PERSPECTIVE | 06 MARCH 2009
Tempting But Investors Resisting Lure Of Cheap Stocks
It is easy to forget about valuations especially in a super bear market where fear overwhelms common sense and logic. It is funny how we all chase after things that are expensive but shunning the same thing when it is cheap, and this can only be explained by the simple reason that we fear today’s seemingly low price will become even lower the next day.
Fear is such a powerful weapon so much so that it can totally knock all sense out of us: We buy and sell at the wrong time and mistakes are often painful.
I remember writing about sentiment being a far important factor than fundamental analysis and/or technical analysis whenever fear grips investors. At this moment, although fear factor is not as high as it was back in October/November, investors have turned despondent and have almost given up hope with some even not bothering to watch the stock market because bad news and more bad news are being reported by the media on a daily and hourly basis.
Nightmare On Wall Street
Watching the DJIA in action was better than watching the famous horror epic “Nightmare on Elm Street”, as Wall Street played out its own version of a horror show.
During the fortnight, the Dow Jones Industrial Average (DJIA) shed about 800 points from 7,555 to 6,726, breaking the October low of 7,449 with the utmost ease and traded to a 12-year low. While there was no fresh spark that triggered the selling, investors just cannot wait to get out of the market – a sign of desperation and exasperation rolled into one.
At the same time, the Straits Times Index (STI) was a battlefield for the bulls and the bears who tried to slug it out in search of a direction. For most part of early-to-mid February, the STI traded sideways refusing to budge even when the US and regional bourses rallied or tanked, with the bears securing a decisive victory on 16 February when the STI went below 1,650 and then tested the next support at 1,570.
In the previous issue of Shares Investment, I mentioned that the STI could test 1,570 and may even overshoot this support if the DJIA were to fall below 7,450. On the other hand, I also mentioned that the STI could move to 1,750 if the DJIA were to go above 8,000 in the most bullish scenario. We were unfortunate that the former came true and the STI had indeed gone as low as 1,502 but had since rebounded on the same day to close at 1,544 on 4 March.
As a matter of fact, all the major regional indices including the Hang Seng Index, the Nikkei 225, the STI and the Shanghai Composite Index did not revisit the October lows while the US indices, the European indices as well as the Australian and Kiwi indices all fell below October levels.
Of all the indices, the Chinese stock market fared the best with a blockbuster 700-point gain from 1,700 to 2,400 from October to February. This phenomenon tells a tale, as it clearly highlights what the world thinks of the Chinese economy and, to a smaller extent, the Asian economies.
Can We Pin Our Hopes On China?
Most people hope that China can help us out of this rut, with the exception of a handful who thinks that their respective economies have the divine right to be the messiah that we have all been crying out for.
No matter who the messiah is, the sooner we get out of this rut, the better it is for everybody.
China is the only major growing economy and with a reserve of some US$1.45 trillion, has the ability to spend its way out of trouble while helping others along the way. Some signs of China being the first to get out of trouble have appeared in the form of the February Purchasing Manager’s Index rising to 49 from 45.3 a month ago. At its worst month in November, the PMI read just 38.8. This is a sign that its US$585 billion stimulus package may be working.
Also, Premier Wen’s remarks that surging loans, growth in retail sales in January, and an increase in electricity output and consumption from the middle of February are signs that government measures are working, which may aid in the first-half recovery of China’s economy.
Most importantly, export orders, which make up a huge chunk of China’s Gross Domestic Product (GDP), rose to 43.4 from 33.7 while employment rose for the first time in six months from 43 to 46.1.
According to reports, government officials have indicated that the authorities may pump in RMB8-10 trillion of “government-sponsored investment” while an expanded stimulus package has been rumoured to be on its way to speed up the recovery.
All these measures, together with the “encouragement” of more lending by banks to unfreeze the credit market, will to a big extent boost an economy that is already strong, in relative terms.
Stocks across the board are looking cheap but buyers do not seem to be suitors as yet. If we were to talk about financial stocks, investors are worried that the contagion effect of a weak US financial system coupled with a weakening global economy may hit the three local banks even further in the next few quarters when non-performing loans start to grow. This is the main reason for the share price of the three banks being hammered.
If stocks were trading at 2X historical earnings, way below the net asset value, then what is stopping investors from jumping at this opportunity?
Flipping through Shares Investment has revealed that former darlings such as Celestial Nutrifoods (CEL) and China Hongxing (CHX) are both trading at 1.6X and 4X FY08 earnings, respectively. On a price to book basis, CEL is now trading 0.17X ($0.125 versus $0.732) while CHX trades at 0.34X ($0.10 versus $0.34).
Ridiculous? There are more such examples but these two companies deserve a closer look despite the troubles that investors believe they are in.
CEL continued to report growth in its net profit for FY08 but 4Q08 showed a profit decline primarily due to higher soybean prices despite higher selling prices. The point of contention now lies in the fact that its cash position (RMB811m) is lower than its debt (RMB1,225m) – a taboo in today’s market – arising from its convertible bonds that could be redeemed as early as 19 June this year. The market now speculates that CEL could follow in the footsteps of Ferrochina and become insolvent in the event that it fails to source for the funds that could allow the company to face redemption.
The more the share price falls, the higher the fear factor will become despite the management reassuring investors that it has several proposals on the table regarding the refinancing on the convertible bonds.
In the case of CHX, and also CEL, the failure to declare dividends for FY08 has also raised fears that both companies are in financial trouble. Although CHX also reported net profit growth for FY08 despite a profit decline in 4Q08, investors are concerned about its business model of providing advances to its distributors for running stores. The amount of RMB1.15b advanced to these distributors is feared to have been “lost” or “uncollectable” and hence the selloff in the share price of CHX.
The RMB1.15b aside, CHX still has RMB1.98b in cash, which translates into about a cash value of $0.149 per share – a premium of almost $0.05 per share over its last done price of $0.10. If an investor were to buy into this stock at $0.10, he would be covered by almost $0.15 in cash and getting the entire shoe/sports operation of CHX for nothing!
Of course the risks involved in buying these two stocks are high, especially if we were to consider the worst-case scenario. But if both companies were to pull through, the rewards could be high especially when CEL owns the hi-tech soybean zone in Daqing City as well as a biodiesel fuel ready for production in 1Q09 while CHX is one of the top five sports shoe brands in China.
Where Do We Go From Here?
A short-term rebound looks likely at the time of writing with the DJIA up more than 100 points 6,830 on 4 March. Should the DJIA not falter for the next two trading days, it is likely to test the resistance at 7,100 before it meets 7,450. While the former looks possible, the resistance at 7,450 looks quite out of reach for now.
Rallies for the past few weeks have been a flash in the pan and nothing more than that. The short-term target for the STI is at 1,570 followed by 1,600 and 1,650. Nothing has changed fundamentally and rebounds are still very much technical in nature and, thus, weakness should follow almost immediately.
Stay nimble and sell into rallies for now.
Comment: Very good article except for the final sentence asking to "stay nimble and sell into rallies for now." We all know what happened to the market after March 2009.
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