Supermx ... Oct11

CIMB Research.


Getting the bounce back in its step
Lower costs should provide some bounce to Supermax’s earnings, which have already hit trough. We are upgrading the stock as its established brand and own distribution network will help it ride out the next 1-3 years of excess capacity better than its peers.

At 72% of our FY11 forecast, 9M11 core net profit was in line with our expectations as well as that of the market. We fine-tune our EPS for a lower dividend payout. Our target price (9.8x forward P/E) rises as we
roll forward to end-2013.

Higher sales and margins
9M11 revenue increased 8.7% yoy to RM750.7m due to a full-quarter contribution from new lines commissioned in the final two weeks of 2Q. Another factor was the 9% pt rise in 3Q utilisation to 80% as
Supermax overcame a labour shortage in 2Q by hiring replacements.

Earnings were also given a boost by lower input costs. At RM8.63/kg, average natural rubber (NR) latex price was 11% lower in 3Q than 2Q. Average nitrile costs rose by 12% qoq to RM6.43/kg in 3Q. Even so,
because 65% of the gloves that Supermax sells are made of NR, 3Q

EBITDA margins increased by 6.6% qoq to 17.1%. The better operating performance was enough to offset a 4% pt qoq increase in Supermax’s effective tax rate, leading to a 16.0% qoq rise in 3Q core net profit.
Lower NR latex prices We agree with Supermax’s view that earnings will improve in the quarters ahead as NR latex prices stabilise. Supermax expects NR latex prices to fall to RM7/kg by end-2011 (current:
RM7.96/kg) due to more latex supply from maturing plantations in Cambodia and Vietnam.

Reiterating guidance
Supermax is confident of achieving an FY11 net profit of RM100-120m, as guided in late Aug 2011. The company is actively adjusting ASPs to mitigate the impact of volatile raw material prices and exchange rates.

Expanding its capacity
Supermax is at an advanced stage of expanding its surgical glove capacity from 2.5m pairs per month to 28m pairs per month. The facility is expected to be completed by the end of 2011. The company indicated that the new capacity will add US$67.2m in revenue (implied ASP: US$0.2/pair) and US$10.1m in net profit to the group in FY12.

Over the next two years, Supermax intends to build two additional plants in Meru, Klang where it has 10 acres of land adjacent to its existing facilities. By building on an existing site, it will have no problem accessing gas. The two plants will add a total of 3.9bn gloves p.a. to the group’s capacity by the end of FY13. The company is also upgrading old lines to improve efficiency.

Stable costs will boost earnings
We believe that less volatile NR latex prices will lead to an earnings re-rating as a result of a) better margins and b) higher demand. Stable costs will enable Supermax to pass on a higher portion of its costs to customers, clawing back lost profits when raw material costs were on the uptrend. Currently, Supermax is
passing on 75% of the cost increase, higher than the 70% passed on in the 2Q. In normal conditions, Supermax is able to pass on 90% of the cost increase.

Also, we believe that less volatile raw material costs will entice distributors to restock their inventories. We gather that inventories are at an all-time low of 1-2 months due to the recent wild swings in rubber prices. This has prompted distributors to hold back their purchases and wait for NR prices to stabilise.

With NR latex prices stabilising at around the RM8/kg level, we believe that distributors will be more comfortable about taking aggressive inventory positions.

Defensive business model and strategy
With its own distribution network, established brand and focus on the dental market, we believe Supermax will ride out the next 1-3 years of excess capacity better than its peers. By owning the network and brand, Supermax controls both the manufacturing and distribution portions of the value chain. Unlike Top Glove which is integrating vertically upwards by buying rubber plantation land, Supermax is investing downstream to enhance its marketing and distribution capabilities.

We are in favour of this strategy as it enables Supermax to bypass distributors and sell directly to the end-user. This means that unlike its larger rival, Supermax does not have to dance to the tune of distributors who may not have the customer’s long-term interests in mind. Note that Supermax sells nearly 70% of the gloves under its own brand, which can add up to 5% pts to the company’s profit margins.

Focused strategy shields Supermax from competition
Supermax will also be less affected by the industry’s overcapacity because of its focus on the US dental market where it has a 9.2% market share and is the 2nd largest player. This puts its ahead of its peers for several reasons a) Supermax has built a dominant position and reputation in this market, giving it first-mover advantage, b) when the company switches customers from NR to nitrile, Supermax will not cannibalise its own products and c) by focusing on a sub-segment of the examination glove industry, Supermax faces less competition by serving a niche market.

Cheaper entry than Top Glove
We believe Supermax provides a cheaper entry into the glove sector than Top Glove. The stock trades at just 8.6x FY12 P/E or more than half of Top Glove’s forward P/E of 19.0x. We do not believe that Top Glove’s premium is justified given the company’s lower ROEs and earnings growth (Figure 1). Supermax is also just as liquid as Top Glove, as both stocks have an average daily turnover of about US$1m and a free float of c.50%.

EPS tweaked for lower dividend payout
While earnings met our expectations, dividends did not. Supermax declared a 3 sen dividend, which was lower than our 5 sen expectation. It also indicated that a 3 sen final dividend is likely, which is again below our 6 sen expectation. We now lower our FY11 DPS forecast from 11 sen to 6 sen. Also adjusted is our FY12-13 dividend payout from 30% to 20% (% of net profit), as guided by Supermax. This leads to a 0.22-1% increase in our FY11-13 EPS forecasts due to a higher earnings retention ratio.

Pantech ... Oct11

By InsiderAsia.

- Sales in 2QFYFeb12 up 5.5% q-q and 3.5% y-y
- Demand gradually gaining momentum
- To resume double-digit growth in FY12-FY15
- Very attractive FY12E P/E of 5.7x with 7.4% net yield

Pantech Group Holdings’ earnings results for 2QFYFeb2012 were broadly in line with our expectations.

Turnover improved to RM100.6 million, up 3.5% from the previous corresponding quarter and up 5.5% q-q. Trading sales accounted for roughly 60% of total turnover while the manufacturing arm contributed to the balance.

The recovery in domestic demand, which accounts for the bulk of the company’s trading sales, is still sluggish – although off the lows. As a result, margins from the trading arm are still at the lower end of its historical range.

Positively, we expect demand – and profitability – to gradually pick up steam over the next few quarters on the back of rollout of oil & gas projects under the various government initiatives, including the Economic Transformation Programme.

The manufacturing arm, on the other hand, is doing comparatively better on the back of the strong recovery in overseas markets. Sales continued to trend higher, to RM40.6 million in 2QFY12, up from RM30.2 million in
1QFY12 and RM25 million in 2QFY11.

The carbon steel manufacturing facility in Klang is operating at full capacity. Operations at the new stainless steel manufacturing plant in Johor Baru are also progressing well. All six initial production lines are up and running at almost full capacity. The lines broke even at end-2QFY12 – and should start to contribute positively in 2HFY12.

Lower losses from the new manufacturing plant more than offset the slight contraction in trading earnings before interest and tax (EBIT). EBIT for the manufacturing arm improved to about RM3.4 million in 2QFY12, up from RM1.3 million in the immediate preceding quarter.

As a result, net profit improved to RM7.2 million in the latest quarter, up from RM6.2 million in 1QFY12.

Earnings Outlook
Pantech is upbeat on the outlook going forward and that its expansion plans are progressing on track.
The recovery in demand for the company’s pipes, fittings and flow control (PFF) products is expected to gain traction, both in the domestic and export markets. Despite prevailing uncertainties over the global economic outlook, the company is maintaining its cautious optimism.

Global economic growth is still positive, albeit revised lower from previously forecasted numbers. Prices for crude oil have held up well through the volatility in financial markets. Crude oil futures on the New York Mercantile Exchange are currently hovering around US$88 per barrel, a level that is supportive of
exploration and production activities in the oil & gas sector.

Meanwhile, even though prices for crude palm oil (CPO) have weakened, demand is still expected to remain fairly resilient. CPO futures on the Bursa Derivatives market are currently trading around RM2,900 per tonne – well above the average production costs for plantation companies and thus, should continue to drive acreage expansion plans underpinned by expectations of rising demand.

The oil & gas and oil palm related sectors collectively account for the bulk of Pantech’s sales for pipes, fittings and flow control products. As mentioned above, the recovery in domestic demand is still somewhat
sluggish. Nevertheless, capital spending in the domestic oil & gas sector is expected to be quite robust for the foreseeable future.

The Malaysian government has pinpointed the sector as one of the key focus areas under its Economic Transformation Programme, accounting for a substantial share of the total value of the projects that have been announced so far.

The national oil company, Petroliam Nasional intends to spend some RM250 billion over the next five years, to develop new projects, including marginal oil fields, as well as undertake enhanced oil recovery from existing oil fields.

Elsewhere, private sector projects such as the Dialog Group’s Pengerang deepwater petroleum terminal are also expected to spur greater investment in the oil & gas related sectors in the country going forward.
The gradual rollout of these projects will translate into greater demand for downstream support services, including demand for Pantech’s PFF products.

