RBNZ cash rate unchanged

The Reserve Bank of New Zealand (RBNZ) left the official cash rate (OCR) unchanged at 3.5%. The rate statement suggested some softening in global economies apart from the US.

A strong construction sector, high net immigration and historical low interest rates continue to support the expansion of the economy. In addition, it is important to note that a further depreciation of the New Zealand dollar is expected.

FOMC does not make sense: Ending QE and expecting inflation to rise

The Federal Reserve (Fed) is set to end its quantitative easing programme end of this month. The asset-purchase so far has added $ 1.66 trillion to the Fed`s balance sheet. 

In the Federal Open Market Committee (FOMC) press release, it was stated that labour market conditions improved "with solid gains and lower unemployment rates." Everything else seems in place except the housing market which recovery is still sluggish. 

Slowness in the global economy and low inflation levels are key risks the Fed needs to combat. Ending quantitative easing (QE) means pumping less cheap money into the US economy, slowing down recovery and driving inflation rates down.
Narayana Kocherlakota, the Minneapolis Fed President dissented "in light of continued sluggishness in the inflation outlook and the recent slide in market-based measures of longer-term inflation expectations, the Committee should commit to keeping the current target range for the federal funds rate at least until the one-to-two-year ahead inflation outlook has returned to 2 percent and should continue the asset purchase program at its current level."

Clarence Lim, a trading associate remarked that the decision to end QE does not make sense although he acknowledges "QE is no longer the fad". 

Business confidence doubles in New Zealand

The ANZ business confidence doubled to 26.5 in October. The report`s subheading "Feeling wheelie good" indicated that business conditions are improving.

Business confidence in Germany drops

Bloomberg mentioned that the German business confidence dropped for the sixth month now, highlighting more trouble in the Eurozone. The confidence level dropped to 103.2, worse than last month`s 104.7.

Economic news/data for the week

On Tuesday, the RBA released its monetary policy minutes. The cash rate is left unchanged at 2.5%. This was then followed by China`s GDP. The economy grew a tad more than expected at 7.3% but still 0.2% off the GDP from the previous period. In addition, the industrial output at 8.0% beat estimates and prior data.

With the acceptable Chinese GDP, the Australian consumer price index (CPI) beat forecasts by growing at a pace of 0.5% on Wednesday. This is the same level as the previous quarter.

In the evening, the Monetary Policy Committee (MPC) released its asset purchase facility votes and bank rate votes. Both were unchanged, in line with expectations. US CPI grew by 0.1% after last month`s disappointing contraction of -0.2%. The core CPI displayed the same number but did not meet the target rate of 0.2%.

It was New Zealand`s turn on Thursday. The CPI remained at 0.3%, failing to meet estimates of 0.5%. China`s HSBC flash PMI manufacturing indicated a growth in the manufacturing sector. The flash PMI bettered estimates and September`s results. More bad news for the Eurozone as the French manufacturing sector contracted yet again as seen from the flash PMI`s uninspiring numbers.

However, Germany did show a growth at a flash PMI of 51.8, ahead of estimates and the previous month. UK retail sales dropped to -0.3%, worse than what economists predicted and last month`s rate. The unemployment claims in the US rose by 17 thousand this week, not what economists predicted.

Finally on Friday, New Zealand`s trade balance stood at -1 350 million. This deficit is more than double of what was expected. UK`s preliminary GDP met the forecast of 0.7%, although this figure is still less than the previous quarter. New home sales in the US increased by only a thousand, falling short of the target sales of 473 000.

First meal in 40 hours

I`ve missed out a number of high importance data from Tuesday. I had a bad case of food poisoning and only recently had a meal since Wednesday night.

I`ll summarize the necessary data I`ve missed in a single post.

ECB is purchasing covert bonds

The European Central Bank (ECB) acquired short-term French and Spanish notes. The IMF has projected a growth of 1.3% next year, down from the 1.5% predicted in July by Mario Draghi. The bond purchasing is expected to improve the deflation risk Eurozone has been facing so far.

With the additional money supply pumped into the economy, the Euro should depreciate against major currencies. EUR/USD is looking good to short for those who have not entered.

Vix index

The guardian has a write up on the Vix volatility index. It`s a good article as it is written with a layman approach.

