Trendspotting

The G20 conference

2009-03-29T07:25:00.000-07:00

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And so, after half a year of waiting, finally the G20 meeting convenes this coming week. Will it be another NATO (No Action Talk Only) meeting ie. an anticlimax yet again?

I tend to think that this will come to be seen as a key event in the annuals of financial history, because of a few factors: (1) it has been six months in the making, which gives various participants the time to think things over and lobby for support; (2) the economic collapses following the Lehman bankruptcy have confounded even the most pessimistic estimates, hence conferring the political impetus for drastic action; (3)long-standing economic imbalances have long been recognised and this is the best opportunity, amidst a crisis emanating from such imbalances, to "upside the downside" (to quote a famous saying from our of our most articulate local ministers).

I believe there will be a few key issues on the agenda as described below, together with the market implications:

(1) Coordination on fiscal spending by all countries. Related to this is the issue of protectionism. For example, countries like Singapore are dead scared of too much fiscal spending because of the fear that much of this money will leak overseas due to our high exposure to global trade. Even mighty Germany doesn't want to end up subsidising the exports of EU member countries. Without global coordination along the lines that each country pulls its own weight in fiscal stimulus such that countries will not end up accusing each other of benefiting from the other's fiscal stimulus, a classic prisoner's dilemma situation could develop where all parties, in trying to protect their own self-interests, end up all losers. If this coordination works, I would expect protectionism fears to ease and trade-related companies to benefit, particularly commodities (which are needed for infrastructure construction).

(2) Greater regulation of the global financial system. This is being championed by the Europeans (my suspicion is that they're pushing this as the top agenda item because they cannot afford to pay for massive fiscal spending like the Americans). Already we're seeing the imminent clampdowns on tax havens and bank secrecy. Most likely hedge funds, with their massive clout unsupervised by any agencies, will get the next round of scrutiny. Greater transparency of OTC markets involving all kinds of derivatives that have caused great uncertainty will be next. The implication: the financial industry will never be the same again. Therefore, rid your portfolios of all banks. The new index heavyweights will be utilities, back to the good old days. Another word of advice: Singapore should really beware of changes in this arena, because we have positioned ourselves so much for the financial industry, in particular wealth management, in recent years. Monumental changes in banking secrecy and tax haven laws will affect our fortunes greatly.

(3) Perhaps the most monumental changes will come in the currency arena. As mentioned, global imbalances triggered the current crisis. The key one is the huge US current deficit due to continuous importing of goods from exporting countries like China, which generate trade surpluses on the other end. This has been sustained by continuous funding of these deficits by the exporting countries, thus resulting in the ironic situation of poorer developing nations lending to a rich developed country in a gigantic parody of vendor financing. It has become clear that the US can no longer be the ultimate demand sink that it has been for the past two decades. Silvio Berlusconi talked of a new Bretton Woods several months back when this G20 meeting was being planned. I also think back to the 1985 Plaza Accord when the US dollar was devalued against the Japanese yen in order to reduce its current deficits and assist its economic recovery. It does look like adjustment of economic imbalances will begin and end with currency adjustments this time round again. I believe talk will centre around (1) a new reserve currency (with China and Russia now clucking about it); (2) new currency pegs that will assist in the rebalancing of global demand. The RMB will probably remain steady, but since it's currently still under capital control, there's no way things will develop too greatly for this currency.

The big gainer, in my view, will be gold. In Bretton Woods, it was used as a peg of value; once the system was "nixed" in 1971, gold was liberated and shot up to US$800/ounce. Now with currency displacements looming once more, we could again see interesting movements in real assets, in particular the original "reserve currency".

(4) Restructuring/recapitalisation of the World Bank and IMF. In recent years these two agencies have grown almost obsolete, mainly because of the stigma associated with accepting IMF assistance. But should SDR, or Special Drawing Rights, become an important reserve currency, these Keynesian brainchilds could once again enter the mainstream of global finance. They will also have to provide funds for an increasing number of emerging countries hit by the global crisis.

(5) The depth by which some countries have been hit by the economic crisis could become clear during the G20 meeting coverage. Striking examples would include countries in Eastern Europe, maybe even more developed nations like South Korea. Hence, one should look to exit positions in countries which one does not have much macroeconomic conviction on.

References:
(1) Bretton Woods
(2) Plaza Accord

Continued weakness in Singapore residential housing

2009-02-28T19:40:00.000-08:00

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I was thinking which of my blogs I should put this article in and decided that the Trendspotting one is the most appropriate although the article is not highlighting a trend to buy into; rather it is advising against buying into something. Besides, I haven't written in Trendspotting for some time already.

There has been pessimism over the property market since mid-2008, and justifiably in my view, given the potential looming supply of private homes coming onstream over 2009-10. However, recently there appears to be a wellspring of renewed optimism in the market, magnified through the press, over the successful launches of several mass-market developments, notably Caspian in Jurong East and Alexis in Alexandra. I also notice threads appearing online trumpeting the recovery of the housing market. And of course, you hear again the boss of one of our local big developers declaring his (perrenially) optimistic views about the property market during the company's results release.

In my opinion this is false optimism tinged with acute conflict of interest from the various parties involved. Let's get the overall feel of things:

1) One of the key failures in the current global market is liquidity shortage leading to tight credit across the board. The logical thing is to expect demand for big-ticket items that require loan financing to be in the first line of fire from a credit crunch. That is why auto companies across the world are seeing an unbelievable slump in demand over the last 2-3 months, especially when they are considered discretionary items as well. In the US, without government assistance (eg. loan restructuring), things would have been worse in their real estate industry. In Singapore, I have heard people claiming that low SIBOR rates (benchmarks for home loans) are evidence that liquidity is available and cheap. This is not true if firstly, the banks are more stringent in their screening process on who to lend to, and secondly if the premium over SIBOR (typically home loans are quoted at SIBOR + premium) are increased accordingly as SIBOR is reduced. I understand both are happening. Really..... if I were a banker, would I be lending like normal times, and at lower rates than normal to loan seekers now? Get real!

2) The supply-demand dynamics just doesn't look exciting. Why would anyone want to buy now why there is a large supply overhang. Let's look at some numbers from URA, the voice of reason (statistics don't lie):

Click on the picture to make it larger. Basically, the figure as of 4Q08 show that currently total available/completed private residential units number about 230,000-240,000 (mostly occupied of course). The supply in the pipeline is about 66,000, half of which are under construction and the other half being planned. Think about it: there is looming supply amounting to one-quarter of Singapore's existing private housing stock, the latter of which was built up over decades. That means massive demand has to come in to absorb this supply overhang, and that demand must amount to say, one-quarter of Singapore's mid-to-upper middle-class (that can afford condos). Are we expecting 25% increase in this population over say, 4-5 years? Of course, there're the cash-rich enblocers, but common sense tells me they can't amount to that many; besides they'll likely want to tighten belts too.

The only reason for people to buy in the face of such an obvious supply overhang, whether for personal dwelling or for investment purposes, will be if prices drop to a sufficiently attractive level..... which brings us to our third point.