Pantech’s manufacturing arm has recovered quite smartly from the slump in overseas demand in the aftermath of the global financial crisis. Sales hit a trough in 2QFY10 and have been trending higher since – despite the
strengthening of the ringgit. The weaker US dollar translates into lower sales for the company in ringgit terms.

The company’s carbon steel PFF manufacturing facility in Klang is effectively running at full capacity. To cater to the expected demand growth, a factory is being built on a piece of land adjacent to its existing plant. The additional machineries to manufacture, primarily, high frequency induction long bends, are slated to commission by end-2011. The factory will also house a heat treatment facility.

Meanwhile, Pantech is in the midst of adding machineries for another four lines at its new stainless steel facility. The additional lines will expand its current production range to include bigger-sized pipes and also fittings.

If all goes to plan, rated production capacity at this plant will rise to 13,500 metric tonnes per annum by early 2012, from the current 7,000 metric tonnes, and will be reflected in the company’s FY13 earnings. Total capex is estimated at roughly RM40 million and RM50 million for FY12-FY13, respectively.

The manufacturing arm has already secured a full order book for the rest of the current financial year. Plus, we expect margins to gradually widen – the initial six lines have broken even while the new lines should start to
contribute positively by 2HFY13. They will also enjoy better economies of scale.

Looking further ahead into 2013, Pantech is actively exploring various options to further expand its range to encompass higher value and margin alloy products such as copper-nickel, duplex and super duplex pipes and
fittings that are corrosion resistant.

The move would expand its customer base and market reach – and is the final piece in Pantech’s five-year plan to hit sales target of RM1 billion by FY15. The company expects manufacturing sales to account for at least 40% of total sales. Domestic demand will also account for a higher percentage of manufacturing sales, currently derived mainly from exports, as a result of import substitution.

Valuation and Recommendation
Pantech’s well-laid out strategy should enable it to achieve double-digit annual growth over the next few years – based on the expected strengthening in demand that is supported by the company’s expansion plans.

Net profit is rising, albeit still at a gradual pace. This is due to pricing competition as there is currently excess capacity in the industry with demand just starting to pick up pace. Margins were also weighed down by start up costs at the company’s new stainless steel plant.

We believe that Pantech’s earnings will be much stronger in 2HFY12 compared to the first half of its financial year. Thus, we are keeping our forecast unchanged.

Net profit is estimated at RM37.7 million in FY12 – up 30% from the RM29.4 million in FY11 – and is expected to grow further to RM46 million by FY13. Based on our forecast, the stock is trading at very modest P/E valuations of only 5.7 and 4.6 times, respectively, for the two years. Plus, the stock is
trading below its net asset of 72 sen per share as at end-Aug 2011.

Pantech’s valuations compare very favorably against most oil & gas stocks listed on the local bourse, as well as the broader market’s average valuations.

Thus, we believe there is significant upside potential for Pantech, particularly for those with a slightly longer investment horizon. We maintain our BUY recommendation on the stock.

Investors can also expect attractive yields 
On top of potential capital gains, shareholders can also look forward to attractive yields.

Dividends totaled 3.3 sen per share in FY11. With stronger earnings going forward, we believe Pantech will gradually raise its dividends. We estimate dividends will rise to 3.5 sen per share in FY12, which will earn shareholders an attractive net yield of 7.4% at the current share price. This is well above the average yield for the broader market as well as prevailing interest rates on bank deposits.

Warrants and ICULS for lower entry price points 
For lower entry price points, investors could consider the company’s ICULS and warrants.
Pantech has some 735 million outstanding ICULS, carrying a 7% coupon rate with a conversion ratio of six to one, exercisable at anytime up to December 2017. Based on the current share price of 47.5 sen, the ICULS,
Pantech-LA, would be “in the money” at roughly 7.92 sen. They last traded at 9.5 sen.

The company also has some 74.8 million outstanding warrants, Pantech-WA. The warrants have a longer maturity period, up to December 2020, and exercise price of 60 sen. The warrants are now trading at 21.5 sen, implying a 72% premium.

Upon full conversion of the ICULS and warrants, Pantech’s share base will be enlarged to some 650 million shares from 452.6 million at present. The larger share capital – in step with its growing business – would improve liquidity and increase the stock’s attractiveness to investors over time.

Happy Diwali

I like to wish all the readers of the Hindu faith a very & prosperous HAPPY DIWALI!

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Zhulian ... Oct11

ZJ Research.

• Zhulian’s 9MFY11 net profit of RM67.3 mln was in line with our expectations, having reached
74% of our full-year estimate of RM91.3 mln.

• 3QFY11 turnover was 1.0% lower q-o-q but 24.9% higher y-o-y at RM91.8 mln. The flat q-o-q growth in revenue was due to lower contribution from overseas markets, which offset the increase in domestic demand that resulted from the pre-Hari Raya stocking-up activities by its distributors. We understand the Group rolled out several new products during 3Q that include new jewellery collections in conjunction with the Hari Raya festive season, healthcare products as well as smart-seal containers for households.

• 3Q operating profit margin recovered to above 20%-level after falling to 18.2% in the preceding quarter. Recall that operating profit margin in 2QFY11 was affected by both appreciating RM and increase in opex. The improved profit margin in 3QFY11 was attributed to lower opex as there was fewer incentive tour campaigns and seminars held. Meanwhile, PBT was further boosted by a substantial 44.1% q-o-q rise in contribution from its associate. Zhulian credited the improvement at its associated company to higher sales arising from increased marketing activities and incentive tour campaigns to motivate distributors.

• Notwithstanding the uncertainties surrounding the global markets, Zhulian registered a 13.9% and 7.2% y-o-y growth in 9MFY11 revenue and net profit at RM270.7 mln and RM67.3 mln respectively. While 9MFY11 net profit margin did decline by 1.5ppt, it is still healthy at 24.9%. We expect the Group to continue its consistent earnings performance in 4QFY11, supported by planned new product rollouts (i.e. new cosmetic products) and ongoing incentive campaigns.

• Zhulian’s operations remain firmly supported by a strong balance sheet, backed by a NTA/share of 82 sen and net cash/share of 29 sen as at end-August 2011.

• With no surprises in the results, we maintain our current FY11 revenue and net profit estimates of RM354.1 mln and RM91.3 mln respectively. We remain sanguine on Zhulian’s prospects and like its focus on growing market share in the ASEAN region. Domestically, the Group is also likely to benefit from the additional half-month bonus payout for civil servants under the recently tabled Budget 2012 as some of its distributors and customers are civil servants.

• As expected, Zhulian declared a third interim single-tier dividend of 3 sen. We continue to project a full year net dividend of 12 sen per share based on the Group’s 60% dividend payout policy, which translates into an attractive prospective net yield of 6.9%.

Recommendation
We maintain our Buy call on Zhulian with an unchanged fair value of RM2.18, derived from pegging the peer-benchmarked target PER of 11x against our FY11 net profit forecast. We continue to like Zhulian for its i) earnings growth prospects, ii) solid balance sheet, iii) higher-than-peers net profit margin, and iv) undemanding valuation at prospective FY11 PER of 8.7x supported by an attractive net yield of 6.9%. In our opinion, Zhulian offers a cheaper exposure into the MLM business by comparison to market leader, Amway Holdings, which is trading at a forward PER of 16x.

Bursa ... Oct11

By InsiderAsia

- Strong growth in derivatives trading volume
- Equities trading volume holding up despite uncertainties
- Bursa remains good proxy for domestic economy
- Upgrade to BUY after recent price correction

Bursa Malaysia’s earnings results for 3QFYDec11 came in ahead of our expectations.
Revenue from both equities and derivatives trading were higher than our forecast. Trading revenue totaled RM62.3 million in 3Q11, up from RM58.4 million in the immediate preceding quarter – and accounted for roughly 65% of the company’s operating revenue.

Revenue from equities trading was higher q-q at RM48.9 million. Even though the daily trading volume was down slightly, to an average of 1.02 billion shares in 3Q11 from 1.04 billion shares in 2Q11, daily trading in value terms was higher at an average of RM1.89 billion compared with RM1.64 billion in 2Q11. This is attributed, in part, to a shift in investor focus to bigger capitalized stocks during the quarter.

Revenue from derivatives trading continued to trend higher, to RM13.6 million in 3Q11, up from RM13.4 million in 2Q11. The number of contracts traded daily rose to 34,169, on average, up from 32,316 in 2Q11 and well above the 25,111 transacted in 3Q10. For the first nine months of this year, a total of 6.33 million contracts were traded, compared with 6.15 million for the whole of 2010.

Bursa attributes the strong derivatives volume growth to improved accessibility and visibility of its products following the migration to the Globex trading platform in September 2010. The company is seeing new traders for its product offerings and believes that it is on target to hit 50,000 contracts daily by 2013.

