Singapore Equity: UOB Kay Hian
Quick update to the portfolio, no major changes, some weakness seen in Compact Metal in line with overall market weakness on small caps:
Do note the ex-dividend dates for Overseas Education (05 May 2015) and Ho Bee Land (12 May 2015).
The following stock, UOB Kay Hian (UOBKH), was highlighted to me a couple of times over the past month as a beneficiary of the recent significantly higher turnover on the Hong Kong Stock Exchange due to the South-bound flows from Mainland Chinese investors into Hong Kong.
I would classify this stock as a momentum trading stock so I won’t be adding this into the model portfolio but it does look significantly undervalued and has a high probability of re-rating if the bull market in Hong Kong continues.
Moreover, the recent announcement of a likely takeover by China Minsheng Bank of a local HK broker cum corporate finance and wealth management firm, Quam (952 HK), at high valuation multiples has brought attention to local brokers in Hong Kong such as South China Financial (619 HK) and Sunwah Kingsway (188 HK).
If UOBKH’s HK operations are re-rated to similar multiples, there is significant upside to the share price.
Company Name: UOB Kay Hian
Share Price: SGD 1.53
Market Capitalisation: SGD 1,122m
UOB Kay Hian (UOBKH) is the largest stockbroker in Singapore, with 947 retail and institutional sales personnel.
Mr Wee Ee Chao has a deemed interest of 24.17% of the outstanding shares and has been increasing his stake via married trades at SGD 1.42 to SGD 1.45 per share.
Do note that UOBKH went ex-dividend on 29 Apr 2015 (SGD 0.05 scrip dividend).
My analysis involves:
1. Estimating UOBKH’s pro-forma 2015 earnings based on the significantly higher market turnover seen in HK in Apr 2014; and
2. Valuing UOBKH on a Sum-of-the-Parts basis.
2015 Pro-forma Earnings Estimate
Briefly:
For Singapore, I have used the average YTD March contribution to full year trading volumes from 2011 to 2014 to estimate 2015 full year trading volumes.
For HK, because the surge in trading volumes occurred only in Apr 2015, I have provided a pro-forma estimate which is the estimated full year volume if the South-bound volumes had started since the beginning of Jan 2015.
For Thailand, I have simply used the YTD March 2015 volumes divided by the YTD March 2014 volumes and applied this ratio to the full year March 2014 volumes to estimate full year 2015 volumes.
Net profits are estimated based on average margins from 2011 to 2014 for all segments.
The forecasts show that UOBKH will potentially record a 3-fold increase in net profits for its HK operations on a pro-forma basis with the higher turnover seen in HK.
On a pro-forma basis, UOBKH is trading at 11.0x FY15 P/E (FY14 P/E: 14.9x).
Sum of the Parts Valuation
A sum of the parts valuation shows that UOB Kay Hian is potentially worth between SGD 2.84 and SGD 3.86 per share assuming similar M&A multiples applied to its Singapore and HK operations.
The bull case valuation of SGD 3.86 per share assumes its HK operations are sold at a similar 5.3x FY15 P/NTA multiple to Quam.
Since it is unlikely that UOBKH will break up its operations, the base case valuation of SGD 2.84 per share is more realistic which assumes UOBKH’s HK operations trades at peer valuation multiples.
Picking up on your very nice piece of analysis, I flipped through their financials. Their trade receivables (long and short term) have been trending up significantly relative to revenue since 2010. Around 2010, the company did a transaction involving credit-linked notes, in which credit default swaps (CDS) were embedded. As at the 2014 financials, the credit-linked notes still seem to be in effect. My mind is not nimble enough to completely digest and understand the information given about the CDS and receivables in the annual report, but given that the term “CDS” does ring bells for me and the trend of increasing trade receivables, I wonder if you had any views on this.
In any case, if one focuses on this as a trading buy until the results of the recent bull market trading come in, perhaps this issue is not of paramount importance.
Keep up the good work, G!
Hi Siew Dai,
Thanks for your comments and observations about UOBKH.
Looking at the 2014 annual report, the 2 biggest asset items are: Trade Receivables and Outstanding Contracts Receivable.
USD and HKD denominated Trade Receivables and Outstanding Contracts Receivable make up the bulk of these 2 items.
Outstanding Contracts Receivable is defined by UOBKH as “Outstanding contracts receivable and payable represent amounts receivable or payable in respect of trades which have been executed on an exchange prior to the end of the reporting period and have not been settled as at the end of the reporting period”….basically outstanding value of unsettled trades.
Trade Receivables is not defined but page 54 of the AR states that: “Interest rate risk arises from financial assets such as receivables from share financing, overdue trade receivables”
So this item is likely to be overdue contra losses and margin financing amounts.
More disclosures in the AR:
Outstanding Contracts Receivable: S$529m
Trade receivables amount: S$1,792m
Collateral for trade receivables: S$5,753m
Net exposure to credit risk for outstanding contracts receivable: S$179m
Net exposure to credit risk for trade receivables: S$639m
This implies the real exposure is S$639m of unpaid contra losses plus any mark-to-market losses on the S$179m outstanding contracts
Barring a Lehman kind of meltdown, margin financing is pretty safe for a broker like UOBKH due to overcollateralised nature. of the financing.
I’m not sure how client credit risk is handled for overseas operations but in Singapore, the remisier is ultimately responsible for the clients’ receivables so again, UOBKH seems protected here. UOBKH charges
As for the credit linked notes with embedded CDS, page 72 of the AR specifies that UOBKH issued these notes to external investors.
The underlying reference asset for these credit notes are medium term notes and distressed debt bought by UOBKH (see AR page 62, points (a) and (b)).
So in the event of a credit event (default by the medium term notes and distressed debts), the embedded credit default swap allows for UOBKH to deliver these medium term notes and distressed debts to the external investors of UOBKH’s credit-linked notes.
So again, UOBKH’s risk is minimised by this arrangement:
S$392m worth of medium term notes and distressed debts against $392m worth of credit linked notes sold to external investors.
The divergence between revenue and trade receivables is a good point. I don’t have the answer to that (maybe you can ask them at the AGM!).
Plausible reasons could be increasing use of margin financing by clients coupled with declining brokerage rates/margin financing rates over the years so asset growth exceeds revenue growth.
Hi Gallen, Thanks for the detailed follow up to my question. I agree with the point you have made that the margin financing business is a safe business given the over-collateralised nature of it. This is backed up by the fact that during the 2008-2009 equity market turmoil, the bad debt provisioning they took was marginal, relative to the size of the P&L. Credit risk management is probably sound, and executed by old hands.
Thanks to your notes, I now also understand the referenced assets are backed by the “Issued Debts” liability. The implication here is that if any of the referenced assets turn bad, the holders of the “Issued Debts” will have to step up to compensate the Company, so the liability side will decrease correspondingly. The question now is whether the holders will stand behind this “put” obligation, but I take some comfort that the amount (though not small) is ring-fenced from the larger “Trade Receivables” number. I also question the economics of this transaction, as it seems that the Company seems to be earning a net yield of 100 to 150 bps only on riskier “distressed debt” assets, which in my mind makes the Credit-Linked Note a yield-enhancer only.
With these questions cleared up, I look forward to see how the trade plays out. Thanks for the discussion!
I think this was an opportunistic transaction:
1. Buy the underlying MTN/debt at distressed prices.
2. When credit spreads normalised, pass on the risks to the credit-linked note holders and earn a “risk-free” yield of 100 to 150 bps as you have mentioned.