3) Price levels are not that attractive. You only have to look at the URA Residential Price Index to make that conclusion:

Look at the purple line, for condominiums. It is the one that has risen at the second-highest pace from 2003. As at 4Q08, this particular index is still above 160, way above the base from 2003-05 at 110-120. Now, assuming price discounts in 1Q09 at ~10% from my understanding, that index would still be >140 as of now. Surely a good reference price point would at least be the base at 2003-05, if not lower (given the tepid outlook not to mention the supply overhang)? Things will only look reasonable, in this context, at another 20% discount from current prices, which brings the index to 2003-05 levels. And to bring strong demand in, you'd need to have distressed sales, which entails further discounts from there.

That is the picture for private residential property -- the liquidity situation, supply-demand dynamics and comparison to historical prices don't look good. It is really not so much about timing, but more about price point, especially for those who plan to buy them for personal dwelling. Note how the current wave of media optimism over properties has coincided with the imminent TOP of many developments. Some people have to get rid of their inventory quickly.

References:
(1) URA website

The resurgence of Singapore retail

2008-07-23T01:23:00.000-07:00

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The subprime crisis and the many malicious tentacles extending from it (the chief one being inflation) have dominated (negative) global attention over the past year but I feel several themes have receded into the background as a result though they still remain compelling stories in their own right. One of them is the remaking of Singapore.

Make no mistake, this is one big story in the making. When you have record construction book orders for several years in a row that is driven by a single-minded governmental drive to reposition from manufacturing to services and consumption, it will generate a displacement effect that benefits certain sectors and affects others in a significant way. A likely beneficiary will be retail, as highlighted in my writeup at the start of 2008: Fundamental Trends to Watch for 2008.

Retail was huge in the 1980s and early 1990s, driven by Singapore's emerging status as a tourism and aviation hub amid the bustling tiger economies of Southeast Asia. They were also the years when infrastructure buildup was strong --- the key one being the MRT, and we had free-spending Japanese tourists as the main foreign spenders while locals' spending power grew prodigiously through a 20-30 year boom period. It was a multi-year secular theme and the hot stocks were retail, hotels, property and construction. It was an era when among the ten richest men was a retail tycoon (the boss of CK Tang).

The local retail industry has had moribund growth since then, affected by several developments: the Asian financial crisis that hit our neighbouring countries hard, miscellaneous crises (911, SARS) and recessions that affected domestic and tourist consumption, plus a shopped-out Singapore consumer that increasingly went overseas in search of cheaper goods given the advent of budget carriers.

While we constantly hear about the problems of retailers (high rent, strong competition), it is worth noting that on the demand side, the locals' spending power and their willingness to spend has never weakened. This is clear from continually rising incomes which now brings us above the median of developed world per capita incomes, and the success of well-placed suburban malls like Jurong Point, the malls at Tampines, and the recently-built Vivocity, which depend mainly on locals' spending. Suburban malls comprise about half of Singapore's retail space. Implict government targets to increase population to 6 million from the current 4.5 million, from both newbirths and immigration, bodes well for future demand at these malls.

Meanwhile, tourist arrivals have been growing steadily over the years and is set to undergo a quantum jump over the next 1-2 years as the two IRs at Sentosa and Marina are completed and as a more subtle multi-pronged approach is launched to attract tourists, including medical tourism, event-driven tourists (MICE and F1 Grand Prix) and enhancing Singapore's hub status (eg. Singapore Cruise Centre). The STB's target --- to triple tourism receipts to $30B and double tourist arrivals to 17M (set in 2005) --- would have implied >10% annual growth for the retail industry if it materialised.

In terms of retail space supply, there is approximately 7 sq ft of available retail space per capita in Singapore as at end 2007. This is similar to Malaysia's Klang Valley but only half of close competitor Hong Kong's ratio of about 16 sq ft per capita, suggesting there could be further growth before saturation. One of the observations that is unique about retail property (especially in the prime areas) is that supply generates demand, as a critical mass generates a reputation and a niche which attracts the fashion-conscious and the affluent who place variety above all other factors in importance (which is why I favour the prospects of retail property even as I am pessimistic about the rest). Driven by the strong growth potential in the Asia-Pacific that has emerged in recent years and their hunger for higher-end goods, Western retailers have increasingly expanded in this region to secure their beachheads and mindshare and Singapore is likely to benefit from this region-wide trend (it is often seen as a launching pad for further expansion). Islandwide retail space occupancy rate has consistently exceeded 90% over the last few years, and rental rates have grown strongly while still attracting takers. For a striking example, prime rental rates along Orchard Road have been in the region of $40-50 psf/month, and I just read that the new iON Orchard is quoting $80 psf/month without any problems attracting bidders. It suggests that there should not be an oversupply of retail space in the prime Orchard Road stretch even with the coming up of new malls like Orchard Central and Somerset Central.

The likely strong growth in tourism receipts would benefit some more than others. Retailers in the Central Region would benefit more compared to suburban malls, while luxury retailers would likely benefit more as well. It is worth noting that among the stronger retail segments according to the Department of Statistics have been wearing apparel and footwear, watches and jewellery, and department stores.

This is not a sure-win story. Retail could yet remain in the doldrums due to a global recession, though in such a scenario none would be spared. But in the more likely scenario --- a less serious slowdown, it is likely that consumers will scrimp on the bigger-ticket items which would require loans, such as property and cars (both of which are already seeing negative growth), while still continuing to spend on consumer goods which are more a function of their incomes/income growth (which should be steadier). Hence retail looks like a better play than other sectors (eg. property) in a "remaking of Singapore" theme.

There are several sub-sectors within the retail sector that look interesting. I have a Retail Sector Index where one can check out the component stocks. One could adopt a Peter Lynch approach by checking out crowd traffic at various malls to assess the popularity of various brand outlets. Personally, I feel that retail outlet outfitters (which benefit from new mall expansions), popular luxury label owners and mall owners (in an environment of floorspace pricing power) all look interesting.

Two things stand out for me, stock market-wise. Firstly, the retail sector has not really surfaced as a hot sector through the last few boom years (though miscellaneous retail stocks have done well), as indicated by the trend of my Retail Sector Index ---- a bullish sign. Secondly, there have been institutional and private investor interest in local retail stocks, as evidenced by recent takeover and privatisation deals --- Royal Sporting House and Robinsons (by Arabs), Sincere Watch, CK Tang (unsuccessful privatisation), Guthrie GTS (partial privatisation), Courts (ongoing) ..... what's next?

References:
(1) Retail Outlook 2007- Opportunities and challenges ahead
(2) Property Report Asia Jul 2008: Singapore retail property highlights

Trends in Upstream Oil and Gas

2008-04-02T19:42:00.000-07:00

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This is a rather broad topic and I'll choose to structure it along several issues of choice: trends in offshore, main development focus of oil companies, ownership trends.

Generally, offshore oil was estimated to account for about 1/3 of the world's reserves at the start of the new millenium; this ratio would likely have grown significantly in recent years with the discovery of major offshore reserves in countries like China and Brazil. Offshore exploration/production is naturally much more expensive in terms of equipment and logistics compared to onshore, but offers much more potential reward; as oil prices kept rising it became increasingly viable.