The stronger derivatives trading volume was also likely due, in part, to heightened volatility in the cash market during the quarter, which would have prompted more price risk management and hedging activities.
Meanwhile, stable revenue in 3Q11 was flattish from the immediate preceding quarter at RM29 million. Stable revenue accounted for some 30% of Bursa’s total operating revenue during the quarter. Stable revenue
consists, primarily, of listing fees, fees for information and broker services as well as fees for depository services.

Non-operating revenue, primarily rental and interest income, increased to RM11.2 million in 3Q11, up from RM8.6 million in 2Q11. This was due, mainly, to the company’s stronger cash position as well as higher returns on investment.

In all, operating and non-operating revenue totaled RM107.3 million in 3Q11, up from RM101.1 million in 2Q11 and RM86.8 million in 3Q10. Operating expenses too increased by at a slightly slower pace than that for revenue. Depreciation was also lower following the cessation of accelerated depreciation for Bursa Trade Derivatives. As a result, net profit increased to RM38.6 million in 3Q11, compared with RM35.7 million in 2Q11 and RM27.7 million in 3Q10.

Outlook and Recommendation
Outlook for the global economy has deteriorated quite sharply over the past few months. Widening of the sovereign debt crisis in the euro zone and disagreements between member countries on the best course forward have further dented investor confidence.

The debt crisis is now threatening to engulf the bigger countries like Italy and Spain. Despite aggressive bond buying by the European Central Bank, yields on new issues by the most debt-laden countries have stayed high. This translates into additional burden on governments trying to bring down their debts. Expectations for a default by Greece are growing.

The resulting austerity programmes in Europe is starting to hurt. A gauge for manufacturing activities in the euro zone contracted in September, falling to the lowest level in more than two years.

The rest of the world is struggling to cope with uncertainties in Europe as well as slowing global demand. Growth in the US remains sluggish while that in emerging economies including China, Brazil and India is also cooling under tighter monetary policies.

The global economy appears likely to soften in 2012, which could translate into slower growth for corporate earnings – and lower expectations for stock gains.

Indeed, risk aversion has grown as uncertainties persisted – sending prices for a broad range of risky assets sharply lower as investors seek shelter in the safest of assets, the US dollar and treasury bonds. Even traditional havens, such as gold, were not spared in the global rout.

Emerging markets too came under heavy selling pressure. The FBM KLCI fell by more than 12% q-q in 3Q11, sending the benchmark index into negative territory for the year-to-date.
Sentiment and share prices rebounded somewhat in October, but visibility remains limited. Positively, the domestic economy should be relatively resilient, supported by domestic consumption and rollout of projects under the Economic Transformation Programme.

Nevertheless, we are assuming trading volume and value on the local bourse to average lower in 4Q11, compared with that in 3Q11 – and to remain slow in the early part of 2012 before picking up in the later part of the year. Thus, we forecast revenue from equities trading to be slightly lower next year, unless sentiment improves faster than expected.

We are however, assuming that the growth in the derivatives market will continue with rising visibility of the Bursa Malaysia Derivatives and its products on Globex. Bursa has been undertaking market awareness
programmes to promote its range of products to global investors.

The company is also pursuing the Dual Licensing Fast Track programme that would allow equity dealers to offer derivatives products. Additionally, Bursa is undertaking more roadshows to attract greater retail participation in the equities and derivatives markets, in both major and smaller cities across the nation.

Stronger revenue from derivatives is expected to offset the slightly lower revenue from equities in 2012.
We are revising up our net profit estimate for 2011 to RM145.3 million after taking into account the better-than-expected 3Q11 results. Net profit is forecast to improve slightly to RM146.1 million or 27.5 sen per share next year. That translates into forward P/E of roughly 23.1 times.

Bursa’s share price has corrected in line with the recent broader market sell off. The stock is now trading well below the year-high of RM9.02. In view of the lowered valuations, we are upgrading our recommendation from HOLD to BUY. We believe the stock should be among the first to rally in the event of a sustained turnaround for the global market.

The company remains financially sound and in a net cash position. It had resources available for use totaling RM547 million at end-September 2011. We estimate a final dividend of roughly 12.7 sen per share for 2011 to be announced in 4Q11, on top of an interim dividend of 13 sen per share that was paid in August.

Dividends are estimated to total 25.8 sen per share in 2012. This will earn shareholders a decent net yield of 4.1% at the current share price.

BStead ... Oct11

CIMB Research Report

Results highlights
• Below. At 33% of our full-year forecast and 36% of consensus estimates, Boustead’s 1H11 core net profit, which excludes RM94.6m gain from the disposal of plantation assets, was below our and consensus estimates. The variance stemmed mainly from lower heavy industries profit. Factoring in higher cost and slower progress billings for heavy industries, we slash our FY11-13 core EPS by 10-31%.

Our RNAV-based target price falls from RM6.45 to RM6.33 as we update our RNAV for the current value of listed assets and reduce the target price for Affin (AHB MK, Underperform) from RM3.57 to RM3.40. We continue to rate Boustead a HOLD as there are no immediate catalysts. For big-cap exposure to conglomerates, investors should opt for Sime Darby (SIME MK, Trading Buy).

• Key surprises. 2Q core net profit fell 38% yoy and 19% qoq due to a plunge in heavy industries contribution. 1H heavy industries EBIT fell 49% yoy, mainly because of cost escalation for certain commercial shipbuilding projects and slower progress billings. Work on the six naval vessels remained at the preliminary stage as the company is still waiting for the government to finalise the value and duration of the project. Meanwhile, the finance division was negatively affected by higher interest expense.

• Cushioned by maiden contribution from Pharmaniaga. Pharmaniaga, which became a subsidiary of Boustead at the end of 1Q11, helped the pharmaceutical division to post a pretax profit of RM36.3m compared to a RM1.1m loss last year. 1H plantation EBIT almost doubled yoy as the 38% rise in CPO price more than
offset a 1% drop in FFB crop. Property EBIT rose 8% due to higher progress billings while earnings from manufacturing and trading gained 13%, thanks to higher sales volume and stockholding gains for petrol retailer, BH Petrol.

Recommendation
Maintain HOLD with lower target price. Factoring in higher cost and slower progress billings for heavy industries, we slash our FY11-13 core EPS by 10-31%. Our target price falls from RM6.45 to RM6.33 as we update our RNAV for the current value of listed assets and reduce the target price for Affin (AHB MK, Underperform) from RM3.57 to RM3.40. We continue to rate Boustead a HOLD as there are no
immediate catalysts. For big-cap exposure to conglomerates, investors should opt for Sime Darby (SIME MK, Trading Buy).

Supermx ... Oct11

CIMB Research Report

Investment highlights
• Maintain HOLD. The main takeaway from Supermax’s 2Q11 results briefing yesterday was the company’s commitment to raising its minimum dividend payout from 20% to 30% from FY12 onwards. After incorporating this assumption, we raise our FY13 gross DPS by 12% but lower FY12 by 7% as we had factored in 33% payout for that year. We make no changes to our other numbers or target price of RM3.64, which is based on a forward P/E of 9.8x or a 25% discount to Top Glove’s 13.1x target P/E. Supermax remains a HOLD as it lacks catalysts and its cheap valuations are offset by overcapacity and weak demand for natural rubber (NR) gloves. For exposure to gloves, we recommend Hartalega which has superior
yields, margins and profitability.

• Switching takes a breather. As highlighted in previous notes, the cost differential between nitrile and NR is narrowing. In Apr 2011, the cost of production for nitrile gloves was as much as 40% below their NR equivalents. But this difference has narrowed to c. 5%. Nitrile capacity remains at 33% of Supermax’s total capacity, similar to 1Q11’s level but higher than 2Q10’s 19%. We sense that Supermax has stopped switching NR lines to nitrile but is ready to do so if input prices change.

• Weak demand for NR gloves. Supermax’s overall utilisation in 2Q11 was 71%. But we estimate that the utilisation rate for its NR plants was much lower at around 55- 60%. These numbers assume 90-100% utilisation of the company’s nitrile plants and a 33% nitrile capacity mix.

• Glove City deferred to FY14. Due to gas shortages, Supermax has deferred the construction of its Glove City project to FY13 and expects this project to start contributing to earnings in FY14. This uncertainty clouds the company’s longer-term growth prospects.

Recent developments
Approximately 60 analysts and fund managers turned up for Supermax’s 2Q11 results briefing yesterday. The presentation was chaired by its executive chairman and group MD Dato’ Seri Stanley Thai, who was flanked by ED Datin Seri Cheryl Tan and group accountant, Andrew Lim. We left feeling neutral about Supermax’s prospects. Supermax’s commitment to raising its dividend payout next year is a positive surprise
but is offset by the subdued picture for NR glove demand.

Dividend commitment. Supermax will raise its dividend payout from 20% of net profitto 30% from FY12 onwards. This is slightly below our assumption of a 33% payout in FY12 but higher than our assumption of a 27% dividend payout in FY13. After rebasing Supermax’s dividend payout in FY12 and FY13 to 30%, we reduce our FY12 gross DPS by 7% to 15 sen but raise FY13 by 12% to 18 sen.

