Singapore Airlines – The harsh operating environment

Ask an American during the 90s whether they know Singapore Airlines (SIA), you are likely to get a confirmed yes. But when you ask him where Singapore was, you may not get a very clear answer. That spoke volumes about how SIA as a national carrier punched above its weight to put itself in the league of the top few national carriers in the world. It was a national icon and there was even an SIA training school to train batches after batches of cabin crew.

The terrorist attack on the world trade centre twin towers on 11 September 2001 that accelerated the bankruptcy of its close rival, Swissair, only affected the SIA share price for a short period of about 6 months. Even the Severe Acute Respiratory Syndrome (SARS) only affected its share price very slightly. But 20 years on, SIA, like all other airlines were suffering from a dearth of travelling passengers due to Covid-19 pandemic. Just two months ago, SIA had to ground 96% of the flight schedules and kept the newly delivered aircraft in long storage in Australian dessert. Apart from the recent rights and Mandatory Convertible Bond (MCB) issues of S$8.8b, SIA had further loans making a total amount raised to about $11 billions according to the Straits Times following a loan of $750m a few days ago. (Covid-19: Singapore Airlines raises additional $750 million, brings total sum raised so far in FY2020/21 to $11 billion.) In the month of July 2020, it has been running at about only 6% capacity and will be increasing to a miserable 7% by August 2020. This is how grave the situation is for the airline industry amidst this Covid-19 pandemic.

(More information on youtube video above.)

On reflection, SIA has been under huge external threats all the time. The Covid-19 pandemic is not the only cause of SIA’s problem. It just helped accelerated and surfaced the underlying problems. First and foremost, there is the budget airlines. It came about in the early years since the turn of the new millennium. Regionally, Mr Tony Fernandez from Malaysia started the Air Asia, and that turned the region into an arena of competition for low-cost carriers (budget airlines). By 2005, almost every regional country has at least one budget airline to its name. Most of the national carriers were under constant threats from the low-cost carriers. Even after mergers and consolidations, most of these low-cost carriers have muscled their way to become the subsidiaries of the national airlines. They were a necessary evil. In fact, I think most main carriers do not want to have them, but could not do without them. Even airports and ground facilities have now been constructed to accommodate them permanently. Definitely, they are here to stay.      

Then there is the oil price. Jet fuel takes up about 30% to 40% aircraft operating cost. Unfortunately, it came from the volatile commodity, the crude oil. In the last 20 years, the crude oil price traded in the New York Mercantile exchange can range from as high as US$140 per barrel to even sub-zero level that happened recently. The oil price volatility, together with the low-cost carriers could wreak significant havoc to the profitability of the national carriers. When the oil price is high, the operating cost balloons up, crimping the profitability of the main carriers. But when the oil price is low, the low-cost carriers become very active, thus chipping away the profitability of the lower segments of the main carriers.   

Then there are huge competitions from other main carriers. The turn of the new millennium saw the emergence of middle-eastern airlines like, Emirates and Qatar Airways as well as the Chinese airlines. To differentiate itself in this cut-throat competition, it has to continue to maintain a young fleet and competing in tooth and nail with its competitors. That led to renewing its fleet continuously. To do this reasonably well, an airline needs to have a deep pocket and a management with good financial management capabilities. In the latest 5 years of operations, SIA has been cash flow positive. However, the free cash flow has been negative except for one of the years. It does not augers well in this environment and it took a perfect storm like the Covid-19 pandemic to surface it. In the end, SIA has to beef up its balance sheet through the recent rights issue of S$8.8 billion, with another $6.2b of MCB bond as an option that can be tapped upon by mid-2021. In addition, SIA also borrowed heavily and deferred the maturity of its existing bonds to help it maintain liquidity. However, the big question of profitability still remains very unanswered because all the airlines are now competing for the hugely reduced pie of air travellers.

There are also other factors that are peculiar to the smaller economies like Singapore. We do not have domestic flights and all SIA flights are international. With many countries closing their borders or have limited access, it is really a disadvantage for SIA without domestic flights. Domestic air travels help cushion/defray the huge fixed costs during the down period and facilitate the recovery phase for airlines.

Post Covid-19, there are likely to be additional cost issue as well. With the current aircraft seats configuration of elbow-to-elbow arrangement, it certainly unable to meet the safe-distancing requirements of at least 1-m apart. With the recommendation of leaving alternative seats empty, it means that aircraft can only operate at 50% capacity at best. Personally, I do not know if operating at best 50% capacity can even cross the break-even threshold for each flight.  In addition, there is also more insurance and more cleaning cost to dabble with. All these little costs can add up to a significant amount over time.