The continuing rise in oil prices also suggests a possible lengthening of the exploration cycle. It was noted in 2007 that we were probably in the middle part of the global oil exploration cycle, which meant that the emphasis would start shifting from drilling towards development of the oilfields. This would shift demand toward FPSOs (floating production storage offloading) vessels and pipelaying vessels that facilitate logistical transfer of the oil/gas from offshore to onshore, and indeed we see quite a number of FPSO and pipelaying contracts for companies like Keppel and Swiber in 2008. However, the continued strength of oil given apparent long-term Asia-Pacific demand growth and tight supply might mean a second wind in the exploration boom --- hence more demand for rigs, where the tightness persists.

The tightness is especially strong in deepwater exploration, which many believe to be the strongest growth segment in offshore exploration. This is due to the confluence of several factors: (1) high oil prices justifying economic viability; (2) technological maturity allowing ever deeper drilling depths; (3) successes in deepwater in recent years encouraging further exploration. It is worth watching one success story to appreciate the potential reward of deepwater:

The figure is self-explanatory. Brazil, under Petrobras, is now one of the world's top deepwater sites. It's worth noting that the above figure was before they made a huge offshore deepwater discovery late last year that could potentially make them among the top three oil producers in the world.

Deepwater is one of the key expansion areas of the oil majors. See, for example, how Shell envisages its production mix to evolve over the next decade:

Key deepwater drilling areas are in Western Africa, off southern Brazil, the Gulf of Mexico, and Southeast Asia. The opportunities in Southeast Asia, particularly, are shown below:

What this suggests is that there will be strong sustainable demand for early movers and dominant service providers in the deepwater segment. This includes manufacturers of deepwater-capable rigs (ie. semi-submersibles) and drillships, and owners of deepwater-capable offshore vessels. Utilisation of these equipment are near 100% and rates are high and growing.

Expanding their gas portfolio is another major thrust of the big oil companies. Looking back at the Shell pie-chart above, we see planned expansions in LNG (Liquefied Natural Gas) and Tight gas sands, as well as a new segment GTL (Gas-to-Liquid). All three are natural gas-related. LNG is natural gas that has been cooled to a liquid form to facilitate transportation. When delivered to the consuming market it is returned to a gaseous state and injected into the standard natural gas pipeline system. GTL uses natural gas as a raw material to produce liquid petroleum products (implicitly it competes with LNG for natural gas as raw material). Key geographical areas are Qatar and Australia's Northwest Shelf. Natural gas from tight sands is conventional natural gas extracted from unconventional reservoirs. The key exploration area is Canada. (Indeed, I would buy C$ for long-term investment if I were a forex trader).

Natural gas remains the most viable substitute for crude oil in in most applications except transportation, and it usually is found together with crude oil. The above plans therefore should not be surprising. It also suggests opportunities for service providers in this area, such as manufacturers of gas compression equipment like Cooper Cameron. Indeed, there is apparently a supply shortage of gas compression equipment.

Ranked on the basis of oil and gas reserve holdings, 14 of the top 20 upstream oil and gas companies in the world are national oil companies. State monopolies represent the top 10 reserve holders internationally. In terms of world oil production, however, only six of the top firms are national oil companies, while ExxonMobil, Royal Dutch Shell, BP and ChevronTexaco represent among the largest oil and gas producers worldwide, reflecting the general superiority of the Western oil majors in operational efficiency and technological ability. The upstream O&G industry has become increasingly politicised in recent years, as supply grows tighter; examples are countries like Russia, Venezuela, Iran and Indonesia looking for ways to nationalise oil assets, renege out of existing deals or use oil as a political weapon. China is looking to tie up energy deals with key suppliers like Australia and Western Africa. In such a "scramble" (a scenario envisaged by Shell over the next 20 years), the operating environment might look increasingly difficult for private oil companies, and small oil companies with little clout might not be as good investments as surging oil prices suggest, especially if they are operating in less developed countries with unstable flip-flopping governments.

References:
(1) A Guide to Oil Reserves and Resources
(2) World Oil Magazine Outlook 2008 Oil industry spending plans grow 9%
(3) How Much Oil From Deepwater: The Brazilian Experience
(4) Shell presentation Mar 2008: Building New Heartlands
(5) Innovation Norway presentation Apr 2007: Deepwater Oil and Gas Malaysia
(6) Exxon Mobil presentation Sep 2007
(7) Chevron presentation Mar 2008: Upstream and Gas
(8) CRS report for Congress Nov 2004: The Gas-to-Liquids industry and Natural Gas Markets
(9) Centre for Energy website
(10) Baker Institute: The Role of National Oil Companies in International Energy Markets

Global inflation

2008-02-22T20:57:00.000-08:00

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It should be pretty obvious now what will be the key theme for 2008, if one just looks at the headlines being blared every other day, detailing concerns and attempts by governments across the world to rein in rising inflation.

Attempts to control inflation vary. Some attempt price caps and export taxes to increase domestic supply, such as Indonesia and China for their agricultural crops. Some provide subsidies for fuel, which apply to a wide swathe of developing nations across Asia where the majority of the populace are poor and the land size is large. Others try to do it via economic growth through which personal incomes rise to counter the debilitating effects of core inflation, such as our very own Singapore. And an increasing number of nations (with the prominent exception of the US) are now trying to maintain strong currencies to counter rising imported product and raw material prices.

Inflation is such an important issue because it can be politicised: nothing gets ordinary citizens going at the government than rising cost of living. China will never forget that the 1989 Tiananmen student riots happened because of high inflation. The US will never forget the 1970s years of stagflation when the central bank was forced to raise rates to >10%. The European Central Bank doesn't dare to lower rates now despite signs of economic weakness because of inflation. Yet the structural factors are aligned against them.

There are underlying demand-and-supply dynamics which will be hard to resolve in the short-term. These apply across the three main classes of commodities: energy, metals, agriculture. Energy and metal commodities are into their 5th or 6th year of bull market; agricultural into their 1st probably. Their prices are driven by the rise of new giant economies, especially China and India which together comprise more than one-third of the world's population. It is increasingly believed that oil production is reaching its peak soon, and this implies future imbalances widening and hence all energy commodity prices being pulled along upwards. Vast infrastructure construction across emerging Asia has driven demand for metals, together with mining industry consolidation which appears to raise the spectre of an OPEC-like cartel that will dictate (higher) prices in the future. Rising food consumption and trends towards higher protein consumption as vast populations become more affluent has brought agricultural product prices to forefront prominence over the past year, with competition for acreage between oilseeds and grain being the current battleground (and leading to skyrocketing prices for both sub-categories). All these commodities, hard and soft, are seeing the effect of under-investment over the past two low-inflation decades, and it will take years to bring new supply to market (especially agricultural commodities).

The next point will be more debatable but I think the now notorious sub-prime crisis might accelerate the commodity inflation process. While US end demand will soften, the rate cuts, or at least halt in rate hikes, around the world will lead to continued glut in capital that has shown signs of being diverted to commodities as an inflation hedge, hence driving up prices further. Furthermore, many commodities' demand tend to be driven by fixed-asset investment demand (metals) and inelastic population consumption (agriculture and energy), and these are likely to be less affected compared to say, discretionary consumer products (eg. electronics).

What this means is that pricing power moves up the value chain, as the bargaining power weakens for end-demand product distributors/retailers (due to softening consumer sentiment), but with little impact on upstream raw material suppliers whose bargaining power is undiminished. The headwind on the former, therefore, is immense: stagnating or declining selling prices, combined with rising raw material and sometimes (to a lesser extent) labour costs.