Switching momentum slowing. The moderation of NR latex prices and higher nitrile prices have slowed the industry’s switch from NR to nitrile gloves. As a result, Supermax is keeping its nitrile mix at 33% for now although we sense the company isready to switch more of its NR lines to nitrile if the cost difference between nitrile and NR starts to widen again.

Earnings outlook
Glove City on hold. Due to gas shortages, Supermax is deferring the start of its Glove City project to 2H13 when the company expects the gas situation in Malaysia to normalise. It expects the project, which will increase its capacity to 15bn pieces of gloves over 10 years, to start contributing to earnings in FY14. We believe that this uncertainty clouds the company’s longer-term prospects.

Utilisation low due to plant shutdowns. Supermax sold 3.13bn pieces of gloves in 2Q on the back of an overall utilisation rate of 71%. 1H 11 sales volumes were 6.5bn pieces of gloves, implying a utilisation rate of 73%. 2Q utilisation was 6% pts lower qoq and 10% pts lower yoy. We believe the lower utilisation is a result of weak demand for NR gloves and an industry glut.

FY11 guidance confirmed. During the briefing, the company confirmed the RM100m-120m FY11 net profit guidance provided in its 2Q results release. It is confident of meeting the high end of the range as it expects 2H11 to be better. As for FY12earnings, Supermax will make an official announcement after its 4Q11 results release next year.

Recommendation
Maintain HOLD. The main takeaway from Supermax’s 2Q11 results briefing yesterday was the company’s commitment to raising its minimum dividend payout from 20% to 30% from FY12 onwards. After incorporating this assumption, we raise our FY13 gross DPS by 12% but lower FY12 by 7% as we had factored in 33% payout for that year. We make no changes to our other numbers or target price of RM3.64,
which is based on a forward P/E of 9.8x or a 25% discount to Top Glove’s 13.1x target P/E. Supermax remains a HOLD as it lacks catalysts and its cheap valuations are offset by overcapacity and weak demand for natural rubber (NR) gloves.

Poh Kong ... Oct11

By Mercury Securities Sdn Bhd

Poh Kong’s 4Q/FY11 results (quarter ended 31st July 2011) were generally slightly above our earlier expectations.

“Strong Q4 performance”
Poh Kong's revenue of RM183.1 million during 4Q/FY11 was higher by 38.8% y-o-y versus the corresponding 4Q/FY10. The increase in revenue was partly attributed to the effect from the group’s 35th Anniversary promotional activities and also the increase in gold price on top of its existing stores registering higher sales. The group's 4Q/FY11 net profit after tax (NPAT) of RM12.2 million was higher by 56.4% y-o-y.

“Best Ever” full year results
The group achieved FY11 revenue of RM692.5 million, which we believe is their highest ever full year revenue. FY11 revenue was higher by 23.4% y-o-y. The group also achieved its “record NPAT” of RM41.6 million, which was higher by 28.0% y-o-y.

OUTLOOK/CORP. UPDATES
Poh Kong’s management plans to continue its drive to build market share by enhancing and differentiating its product offerings to its targeted market segments. The group actively evaluates various initiatives and opportunities to attract new customers through the introduction of new product lines/designs and enhanced customer service.

“Domestic Demand still holding well”
Malaysia had reported reasonably stable CPI of 3.3% (August 2011) and unemployment rate of 3.0% (2Q/2011). In early September 2011, Bank Negara Malaysia (BNM) had maintained its overnight policy rate (OPR) at 3.0%. According to BNM, Malaysia’s 2Q/2011 GDP rose by 4.0%, following a revised 4.9% GDP growth in 1Q/2011. A steady economic growth would also lead to higher consumer optimism and hence assist to raise domestic consumption, including spending on retail gold or jewellery products.

Malaysia Retailers Association (MRA) said in its latest Malaysia Retail Industry Report, that local retailers saw sales rise by 9.1% in the April-June 2011 (2Q/2011) period as they offered attractive discount to lure shoppers. Malaysia’s retail sales growth has been revised upwards to 6.5% from 6.0% previously, following an encouraging 8.2% growth in 1H/ 2011. This growth will bring estimated total retail sales for the year to RM82 billion. Retail sales grew 8.4 % in 2010, with total sales value estimated at RM77 billion. Nevertheless, rising costs and discounts may see retailers' profit margins being squeezed.

“Gold Prices – above US$1600/ounce”
Reflecting concerns in Europe, the spot rate for gold traded on the NYMEX (New York Mercantile Exchange) has dropped to around US$1635/troy ounce after reaching a high of around US$1921/troy ounce recently. According to the World Gold Council, robust gold market fundamentals, including evidence of stronger demand for gold jewellery in China and India, have continued to support gold prices. Gold plays a role in hedging and has been regarded as a safe, long term investment that provides protection against unforeseen risks in the economic cycle.

Large jewellers like Poh Kong do have revenues coming from sales of gold bars, though its management has not given any guidance on the quantum. Gold bars, which are 999.9% pure gold, are available in 1g, 5g, 10g, 20g, 50g and 100g weight denominations. Gold wafers are sold in the denominations of 25g, 50g and 100g. More often than not, gold jewellery are bought largely for ornamental usage e.g. for wedding dowry, ceremonial/formal functions and as gifts to spouses or close family members.

Besides gold wafers, gold bars and gold-based jewellery, there are also other gold-investment options. Consumers nowadays have the option of investing in gold via commercial banks (via “gold investment accounts”) or even via MLM (multilevel-marketing) companies that may offer gold-based investment products (e.g. gold coins and gold bars). In some countries, gold-related investments could also be done via gold ETFs (exchange traded funds), gold certificates and gold-based derivatives.

Currently Poh Kong has no plans to expand its outlets to overseas locations. In terms of revenue, about 80% of Poh Kong’s revenue is derived from gold, with the remainder 20% from gem stones (e.g. diamonds). From the gold-revenue segment, about 75% is derived from yellow-gold sales while 25% is from white-gold sales. The ‘Malay and Indian’ market clientele traditionally prefers yellow-gold based ornamental products.

Poh Kong practices the 4 core business principles of quality, value, trustworthiness and choice, to target its market segments. This incorporates values such as design, craftsmanship, reputation, and competitive pricing. The group constantly evaluates its operational efficiency/costs, capital expenditure, outlet-expansion plans, gearing, cash flow needs and gold inventory levels. The group constantly selects stores to refurbish and also find strategic locations for outlets across the country which has the best potential for higher revenue growth and consumer demand. On the marketing side – the group’s intensified efforts in A&P (especially during festivals), merchandising and product launches, sponsorships and road shows during the year would help to maintain the group’s market leading position.

In May 2011, Poh Kong announced a proposal to undertake an Islamic Commercial Papers/Islamic Medium Term Notes (ICP/IMTN) Programme (up to RM150 million in nominal value), to be guaranteed by Danajamin Nasional Berhad. Pursuant to this announcement, Danajamin Nasional Berhad will provide a guarantee facility to Poh Kong’s payment obligations under the proposed ICP/IMTN Programme.

VALUATION/CONCLUSION
“Consistent DPS but dwindling Dividend Payout Ratio”

Poh Kong’s board of directors (BOD) had proposed a first and final dividend per share (DPS) of 1.4 sen single tier for its FY11 ended 31st July 2011. The proposed dividend will be subject to shareholders' approval at the next AGM to be held on a date to be announced later. The entitlement and payment dates for the dividends would also be announced later. Poh Kong’s future dividends would be largely determined by the performance and cashflow needs of the group. We note that the group’s dividend payout ratios have been dwindling over the past few years due to its constant annual DPS despite of its rising earnings.

Even with an adjusted beta (correlation factor) of 0.76 to the KLCI, Poh Kong (-18.4% YTD) had underperformed the KLCI (-8.7% YTD) this year. Market conditions have also been volatile in recent months, impacted by the political uprisings in the Middle East/North Africa, debt ceiling issue in the US, sovereign debt issue in Europe and the Tohoku disaster in Japan. As Poh Kong is not a particularly large market-cap stock, this may put a dampener on its market visibility and trading volume.

“Upgrade to Buy Call”
Based on our forecast of Poh Kong’s FY12 EPS and an estimated P/E of 4.5 times (within its historical range), we set a FY11-end Target Price (TP) of RM0.53. This TP offers a 32.1% upside from its current market price, and represents an upgrade to a Buy Call. This upgrade is due to its price being near to its 52-week low and also the improved results. Our TP for Poh Kong reflects a P/BV of 0.56 times over its FY12F BV/share. Meanwhile, the local “Clothes & Accessories” sector’s average P/E and P/BV is 9.3 times and 0.8 times, respectively.