As I try to follow the challenges facing SIA of late, I find the fuel hedging extremely unsettling. (SIA posts S$732m Q4 loss as bad hedges worsen virus woes). For FY 2019/2020, SIA could have been profitable or nearly profitable if not for the $710 million mark-to-market loss due to hedging. The average hedging price was about $73 per barrel for the year. There appeared to be no advantage using hedging instruments. A quick survey oil price seemed to suggest that the premium to process jet-fuel from crude oil is about $20 to $25 per barrel. Perhaps, by around the crude oil price of about US$55 per barrel, the US shale oil shafts would be cranking busily, thus putting a huge ceiling on the jet-fuel price to around US$75 to $80 per barrel at most. Certainly, it would take a huge war to push the crude oil price to beyond $100 per barrel given the glut situation that started in 2014. The oil hedging did not seem to protect the upside, and risking it on the downside as the oil price fell significantly. So, in the first place, why bother to hedge at all and in lengthy long position of several years down the road. It may be better off to buy on spot prices or at most for 3-month or 6-month contracts. As a user, perhaps SIA should only, hedge according to its needs than taking on a huge long position. Consequently, SIA did not get to enjoy the low oil price as a result of this global glut. In fact, it is a huge loss to SIA as it has to take the oil delivery based on their contract prices.

             

Certainly, I count myself extremely lucky to have sold my SIA shares just before the global financial crisis. In the next 13 years that followed, I was looking for opportunities to get back in again and that explained why I have been following SIA developments. However, I find it extremely difficult to do so due to the ever-changing operating environment that SIA has been subject to. In fact, in the last 10 years prior to Covid-19 pandemic, its share price has been relatively stagnant. It has been a blessing in disguise that the ‘opportunity’ to buy never came. Should I have lost my patience, and bought SIA shares, I would be dragged into taking up the recent rights shares and the MCB issues. I think it will take at least a few years down the road before things become normalise again for SIA.                   

Note: The writer does not have any SIA shares. The write-up is a personal opinion of the writer on SIA and its share price. It is not a recommendation to buy or sell the said securities.

Brennen has been investing in the stock market for 30 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is the instructor for two online courses on InvestingNote – Value Investing: The Essential Guide and Value Investing: The Ultimate Guide. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

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Sembcorp shareholders’ hands are tight

It has been more than a week since the submission of a proposal to SGX by Sembcorp Industry and her subsidiary Sembcorp Marine (SCM) to raise fund of $2.1b for the SCM, and for the demerger between the two entities. (Click youtube channel for the details of the proposal.)

As mentioned in the proposal, the extraordinary general meetings (EGM), for the SCI and SCM shareholders, are likely to convene on the same day in end August/early September. While there may be several resolutions to be tabled at the two EGMs, the success of the whole proposal depends on three items that are inter-conditional:

  • SCI shareholders to agree/disagree to receive SCM shares in lieu of cash dividends.
  •  SCM shareholders to agree/disagree to waive their rights to receive Temasek Holding (TH) of making a general offer for SCM shares following the proposed resolution. (“Whitewash Resolution”)
  • SCM shareholders to agree/disagree on the 5-to-1 rights share issue at a proposed price of $0.20.

It is likely that Resolution (a) will be accepted by SCI shareholders. SCI has been encountering dwindling dividends over the last few years, partly due to results of SCM. The proposed dividend in specie of between 427 to 491 SCM shares priced at 20 cents per share (note that this is not necessary the future trading price) for every 100 SCI shares owned, is a significant premium over the past cash dividends. On paper, for every 100 SCI shares owned, shareholders get between $85.4 and $98.2. (Again, note that this is only theoretical because SCM’s share price will change going into the future.) However, based on the price of $0.20, it takes a significant drop in SCM’s trading price before it falls below SCI’s dividend last year.

I empathize with the minority shareholders, it is likely that many would not want to agree on the resolution (c), especially with the fact that SCM shares have been sliding in value in the last few years. Voting for the resolution would exacerbate the situation as it means the existing shareholders would have to fork out more money to subscribe for the rights share in order not to dilute their stake in SCM. This is likely the sore point for the minority shareholders especially when its prospect remains relatively weak. However, given that SCI is still the 61% majority shareholder of SCM, the fate of this resolution, in effect, lies in the hands of SCI. Based on the following extract from the proposal document, SCI had given the undertaking that she will vote in favour of the rights issue.

