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Thursday, January 30, 2014

Runaway prices of M'sian small-cap stocks point to signs of overheating.


PETALING JAYA: After galloping to historic highs last year, are small-cap stocks at risk of a bubble? Yes and no, said market watchers.
For Hwang Investment Management head of equities Gan Eng Peng, the small-cap sector is looking increasingly frothy.
“It is a case of too much money chasing the same space. Half-baked business models and unproven management are rewarded with a spectacular run in stock prices.
“From experience, we know this kind of event corrects itself in time,” he told StarBizvia email.
There are many reasons why small-cap stocks have seen a “feeding frenzy” leading to outsized gains over the past year, with the FTSE Bursa Malaysia Small Cap Index rising 36% in 2013 versus 12% for the benchmark FTSE Bursa Malaysia KL Composite Index (FBM KLCI).
One of them is “trapped liquidity”, along with the “structural premium” caused by the presence of large domestic investors, Gan pointed out.
“Stocks in Malaysia trade at a 30%-100% premium to similar businesses listed overseas. You can see this in plantation, and oil and gas (O&G) counters.
“Other examples include CIMB Group Holdings Bhd and Axiata Group Bhd, whose Indonesia-listed subsidiaries trade at less than half of their Malaysian parents, despite being their key growth drivers.
“As long as domestic liquidity is intact, investors would put money in the small- and mid-cap space for the simple reason that there is more ‘value’,” he explained.
But don’t rule out this sector just yet. While the shelf life of a bubble can be hard to predict, they always have the best returns towards the end, according to Gan.
“The challenge is to figure out when the party will end. Froth can last for sometime, and riding it can be a very rewarding process.
“First, know the context of the market you are investing in. Be aware that easy money made is not fundamentally driven. Second, invest with caution and be nimble, as things could turn eventually,” he said.
If, or when, the ground shifts, institutional investors will all try to get out of the “same small door”, Gan quipped.
And in the event of a selldown, small-cap stocks are unlikely to enjoy the same buying support as blue-chip counters.
Gan noted that Hwang Investment Management’s small-cap portfolio had returned 63% over the past two years, 47% of which was recorded in 2013 alone. His strategy is not to be “sucked into obvious plays”.
“We think such a strategy, combined with an eye on when things could go wrong, would allow us to generate decent returns this year if the frothy market holds up,” he said.
The Small Cap Index was trading at a current price-to-earnings (PE) multiple of 20.9 times, compared with 17.1 times for the FBM KLCI, but a forward PE of 10.4 times, against the FBM KLCI’s 15.8 times, Bloomberg data showed.
Danny Wong of Areca Capital Sdn Bhd, however, takes the opposite view.
“There is no bubble in small-cap stocks. If you look closely, the rally was not broad-based, but limited to select counters.
“Our bias this year is actually toward the small-cap sector, where we still see value despite the run-up in prices,” he told StarBiz.
Wong, who is chief executive officer of local fund house Areca, said he expected small-cap stocks such as Inari Amertron Bhd and Globetronics Technology Bhd to benefit from improving electronics and electrical exports, as well as a stronger US dollar and growing demand for consumer electronics.
Wong believes other stocks that may be worth watching include O&G plays Barakah Offshore Petroleum BhdUzma Bhd and Coastal Contracts Bhd, while smaller-sized glove makers Kossan Rubber Industries Bhd and Hartalega Holdings Bhd have room for upside.
Eastspring Investments Bhd chief investment officer for equities Yvonne Tan also does not believe that small-cap stocks are setting up for a bubble.
“The rally in small-cap stocks was due to a PE expansion and rising appetite for small-cap ideas, as well as earnings growth. The Small Cap Index is trading at a significant discount to big-cap stocks.
“For select small-cap stocks, their risk-return is favourable vis-a-vis large caps. We see plenty of opportunities in the small-cap space.
“There are stocks with double-digit earnings growth trading at attractive valuations,” she said.
Credit Suisse had told clients in a December note that Malaysian small-cap stocks were poised for a difficult year amid a freeze in pre-election goodies, the Government’s subsidy rationalisation and rich valuations.
In particular, the research house highlighted that the premium between large- and small-cap stocks had narrowed to 6%, a far cry from the long-term average of 21%, which has the effect of boosting the attractiveness of blue-chip counters.
Citing an example, Hwang’s Gan remarked that news of Government contracts was all it took to lift the market capitalisation of a small-cap counter to nearly RM800mil from RM100mil just months before.

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