One might choose to avoid investing completely given that "inflation is bad", and that is looking at the half-empty part of the glass. Or he might adjust his investing allocation, for there are still opportunities in stocks in such an inflationary environment. Indeed, my argument is that it might be better to buy (the correct) stocks than to buy commodities directly now, simply because stocks have corrected so sharply across the board that the risk-reward looks likely to be better in (commodity-linked) stocks than pure commodities.

Generally, it looks like there're two main categories of stocks that could benefit from a global inflationary environment:

1) Upstream stocks. Not just commodity producers like miners or plantations, though they're the most obvious. But also service providers, say oil services providers, offshore logistics companies, bulk handlers/shippers (need to watch looming vessel supply), agricultural machinery/fertiliser/animal feed companies etc. Their margins are likely to be maintained or might rise.

2) Capital-intensive stocks. Depreciation costs are flat, while selling price (revenue) could be adjusted in-line with inflation; this in effect transforms the inflationary environment to the company's advantage. Asset owners belong to this category: owners of vessels, construction equipment, completed properties (especially those with short leases that are renewed routinely). Because these capital assets now cost more to build (due to rising raw material costs), they are also worth more now than implied on their balance sheets.

At the same time, stocks with domestic focus in strong economies underpinned by domestic reflation are also likely to continue to do well as long as they are not affected by foreign trade flows (ie. avoid exporters) or foreign capital flows (ie. avoid high-end properties even though they might benefit from the reflation trend).

Fundamental trends to watch for 2008

2008-01-06T11:33:00.000-08:00

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Finally got around to writing this article. I wrote one last year (see link) and it served well as a guide for myself over the course of the year.

In the context of the volatility and some say possible recession looming in 2008, it is useful to note that there will be bull sectors during any part of the market cycle. For example, even in the stagflation years of the 1970s, not only did coal and energy-related stocks do very well, but one would also have made money if he had spotted the nascent high-growth small computer sector. A very useful book which lists out all bull sectors annually since the 1950s is William O'Neill's How to Make Money in Stocks.

At the same time, some of the themes below serve more as guides on asset allocation, rather than pin-pointing bull sectors. For example, the theme on global inflation.

Here I venture some personal views on likely trends for 2008. Some may be already mentioned in previous blog articles, in which case I include the link as well. For the new ones, I will probably writeup on some of them in the future.

Domestic
1. Retail (especially luxury/specialty goods)
2. Rise of alternative energy (and associated infrastructure)
3. Global prominence as water engineering base
4. Liberalisation of utilities (power, natural gas, telecom)
5. Singapore MasterPlan 2008 and impact on property
6. Continued tight capacity in construction sector
7. Continued buildup/re-characterisation of Singapore's waterfront
8. Major M&A cycle in family-owned companies (to foreign interests)

Regional(ASEAN)
1. Vietnam property boom
2. The 9th Malaysian Plan (particularly infrastructure and water projects)
3. Plantations (in Indonesia and Malaysia)
4. Southeast Asia as an energy resource hotzone
5. ASEAN integration (with transportation links being first step)

Asia-Pacific
1. Basic infrastructure construction across Asia
2. Continued weakness in traditional export economies
3. Beijing Olympics
4. Increasing focus on environmental protection/conservation in China
5. Increasing focus on quality control of products in China
6. Rise to prominence of India (no longer in China's shadow) and Australia
7. Inflation in China
8. Possible conflict across Taiwan Straits
9. Continued tightness in shipyard capacity
10. QDII/CIC funds from China

Global
1. Soft commodities, especially agricultural (theme of the year)
2. Widespread inflation (co-theme of the year)
3. Shift in oil exploration cycle- deepwater exploration and rise of FPSOs
4. Secular decline in US consumption
5. Emerging Africa (particularly in resources)
6. Latin America as hard commodities hotzone
7. Major currency realignments (especially USD and Chinese yuan)
8. Rise of sovereign wealth funds

Be imaginative about playing the various themes and good luck to all of us!

Rising coal demand in Asia-Pacific

2007-10-13T23:40:00.000-07:00

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One of the more visible trends developing in recent months has been the rising prominence of coal as an energy commodity, with coal prices rising along with surging demand and brokerages setting amazing price targets on key coal producers like Shenhua (China's top coal producer) and Singapore's Straits Asia surging in sympathy.

The key reason: China has become a net coal importer of coal. Together with iron ore and cement, coal now forms the triumvirate of commodities widely seen to be responsible for the surge in the Baltic Dry Index of late; the BDI measures the charter rates of bulkers and is an indicator of dry-bulk trade.

Coal is usually divided into thermal coal and coking coal; the former is used for steam generation to produce electricity while the latter is used for producing steel. According to IEA (International Energy Agency) figures, international thermal coal trade has grown much more significantly than coking coal, almost doubling to 590Mt in 2006 from 1996, compared to coking coal's puny ~10% growth over the same period to 220Mt.

The prices of both thermal and coking coal are projected to rise continuously over the medium-term; the former due to its being the fastest-growing energy source as rising oil prices prompt users to switch fuels, the latter due to rapidly rising steel production in China and India. The attractiveness of the substitution trend can be seen in their relative prices in 2006:

The swing of China from net coal exporter to net importer is significant because it is both the world's top coal consumer as well as its top producer. China produces about 2.5X as much as the next biggest coal producer (USA). Hence the swing to net importer suggests significant future growth in demand-supply imbalance, in absolute terms. At the same time, it also becomes a source of competition for global coal imports to the incumbent biggest importers: Japan, South Korea, Taiwan --- all in the Asia-Pacific! Not to forget the rapidly expanding economies of India and Vietnam. No wonder there is sudden bullishness on coal.

Although the upstream segment of the value chain is poised to benefit the greatest and has come in for market attention recently, the demand pull effect should pull margins upwards along the entire value chain. This would include marine logistics service providers (owners of tugs and barges), supply chain managers (that manage the movement from source to destination), shipbuilders (which build the bulkers). There is still value in many of these related stocks. As for main country beneficiaries, one only has to look at the main incumbent coal exporters: Australia and Indonesia. Of the two, Indonesia (see "Southeast Asia as an energy resource hotzone") seems to have better investment potential because of (1)environmental concerns in Australia; (2)port congestion problems in Australia that cannot be resolved in the short-term; (3)higher composition of thermal coal export(80%) as proportion of total coal exports for Indonesia. Thermal coal is seen as the more critical resource as power generation cannot be outsourced, while steel can be imported (indeed, China is itself trying to limit steel production). However, if Indonesia decides to cut exports and save the coal for its own domestic needs (as in the case of natural gas), then it might drive supply further down, and coal prices further up.

References:
(1) World Coal Institute
(2) China Coal Market Analysis and Forecast: Sep 2007
(3) Bloomberg report Sep 13: Indonesian Coal Shares Surge as China Exports Decline

Future state industrial development focus in Singapore

2007-07-19T20:01:00.000-07:00

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Singapore is in the midst of a transformation, best exemplified by a certain senior politician's optimistic description of it as a "golden period". Certainly, this is putting a spin on things, because a situation can be seen in different ways. Economically, yes, there are many golden opportunities around.