(Extract from SCI proposal document)

The way it is, there is not much leeway for the minority shareholders to choose. This resolution is likely to be accepted given the majority shareholding of SCI. Perhaps, many minority shareholders would not go ahead inject more funds to buy the rights shares, leaving TH to become the majority shareholder of SCM. Those who do are likely the entrepreneur minority who believe the oil price will turn around to above $60 per barrel at a sufficiently sustained period. This prospect may seem bleak now, but not impossible though.

In essence, there left with only one resolution (Resolution B) that SCM shareholders can rely on if they really want to block the cash call. This resolution is really in the hands of minority shareholders as both TH and SCI have abstained from voting, leaving the minority shareholders to vote for or against the resolution.

The real issue lies in the uncertain prospect of SCM going forward. At the ongoing trading price today, it is trading below 0.5 price-to-book value. It is already deep in value. Even if the minority has the power to block the deal and to make the situation remains status quo, the future prospect remains very milky. It takes the oil price to hit at least $60 per barrel sustained over a period of 9 to 12 months before the demand for deep sea oil exploration equipment and oil rigs can really gain traction. It is not impossible but at best, can only happen 1-2 years down the road, especially with the glut worsen by the pandemic.    

 Note: The writer does not have any SCI or SCM shares. The write-up is only an opinion offered by the writer. It is not the intention of the writer to swing shareholders of SCI or SCM into agreeing or disagreeing with the stated resolutions. It is also not a recommendation to buy or sell the said securities now or in the future.

Brennen has been investing in the stock market for 30 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is the instructor for two online courses on InvestingNote – Value Investing: The Essential Guide and Value Investing: The Ultimate Guide. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

Posted in Keppel Corp, SembCorp Marine, YZ-Offshore & Marine, Z-FINANCIAL EDUCATION, Z-INVESTMENTS | Tagged | Leave a comment

Looking for certainties in the environment of uncertainties

Recent poll:

In a recent poll of

  • A sure win of $200
  • 60% of win of triple of $200 and 30% of a loss of double of $200

There were altogether 58 respondents to this poll, of which 37 (representing 63.8%) chose A and 21 chose option B (representing 36.2%).

Mathematically, it is not difficult to calculate that the expectation of option B is higher at $240. Certainly, many of those who polled know the mathematics behind this, but yet the polls showed that almost two-third of them chose Option A, that is, to put the money in the pocket than rather than chasing a possibility of higher return. After all, as the proverb goes, a bird in the hand is worth two in the bush, right?  So, what can we conclude from here?

One conclusion that we can draw from this is that despite the uncertainties of stock investing, we being human being beings, tend to look for certainties within this environment of uncertainties. That’s why investors tend to look for stocks that pay dividend than those that do not. This also means people tend to buy dividend stocks (or high yield stocks) than going for growth stocks (that pay little or no dividends). That could possibly be the reason why there are so much attention on REITs, despite that price change in REIT is not exactly significant over time. In fact, this Covid-19 pandemic, surfaced this. When people realized that their future distribution per unit (DPU) is at risks, everybody rushed out of the exit door resulting in a stampede. Those REITs that tanked 15%-20% were considered to be the better performing ones as some of them dropped as much as 40%-50%.

Even that, Singapore, by itself, is not exactly a good sample to compare growth stocks and dividend stocks because the number of true growth stocks are few and far in between. But over in the US, some growth stocks indeed can outgrow dividend stocks. Just look at companies like Microsoft. Its dividend was $2.04 per year as of FY 2019. The dividend yield based on today share price is merely 1.05%. In FY 2018, the dividend yield was hardly 1.5%, but yet its stock price ran up more than 50% in the last two years from $120 per share to almost $200 now.

Extending this finding further, it is not difficult to see why the penetration rate of Singaporeans investing in stocks is only 8% (can’t remember the source of this statistics). It means that despite knowing that stocks offer better returns in the long run compare to bank deposits and insurance, still people choose to put most of their money in the bank as deposits or buy insurance.