“Poh Kong – a Value Buy”
We find that Poh Kong’s FY12F P/E and P/BV valuations are very undemanding, while it has reasonable net gearing ratio, dividend yield and ROE. We are pleased with Poh Kong’s positive performance during its FY11. Nevertheless, the group also face routine business risks such as any future economic downturn, consumer pessimism, uneven monthly sales (due to festive seasons), fluctuating raw material prices and foreign exchange rates and strong competition from its peers. Going forward, the group’s upside would be largely dependent on its management’s marketing and growth strategy, and also on the overall economic conditions.

Salcon ... Oct11

Inet Research

1. Recent developments
- Salcon announced that its wholly-owned Salcon Engineering Berhad through its consortium Hydrotek-Salcon Consortium has been awarded with a project for the construction of reservoirs for Phet Kasem and Rat Burana distribution pumping stations and related works in Bangkok, Thailand from Metropolitan Waterworks Authority, Thailand.

-  This contract, with a value of RM22.0m
(THB215.7m), is expected to be completed in within 2 years from Notice to Proceed.

- This project, which is under the Eight Bangkok Water Supply Improvement Project, is funded by
Japan International Cooperation Agency (JICA).

- This represents Salcon’s 4th project in Thailand after the Min Buri water distribution pumping station,
supply and installation of trunk mains and the construction of Sam Lae Raw Water Pumpting Station.

- The pace of the secure of new projects has picked up in 2HFY11 after a slower progress in 1HFY11. In
Jul-11, Salcon secured a maiden project in India worth RM16.2m for providing and laying of raw water
pumping main in Davanagere City, Karnataka, India.

- Subsequently in early Sep-11, Salcon secured a sub-contract project for the upgrading, repairing works
and its related works of Sg. Chukai, Kemaman, Terengganu (Chukai flood mitigation plan), with a
project value of RM20.4m.

2. Earnings Outlook
-  This new project will take Salcon’s outstanding orderbook to RM1.3bn. The unbilled sales of RM322m
represents a turnover cover of 1.2x based on the turnover of RM271.8m for its construction division for
FY10.

3. Valuation and Recommendation
- We are maintaining our Buy recommendation on the stock for its growing recurring earnings stream from
concession business and strong orderbook.

- The stock is currently trading at 44% discount to its NTA of RM0.75/share, which does not reflect the
promising long-term prospects of its growing concession-based business in China and the doubling in
design capacity of its China concession by end-FY11.

SCIENTX ... Oct2011

Scientex Berhad - TA Securities.

1. Review
Scientex Berhad will announce its FY11 results sometime next week. We continue to like Scientex for its diversified two core business operations; i) manufacturing and ii)property coupled with expansion plans that will sustain growth over the mid-to-long term.

Some recap, Scientex has reported a 33% growth in net profit to RM57mn for 9M11. The growth was mainly contributed by the property division which saw a 62% growth in revenue. To add, margin of property soared by 7p.p. thanks to favourable product mix.

On a negative note however, Scientex was impacted by the depreciation of USD which led to a contraction in margin. 80% of its products are exported whilst 65% of its purchases are denominated in USD.

2. Outlook
Going forward, we are positive on Scientex thanks to its mid and long term expansion plans. For its manufacturing line, Scientex will raise production capacity to 120k MT, or a 20% increase by FY12 which will put Scientex as the fifth largest stretch film producer in the world. It will also increase its strapping band production capacity to 24k MT by end-2011, or a 50% growth.

Over the long term, Scientex has entered into an S&P agreement for the purchase of land opposite its current
facility for RM12mn. Thus, we expect capacity to doubleup in 3-5 years time.

This is positive as we expect Scientex to benefit from economies of scale and improved margin. We believe that demand of stretch film is on the rise.

Scientex has also shown defensiveness in its property division with an almost fully-take up rate of its
developments. To add, its high-end property developments command a strong 35-45% margin.
According to the management, its property division’s revenue may contribute up to 30% of total revenue by
FY12 as compared to 25% in the previous year. We  believe its Taman Mutiara Mas and Taman Muzaffar
Heights will contribute strongly in FY11 as seen in 9M11. Going forward, Scientex has enough landbank to keep them busy until 2019, a total GDV of RM2.1bn.

3. Results Preview
We have fine-tuned our earnings estimates for Scientex for FY11 and we are leaving FY12-13 estimates unchanged. We cut our earnings estimates for FY11 by 4.8% to RM75.8mn. The adjustment was
made to impute slightly weaker margin for the manufacturing division due to the impact from USD
and higher raw material prices whilst offset by better property contribution.

Hence, for the FY11, we expect Scientex to report a net profit of RM75.8mn, or a 22% growth against FY10. In our assumption, we expect the property division to contribute 25% to total revenue or RM195mn and RM575mn for manufacturing.

We are expecting equal contribution from the property and manufacturing division to the EBITDA for FY11. This is mainly thanks to better margin of high-end property developments.

4. Valuation
We derive a new target price of RM2.90 based on Sum-of- Parts valuation method. We have cut our sectors target PER in line with the recent downgrade of FBMKLCI. Hence, we attach a 7x FY12 PER (from 9x previously) to the property segment and 6x (from 8x previously) for the manufacturing segment. Maintain Buy.

Unimesh ... Oct2011

Unimech Group Berhad  - By ZJ Research.

2QFY11 Results Review
• Unimech Group Berhad (Unimech) produced another set of consistent results with 2QFY11 net profit coming in at RM5.4 mln, taking 1HFY11 net profit to RM9.5 mln. The results were within our expectations with 1HFY11 profit reaching 53% of our full year projection.

• Unimech’s 1HFY11 turnover and net profit increased 33.8% and 20.0% y-o-y to RM96.7 mln and RM9.5 mln respectively, mainly on higher demand for its valves, fittings and related products. The industrial valves and related products division remains the largest business segment, contributing 79% to Group revenue and and 89% to operating profit in 1HFY11. To recap, Unimech’s other key businesses include heat and steam engineering systems; manufacture of electronic products and electronic automation control systems; as well as
design, fabrication and assembly of pumps.

• Sequentially, 2QFY11 revenue declined a modest 4.3% on lower contribution from the industrial valves and related products division. However, despite the lower turnover, net profit surged 35.6% to RM5.4 mln, due to higher gross profit margin achieved during the quarter under review. The improved performance in 2QFY11 made up for the lower margin experienced in 1QYF11, and as a result, Unimech’s 1HFY11 operating profit margin was sustained at 16.8%, which is comparable to the 17% margin achieved a year ago.

• Meanwhile, Unimech’s operations also remain firmly supported by a solid balance sheet with a low net gearing of 0.26x and a NTA/share of RM1.22 as at end-June 2011.

• With 1HFY11 results in line with our expectations, we continue to maintain our current FY11 revenue and net profit estimates of RM182.1 mln and RM17.9 mln respectively.

• No dividend was declared for the quarter under review.

Recommendation
We maintain a Buy recommendation on Unimech, but lower our fair value to RM1.05 (from RM1.18).

Our fair value is derived from ascribing a PER of 8x (from 9x) against our FY11 net profit projection.
The reduced benchmark PER is in tandem with the lower average PER of small-cap companies in the
industrial products segment, following the recent sell down in the broader equity market.

We continue to like Unimech for its earnings growth prospects, underpinned by the steady rise in the
demand for its industrial valves and related products. Its consistency in earnings delivery is also
another plus point for the Group.

We view the recent fall in Unimech’s share price as a reflection of the uncertain macroeconomic
environment and poor investor sentiment, as the Group’s fundamentals remain intact and backed by
solid a balance sheet. Valuation, at prospective FY11 PER of 6x and P/BV of 0.6x, remains
undemanding, in addition to the attractive potential net dividend yield of approximately 5%.

CRESNDO ... Oct2011

Crescendo Corporation Berhad - By TA Securities.

Crescendo’s 1HFY12 revenue and net profit accounted for about 51% and 57% of our full-year forecast respectively. We consider this within expectations as we expect a slowdown in construction progress in 3Q in conjunction with Hari Raya break.

YoY, Crescendo’s 2QFY12 net profit jumped 60.5% driven by: 1) 36.4% increase in revenue; 2) 2.1ppt increase in the PBT margin; and 3) lower MI. Stronger margin is largely attributable to better product mix and decline in finance costs.

Sequentially, Crescendo’s earnings grew by 40.3% on the back of strong revenue growth in all divisions. However, property development and construction division, and manufacturing and trading division have seen 3ppt and 2ppt margin compression respectively, as a result of higher building material and labour cost.

2. Recent Developments
We estimate Crescendo to record new sales of RM90mn for 6MFY12, mainly from the sales of
industrial units at Nusa Cemerlang Indutrial Park. Unbilled sales were approximately RM128mn as at
July-11, which is 1.2x the revenue recognized from the property division in FY11.

3. Earnings Outlook
No change to our earnings projections as we anticipate a modest slowdown in the progress billing
in 2HFY12. We believe market uncertainties may dampen corporate confidence and thus put expansion
plans on hold. Nonetheless, we expect Crescendo’s future earnings growth to be driven by 1) current
outstanding unbilled sales of RM128mn; 2) projected sales of RM176-245mn for FY12-13; 3) ample
landbank of more than 3,000 acres for future development.