For the stock investor, my view is that often it is the less obvious themes which offer the greatest opportunities for profit. Even as the residential en-blocs and commercial property private equity deals take up all the attention, let's not forget that the main economic, as well as social, pillar is the industrial sector. This is an oft-neglected non-headline theme but billions are being poured to reposition Singapore's industrial niches, and in the long term, stock prices will follow where the money goes.

JTC is traditionally the lead agency behind most of Singapore's broad industrial thrusts so it is interesting to watch its moves. In particular, its plan to relieve its balance sheet of many of its industrial assets (factories, business parks) through a multi-billion-dollar REIT suggests its need for massive infusions of new capital to be channeled into new developments. Below are where I think the main industrial foci will be in the foreseeable future:

one-North
There is a major billion-dollar investment push in the Buona Vista area. Positioned as the future research hub of Singapore supporting knowledge-intensive activities in biomedical, infocomms and media industries, the potential of this area --- 200 hectares is designated for the entire development --- is enormous, regardless of whether the investments pay off or not. That is because the investments themselves are already going to provide a strong pipeline of development/construction projects for clued-in developers in the coming years --- the masterplan calls for a 20-year development.

The two main research sub-hubs in the area are Biopolis and Fusionopolis, for biomedical and IT/media respectively. These have been in development since 2001. The interesting follow-up developments will be coming in the next few years, because one-North is to be developed as a multi-faceted work-live-play self-sustaining ecosystem (probably inspired by Silicon Valley) to attract the scientists, entrepreneurs and researchers. I believe the main drive for these started in 2006, and will continue for the next few years in a self-reinforcing cycle.

To start off, there will be two new Circle Line MRT stations (NUH and one-north) built along the north-western border of the site, as well as the Circle-line extension of Buona Vista MRT. The first residential developments are coming up, which are one-north Residences by UOL and a mixture of developments, including a business hotel, residential and mixed-use complex (Vista Xchange) by United Engineers. The Rochester Park area is being redeveloped as an entertainment/lifestyle area. These are but the beginning, and developers who position themselves well at the initial stages will reap the rewards for years to come.

The future of Singapore's industry lies in high-end manufacturing supported by research and development, and hence the government will do everything to make sure that it succeeds in the targeted areas. One-north, in my view, is the most promising and yet overlooked industrial development so far.

Petrochemical infrastructure investments
This theme had already been extensively explored in an earlier article: "Singapore oil and gas infrastructure construction". While direct investments are mainly private in nature, the state (eg. JTC) also builds supporting infrastructure to attract these investments. Petrochemical-related infrastructure on Jurong Island are another major thrust of JTC for the future, in-line with Singapore's drive to maintain its position as an oil refining/trading hub while extending its reach upstream into energy exploration/research. The upcoming Jurong Rock Cavern for underground hydrocarbon storage, and the proposed LNG import terminal, are two of the biggest examples of state-driven petrochemical infrastructure investments.

Seletar Aerospace Park
This is one for the future. Aerospace is a high value-add industry, and countries moving up the development ladder typically see aerospace as a key target sector. A key pillar of the US's exports, for example, is aerospace. Clearly Singapore is not up-to-scratch to manufacture aircraft, but has carved a niche in aircraft maintenance/repair/overhaul/conversion over the years by leveraging on its air hub status; today, it has a quarter share of the Asian aviation MRO market. The aerospace industry has registered strong growth over the last decade, with 12% annual growth rate.

Seletar Aerospace Park will be 140 hectares in size (2/3 size of one-north) and is meant to build on the MRO facilities of Singapore as well as housing aerospace equipment manufacturing plants and training academies, centering on the existing Seletar Airport which will be upgraded. Target completion is from 2015-18, still a long time away.

These mega-size industrial developments show clearly what the emphasis of the state will be for the foreseeable future, and suggest credible secular buy-and-hold themes with a tailwind (state funds and long-term commitment) behind them.

References:
(1) JTC Annual Report 2006

Section 44 tax credits

2007-06-18T06:19:00.000-07:00

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On the first day of this year I had penned down some fundamental themes to watch out for in 2007 and promised I would elaborate on some of them. Well, I haven't kept to that promise so far as I drifted into a long series on Malaysia, so thought I'd start here with a writeup on the Section 44 tax credits theme, one of the domestic themes that I'd thought would be an interesting play.

Prior to the start of 2003, Singapore's corporate tax system was known as a "full imputation system"; however from 2003 onwards it adopted a "one-tier corporate tax system" which would apply to all companies starting January 2008. The mechanics of these tax systems are not necessary to understand; suffice to say that the difference is mainly in the maintenance of a "Section 44 account" which was necessary under the old system but would not be needed under the new system. However, companies which had accumulated large balances in their Section 44 account up till end-2002 obviously had to be given a chance to clear these accounts, and hence a transition period was declared from 2003 to December 2007 for these companies to fully utilise their Section 44 tax credits via issuing franked dividends. Technically, these Section 44 credits belong to the shareholders and in my opinion, it is the duty of the companies to fully utilise them. Any Section 44 balances that remain unutilized as at 31 December 2007 would be forfeited and no longer available to pay future franked dividends.

The utilisation of the tax credit is as follows. If the company has $1M Section 44 tax credit, it would need to pay out $5M in dividends to fully utilise the tax credits. This is obtained by dividing the $1M by the corporate tax rate of ~20%. The amortisation of this balance can be distributed over an extended duration up till end-2007, but of course, now we only have another 6 months left.

Many companies are reluctant to reveal their Section 44 balances. Understandably so, because the next demand made by shareholders would be for them to fully utilise the balance via issuing dividends, which they may feel hard-put to do (eg. because free cash balance is low, or because controlling shareholder unwilling to do so for various reasons). Just look at the case of Isetan and the shareholder lobbying.

This might be an interesting theme coming up for the August interim results announcement period, given that time is running out. Although many companies are tight-lipped, it may be reasonable to expect substantial Section 44 balances primarily in older companies. Note that the bulk of Section 44 balances for companies were accumulated before the transition period commenced in 2003. Except for certain technical adjustments post-2003, the abovestated observation suggests that it makes sense to target older Singapore-resident companies lasting far back into the early 1990s or earlier, which would have allowed them to build substantial Section 44 balances. For those newer companies established in 2000 or later, they are likely to possess insignificant balances, however fast growers they are. For companies with substantial foreign operations, it is a bit unclear about their tax situation but it is possible that they might not even have Section 44 balances at all (this point should be independently verified). For a cross-section of those which have already utilised their balances: Allgreen, Hupsteel, Rotary, Hiap Seng, Low Keng Huat, Tai Sin, Federal, Sing Investments, Amtek: all companies with long histories with the tax board. It will be useful to ferret around for others that exhibit similar characteristics which still haven't played their card. Perhaps the best plays would be those stalwarts that have faded into the background in recent years, which had their best years in the 1990s. Of course, the company must be shareholder-friendly in the first place, else it is possible that they might just let the balance dissipate quietly over 2007-08.