Brennen has been investing in the stock market for 30 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is the instructor for two online courses on InvestingNote – Value Investing: The Essential Guide and Value Investing: The Ultimate Guide. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

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Demerger of Sembcrop Industries (SCI) & Sembcorp Marine (SCM)

On 8 June 2020, Sembcorp Industries (SCI) and its subsidiary, Sembcorp Marine (SCM), jointly announced a proposal of $2.1 billion renounceable rights issue for SCM. This involves a 5:1 rights issue to existing SCM shareholders as well as Temasek Holding (TH)’s upfront billion cash injection of $0.6 billion. Following the rights issue, SCM will be demerged from being the subsidiary of SCI to become a separate independent entity. The extra-ordinary meeting to convene the meeting is to be held on August/September period and will involve the two corporate entities as well as three parties, being TH, SCI shareholders and SCM shareholders.

Personally, I do not have any SCI or SCM shares. Therefore, I will not be involved in either of the two meetings. I can only envisage the possible situation and the post-merger impact on the companies if the resolutions are agreed upon.

The operations, post de-merger, will be neater for both Sembcorp Industries and Sembcorp Marine. Each entity can operate independently, focusing on their respective technical strength, and will not be encumbered by the other’s performance. However, this comes at a cost that requires $2.1 billion cash injections via rights issues from existing SCM shareholders and TH. Certainly, this is likely to be a sore point among the minority public shareholders, especially when this rights issue is highly dilutive. However, given the weight of SC’s holding of SCM shares, it is highly likely that this resolution will be successfully passed. The other two resolutions would be interesting to watch as the Security Investor Council (SIC) has ruled that TH and SCI be abstained from voting in the Whitewash Waiver in SCM EGM, and TH be abstained from voting in SCI EGM on the dividend distribution.

Post demerger, even though, the pressure on SCM’s debt obligations is somewhat relieved, the earning visibility is likely to remain very challenging. The oil glut situation leading to the recent crash in oil price is certainly going to weigh on SCM’s profitability and its share price in the near term. For SCI, the unloading of SCM would help boost its performance in its core business focusing on energy as well as urban developments. Lumpy revenues, high project costs and high debts remain the natural characteristics of the entities.

Good luck to shareholders of SCI & SCM.       

Brennen has been investing in the stock market for 30 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is the instructor for two online courses on InvestingNote – Value Investing: The Essential Guide and Value Investing: The Ultimate Guide. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

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The lockdown mailers

10th to 14th March 2020:

The market was very bad. The STI tanks around 16% (2960.93 to 2493.95) and was still on the way down. The Dow Jones also had a bad outing. The worst performing stocks on the SGX sank as much as 50%.

15 May 2020:

It’s a period of lull. The STI was range bound between 2500 and 2600 for more than a month. The lockdown for schools and many public places has already taken place for about 1.5 months. People were feeling uncomfortable of the lockdown, especially with the uncertainties lying ahead.

31 May 2020:

While many welcome the lift after the lockdown, the discomfort of the future remains. The way we do our businesses in post covid-19 is not going to be the same as before. There are likely to be job losses. We need to extend our comfort zone to embrace risks.

Interestingly, the market roared. It ascended by about 10% within the last 5 days. It coincided with the level when the 1st mailer was sent. Those who panic sold their stocks in the 1st week of March 2020 would probably regret their action.

Compiled by: Brennen Pak

Brennen has been investing in the stock market for 30 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is the instructor for two online courses on InvestingNote – Value Investing: The Essential Guide and Value Investing: The Ultimate Guide. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

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Singapore Airlines (SIA)

On the requests of students concerning the recent SIA rights and MCB R, I have made a video to explain the technicalities of the rights issue. The last time I had SIA shares was more than 10 year ago While I have not been analyzing about SIA stock in particular, I do read about news related to the aviation industry.

As a matter of fact, the airline industry is a difficult sector to invest in. Many factors that can adversely affect an airline’s profitability are not within the control of the management. Recently, even the great investor like Warren Buffet also got rid of the entire stake of airline stocks in Berkshire Hathaway. The oil price and the emergence of low-cost carriers in recent years have sandwiched premium airlines into a relatively thin operating segment. To stand out in that segment, an airline has to have good service and a young fleet. While these traits that SIA has have won the praises of many passengers, they come with a heavy price. Good service is a reproducible trait that other airlines can mimic relatively easily. And, to always maintain a young fleet, it takes the airline to have good cash flow and fund management abilities. Out of the past 5 years, only one year in SIA’s financial reports showed positive free cash flow. Even that, the positive free cash flow in the FY 2016/2017 was not high compared to the negatives in the other years. Despite showing positive net profits for the past 4¾ years, it took just one last quarter in 2019/2020 to bring down the whole year profit into a negative region.