How to make a million dollars

I was reading "The Millionaire Messenger" by Brendon Burchard yesterday. To be blunt, it`s one of the less interesting/ impactful books I`ve read this year. Do not be fooled by its philosophical title, the focus is on informational marketing. However, there is one chapter that stands out regarding cash flows.

As per title, how to make a million dollars? The idea is this, conduct a seminar that charges $ 1 000 per person and get 1 000 people to attend (at once or through multiple seminars). There`s your million, as simple as that.

This of course is an extremely basic and theoretical approach on cash flows and one of the reasons why this is not the kind of book I would recommend others to pick up and read. The ideas are too simple and the content lacks any real depth to be impactful. I feel that the book is just another tool for the author to sell his advanced programmes. In addition, the author constantly brags on how much he can charge his clients.

1.02 million new building permits approved

Slightly over a million new home construction took place in September. This is a growth of 6.3% from August`s 957 000.

Tune Ins

Tune Ins was my favourite counter last year as it had solid fundamentals and its price range was easy to predict. It peaked to nearly RM 2.50 this year before dropping below RM 2 this week. Here are my findings from the 2013 annual report.

Income related: 

- Revenue growth of 30.85% (geometric growth).
- Net claims increased by 116%.
- Net claims rate per revenue of 24.2% in 2013 as opposed to 19.18% in 2012.
- Fees and commission expenses nearly doubled.
- Finance costs dropped to just 20% of the cost in 2012.
- Management expenses nearly doubled.
- EPS of 9.29 cents in 2013 versus 16.25 cents in 2012.

Cash flow related:

- Net cash from operating activities dropped by RM 30 million in 2013.
- Investing activities only used RM 2.7 million in 2013 compared to RM 79.2 million in 2012.
- Financing activities show a positive inflow of cash due to the issue of new shares.

Notes to the financial statements:

- In Note 17, the company was given a loan of RM 160 million. The weighted average effective interest rate at 6.25% is way higher than a standard bank loan.


Valuations 

1. Book value plus model would put it at RM 0.52 per share.
2. EVA gives a meager RM 0.07 per share.

Intrinsically this counter is not at a discount. The fundamentals may be solid, but its charm has slightly eroded compared to its performance last year.

S&P yearly gains wiped out

The global stock market continued its bearish tone today, with the S&P falling by 1.2% today, losing its gains for the year. Crude oil fell below $80 per barrel  and 10 year Treasury yield lost 7 basis points.

I recommend reading this article from Bloomberg.

Industrial production advanced

The industrial output in the US grew by 1%, bettering estimates and last month`s -0.2% decline. Bloomberg stated that this is the best increase since November 2012.

After the unexpected drop of the USD/JPY pair earlier this week , fundamentals would dictate that is it possible to long this pair with the solid results today.

Jobless claims at a 14 year low

The weekly unemployment claims in the US decreased by 23 000 to 264 000. According to a Bloomberg reporter, "it is rare to go this long below 300 000."

More red data from US: Consumers are taking a break

Core retail sales contracted by -0.2% as opposed to a forecasted growth of the same number after recording a growth of 0.3% in August.

Retail sales missed targets as well, contracting by -0.3% while economists were predicting a smaller decline of -0.1%. Bloomberg said consumers are taking a breather.

The third miss for the day, the producer price index (PPI) decline to -0.2%, worse than the stagnant results of August. This is good news for consumers but bad for companies and investors.

I should have held on to my short positions in USD/JPY much longer.

Unemployment falls in UK

The unemployment rate in the UK fell to 6%, better than the forecasted 6.1% and an improvement over last month`s 6.2%.

However,  only 18 600 less people filled for unemployment benefits. This is uninspiring after last month`s solid 33 200 less claims.

The average earnings index remained at 0.7%.

Inflation in China slower than expected

Following yesterday`s poor trade balance data, the consumer price inflation (CPI) fell to 1.6%. Economists were expecting 1.7% after last month`s 2.0% growth.

Further economic slowdown in Germany expected

The ZEW indicator of economic sentiment suggests a further economic slowdown in Germany is expected. This is certainly bad news for the global economy. China, UK and Germany have missed the targets of high importance economic data this week and one may start to wonder when to pull out from equity markets in anticipation of the next recession.