References:
(1) Deloitte Singapore Tax Briefing
(2) Ernst & Young One-Tier Corporate Tax System writeup

The Bohai Bay Rim Economic Zone

2007-05-18T20:15:00.000-07:00

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The Chinese economic engine has been booming for several years now, and recently it appears that their financial markets have caught up and even surpassed the fundamentals. The euphoria is worrying, but yet the fundamentals are solid, and I have highlighted several interesting development trends in the past. Here I highlight the most promising development region for the next decade.

The Bohai Bay Rim economic region is made up of Beijing, Tianjin, Hebei, Shandong and Liaoning, the so-called 3+2 area. The area has a population about one-sixth of China's total, and generates more than one-quarter of the country's total GDP. It is widely considered as among the three most important economic regions in China, together with the Pearl River Delta centering on Shenzhen and Hong Kong, and the Yangtze River Delta centering on Shanghai. The latter two have overtaken the Bohai Rim region in economic importance over the last two decades, but there are signs that foreign investments and development focus are moving northwards towards this region.

The Bohai Bay region

The key to its re-emergence is the Chinese government. China watchers essentially must watch the government moves. The country essentially still retains a strong central-planning economic legacy despite recent years of private sector-driven growth, and its importance is augmented by the fact that its central bank is just another government policy instrument and that the government has access to vast state reserves --- ie. effectively the government controls and is a source of massive liquidity. This government has a history of driving growth in specific economic zones, first in the Shenzhen SEZ after Deng Xiaoping's southern tour, and then Shanghai under former mayor/new president Jiang Zemin. Recent government initiatives, concessions and appointments indicate the Bohai Bay Rim to be the next centre of focus.

The Bohai Rim region has been traditionally well-developed in heavy industries, with strengths in ports (Tianjin), logistics (Tianjin), steel (Anyang, Shenyang), petrochemicals (Beijing, Tianjin), oil exploration (Bohai Sea). The development of the automobile, electronics and high-tech industries, and the construction of energy bases and transportation channels are emphasised for the future; all these are major sector thrusts for China as a whole (high value-add, R&D-intensive industries), suggesting that the Bohai industrial region will be the seat of major investments for years to come. This will be facilitated by the advanced communications, strong contingents of scientific and technical personnel and wealth of natural resources available in the area. China's biggest oil discovery in recent years just several weeks back in Bohai Bay is set to attract vast refinery and petrochemical investments in the region.

In particular, Tianjin is set to become China's third economic powerhouse after Shenzhen and Shanghai Pudong. Its development and integration with Beijing and Hebei Province are now a national development priority, written into China's 11th Five-Year Plan. It is the birthplace of PM Wen Jiabao. Notable foreign investors have piled into the city, including Motorola, Samsung, Matsushita Electric, Toyota, GlaxoSmithKline, Coca-Cola and Nestle. The most recent high-profile foreign investment is Airbus' first A320 aircraft manufacturing plant in China. Most foreigners see the city as a gateway to the inland regions, given its strong logistics facilitating inland communications, its deepwater ports facilitating export/import access, and its proximity to the administrative capital of Beijing. Within Tianjin, the Tianjin Binhai New Area is government-decreed to be the comprehensive systematic reform experimental area, to draw on all the abovementioned competitive strengths (gateway status, high-tech manufacturing and R&D, shipping & logistics) into one core area; this will be the one to watch.

The emergence of Tianjin as a financial centre will be another development to watch. Its mayor Dai Xianglong is a highly-respected former central bank governor, and his appointment to Tianjin was a sign of (good) things to come. The recently-planned Bohai Bank will be the first national bank approved in a decade. There are also plans to set up China's third stock exchange, still pending approval. A vibrant financial sector will be important in stimulating the growth of a services economy.

Companies with exposure to this development region, set to become China's third coastal megalopolis within the next few years, should do well. Firstly, there will be government incentives to stimulate new investments. Secondly, there will be a boom in foreign/domestic investments that provide critical mass and drive needs for various supporting industries/services. Thirdly, consumption expenditure is headed for robust growth as the population increases and becomes more affluent.

Bottomline is, you can't go wrong betting along with the Chinese government.

References:
(1) Apr 2006: Tianjin at a glance
(2) Oct 2006: Dai Xianglong's speech on WICO forum
(3) GIWA regional definition: Bohai Sea
(4) People's Daily report July 2005: Tianjin Binhai New District- new engine of Bohai Bay-rim

Malaysia Series: Banking and Real Estate

2007-04-27T19:58:00.000-07:00

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One of the reasons why Malaysia is viewed with renewed optimism these days is the strength of its domestic economy. All around Asia, domestic reflation is THE theme for the next few years, with the trend of US consumption slowdown finally becoming mainstream thinking meaning that exports are expected to stagnate at best. Prime beneficiaries of rising domestic consumption has always been the suppliers of domestic capital, and the main consumers of it --- the banking sector and the real estate sector, respectively.

With capital markets becoming globally integrated and capital becoming mobile nowadays, governments all over the world have been liberalising controls and opening up their markets in competition for the same capital pool, and Malaysia is no exception. This is a recurring theme for the abovesaid two sectors as well, and below I highlight some dominant themes and pervasive trends likely to propel growth in these two sectors for the next few years.

Banking

Key banking stocks: Malayan Banking Bhd, Bumiputra Commerce, Public Bank Bhd, AMMB Holdings Bhd, RHB Capital Bhd, EON Capital Bhd, Affin Holdings Bhd, Hong Leong Bank Bhd, Alliance Bank Bhd.

Industry consolidation
In 2002, the Malaysian banking industry was spruced from 54 banks (which included finance companies, merchant banks and discount houses) to just 10, in-line with the Malaysian government's 10-year Financial Sector Masterplan (FSMP) in 2001 to fully liberalise the banking industry by 2010.

The second round of consolidation was apparently sparked in 2006 with the takeover of Southern Bank by Commerce-Asset Holding (now known as Bumiputra-Commerce under which CIMB is a subsidiary). Since then, AMMB sold a 25% stake to a foreign bank (an Australian banking group), Utama's RHB Capital stake became the subject of a tussle which included Kuwait Finance House and EON Capital and which eventually ended up in the state pension fund's hands (which is now seeking buyers for the RHB stake again!), and recently Affin sold a 25% stake to Hong Kong's Bank of East Asia. Analysts are speculating on another merger of two or three banks in 2007, probably with government/central bank intervention.

The plan according to the FSMP is for Malaysia to have six to eight domestic banks operating by 2010 — three to four large banks providing a full range of financial operations and another three to four medium-sized banks offering more specialised services. Many believe Maybank, CIMB Bank and Public Bank could easily withstand competition in a liberalised banking environment, but the smaller banks may have to consolidate to survive (similar to Singapore). Operating restrictions are already being lifted on fully-owned foreign banks, including allowing them to open more branches and ATM networks for customers.

As usual, when consolidation takes place, there are opportunities for good speculative gains for investors of the acquired banks, going by Singapore investors' experiences in Keppel-Tat Lee, UOB-OUB, OCBC-Keppel etc. The recent experience of RHB points to strong interest by reputable foreign investors which means it is likely to be a demand-driven consolidation process.

Islamic finance
Islamic finance was highlighted as one of the global banking sector's growth drivers in my article on Finance and Investments in the Middle East. Globally, this sector is growing at a rate of 15-20 percent a year and is estimated to be worth up to US$400B, from only US$70B a decade ago. It is effectively a beneficiary of the resurgence of Muslim capital, which is in turn fuelled by petrodollars.