Peculiar to SIA, Singapore without a hinterland, it is almost impossible to operate effectively, let alone profitability. Now, with 96% of the fleet capacity grounded in the desert, it speaks for itself the expected profitability of SIA in the near term. Even with countries gradually lifting up their lockdowns, it would be a miracle for people to fly freely again in the next few months.

Then, there is difficulty in timing the jet fuel hedging and taking aircraft deliveries. With fuel taking up about one-third of its operating cost, it is not surprising that SIA hedges its fuel price to stabilize its operating cost. But with the crude oil slamming all the way from $70/barrel to the negative region within a quarter, it appeared extremely untimely even to hedge jet fuel at all. Like any other transport operators, once taken delivery, the assets have to work tirelessly to generate revenue. And, with the new aircraft like A380 unable to fly, the parking cost and depreciation are certainly going to put a further strain on its profitability at least in the near term.

In all, it takes a confluence of several favourable but largely uncontrollable factors for an airline to be profitable and free cash flow positive. Notwithstanding that, SIA is still the airline of my first choice.

Happy Investing and looking forward to seeing you in the new course (Stock 101)!

Disclaimer – The above points are based on the writer’s opinion. They do not serve as an advice or recommendation for readers to buy into or sell the mentioned securities. Everyone should do his homework before he buys or sells any securities. All investments carry risks.

Brennen has been investing in the stock market for 30 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is the instructor for two online courses on InvestingNote – Value Investing: The Essential Guide and Value Investing: The Ultimate Guide. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

Posted in SIA, YZ - AIRLINES, Z-FINANCIAL EDUCATION, Z-INVESTMENTS, Z-Personal Finance | Tagged , , | Leave a comment

Investing lessons to learn from the Covid-19 coronavirus pandemic

The past 2 months or so has been quite punitive for stock investors and traders alike. Despite a few early cases of Covid-19, the month of February had been almost a non-event. The STI, despite sinking gradually, continued to stay above the 3,000 mark. Many market players took this gradual drop as an opportunity to load up stocks at a more decent price. The yield based on past dividend distributions was extremely attractive as stock prices fall. Local bank yields were heading towards 6% mark, an unthinkable number for the past 10 years or so. Until recently, despite rising dividends in the past 10 years or so, stock prices of banks have been correspondingly rising, resulting in bank yield falling in the range of about 3.5% to 4.5%. 

That changed altogether in the next two to three weeks when the market slide from the close of 3011.08 on 28 February to 2233.48 at close on 23 March 2020, a retreat of 25% in less than 3 weeks. That had caught many people off guard. Many had been buying in the month of February, in hope, either to get better yield for their stocks or to average down their purchase price after having bought some stocks at high prices. The REITs have it worse. Retail REITs like CapitalandMall Trust sank more than 40% from the high of $2.61 per share to $1.52 before making back to $1.85 level after MAS threw a few lifelines for REITs last week. The drastic change in the last three weeks had caused some distress among many market players. The whole global economic picture changed from a very optimistic state to be very pessimistic one as the world realized that the coronavirus pandemic is not just a passing one, but a much longer one causing many countries to be in a state of a lockdown or near to one.

The next three weeks since the last week of February to mid-March seemed to be better as many governments dipped into their pockets to help save their economies as a result of the lockdown. Since then, stocks have recovered about 50% from the steep fall.

Within a short span of just one quarter, the Covid-19 had already surfaced out several common investing mistakes.