During the quarter under review, Crescendo declared a gross interim dividend of 5 sen (2QFY11:
4 sen). Based on a 40% payout ratio, we expect crescendo will declare a final dividend of 6 sen and
maintain our dividend projection of 11 sen for FY12.

4. Competitive Analysis
Refer to the table above, Crescendo scores lower against KSL in term of PE multiple. Also, it is trading
at a low P/NTA multiples, despite offering higher yield. This indicates that Crescendo is undervalued
against its peers.

5. Key Investment Risk
High concentrated risks drawing from its exposure to the state of development of Johor or Iskandar Malaysia. Note that all Crescendo’s property projects are in Johor. Also, liquidity of the stock can be a concern given a free float of 34%.

6. Valuation
We continue to value Crescendo base on an unchanged PER of 6x, which is at a discount to our sector PE of 10x for the mid-cap property stocks. This is to factor in the concentrated risks in relation to its sole exposures to the property development in Johor.

7. Recommendation
We maintain our target price of RM1.84/share. We continue to like Crescendo for its 1) unbilled sales of
RM128mn provides medium term earnings visibility; and 2) attractive dividend yield at 8.2%. Given the potential upside of 37%, we reiterate our Buy recommendation on Crescendo.

MUDAJYA ... Oct2011

Mudajaya - CIMB Research Report

Investment highlights
• MD’s departure not a big worry. The resignation of Mudajaya’s MD Ng Ying Loong caught us by surprise. Although it may trigger concerns due to its sudden nature, we see no reason to view it negatively. While we are disappointed that there had been no warning, Mr Ng’s departure is for personal reasons and there is no hint of conflicts at the management level or issues with the strategic direction of the group. Management remains optimistic that the changes at the helm do not affect its ability to clinch projects under the 10MP and ETP. We make no changes to our forecasts or BUY call but raise our RNAV discount from 20% to 30% in view of the short-term concerns that this change in leadership is likely to stir. Our target price goes down from RM5.50 to RM4.81. The main potential re-rating catalyst is contract wins.

• Transition completed. Ng’s role will taken over by Anto Joseph who we view as equally credible. We gather from management that the transition started in Apr 11 when Anto Joseph took on the role of joint MD. Over the years, Anto and Ng charted the group’s growth strategy and led the group through its various ventures including its Indian IPP. Dato’ Yusli Mohd Yusoff, former CEO of Bursa Malaysia, will take on the role of chairman, replacing Asgari Mohd Fuad Stephens who will be a board member.

• Outlook remains positive. Locally, the group’s outlook remains positive. Management remains optimistic that despite the changes at the helm, it is wellpositioned to benefit from projects under the 10MP and Economic Transformation Programme (ETP). It is already one of the main beneficiaries of power plant
extension projects, having recently won a RM720m contract for the civil works of the extension of the Janamanjung power plant. It is one of the frontrunners for the extension of the Tanjung Bin power plant. The potential for order book replenishment remains healthy, suggesting upside to the group’s current outstanding order book of RM4.8bn.

Recent developments
Mudajaya announced yesterday that its MD Ng Ying Loong, aged 57, has tendered his resignation, citing family commitments as the main reason. This will take effect on 30 Sep 11. His role will be assumed by current joint MD Anto Joseph, who has been with the group for 18 years. Ng will continue to play a key role as advisor to the board.

Key takeaways from the group’s press statement:
“The change is a good move for the group and it is with great faith that I pass on my responsibilities to Anto who will undoubtedly embrace this role with great ease and propel us forwards in meeting our financial targets.” Ng Ying Loong said in a press statement. “This is also not the final chapter for me in Mudajaya. With my significant shareholding in the company and my new advisory role, I intend to actively participate
in our business but now from a difference perspective.”

Anto, aged 59, is a professional engineer who has been with the group since 1993. He held various posts including executive director since 1996. He holds a Bachelor of Technology, Civil (First Class) from the Indian Institute of Technology and is a member of the Board of Engineers, Malaysia and a Chartered Engineer. “The key strategic thrusts in place that include enhancing our presence in the power sector via
projects like the Manjung power plant and tapping opportunities in regional markets like India. I am certain we will continue to deliver a strong performance by leveraging on the group’s strength and solid management team to maximise shareholders’ value.” Anto said.

Mudajaya also announced that Dato’ Yusli Mohd Yusoff, former CEO of Bursa Malaysia, will take on the role of chairman, replacing Asgari Mohd Fuad Stephens who will be a board member. “The group is on stable footing and we have been recording solid performances in recent quarters. I am confident that with Anto at the helm coupled with Dato’ Yusli’s experience, Mudajaya can indeed look forward to stronger days ahead.” Asgari said.

Outlook
The resignation took us by surprise. Although this news may trigger concerns, we see no reason to view this development negatively. His departure is said to be for personal reasons and there is no hint of conflicts at the management level or issues with the strategic direction of the group. Ng remains the major shareholder through Dataran Sentral, which holds a 24.3% stake. From our conversation with management, we
gather that the transition started in Apr 11 when Anto Joseph took on the role of joint MD. Over the years, Anto and Ng charted the group’s growth strategy and led the group through its various ventures including its Indian IPP.

Locally, the group’s outlook remains positive. Management remains optimistic that despite the changes at the helm, it is well-positioned to benefit from projects under the 10MP and Economic Transformation Programme (ETP). It is already one of the main beneficiaries of power plant extension projects, having recently won a RM720m contract for the civil works of the extension of the Janamanjung power plant. It is one of the frontrunners for the extension of the Tanjung Bin power plant. The potential for order book replenishment remains healthy, suggesting upside to the group’s current outstanding order book of RM4.8bn.

Recommendation
Maintain BUY with lower RM4.81 target price. The resignation of Mudajaya’s MD Ng Ying Loong caught us by surprise. Although it may trigger concerns due to its sudden nature, we see no reason to view it negatively. While we are disappointed that there had been no warning, Mr Ng’s departure is for personal reasons and there is no hint of conflicts at the management level or issues with the strategic direction of the
group. Management remains optimistic that the changes at the helm do not affect its ability to clinch projects under the 10MP and ETP. We make no changes to our forecasts or BUY call but raise our RNAV discount from 20% to 30% in view of the short-term concerns that this change in leadership is likely to stir. Our target price goes down from RM5.50 to RM4.81. The main potential re-rating catalyst is contract wins.

KPJ - Oct2011

KPJ Healthcare Berhad - By Insider Asia

• Leading private healthcare provider
• Steady rise in demand for healthcare services
• Long-term growth supported by expansion plans
• Relatively defensive industry and earnings

KPJ Healthcare Berhad (KPJ) is Malaysia’s leading provider of private healthcare services.

The company opened its first hospital back in 1981 in Johor Bahru and has since grown from strength to strength, through both the acquisition of existing hospitals as well as developing new greenfield projects.

Today, the company manages 20 hospitals – 10 of which are accredited bythe Malaysian Society for Quality in Health (MSQH) – in the country, plus another two in Indonesia.

KPJ is estimated to have some 24% share of the country’s private healthcare services market – and is sanguine on its prospects going forward. The industry is relatively recession-proof. Demand for healthcare services – healthcare expenditure is still a relatively low 4.7% of GDP – is expected to trend steadily higher for the foreseeable future.

Some of the main drivers for demand growth include greater affluence and the rise in lifestyle-related diseases, growing awareness of and improved access to quality care, as well as longer life spans and ageing population.
The growth in demand for healthcare services will exert increasing burden on the public healthcare system, which, in turn, is very likely to drive more demand towards the private sector. As it is, the patient-to-doctor ratio for the public sector is now well over two times that for the private sector.

Additionally, the number of medical specialists in the country is heavily biased towards the latter.

Aside from rising per capita income, the increasing awareness and adoption of medical insurance amongst the population, including the younger generation, has made private healthcare more affordable. Industry statistics
show that the health insurance sector has been growing at a double digit pace annually.

Medical tourism is another potential key driver for longer-term growth.

Indeed, our government has identified the sector as one of the national key economic areas.

Asia is experiencing robust demand growth for healthcare services in recent years, driven primarily by attractive pricing compared with that offered in the US, Europe and Australia.

As at end 2010, KPJ had catered to some 12,000 health tourists, who provided almost RM25 million in revenue. The company intends to grow this segment of the market. It is boosting marketing efforts overseas on the one hand and upgrading and investing in new technology, facilities and innovative services as well as gaining accreditations for its network of hospitals on the other.

KPJ has a multi-pronged strategy for sustainable long-term growth. For the near to medium term, it plans to add one to two hospitals to its network every year. This is on top of expansions to the bedding capacity, facilities and range of services offered at existing hospitals – in lockstep with demand growth.

The network expansion will translate into greater economies of scale, for instance in terms of the implementation of common systems and processes as well as centralized purchasing of equipment and medications. Capital expenditure is estimated to total roughly RM150-RM200 million per annum.