Malaysia is acknowledged as the leading Islamic financial centre, with its banks having operated in this niche for years by virtue of its cultural roots. International financial groups are rushing to tap this market but it is not easy when barriers to entry are tied to cultural and religious roots! That's why Singapore is eyeing this pie hungrily but by governmental admission, the local banks' progress have been less than satisfactory. Muslim money with strict syariah principles to be handled by banks with Muslim traditions and with compliance departments that understand what these principles are all about --- one would expect that to be the case for years to come.

Islamic banking has been growing at ~20 percent annually over the past five years in Malaysia, which also accounts for 70 percent of total global Islamic bonds in issue and 40 percent of global Islamic unit trust assets. The critical mass is there, and Malaysian banks with a good grasp of this market are bound to outperform (I'm not sure yet which ones these are).

Real estate

High-end housing segment
Key stocks: KLCC Properties, IOI Properties, SP Setia, IGB, Sunway, Sunrise, United Malayan Land, Mah Sing

Two big reasons. Firstly, property stocks have historically outperformed the KLCI in bullish market conditions. Secondly, the wealth effect of a rising market typically spills over to physical properties.

This is what Singapore has found itself in from 2005 onwards, as the property sector has outperformed, and we can apply this hindsight in broadstrokes to the Malaysian property sector. And indeed, the general demand-supply dynamics might be applied to both countries, with abundant supply in the mass-market housing segment putting a drag on prices while surging foreign demand as a result of relaxation of governmental requirements on purchases by foreigners leads to an outperforming luxury segment (see "Singapore high-end residential property boom").

The abolition of the 30% RPGT (real property gains tax) in March is seen as the most significant measure aimed at attracting foreign property buyers and will have reverberating effects for years to come, much like how Singapore's package of asset measures announced to improve housing affordability in July 2005 (together with the IRs) served as the catalyst to propel the property segment to a boom till today. Naturally, rising residential property sales and higher selling prices will flow through to the bottom lines of developers, justifying further rises in their share prices.

Going by the current argument that Singapore property still has some way to go towards the astronomical psf heights in global cities like Hong Kong, London and Tokyo (an argument which is arguable), prime properties in Kuala Lumpur would surely look attractive for Singapore and global investors, selling for peak RM1,500 psf (more typical prime rates would be RM1,000 psf) or thereabouts. In a market driven by the wealth effect, you can't go wrong with prime areas (akin to our District 9/10/11) such as the Golden Triangle (KLCC), Mont'Kiara/Sri Hartamas, Bangsar/Damansara Heights.

It is worth noting, however, that outside of Kuala Lumpur, the market is more focussed on landed property and the demand for condominiums and apartments are more subdued. This is a clear sign of a two-tiered market: local demand in the suburbs/satellites vs foreign demand in the city centre.

The emergence of REITs in Bursa might also help to support the growth of industrial and commercial properties. Key regional players like Capitaland, via its Quill REIT, are already taking foothold. Other significant Singapore players are also re-emerging in the area, such as Wing Tai (via DNP) and UOL.

Iskandar Development Region
Key stocks: UEM World, Tebrau Teguh, Mulpha, Ekovest

The Iskandar Development Region (IDR), formerly known as the South Johor Economic Region (SJER), is the primary development focus of the 9th Malaysian Plan into which the state government is pouring billions of infrastructure investments in the hope of attracting tens of billions more of foreign investments. The speculation over the property stocks linked to the IDR reached fever pitch in early 2007 over what is essentially a concept without actual profitable implementation, but there is general recognition of its potential.

There is unabashed proclamation of the aim of the IDR: to tap on Singapore's strong economy in the way that Shenzhen serves as a hinterland to adjoining financial centre Hong Kong. That this development is a prime focus of Badawi's government means there is strong governmental support and indeed there are already many incentives to promote foreign investments and property ownership.

Development will be initially focused in concentric circles in the waterfront areas around Johor Bahru (A) and Nusajaya (B), and the logistics centres of Port of Tanjung Pelepas (C), Pasir Gudang (D) and Senai Airport (E) (refer to map above). Key developments include the Danga Bay Waterfront City development facing the entire western coast of Singapore, a planned petroleum storage hub at Tanjung Pelepas (West Gate) and a biodiesel hub at Tanjung Langsat (East Gate). Nusajaya and Johor City Centre are expected to house the services hubs including education, healthcare, creative industries etc.

There is anticipation that foreign investors, in particular those from the Middle East, would soon enter the scene at much higher prices, after the moratorium on land transactions in Johor was lifted recently. Large landlords at the southern tip of the IDR and adjoining the waterfront facing Singapore will be prime beneficiaries if the IDR takes off, and as such the "key stocks" listed above have already soared.

Although speculative fervour might have abated a bit with the withdrawal of the "free access zones" proposals for the IDR, this is the second region in Malaysia to watch closely for property reratings in the future, as THE major focus of the Badawi government.

References:
(1) New Straits Times report Apr 2007: Banking on Consolidation
(2) Price Waterhouse: Malaysia: Leading Islamic Finance
(3) The Edge Daily report Mar 2007: Property back in limelight
(4) The Edge Malaysia Apr 2007: Boost for KL luxury condo market
(5) The Edge Daily report Feb 2007: Shares in South Johor linked firms rise
(6) Media statement Mar 2007: Iskandar Development Region: Initial incentive and support package
(7) Skyscraper city forum: The South Johor Economic Region
(8) The Star Online report Jul 2006: Danga Bay to spur south Johor growth

Malaysia Series: Government restructuring

2007-04-07T00:27:00.000-07:00

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Considering the Malaysian stock market and economy from a macro perspective, it is not difficult to make a case for it. In the mid-1990s, before the 1997-98 currency crisis, it had the third largest stock market in Asia by market capitalisation (after Japan and Hong Kong) but today it lags behind countries like South Korea, Taiwan, Singapore and of course China and India. Yet it has made a sizeable recovery since 1998 and many of the factors and controls that discouraged foreign portfolio investment are now removed.

Teh Hooi Ling wrote an interesting piece in today's Business Times on how investors learn from past experience with the result being less volatility and lower probability of bubble formation; I feel it is especially pertinent in Malaysia's case where things like the CLOB debacle have scared off many Singapore investors. Today Malaysia is seen as one of the more undervalued markets, and indeed it is safer precisely of such bad memories/legacies.

What do I mean by government restructuring? It not only refers to restructuring of government-related institutions, but also of attitudes towards foreign investment and social development. From a top-down perspective, it prepares the ground for a more benign investment climate and better market valuations.

Restructuring of foreign investment policies
The biggest bugbear of foreign investors has been the capital controls and currency peg of 1998 which restricted inflow and outflow of capital, and basically left the stock market in the doldrums in the early 2000s because of a lack of foreign institutional demand. The peg and controls have been removed since 2005 under Abdullah Badawi.

Some reform has been done on property investment by foreigners as well. Foreigners can now buy any number of residential properties in Malaysia priced above RM250k and take any number of loans from local banks. The abolishment of the long-time real property gains tax will stimulate long-term foreign demand for Malaysian properties, widely acknowledged to be one of the cheapest for a relatively well-developed Asian economy.