  • The chase for yield can end up quite miserably. The hope to get high dividend can result in steep falls in stock prices during trying times, thus negating several rounds of future dividends. In fact, with the possibility of reducing dividends in future, this could push the ‘break-even’ point further down the road. This is not the only situation and certainly not going to be the last. The oil price crash in 2016 had put many bond-holders realized the heavy price to pay for the capital loss in bond prices. The recent Hyflux saga was the other one. These are the two recent examples that punished investors badly when we focus too much on yields. For a long time, this has been a learning point for me. It can come in many forms. On the whole, I realized that upside is more important than yield when looking for good investments. It gives us the margin of safety as an economic moat to ensure that we are still in the money even if the stock price weakens. Good yields will naturally follow when the fundamentals of our stocks gain traction.    
  •  REITS have been an income instrument for many people. REITs prices have been chased up and then slammed down about 30% in the midst of the crisis. The rebates that have to be doled out to retain tenancies would mean that investors are not going to enjoy the same returns like in the previous years. In fact, SPH REIT has already fired the first salvo to cut the DPU payout by78.7% to 0.3 cents per unit for Q2 in FY2020. Some other REITs are likely to follow suit to avoid cash calls that they need badly at this time. It has been lucky that MAS threw a few lifelines to save the situation last week. The has helped to push up REIT prices somewhat. The short-term effect for retail investors, however, is the reduced DPUs in the coming quarters. This certainly is going to be an extremely difficult time if one were to hold a huge portfolio of REITs.         
  • Let’s face it. We never like to lose. Even when our stocks are declining, we think of ways how to win back. We cannot control the on-going stock prices, so what we try to do is to average down. But averaging down in a down market is bad strategy unless we are very sure of a turnaround. The worst thing is when we are averaging at the beginning phase of the down market. This is a very common problem, especially when an investor believes that he has sufficient fire-power to overcome the price decline. Before we know it, we have parted our liquidity and, certainly, the confidence that goes along with it. Assuming if an investor has a portfolio of worth $200,000 and cash of another $100,000. For simplicity, let’s say the whole portfolio is made up of only DBS shares at an average price of $25. This means that he has a total of 8,000 DBS shares at the start. If he were to buy 1,000 shares for every decline of $1, he would have accumulated 12,000 shares at an average price of $24.17 when he expended nearly all his cash. Unfortunately, the on-going share price is at $21 which is way below his average price. In the recent decline, DBS stock price had actually gone below $17, which is a 30% down from his average price. It is extremely daunting in such a circumstance. That said, it is also unwise not to buy stocks when their value emerged. Remember, during a stock avalanche, good stocks and bad stocks get thrown out as fund managers need to maintain liquidity. So, the best policy is to space out our purchases, buying in small quantities. To stifle my itchy fingers in this circuit breaker period, I embarked on a project that I never had a chance to embark on during other times. This was the result of the project. I believe only a segment of the population knows about this historical monument.

 Happy Investing!

Disclaimer – The above points are based on the writer’s opinion. They do not serve as an advice or recommendation for readers to buy into or sell the mentioned securities. Everyone should do his homework before he buys or sells any securities. All investments carry risks.

Brennen has been investing in the stock market for 30 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is the instructor for two online courses on InvestingNote – Value Investing: The Essential Guide and Value Investing: The Ultimate Guide. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

Posted in YZ-BANKS, YZ-E_commerce, YZ-REIT, Z-FINANCIAL EDUCATION, Z-INVESTMENTS, Z-Personal Finance, Z-STOCK INDICES | Tagged , , | Leave a comment

ComfortDelgro Ltd

Since the video on Covid-19 was made in the week immediately after the Chinese New Year (CNY), signs are now beginning to surface of the near-term situations of transport companies. ComfortDelgro (CDG), which has been facing a dwindling operating taxi fleet from more than 16,000 in the beginning of 2017 to slightly more than 11,000 by end of FY 2019, is likely to be affected further as the effects of Wuhan Coronavirus start to bite.

 Operating model

Sans the onslaught of the Covid-19 epidemic, CDG’s business model has been under pressure in a few fronts. First, the operating taxi fleet has been dwindling for the past 3 years due to the competition from ride-sharing cars. Over the last three years, the operating taxi fleet has been shrinking in size from more than 16,000 in early 2017 to a little more than 11,000 in end 2019. For FY2016, the operating profit against revenue of taxis were $167.5m and $1340.8m, while for FY2019, the corresponding figures were $104.2m and $668.2m respectively.

Although the bus operations in United Kingdom (UK) and Australia remain relatively free from serious disruptions in the recent years, the exchange rate of the British Sterling and Aussie dollars have declined against Singapore dollars. In effect the reported profit from these two fairly large contributors have been affected as well. In Singapore, the Public Transport Services remains relatively shielded due to the need for yearly review on transport fares.

With the spread of Covid-19 gaining momentum by the 1st quarter of FY2020, it is highly likely that the taxi business gets deteriorate further, both in Singapore and China. Taxi operations, in China contributes about 4% of the revenue and 9% of the total profit in FY 2019. Together with the taxi operations in Singapore, they form a very significant contributor to the group’s profit and revenue. So, the 1st quarter and even the 2nd quarter, is likely to turn out to be worse that Q4 2019, especially with the rebates that CDG has to pay to retain drivers.