The company is also exploring opportunities in providing healthcare business development and hospital management expertise to other providers overseas, in management or consultancy capacities – on the back of its experience and track record.

For the long-term, there are plans to diversify into new market segments such as retirement villages and aged care services. With Malaysia forecasted to reach the stage of ageing population by 2015, demand for affordable retirement homes that include quality medical and nursing care is expected to be on the rise. Retirement healthcare for the elderly is already a huge income generator in many developed nations today.

In this respect, KPJ is in the midst of acquiring a 51% stake in Jeta Gardens, which owns and operates a 64-acre retirement village in Queensland, Australia. Whilst earnings contribution is expected to be minimal, the
company intends to gain valuable insights and experience from this venture, a business model it hopes to emulate locally.

At the same time, the company is rolling out plans to develop its education arm, KPJ International University College of Nursing and Health Sciences into a leading centre for nursing and medical-related studies in the country.

Aside from being an additional source of revenue, the college will provide a steady stream of qualified and capable nursing and support staff to its growing network of hospitals – and retirement homes venture, if all goes to plan.

The company intends to spend some RM120 million to expand its main campus in Nilai, Negeri Sembilan over the next four-five years. It aims to achieve full University status by 2016, complete with its own medical school and student capacity reaching 10,000. Currently the university college has a capacity of about 2,500 students.

To fund the expansion plans we expect KPJ will continue to inject assets into 49%-owned associate, Al-’Aqar KPJ REIT. This will keep its balance sheet asset-light and allow the company to focus on its key strength, which ishospital management. Gearing stood at a modest 30% at end-June 2011.

Based on the expected industry growth and KPJ’s own expansion plans, revenue growth is forecast to remain in the double-digit range over the next few years. The company’s revenue expanded at an average compounded annual growth rate of 18.8% between 2006 and 2010.

The stock is currently trading at roughly 20.9 and 19 times our estimatedearnings for 2011-2012, respectively, based on its enlarged share capital of 659.5 million shares. Whilst higher than the broader market’s average valuations, we believe KPJ will offer positive returns over the long run based on its growth prospects. We recommend a BUY on the stock.

The company does not have a fixed dividend policy. Net dividends totaled 11.25 sen per share in 2010, equivalent to 52% of net profit. Assuming a 50% earnings payout going forward, dividends will total 10.3 and 11.3 sen per share for 2011-2012, respectively. That translates into net yield of about 2.7-2.9% at the prevailing share price.

Background
KPJ opened its first hospital on 10 May 1981, in Johor Bahru. Since then, the company has been on an expansion trail, acquiring existing hospitals – and turning around those that were loss-making – and, eventually, developing its own greenfield projects.

In the initial years, the company acquired expertise from external consultants from the US and Europe. Three decades on, KPJ has amassed a solid track record in developing, commissioning and managing the largest network of private specialist hospitals in Malaysia. It has also ventured abroad, having managed hospitals in Bangladesh and the Middle East and at present, runs two hospitals in Indonesia.

KPJ is the leading private healthcare provider in the country with 20 hospitals and over 2,600 licensed beds under its management currently. With almost 800 medical consultants and more than 8,000 staff members, it is the largest employer of private healthcare professionals in Malaysia, second only to the Ministry of Health. It catered to some 226,000 inpatients and more than 2.2million outpatients last year.

KPJ is the healthcare arm for Johor Corp and was listed on the Main Board of Bursa Malaysia on 29 November 1994. The latter retains a 43% stake in the company. KPJ is the only healthcare group in the country that is listed on the local bourse with the exception of TMC Life Sciences and StemLife, both
of which are focused on stem cell storage and related businesses. In 1991, the company diversified upstream, by starting its own nursing college. The Puteri Nursing College was the first in the country to offer the
Diploma in Nursing Programme, jointly offered through its collaboration with the University of South Australia. This was later expanded to include Diploma in Health Sciences programmes (Pharmacy, Medical Imaging and Physiotherapy).

The plan was to provide KPJ with a steady stream of professional nurses for its rapidly growing network of hospitals. To cater to its growing presence, a branch campus was opened in Johor Bahru in 2008 and this year, a second branch campus opened its doors in Bukit Mertajam.

The nursing college was upgraded to University College status in July 2011, and renamed KPJ International University College of Nursing and Health Sciences (KPJIC). It can now offer ‘homegrown’ degree programmes ranging from Medicine to Nursing, Pharmacy and others.

Currently, KPJIC has total capacity of about 2,500 students and offers some 15 programmes ranging from Master to Certificate programmes either in collaboration with international partners like Hertfordshire University and Liverpool John Moores University or a ‘homegrown’ programme.

Cognitive of its ambitious expansion plans and the need to maintain reasonable gearing, KPJ came up with an innovative exercise to lighten its balance sheet. It set up the Al-’Aqar KPJ REIT in 2006 and under a sale and
leaseback arrangement, injected six of its hospitals into the real estate investment trust (REIT).

The assets are leased back from the trust for a 15-year period with the option of another 15 years. Rental rates are reviewed every three years, after taking into account the prevailing market value of the properties and benchmark rate of returns.

Al-’Aqar was listed on the local bourse in August 2006, as the world’s first Islamic healthcare REIT.
The move served to unlock value in the company’s assets, free up cashflow for further expansion while retaining stable dividend income from its now 49% stake in the trust.

Two more rounds of assets injections were completed in March 2008 and July 2010. A total of 20 investment properties, including the nursing college,valued at some RM943 million have been injected into the REIT.

KPJ is currently in the midst of finalizing the sale of three more hospital buildings to Al-’Aqar valued at a combined RM139 million. The exercise is slated for completion by end-2011, once construction of the new Bandar Baru Klang Specialist Hospital is completed.

KPJ is an integrated healthcare provider. The bulk of the company’s revenue consists of income from operating its network of specialist hospitals. Other sources of revenue include the provision of support services such as management, pathology and laboratory services, marketing and distribution
of pharmaceutical, medical and surgical products as well as income from the nursing college.
The company is the leading provider of private healthcare services in

Malaysia, with an estimated 24% share of the market. Private healthcare, in turn, is estimated to account for roughly one-quarter of the total expenditure for healthcare in the country.

Plans to add one to two hospitals per year KPJ’s network of specialist hospitals covers the entire nation, with the exception of the states of Perlis, Melaka and Trengganu. Going forward, KPJintends to add another one to two hospitals to its network every year. It successfully acquired the Sibu Specialist Medical Centre in Sarawak in April 2011. Construction of the 200-bed Bandar Baru Klang Specialist Hospital is underway and the first phase is slated for completion by end-2011. Once operational, this hospital will be sold to Al-’Aqar, along with the Kluang Utama Specialist Hospital and Rumah Sakit Bumi Serpong Damai in Indonesia for a collective RM139 million.

Two other smaller hospitals – of about 120 beds each – are planned for commissioning in 2012, in Muar and Pasir Gudang. Additionally, construction for a new hospital building in Kota Kinabalu is currently underway. Upon completion, by 2012, the Sabah Medical Centre will be relocated from its existing facility to the new building. The new 250-bed hospital is expected to cost about RM180-RM200 million. Recall that KPJ acquired a 51% stake in Sabah Medical Centre, back in June 2010 for RM51 million.

Looking slightly further head, KPJ has plans for two other hospitals on the drawing board, the first of which is a 70:30 joint venture with Pasdec Corp. Located in Tanjung Lumpur, Kuantan, this 180-bed capacity hospital is slated for commissioning in 2013.

The second is a 60:40 joint venture with the Yayasan Islam Perlis in the state of Perlis, expected to commission sometime in 2014. The company is also in preliminary discussions to set up a bigger 400-bed hospital project in Bandar Datuk Onn, Johor.

The new hospitals and organic expansion will underpin growth over the next few years. Typically a new hospital will open in phases, with the addition of more beds, facilities and range of services over time in lockstep with demand growth.

Given its experience, KPJ is also exploring opportunities to provide consultancy to other providers, both locally and abroad, in areas such as healthcare business development and hospital management.

Steady growth envisioned for healthcare industry Demand for healthcare services in the country is expected to trend steadily higher for the foreseeable future. Some of the main drivers for demand growth include greater affluence and the rise in lifestyle-related diseases, growing awareness of and improved access to quality care as well as longer life spans and ageing population.

The increasing global interconnectivity also translates into faster and wider spread of infectious diseases, resulting into more frequent epidemics and potential pandemics.

With the expected rise in demand for healthcare services, it is envisioned that the additional burden on the public healthcare system will gradually drive more demand towards the private sector. As it is, the patient-to-doctor ratio for the public sector is now well over two times that for the private sector.

Additionally, the number of medical specialists in the country is heavily biased towards the latter.
Increasing awareness and adoption of medical insurance amongst the population, including the younger generation, will help aid the switch.