The indicator showed a contraction of -3.6. This misses estimates of 0.2 and the prior period`s 6.9.

The ZEW press release can be viewed here.

UK inflation lower than BoE`s expectation

The Consumer Price Inflation (CPI) grew by 1.2% in September, less than the target of 1.4% and the prior period`s 1.4% inflation growth.

The key points from the CPI report are:

• The Consumer Prices Index (CPI) grew by 1.2% in the year to September 2014, down from 1.5% in August.
• Falls in transport costs (notably sea fares and air fares) and prices for a range of recreational goods provided the largest contributions to the slowdown in the rate of inflation between August and September.
• Housing & household services (including utility bills) accounted for a third of the rate of inflation in the year to September. If falling food and motor fuel prices were excluded, the rate of inflation would be a third higher.
• CPIH (not a National Statistic) grew by 1.2% in the year to September 2014, down from 1.5% in August

Business confidence in Australia is low

The NAB business confidence survey is at a worrying level. According to Business Insider Australia, the confidence level is at its lowest since the election.

Potential in Censof?

A number of friends have added Censof Holdings Bhd (Censof) to their portfolio. Let`s take a look at this counter`s intrinsic value. Censof is not undertaking any mergers or acquisitions exercise, hence the valuation techniques used are from my part 1 article.

The values used for this post are derived from the 2014 annual report.

1) Book value plus model

	(RM)`000
Total value of net assets	411 722
Less: Intangibles	63 554
Non-current liabilities	(76 862)
Net value of equity	398 414

Total number of shares (Note 16 in the financial statements) = 399 576 (`000)

Value per share = Net value of equity / total number of shares

                          = 398 414 / 399 576

                          = 0.997

The book value plus model gives an intrinsic value of close to RM 1 per share. 

2) Economic Value Added (EVA)

Weighted average cost of capital (WACC) calculation:

(i) Cost of equity = Dividends per share/ Share price
(Note: I`ll assume the share price used for this calculation is the market value today, which is RM 0. 585)
                            = 0.01 / 0.585

                            = 0.0171

                            = 1.71%

(ii) Cost of debt

Ignoring any adjustments, I`ll use the interest paid over total borrowings.

                           = 3 835 / 152 549
                           = 0.0251
                           = 2.51% 

(iii) WACC = [ 0.0171(39 960) + 0.0251(152 549)] / 39 960 + 152 549
                    = 0.0234
                    = 2.43%

EVA = NOPAT - (WACC x Book value of capital employed)

         = 4 129 - 0.0243(39 960)

         = 3 157.97

Value per share = 3 157.97 / 399 576

                          = 0.0079

EVA would give this counter a value of RM 0.0079 per share.  


3) Market Value Added (MVA) 


The MVA is simply the present value of EVA and in line with, it gives too low a value for a meaningful comparison.


Conclusion 
If compared to the book value plus model, this counter is trading at a discount. However, the economic profits are meager which should raise the alarm for value investors. In addition, the level of debt of this company is rather high, exceeding the value of equity. 

Regular, accounting profits would give an earnings of RM 0.30 per share. This translates to every RM 1 invested in Censof makes RM 0.51. 

Bursa closes below 1800 post Budget 2015

The KLCI index closed at 1792.2, close to a 12 point drop from Friday.

A sharp selloff happened after 4 pm causing the index to fall below 1800 level.

Mr Clarence`s prediction was correct.

China`s trade balance drops in line with the global economy

China`s trade balance dropped to 30.1 billion from an estimated 41.2 billion and the previous month`s 49.8 billion.

This data is in line with the global economy slowdown.

Valuation of acquisitions (Part 2)

In part 2 of my acquisition series, we`ll head over to type 2 acquisitions where the acquiring company is exposed to financial risk only. Business risk remains unchanged here.

The average investor/ trader would rarely use this method to intrinsically value a counter unless there`s an acquisition that changes the financial risk of the joint entity.

An example of this type of acquisition is the recent merger between CIMB, RHB and Malaysian Building Society. Fundamentally, all three companies are involved in a similar business but the financial risk is changed due to the differences in capital structure and debt.