The drop in earnings of Q4 FY2019, in effect pushed up the historical PE to above 20. Unlike 3 years ago when CDG was in net cash position, it is now in net debt position with less leeway for growth via acquisition. The pressure on the share price is likely to continue in the months ahead based on the calculated PE. With the dividend payout at 80% even after the recent dividend cut, it may be imminent that a further cut in dividend be expected in mid-2020 for cash conservation. The share price to sub-$2 or even sub-$1.90 is all possible, hopefully temporarily and get pass quickly.

Disclaimer – The above points are based on the writer’s opinion. They do not serve as an advice or recommendation for readers to buy into or sell the mentioned securities. Everyone should do his homework before he buys or sells any securities. All investments carry risks.

Brennen has been investing in the stock market for 30 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is the instructor for two online courses on InvestingNote – Value Investing: The Essential Guide and Value Investing: The Ultimate Guide. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

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Wuhan Coronavirus and the STI

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Digital Banks

Digital banks are banking establishments without brick-and-mortar presence. Technically, this would be unimaginable say twenty years ago. How can we be able to make what we called as bank transactions without the need of a physical bank? Thanks to the huge advancement in fintech (financial technology) developments, it has made it so convenient that one almost need not have to go to a bank to do many types of transactions, apart from the compulsory ones like opening or closing of accounts. Almost all our ‘conventional banking transactions’ can now be carried out online.

Naturally, the banking scene in Singapore has to move along with the changing times. Monetary Authority of Singapore (MAS) will be issuing two Digital Full Bank (DFB) and three Digital Wholesale Bank (DWB) licences for operating digital banks in Singapore. To date, 21 participants have submitted their applications in a bid for the 5 licences. The results will only be known by the middle of the year. Except for Sea Group, ByteDance and Art Financial who applied for the respective licence in solo, all the other applicants are newly-formed consortiums backed up by financially deep-pocket corporations. The results of the successful applicants will only be known by 20 June 2020.

But then, what is the impact on us as individual bank customers, business owners and incumbent bank shareholders amidst the dynamic business environment and the restrictions imposed by the regulators? As always, there is no fixed answer to this question. The only way to break down the issue and analyze them accordingly.

  1. Digital Full Bank (DFB) licence

The DFB licence permits the holder to take in deposits and operates like a brick-and-mortar bank. However, this can only happen when everything is in a ‘steady-state’ at least 3-5 years down the road after commencing operation. Before the DFB licence holder can reach this stage, it has to pass a series of ‘litmus tests’ to establish if the DFB can sustain itself as a full-licence digital bank.

While the paid-up capital for the first few years of operations is fairly low at $15 million, the real hurdle is the ceiling or the cap on the aggregate deposit and individual deposits. The imposed aggregate deposit of $50 million certainly pales against the incumbent banks’ deposits of between $290 billion and $380 billion based on their FY 2018 annual report. As it is, the cap on each deposit stands at $75,000, and this can only be come from the shareholders, employees and related parties. Subject to banks’ capital ratio requirements, it also means that there is a limit in which the DFB can lend out.

At the first instant, the conditions may appear to be very draconian. How can the digital banks compete with the existing goliaths? Why does the authority even bother to issue out digital bank licences only to make the DFBs unable to survive?  First and foremost, the idea of having digital banks is not to take away businesses from the existing brick-and-mortar banks. If, by doing so, means using digital banks are able to chip away businesses from existing banks, then it totally missed the whole point of having digital banks. In fact, any simple person would have envisaged that DFBs would raise the deposit rate to attract funds even at the expense of their short-term profitability. Certainly, this will cause huge disruptions to the incumbent banks as there is a huge pool of depositors looking for higher interest rates to park their money. This is not what the authority wants to achieve. Their primary objective is to enable the non-bank corporates to innovatively create products for the unmet, un-serve or the under-serve segments, in particular the SMEs. That explains why the initial deposits have to come from the DFB’s shareholders, their employees and the related parties and not any other depositors looking for higher interest rates. The relatively small aggregate deposit of $50 million also presents a challenge for the DFB to bit-size their loans to mitigate their lending risk, and to make use of their enterprising experience in non-bank businesses to make the DFB work. It is only after these restrictions are lifted, perhaps 3-5 years down the road, before the DFBs can operate as a full-fledge digital banks co-existing with the incumbent brick-and-mortar ones. Only then would the paid-up capital be increased to $1.5 billion. Perhaps, the final paid up capital requirement may not be the real issue as most of the applicants are backed up by deep-pocket corporates. However, to build up the whole eco-system to match that of the incumbent banks remain an uphill task. Thus, in the retail space, at least, the incumbent banks have a 3-5 years lead before they are subject to the real competition from the DFBs. In fact, in the last few years or so, the incumbent banks have already built sufficiently strong ecosystems well-protected by thick firewalls for the DFBs to break through. This should serve as an excellent economic moat against the DFBs for the time being.                 

