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Wednesday, May 15, 2019

Labour is lowly paid but not underpaid in Malaysia

Tong's Value Investing Portfolio as of May 9, 2019

With the one year anniversary of the Pakatan Harapan-led government now in the rear view mirror, one thing is certain – much more remains to be done. In particular, the issue of rising cost of living continues to top surveys as the biggest challenge for Malaysians.

Over the past year, the government has implemented various measures to tackle high living costs, including the reversal of the goods and services tax (GST), reinstating a cap on petrol prices, cutting broadband costs and launched a fixed-priced monthly public transportation pass. It is also looking to dismantle monopolies to promote competition and hopefully, lower prices.

But whilst these moves have tempered inflation, somewhat, costs have not fallen. Anecdotal evidence suggests the average Malaysian is still struggling. There is no question that the situation needs to improve further. We know this. The government knows this.

We could probably reduce costs further by leveraging technology and the sharing economy over the longer-term. But unless, there is outright deflation (which is actually bad news for economies), to raise living standards, we must address the other key issue – wages, income growth and job opportunities.

Ask anyone and they will, almost unequivocally, tell you that salaries are too low, and have consistently failed to keep pace with inflation. This is borne out by the downtrend in national savings rate and rising household debt levels in the country. Malaysians are saving less and borrowing more to maintain their lifestyles.

This perception appears vindicated by a recent Bank Negara study, which starts with the conclusion that Malaysians are not being paid enough for every US$1,000 worth of output produced, compared with that in Singapore, Australia, the United Kingdom, US and Germany.

Labour as a percentage of GDP is also below prevailing levels in these benchmark countries, implying that the greater share of national income is going to capital owners. (See Chart 1) Although the study goes on to delve deeper into the underlying causes and suggested solutions, it was the headline that struck a chord and stuck – workers are underpaid.

Making any conclusion based on labour as a percentage of GDP has to be an over-simplification and theoretically flawed. For one, we should take into account the differences in the structure of economies.

Our services sector, for example, is much smaller as a percentage of GDP (see Chart 2). Also, the components that make up the sector are important. If our services sector continues to be driven by employment for maids, retail and restaurant workers rather than software engineers, then naturally, wages (and share of income) would be low. But this is not our focus this week, though we may explore this in the future.

What we want to focus on is this: Whilst we agree that Malaysians are “lowly paid”, we do not believe that the majority are “underpaid”, contrary to the views held by many. Why do we say this?

Economists classify resources needed to produce goods and services as factors of production – traditionally, land, capital, entrepreneurship and labour. We simplified this equation into:

Returns on factors of production = Returns on Capital employed + Returns on Labour employed

N + i + l = kC + L

N = net profit
i = interest expense paid
l = wages, salaries, bonus, etc.
C = total capital employed
k = required rate of return on capital (weighted average cost of capital, WACC*)
L = economic return on labour employed

N + i – kC = L – l

Thus, if N + i – kC > 0, then L > l
This means, actual payment to labour is too low relative to economic return to labour

If N + i – kC < 0, then L < l
This means, labour is overpaid, relative to economic return to labour

* WACC = [Equity/C x cost of equity] + [Debt/C x cost of debt]
Cost of debt = Total cost of debt x (1- effective tax rate)
Cost of equity = risk free rate + beta (expected market return - risk free rate)
Using the above formula, we tabulated the actual financial performance for companies listed on the Bursa Malaysia, 769 in all, based on their latest available annual reports. (We excluded financials and real estate investment trusts as they have different reporting formats as well as plantation and oil & gas stocks, where earnings are heavily dependent on volatile commodity prices.)

What we found was that just over one-third of the companies have N + i – kC > 0 while for the remaining majority, N + i – kC < 0.

This suggests that for two-thirds of all the companies, labour is, in fact, “overpaid”.

Put it another way, N + i < kC.

What this means is that even when companies are profitable, their returns are, in fact, below the required rate of return based on total capital employed and risks.

The issue, therefore, is not about companies not paying their workers enough. Truth of the matter is, many businesses simply cannot afford to pay more – given that capital is also not getting sufficient returns. Returns, in fact, have been falling for some years now.

From 2010-2017, investments (net capital expenditure) have grown at a compounded annual rate (cagr) of 7.9%. Sales, on the other hand, have increased at a slower annual rate of 5.7%. Crucially, Ebitda and net profit have expanded even slower, at only 4.1% and 3.6%, respectively. In other words, investments are not generating enough sales and margins (profitability) are falling.

Businesses cannot pay labour more at the expense of capital. To do so will only drive down new investments. Instead, we must understand and address the more fundamental challenge – of why total returns on factors of production (capital and labour) are low.

These numbers underscore what some of us already know, that the persistently sub-par corporate results are reflective of much deeper structural issues.

