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This article first appeared in The Edge Malaysia Weekly on June 25, 2018 - July 1, 2018

ALIBABA Group opened an office in Bangsar South, Kuala Lumpur, last Monday — a reflection of the group’s commitment to Malaysia. While he was in town for the opening, executive chairman Jack Ma met Prime Minister Tun Dr Mahathir Mohamad in Putrajaya for an hour.

This is seen as an affirmation of the new government’s support of the development of the Digital Free Trade Zone (DFTZ), which was initiated by former prime minister Datuk Seri Najib Razak.

When the DFTZ was unveiled in March last year, logistics counters such as CJ Century Logistics Holdings Bhd, GD Express Carrier Bhd (GDex), Tiong Nam Logistics Holdings Bhd and TASCO Bhd rallied on Bursa Malaysia with their share prices climbing to all-time highs in the following months.

But investor reaction to the latest developments seems muted despite the reassurance that the DFTZ is on.

“The surge in logistics counters after the announcement of DFTZ [last year] was overdone, in my opinion. Several of them have been gradually sold down after the initial spike,” Hong Leong Investment Bank analyst Andrew Lim tells The Edge.

While the DFTZ is undoubtedly a catalyst for the logistics sector, Lim says the current environment is too competitive as companies are aggressively cutting prices to secure a piece of the e-commerce pie.

He says the volume of e-commerce is growing but this has not translated into higher earnings as companies are gaining business at the expense of thinner profit margins.

“Overall, we are not expecting anything big this year, and we are ‘neutral’ on logistics counters. Talk of a boom in e-commerce has been going on for a while now but we have yet to see this reflected in companies’ earnings,” Lim says.

The competition aside, some logistics companies are incurring higher costs as they expand their operations and venture into new segments to gear up for the anticipated surge in e-commerce activity upon the completion of the DFTZ.

This was a recurring theme cited by most logistics companies — which had largely reported lower-than-expected results — during the first-quarter corporate earnings season.

GDex reported a 67% year-on-year drop in net profit to RM2.62 million in its third quarter ended March 31 (3QFY2018), which was mainly attributed to its ongoing investment in networks, sorting facilities, fleet and technology for network expansion to maintain its competitiveness.

CJ Century’s net profit dropped 45% year on year to RM2.64 million in its 1QFY2018 ended March 31, partly due to the set-up costs of its courier services venture, marking the group’s entry into the business-to-consumer (B2C) segment as it diversifies from its traditional business-to-business (B2B) operations.

Tiong Nam’s logistics division remained in the red with a loss before tax of RM1.9 million for its full FY2018 ended March 31, against a pre-tax profit of RM20.8 million in FY2017, amid higher operating expenses stemming from the expansion of its warehousing capacity and overseas distribution centres.

Affin Hwang Capital Research senior associate director Loong Chee Wei says the decline in logistics stocks is largely a sentiment issue, following the disappointing corporate results.

“When these companies expand their warehouses, depreciation sets in, and in the case of CJ Century and Tiong Nam with their new parcel delivery operations, there will be running costs while they are working on ramping up their revenue.

“It will take time for them to reap the benefits of their expansion plans as there needs to be a certain level of volume before they break even,” Loong says.

He adds that the DFTZ will be a significant long-term catalyst for logistics players but it will not translate into earnings in the immediate term.

Affin Hwang is “neutral” on the transport and logistics sector, says Loong, amid several emerging risks, including a possible trade war between the US and China and higher crude oil prices.

Loong has a “buy” call on CJ Century and Tiong Nam due to their relatively attractive price-earnings valuations of 19.53 times and 14.96 times respectively, compared with the high PE valuations of the likes of GDex (82.22 times) and Pos Malaysia (33.12 times).

“Valuation-wise, CJ Century and Tiong Nam are attractive but this year will still be challenging for them. They are both expanding and adding a new B2C stream to their traditional B2B and cargo business, which will take some time to build,” says Loong.

CJ Century executive director Edwin Yeap says that e-commerce has seen significant growth, even without the involvement of the DFTZ.

In fact, CJ Century has expanded its fleet of trucks from 30 to 130 in the past six months alone, after launching its courier service in November last year.

“We have seen a tremendous pickup in volume from e-commerce activities, not just because of Alibaba or the DFTZ,” Yeap says. The e-commerce penetration rate in Malaysia is lower than that of its regional peers, he adds.

“Margin pressure from the last-mile delivery business will persist for the next few months,” he says, explaining that there will be a gestation period as CJ Century plans to continue increasing its fleet size.

While Yeap sees the building of a warehouse and new cargo terminal at the KL Aeropolis site as complementary to Malaysian logistics firms, he believes that the development of the DFTZ logistics hub is still in the preliminary stage.

“We did not see much progress on the site itself (as at) the end of last year,” he tells The Edge.

A joint-venture company formed by Malaysia Airports Holdings Bhd (MAHB) and Alibaba’s Cainiao Smart Logistics Network (Hong Kong) Ltd will develop various facilities — including a cargo terminal, sorting centre, warehouse and operations offices — on the 60-acre site in Sepang, Selangor, MAHB managing director Datuk Badlisham Ghazali told reporters in April.

At the time, Badlisham said RM800 million would be invested in developing the KL Aeropolis DFTZ Park by 2020.

This time frame was reaffirmed by Alibaba’s Ma in an interview last Monday. He also said construction is starting this year.

 

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