Lead Story: Some GLCs trading at high valuations

This article first appeared in Capital, The Edge Malaysia Weekly, on August 13, 2018 - August 19, 2018.
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IT has been almost 100 days since the Pakatan Harapan (PH) coalition took over Putrajaya. With the winds of change continuing to blow, creating uncertainty in the market over the past three months, the FBM KLCI has declined 2%. It closed at 1,805.75 points last Friday.

The benchmark index has underperformed the Dow Jones Industrial Average (DJIA), which has risen 4.7%, as well as the Bursa Malaysia Small Cap Index, which has gained 3.7%.

Post-election, some fund managers have repeatedly urged investors not to just look at the constituent stocks of the FBM KLCI, mostly large caps and government-linked companies (GLCs).

Instead, they prefer the so-called non-GLCs and those with minimal political connections following the general election on May 9.

One reason is that under the previous administration, economic growth was largely driven by the public sector and the GLCs, which were seen to be crowding out real private investment as they were believed to have preferential access to government contracts and to benefit from favourable regulations.

However, with the new government’s rebalancing Malaysia’s fiscal position, investors have been warned of a significant pullback by GLCs as key growth drivers.

A GLC is defined as a commercially-driven company under the control of a government-linked investment company (GLICs). There are seven GLICs at the federal level, including Minister of Finance Inc, Employees Provident Fund (EPF), Permodalan Nasional Bhd (PNB) and Lembaga Tabung Haji (LTH).

While it is not right to take a blanket view and say all GLCs will underperform non-GLCs in the coming years, it is important to note that certain GLCs are currently trading at high valuations, which may not be sustainable.

For instance, integrated healthcare service provider IHH Healthcare Bhd — a unit of sovereign wealth fund Khazanah Nasional Bhd — is trading at a trailing 12-month price-earnings ratio (TTM PER) of 94 times, compared to its two-year PER average of 66 times.

Regional telecommunications conglomerate Axiata Group Bhd, in which Khazanah is the single largest shareholder, is trading at a historical PER of 76 times, compared to its two-year PER average of 71 times.

Sime Darby Bhd, a diversified giant controlled by PNB, saw its TTM PER almost double to 40 times while Malaysia Airports Holdings Bhd’s was 29 times (see table).

By comparison, Apple Inc, which recently became the first US company to achieve a market capitalisation of over US$1 trillion, is only trading at a PER of 19 times.

The Dow, FBM KLCI and Bursa Malaysia Small Cap Index are trading at PERs of between 18 and 19 times.

Geoffrey Ng, investment adviser and director at Fortress Capital Asset Management (M) Sdn Bhd, says the change of government had an immediate impact on the corporate world, especially the GLCs.

“This is a structural change that needs to happen. The crowding-out effect brought about by the government has been going on close to two decades, which has seen consolidation in favour of the GLCs. For the private sector to come back in a big way, to be competitive and a major part of the economy again, will take just as long,” he tells The Edge.

While Ng does not say that investors should avoid GLCs, he reiterates that growth going forward will be driven by the private sector.

“It really depends on what message individual GLCs send to the market. Some GLCs will be restructuring by getting rid of non-core assets.” If these GLCs are taking a strategic look at their assets and restructuring from there, investors might be able to find some interesting opportunities, he adds. “If they are unlocking their value, we want to be part of that. We want to participate in their exercises.”

Areca Capital CEO Danny Wong Teck Meng concurs. “I think growth is still there for big caps (GLCs), but that of the private sector’s should be higher. Some GLCs will be affected by the changes in government policies.”

Wong believes the local equity market will be driven by the private sector in the next two to three years, and small and mid caps are expected to do better than big caps in a growing economy.

“Foreign investors like this kind of political reform or economic reform theme,” he says on the change of government. As local sentiments improve, people are willing to spend and companies are willing to expand, he adds.

Pheim  Management Sdn Bhd executive chairman Dr Tan Chong Koay lauds some of the initiatives taken by the government to reduce wastage and expenses.

“So far, most are quite comfortable with what the government has done,” he says.

He believes growth in the coming years could come from technological innovation in e-commerce, transport and 5G connectivity, among others.

“Thus, for semiconductors, even though it might slow down a bit, I think there is still growth potential for players in that sector.

“Crisis is an opportunity ... it is how you read it. There was an opportunity then (when the stock market fell after GE14),” Tan says, pointing to the recovery in some stocks that saw a significant selldown after the election.

Going back to the GLCs, can institutional funds afford to ignore them, given that some may have an investment mandate to invest in large caps?

Rakuten Trade Sdn Bhd vice-president of research Vincent Lau says that generally, fund managers have to invest in bigger companies with liquidity.

“Many of the GLCs are KLCI component stocks, hence fund managers need the weighting of such shareholdings.”

Lau believes the GLCs will still be attractive even if the private sector takes on a bigger role.

“GLCs are the bellwether of our economy and are entrenched in major sectors. We believe there will be pockets of opportunity for investors to buy into the GLCs as they undergo transformation and management change, with better returns going forward,” he says.

Fortress Capital’s Ng says that over the years, the mandate of fund managers has been to expand their portfolios, but not necessarily just by investing in large caps.

“Of course, if you run exchange-traded funds or have a passive mandate, then probably you will be heavily tilted towards blue chips. But as far as we are concerned, we are quite okay. In terms of investment value, GLCs constitute less than 15% of our Malaysia portfolio.”

Areca Capital’s Wong says GLCs make up less than 5% of its portfolio and he does not intend to increase exposure to them in the near future, considering there are small and mid cap companies that could provide better upside.

“There are certain mandates for some fund managers. I don’t like this... I want flexibility. We should not restrict the fund managers’ choices. Don’t get me wrong ... we are not avoiding GLCs, but we are not focusing on investing in them.” 

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