Although capex is growing, expenditure for research & development is small. As a result, goods produced are low value added and investments are not generating productivity improvements. These make it increasingly harder for local companies to compete in global markets.

Businesses are not innovating and capitalising on advancements in the knowledge economy and use of technology. This could be related to issues such as the quality of education, lack of training and upskilling, skill set mismatch, availability of cheap low-skill foreign labour, etc.

There is insufficient investments into new areas of growth and too often, businesses continue to rely on “old” sectors like property and construction. Banks too may be guilty of being overly conservative in lending policies, resulting in restrictive funding options for enterprises without land/buildings as collateral or long profitable track record and startups.

It is reactive, our need to treat the symptoms as they occur. Rising cost of living? Rollback the GST and cap petrol prices with subsidies. Need to raise incomes for the poor? Increase the Bantuan Sara Hidup (cash aid transfers). These are populist fixes that can provide quick relief in the short-term. Some are necessary as stopgap measures. But that is exactly what they are – stopgap. To cure what ails, we have to treat the underlying root cause.

Why are Malaysians having such difficulty in coping with cost of living? It cannot be that cost of goods domestically is so much higher in a globalised world where there is free movement of people and trade. The answer must then be because our salaries have been too low for too long.

By that I do not mean we should artificially inflate wages through direct government income supplement. Sustainable income growth and job opportunities must be driven by the private sector and based on realistic market prices.

The government has a major role in helping achieve higher incomes for the people – by setting policies to address the underlying structural issues. The fixes will neither be simple nor quick. Some may even be unpopular. Solutions have to be sustainable for the longer-term, if we are to arrest and reverse the decline in living standards.

The Global Portfolio did comparatively well, falling by just 0.1%, in a difficult and volatile week where markets were, once again, buffeted by trade conflict. Notably, shares for Builders FirstSource bucked the broader market’s drop.

Despite last week’s slight decline, the Global Portfolio is now out-performing the benchmark index, up 5.3%, since inception. Over the same period, the MSCI World Net Return Index is up by a lesser 4.1%.

The Malaysian Portfolio, on the other hand, did not fare so well. Total portfolio value was down 1.5% for the week, dragged down by losses for YSPSAH. Last week’s losses pared total portfolio returns to 47.7% since inception. Nevertheless, this portfolio continues to outperform the benchmark index, FBM KLCI, which is still down 11.5% over the same period, by a long way.


Performance Comparison Since Inception (%)
%-11.547.7-15-10-50510152025303540455055
  • Tong's Value Investing Portfolio
  • FBM KLCI
SHARES HELDQUANTITYAVERAGE COSTCOST OF
INVESTMENT
CURRENT
PRICE
CURRENT
VALUE
GAIN /
(LOSS)
GAIN /
(LOSS)
SCGM BHD11,0661.72919,190.70.97510,789.4(8,401.4)(43.8%)
AJINOMOTO (M) BHD1,50011.81317,720.017.62026,430.08,710.049.2%
Y.S.P.SOUTHEAST ASIA HOLDING10,5002.41325,340.02.44025,620.0280.01.1%
FORMOSA PROSONIC INDUSTRIES18,0001.44025,920.01.72030,960.05,040.019.4%
POH HUAT RESOURCES HOLDINGS13,0001.49019,370.01.52019,760.0390.02.0%
SUPERLON HOLDINGS BHD15,0001.28919,327.51.06015,900.0(3,427.5)(17.7%)
Total  126,868.2 129,459.42,591.12.0%
        
Shares bought       
CIMB GROUP HOLDINGS BERHAD6,0005.14030,840.05.13030,780.0(60.0)(0.2%)
        
Total shares held  157,708.2 160,239.42,531.11.6%
        
Shares sold       
No transaction.       
        
Cash Balance    135,193.4  
Realised Profits / (Losses)    92,901.6  
        
Change since last update May 2, 2019       
Portfolio      (1.5%)
FBMKLCI      (0.8%)
        
        
Portfolio Returns Since Inception  200,000.00 295,432.895,432.847.7%
Portfolio Returns (Annualised)      10.4%
        
Portfolio Beta      0.915
Risk Adjusted Returns Since Inception      52.1%
        
        
Performance ComparisonAt Portfolio StartCurrentChangeRelative Portfolio Outperformance
FBM KLCI1,829.71,618.5(11.5%)59.3%
FBM Emas12,700.411,428.0(10.0%)57.7%
Footnote: 
*Current price is as at May 9, 2019. 
*Portfolio started on Oct 10, 2014 with MYR200,000. 
*This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks.