  • Digital Wholesale Bank (DWB) licence

Unlike the DFB, the DWB capital requirement is lower and so is the foreign ownership restrictions.  Although head-quartered in Singapore, the motivation really is to serve the Asean region, which is generally underserved. The paid-up capital for DWBs is $100 million, which in my opinion, is not high in view that most of the applicants have deep-pocket financial backers. While the DWBs are not allowed to take in Singapore dollar deposits, they can take in current account deposits. So, if they are able to correctly provide the market with the right offers, then they are just as good as the DFBs. In fact, given that the DWBs are not subject to any deposit caps, they may even able to surpass the DFBs in terms of aggregate deposit. More so, is the fact that current account deposits attract less interest, meaning that the DWBs, in effect, have a lower cost of fund.

The battleground

For the start, the battleground for the digital banks, or digibanks in short, can be lumpy, fill with potholes and can be quite piecemeal. Given the incumbent banks’ long existence in the local scene, the juicy parts of the whole traditional banking business have already been sapped out. In the local deposit space, the incumbent brick-and-mortar banks made up of the three local banks, foreign full-licence banks and finance companies have already laid their hands in it. In fact, it was said that 98% of Singaporeans above the age of 15 years old have already have a bank account. However, that cannot be said of the region at the moment. More than two-third of the population in Myanmar, Vietnam, Indonesia and Philippines do not have a bank account. So, in the long-term when the DFBs become full-fledged digibanks, they could possibly slice out a piece of the pie of these un-served individuals, just like what the local brick-and-mortar banks have been doing in the recent years.

Then there are changes in consumer behavior and the rise in the use of apps. All these have a part to play in levelling the playing field between the digibanks and the traditional ones. Paper cheques are now push into near-obsolescence. Many, if not all, C2B payments can be made via credit cards, bank-apps, ecommerce platforms and e-wallets rendering all these transactions to become cashless, and blurring the functions between a bank or a recipient company. This is where the strengths of ecommerce companies strength are. Shopee, whose parent company SEA is one of the several ecommerce applicants for a DFB licence, has 100 million mobile users under its belt. This could easily dwarf the 10 million DBS bank customers by 10:1. In fact, all the participants vying for the digibank licences have huge data bases many times the population of Singapore. While the incumbent banks have a lead in terms of their digitization investments, the digital banks have parents, who possess a huge network of consumer data.

Finally, there is the SME segment. Whether B2B, C2B or B2C transactions, they have been made so seamless that we almost do not need, or at least, to perceive not to require a bank intermediary for these transactions. While the physical banks have entrenched deeply in this space, I think it is only a matter of time that the deep-pocket digibanks could close up the gap. In fact, I think this space could be the first cross-fire between the brick-and-mortar banks and the digibanks when they commence operations.

Effect on the brick-and-mortar banks

Certainly, it would be too naive to pretend that digibanks have no effect on the profitability of the brick-and-mortar banks in the long run. There will certainly be some impact if everything remains static. A lot depends on how the development of the digibanks is going to pan out and what the incumbent banks are doing to maintain their lead. If the incumbent banks are able to continue to successfully penetrate into the foreign markets while maintaining the stronghold position in the local scene, then the impact of the digibanks on the incumbent banks may not be so great or even negligible. That said, we should not forget that our neighbouring countries, are also planning to issue out digital bank licence pretty soon. That again could hamper the market development of both the brick-and-mortar banks and the digibanks going forward.                          

Disclaimer – The above points are based on the writer’s opinion. They do not serve as an advice or recommendation for readers to buy into or sell the mentioned securities. Everyone should do his homework before he buys or sells any securities. All investments carry risks.

Brennen has been investing in the stock market for 30 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is the instructor for two online courses on InvestingNote – Value Investing: The Essential Guide and Value Investing: The Ultimate Guide. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

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