it used to command has narrowed. Based on 2020 projections, the stock is trading about 13 times earnings and 1.6 times book, with a projected dividend yield of 3.8%.
Stocks in the Global Portfolio traded broadly lower for the week ended Oct 24, paring total returns since inception to 7.2%. The portfolio now underperforms the benchmark MSCI World Net Return Index, which is up 8.9% over the same period.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
This story first appeared in The Edge Singapore (Issue 905, week of Oct 28) which is on sale now