Think of the acquisition in terms of a project, when the capital structure changes, the adjusted present value (APV) model is used. This model can indicate how the net present value of a project (or in this case, an acquisition) is affected by the difference in financing. An acquisition is valued by discounting the free cash flows by the ungeared cost of equity followed by adding the present value of the tax shield.

APV = Value of target company (Fully equity financed) + PV of debt tax shields - Initial investment 

Steps:

1. Calculate the net present value as if it is ungeared.

2. Add the present value of the tax saved from the debt interest payments.

3. Deduct the debt of the target company to arrive at the value of equity.

4. Minus out the cost of acquisition to arrive at the net equity figure.

US indices are taking a beating

Go over to bloomberg for the article.

S&P 500 dropped 1.1% to 1906.13 points. This is more bad news for Bursa.

Mr Clarence, a trading associate predicted that Bursa Malaysia will fall below 1800 on Monday and a recession is scheduled for 2016.

Bursa Malaysia is not healthy

Bursa Malaysia certainly was not pretty today with the much awaited budget causing investors to be vary, the index fell 20.85 points, a -1.14% decline to close at 1808.88 points today. This level is a 6 month low for Bursa.

From a purely technical point of view, the index failed to break its resistance at 1880 points. Chartists would have noticed a triple top formation, testing resistance once in August and twice in September. Buying power was not powerful enough to propel Bursa to the 1900 mark.

The first Williams %R crossover was on 25/08 alerting investors of a potential sell. This trend repeated itself on 29/08 and 10/09.

The moving average convergent divergent (MACD) indicator had prominent crossovers of the red signal line as early as mid July and mid September to confirm the Williams %R results .

Expect the new support to be at a wobbly 1800. Monday is a crucial period to see where Bursa will head post budget 2015.

This is a historic comparison of the index in 2012, 2013 and 2014. The present level is approaching dangerously close to where the index was last year.

Weekly jobless claims drop

The weekly unemployment data showed improvements, 1000 less people filled for unemployment claims this week. This brings the unemployment claims for the week at 287 000, beating what economists` predicted at 291 000 by a respectable margin.

No change in UK asset purchase and bank rate

The Bank of England maintains the bank rate at 0.5% and asset purchase at 375 billion.

Rating it yourself: Kaplan-Urwitz model

Ever wondered how rating companies like Standard and Poor or Moody`s issue credit rating? These credit rating companies use a combination of statistics and financial ratios to arrive at a credit score.

Over time, researchers have tried to predict the formula used by these companies and one of the models used in financial management is the Kaplan-Urwitz model. There are separate formulae for quoted and unquoted companies:

1) Quoted companies 

The formula for quoted companies is given as:

Y = 5.67 + 0.011F + 5.13π - 2.36S – 2.85L + 0.007C – 0.87β – 2.90σ

Where

Y = The score the model produces

F = Size of the firm (Total assets) 

π = Net income / total assets 

S = Debt status ( subordinated debt = 1, else = 0)

L = Gearing (Long term debt / total assets)

C = Interest cover (PBIT / Interest payment)

β = Beta of the company from CAPM 

σ = Variance of the residuals from CAPM equation

 ( √(σ² – β² – σ²_m ) )

where σ²_m is the variance of the market

 2) Unquoted companies 

There is a subtle difference in the constants of the equation and no beta is present given this is a company that is unquoted. 

Y = 4.41 + 0.0014F + 6.4π - 2.56S – 2.72L + 0.006C– 0.56σ

 Where (Only σ is different from the top)

Y = The score the model produces

F = Size of the firm (Total assets) 

π = Net income / total assets 

S = Debt status ( subordinated debt = 1, else = 0)

L = Gearing (Long term debt / total assets)

C = Interest cover (PBIT / Interest payment)

σ = Standard deviation of earnings


Credit rating categories 

Score (Y)	Rating
Y > 6.76	AAA
Y = 5.20 – 6.75	AA
Y = 3.29 – 5.19	A
Y = 1.58 – 3.28	BBB
Y = 0 – 1.57	BB

For those with Harvard log in credentials, the full research can be obtained here.

Reference:
1. ACCA P4: Advanced Financial Management. London: BPP, 2013. 230-32. Print