Industry statistics show that the health insurance sector has been growing at a double digit pace annually. Coupled with the expected increase in per capita income, private healthcare will become more affordable.
Medical tourism is another growth driver Medical tourism is another potential key driver for long-term growth. Indeed, our government has identified the sector as one of the national key economic
area. The majority of Malaysia’s medical tourists come from Indonesia, due to our higher quality of healthcare services. Patients from richer countries such as Singapore, Japan and the Middle East are also attracted to the lower prices for treatments compared with that offered in the US, Europe and Australia.

As at end 2010, KPJ had catered to 12,000 health tourists, who provided almost RM25 million in revenue. The company intends to grow this segment of the market by boosting its marketing efforts overseas on the one hand and upgrading and investing in new technology and innovative services as well as gaining accreditations for its network of hospitals on the other.

Continuous investments in IT and technological advancement. Its network of hospitals is continuously upgraded with state of the art facilities and the newest diagnostic and treatment processes. The company has also kept up with investments in administrative technology and human resources.

For instance, its hospitals are increasingly able to run as paper-less hospitals. E-ordering by consultants for radiology investigations will be captured and transmitted to the radiology equipment. X-ray images and
results will then be transmitted back online.

Similarly, introduction of the e-pharmacy module has enhanced communication between consultants and pharmacy. The hospitals also operate a centralized dispensing, billing and collection system. Its staff are encouraged to undertake further training and development courses at the Bachelor, Masters and even PhD levels. A target has been set for each staff member to receive a minimum of 30 hours of training every
year.

Expanding education arm
As mentioned-above, KPJ first ventured into the education industry in 1991 with the setting up of its own nursing college. Initially, the primary aim was to guarantee a steady pool of capable and qualified nursing staff to its expanding network of hospitals. The college was awarded University College status in July 2011, which allows it to offer its own degree programmes.

In view of its relative success, the company is now intent on developing KPJIC into a leading center for nursing and medical-related studies in the country – to produce qualified healthcare personnel for both the public and private sectors.

KPJ has an edge over similar education groups in the market in that the company can leverage on its existing infrastructure. For instance, its medical consultants and senior nurses can give lectures and guidance to students undergoing clinical practice in its network of hospitals.

Also, branch campuses can be fashioned out of relocated hospital buildings, already outfitted with various facilities and equipment. For example, the new Bukit Mertajam branch campus used to be a hospital before operations were relocated to the new Penang Specialist Hospital that opened in 2009.

Currently, KPJIC has total capacity for 2,500 students at its main campus in Nilai and two branch campuses in Johor Bahru and Bukit Mertajam. Some RM120 million has been budgeted to expand the campus in Nilai in two phases. The company expects capacity to increase to 5,000 students by 2013. Revenue contribution from the education arm is forecasted to increase to RM100 million by then, up from RM30 million last year.

By 2016, KPJIC hopes to achieve full University status, with its own medical school and total student intake capacity of some 10,000, including both local and foreign students.

Longer-term venture in retirement village and aged care facilities Over the longer-term, KPJ is looking to expand its services to include retirement homes and aged care facilities.

According to the latest Census 2010, there is a gradual shift in Malaysia’s demographics with the proportion of those below the age of 15 falling to 27.6% from 33.3% in 2000 while that aged 65 and above rose to 5.1% from 3.9% over the same period. At this pace, we will hit the definition of ageing population by 2015. The average life expectancy is also on the rise.


Although sending elderly parents to nursing home is still somewhat taboo in Asian culture, this perception is likely to change with smaller nucleus family structure and rising affluence. Indeed, the elderly with financial independence may well ‘choose’ to stay in well developed retirement homes that encompass quality medical and nursing care.

As such, KPJ believes that retirement homes and aged care facilities will be a growth segment in the future. This market is already a big business in most developed countries.

To gain a first mover advantage, KPJ is in the midst of acquiring a 51% stake in Jeta Gardens for RM19 million. Jeta owns and operates a 64-acre retirement village in Queensland, Australia. The project is still only partially developed and currently consists of 23 retirement villas, 32 apartments and a 108-bed aged care facility. The longer-term plan is to develop it into a onestop center that includes aged care nursing college and medical center.

Whilst earnings contribution is expected to be minimal, the company intends to gain valuable insights and experience from this venture, a business model it hopes to emulate locally.

Earnings Outlook
Taking into account the organic growth in healthcare demand as well as KPJ’s expansion plans, we expect revenue will expand in the double digit range for the next few years. Between 2006-2010, the company’s revenue grew from RM831.5 million to RM1,654.6 million, equivalent to a compounded annual rate of 18.8%.

In view of the larger revenue base, the pace is expected to taper off slightly, but we forecast revenue growth will remain within the range of between 12-16% per annum over the next three years.

Net profit is estimated at roughly RM119.5 million in 2011, up from RM110.7 million in 2010 (after excluding one-off gains totaling some RM8.2 million). Earnings are forecast to expand further to RM131.2 million in 2012.


Balance Sheet
KPJ plans to spend about RM150-200 million per annum on capital expenditure.

The company maintains an asset-light balance sheet by selling – and leasing back – most of its assets to 49%-associate, Al-‘Aqar. Gearing stood at 30% at end-June 2011 with net debt totaling RM244.6 million.
KPJ is in the midst of finalizing the fourth tranche of assets injection into the REIT, valued at RM139 million. The sale will be finalised once the Bandar Baru Klang Specialist Hospital is completed, expected by end-2011.

We expect the sale and leaseback arrangement will continue for the company’s future developments.

Investment Risks
Cyclical and business risks
Every industry is affected by economic cycles, some more so than others. Healthcare is generally viewed as one of the most defensive sectors – the sick need medical care regardless of whether it is boom or bust time.
Indeed, KPJ’s revenue and earnings track record for the past five years showed a steady uptrend, including through the last recession in 2008-2009.

We expect this to remain the case going forward.

Competition
Strong growth expectations and the industry’s relative resilience have, in turn, attracted increasing investments in the private healthcare segment. Competition is growing. KPJ is currently the leading private healthcare provider in the country with the largest network of specialist hospitals. However, its competitors are also
on the expansionary path. Some of its biggest competitors are Pantai Holdings and Columbia Asia. The
former’s network of 11 hospitals includes the flagship Pantai Hospital KL as well as Gleneagles KL. Columbia Asia, which recently opened its 9th hospital in Cheras, has presence in both East and West Malaysia, as well as in neighboring Vietnam, Indonesia and India.

The Sime Darby Healthcare Group, which operates the Sime Darby Medical Centre Subang Jaya, is in the midst of completing two new hospitals in Ara Damansara and Desa ParkCity. Another major player in the Klang Valley is Sunway with its Sunway Medical Centre in Bandar Sunway. There are also many smaller privately owned hospital operators in the country.

Whilst there are zoning regulation that limits the number of hospitals based on population count, it is possible that there could be short-term oversupply of beds in select locations. Nevertheless, the longer-term uptrend in demand for healthcare is intact and any excess capacity should gradually work itself out. KPJ aims to maintain its track record and quality of service to remain competitive. The company has a low turnover in terms of its medical consultants and support staff.

Cost escalation
Cost escalation for technology, processes and equipment is another concern, resulting in rising overall cost for healthcare. At the same time, insurance companies are negotiating for bigger discounts as they gain more bargaining power. In this respect, KPJ hopes to minimize the impact with economies of scale gained through its expanding network

Based on our earnings forecast, the stock is currently trading at roughly 20.9 and 19 times fully diluted P/E multiples for 2011-2012, respectively. This is higher than the average valuations for the broader market. We suspect this is due to the company’s relatively defensive business as well as its positive longer-term growth prospects.

The stock did not escape unscathed in the recent global equity sell off, falling off the peak of RM4.72 to the current RM3.85. There could be further downside risks if sentiment for equities deteriorates from hereon.

Nevertheless, we believe the stock will yield positive returns in the long run. Hence, we recommend a BUY on the company. KPJ paid out roughly half of annual net profit as dividends in the past four years, on average. Assuming a similar payout ratio going forward, dividends are estimated to total 10.3 and 11.3 sen per share in 2011-2012, respectively. That translates into decent net yields of about 2.7% and 2.9% for shareholders over the two years.

KPJ pays dividends on a quarterly basis. Net dividends totaling 4.8 sen per share have already been paid so far this year. The company will receive some 56.6 million units in Al-‘Aqar – worth roughly RM62.3 million at the current unit price of RM1.10 – as part payment for the injection of three hospital buildings into the trust. It could distribute these units to shareholders as dividends in specie or sell them in the open market.

KPJ opted for the former option with respect to units received for two of its earlier assets injections, back in 2007 and 2008. This is so that the company can maintain its stake at less than 50% to keep the REIT’s assets and borrowings off balance sheet.

The company has some 79.8 million warrants outstanding. The warrants can be converted into ordinary shares at anytime up to January 2015 at an exercise price of RM1.70. At the prevailing price of RM2.18, the warrants are trading at a very slight 1% premium.

Assuming full conversion, KPJ’s total share capital will increase to 659.5 million shares, from the current 579.8 million shares.

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