STOCKS SOLD IN THE LAST 12 MONTHS (Currency: MYR)
SHARES SOLDDATE BOUGHTDATE SOLDQUANTITYAVERAGE 
COST
COST OF 
INVESTMENT
PRICE SOLDSALES 
PROCEEDS
GAIN /
(LOSS)
GAIN /
(LOSS)
THONG GUAN INDUSTRIES BHD12-Dec-1608-Dec-175,0004.24321,215.04.10020,500.0(715.0)(3.4%)
KERJAYA PROSPEK GROUP BERHAD12-Jan-1715-Mar-1811,0001.02511,280.01.54016,940.05,660.050.2%
KERJAYA PROSPEK GROUP BERHAD - WARRANTS B 2018/202308-Mar-1815-Mar-183,0000.0000.00.330990.0990.0-
LUXCHEM CORPORATION BHD30-Aug-1715-Mar-1816,5000.73212,072.50.72011,880.0(192.5)(1.6%)
WILLOWGLEN MSC BHD14-Dec-1722-Mar-1820,0001.01020,200.01.26025,200.05,000.024.8%
MUAR BAN LEE GROUP BERHAD26-Oct-1722-Mar-1813,5001.24016,740.01.17015,795.0(945.0)(5.6%)
CHOO BEE METAL INDUSTRIES BHD07-Sep-1716-May-188,0002.19017,520.02.44019,520.02,000.011.4%
CHOO BEE METAL INDUSTRIES BHD07-Sep-1721-May-188,0002.19017,520.02.30018,400.0880.05.0%
SUPERLON HOLDINGS BHD01-Dec-1721-May-186,0001.1757,050.01.5509,300.02,250.031.9%
OKA CORPORATION BHD14-Dec-1728-Jun-1812,0001.54118,488.01.27015,240.0(3,248.0)(17.6%)
SUPERLON HOLDINGS BHD01-Dec-1728-Jun-186,0001.1757,050.01.2107,260.0210.03.0%
WILLOWGLEN MSC BHD14-Dec-1728-Jun-181000.50050.00.54054.04.08.0%
PANTECH GROUP HOLDINGS BHD17-May-1802-Aug-1843,0000.58024,940.00.56024,080.0(860.0)(3.4%)
KERJAYA PROSPEK GROUP BERHAD10-Jan-1706-Sep-1811,0001.02011,225.01.40015,400.04,175.037.2%
LUXCHEM CORPORATION BHD25-Aug-1706-Sep-1816,5000.71711,825.00.65510,807.5(1,017.5)(8.6%)
HOCK SENG LEE BHD19-Apr-1806-Sep-1814,5001.52022,033.01.37019,865.0(2,168.0)(9.8%)
GENTING MALAYSIA BERHAD06-Sep-1828-Nov-183,8005.07019,266.03.06011,628.0(7,638.0)(39.6%)
TOP GLOVE CORPORATION BHD06-Sep-1806-Dec-183,6005.50019,800.06.03021,708.01,908.09.6%
MAH SING GROUP BHD28-Jun-1814-Jan-1919,0001.00519,095.00.93017,670.0(1,425.0)(7.5%)
WILLOWGLEN MSC BHD14-Dec-1714-Feb-1919,9000.5009,900.00.4649,236.0(714.0)(7.2%)
SAM ENGINEERING & EQUIPMENT14-Jan-1914-Mar-193,0007.38022,140.07.90023,700.01,560.07.0%
PANASONIC MANUFACTURING MSIA16-May-1818-Apr-1960026.15717,182.037.87022,722.05,540.032.2%
HONG LEONG INDUSTRIES BHD14-Dec-1718-Apr-192,0009.12618,251.010.64021,280.03,029.016.6%
MALAYAN BANKING BHD16-May-1818-Apr-193,00010.25030,750.09.13027,390.0(3,360.0)(10.9%)
ECO WORLD DEVELOPMENT GROUP BERHAD28-Jun-1818-Apr-1915,2001.23518,772.00.92013,984.0(4,788.0)(25.5%)
DIALOG GROUP BHD06-Sep-1818-Apr-195,7003.45219,676.43.11017,727.0(1,949.4)(9.9%)
HARTALEGA HOLDINGS BHD28-Mar-1818-Apr-1911,0004.61050,710.04.75052,250.01,540.03.0%
A Note to Readers

It is my pleasure to share with you my Value Investing Portfolio. However, I must emphasize that it is by no means a recommendation or a solicitation or expression of views to influence you to buy or sell any stocks. I am just sharing openly on what I am doing with my stock portfolio.

Further, I like to remind all investors that investing is not just about the profits or returns. You will inevitably suffer stock losses too. You need to understand your own investment objective, risk appetite and the amount of loss you can afford to bear. So, while many investors talk only about absolute returns, I am also sharing the computed risk-weighted returns of my portfolio.

Tong Kooi Ong

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