With regard to foreign direct investment, the fact that for the much-publicised Iskandar Development Region, the Bumpitera equity ownership requirement is set to be relaxed for a number of sectors to increase foreign investment, is also an indication of a warming investment climate.

Key property stocks: KLCC Properties, IGB, IOI Properties, I&P, MK Land, SP Setia, UM Land, Mah Sing

Restructuring of government-linked companies (GLCs)
This is one of the key themes that has attracted funds back into the Malaysian market. Encapsulated in the GLC Transformation Program in 2004, it has been one of the key programs launched under Badawi's new administration to improve corporate management and efficiency, consolidate operations if necessary, and increase overall competitiveness and value-add of the government-linked companies in which the two key government investment agencies, Khazanah and PNB, hold substantial ownership.

A sample list of companies held under these two agencies, published in March 06:

Another list of these GLCs, published in 2007. The 20 companies in bold, known as the G-20, are the key companies whose performances are tracked under the GLC Transformation Program:

Listed GLCs comprise more than 1/3 of total market cap in Bursa, and have roughly tracked the main KLCI index's movements. The strong move by the KLCI from late 2006-07, making Malaysia among the top market performers worldwide, can thus be strongly attributed to these stocks and their improved performance and perception by mainstream investors.

Among the main restructurings:
- A top development over recent years has been consolidation and expansion overseas in the banking sector. BIMB recapitalised via sale of a stake in Bank Islam to Dubai Investment Group; Bumiputra Commerce merged with Southern Bank in 2006 and CIMB acquired overseas operations (GK Goh); A three-cornered fight for RHB Capital which eventually went to Employee Provident's Fund. Coupled with the entry of foreign investments, notably Arab money, these restructurings and consolidation are said to make Malaysian banks more competitive.
- Another restructuring coming up is the consolidation of the plantation sector, with the merger of the GLC plantation stocks Sime Darby, Kumpulan Guthrie, Golden Hope
- Shakeups at Malaysian Airlines and Proton, with success (supposedly) in the former and impending foreign takeover in the latter

Restructuring of political stance
Social policies are not so easy to reverse but in order to encourage foreign investment, a top priority of the government nowadays, it is likely that the bumiputra policy, especially the requirement for 30% business equity ownership, will be diluted with time starting from new developments like the IDR.

There are also signs of warming relations with its closest neighbour Singapore, with plans to increase flight links (ending the KL-SG monopoly flying rights held by SIA-MAS), build rail links (unconfirmed), encourage cross-border investments (Genting in Sentosa IR, Singapore probably in IDR, being two of the bigger developments).

There is tremendous potential synergy in this relationship, and it is high time both parties take steps to building it.

References:
(1) AMB report Mar 2006: Preview of Khazanah Nasional’s report card
(2) CIMB report Apr 2007: Above The Crowd
(3) GLC Transformation Programme Progress Review Mar 2007

Malaysia Series: Resources Boom

2007-03-30T23:34:00.000-07:00

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One of the most reliable secular themes, if one believes that Asia is poised for a long-term boom (a view which has gained tremendous currency with the rise of the twin engines in China and India), is infrastructure construction. I have written on the infrastructure boom previously and allied to this idea will be that of a resources/commodities boom which we have already seen taking root in recent years. As a resource-rich country, Malaysia is a likely strong beneficiary.

Out of the nation's total export goods, mining goods (oil & gas, tin) and agricultural goods (palm oil, rubber, timber) comprise >20% of total exports. Their influence extends further than that, because a large proportion of domestically-mined/produced resources are supplied as inputs to the manufactured goods segment which form the balance 80% (in the form of petrochemicals, wood products, rubber products etc). Industrial sector growth drivers are categorised as resource-based and non-resource based (primarily electronics) ---- a measure of their importance.

The interesting aspects of the various natural resources that Malaysia is rich in are listed below, together with some Malaysian stocks that are considered good plays in the particular resource (only for reference, not recommendations):

Oil and Gas
What more needs to be said? With oil prices sustaining at US$60/barrel over the past two years, Malaysia's O&G industry is one of the key beneficiaries. Oil production occurs offshore and primarily near Peninsular Malaysia (off Terengganu); it also takes place offshore of Sabah and Sarawak. The oil industry is of a declining tendency, though, due to the lack of major new oil discoveries in the last years. The natural gas industry however looks more optimistic, with Malaysia being probably the world's third largest LNG producer after Algeria and Indonesia.

The natural resource also supplies feedstock to the downstream petrochemical industry, at which exports have been growing at 20% per annum over the last decade --- a growth industry. The potential lies in the expansion of petrochemical facilities, especially the development of new petrochemical zones in possibly Sarawak, Johor or Labuan; there are currently three petrochemical zones in Kertih (Terengganu), Gebeng (Pahang), and Pasir Gudang-Tanjung (Johor). Petronas is a major domestic investor in the industry. Malaysian oil and gas engineering services companies have also emerged as competitive global players.

Key players: Petronas, Scomi, Dialog, KNM, Wah Seong

Palm oil
I have covered the coming biodiesel boom in Indonesia and Malaysia in an earlier article. Malaysia is the world's largest producer of palm oil (45% share), and is aggressively positioning itself to benefit from Europe's drive to wean itself off oil into alternative energy products, specifically biodiesel.

Even without the emergence of biodiesel, palm oil has been taking market share in the world oils and fats market over the years, recently overtaking soybean oil as the top product. Palm oil processing facilities include palm kernel crushers (self-explanatory), refineries and oleochemical plants; product categorisation include palm oil/palm kernel products, oleochemicals (used in personal care products), biodiesel, palm biomass products. China and the EU are incumbent key export destinations.

Sabah has the largest oil palm cultivated area in the country, and the recent 9MP (9th Malaysian Plan) has earmarked new clusters along the Johor-Pahang border, along the Kelantan-Terengganu border, in Sabah and in Sarawak. It has also been issuing biodiesel production licences aggressively, with resultant heavy market speculation in the plantation sector late last year. Investments in the palm oil sector are likely to be among the highest of all sectors in the coming decade, with projected 8% growth in annual investments year-on-year. Finally, there has been a wave of consolidation within the sector with government acquiescence: the Wilmar-PPB Oil merger (now we're familiar with that!) and the PNB-driven Sime Darby+Kumpulan Guthrie+Golden Hope merger (to create the world's largest palm oil producer).

Beware valuations though!

Key players: IOI, Synergy Drive (the result of the abovementioned triple-merger), Asiatic, KL Kepong, Kulim

Timber/wood products
Primary processed products include sawn timber, veneer and plywood; secondary processed products include wood-based panel products and builders' carpentry/joinery; tertiary products include furniture and pulp&paper.

Malaysia is among the world's top three exporters in all primary wood products. There is tremendous downstream integration as well, where Malaysia is a leading global exporter of medium-density fibreboards (No. 4) and furniture (No. 2).

There is a developing situation of growing demand and tightening supply, which has led to rising timber prices rising >20% over 2005-06. On the demand side, there has been firm demand from China and India, as well as a recovering Japan. On the supply side, there has been a crackdown on illegal logging particularly in Indonesia, and in the long term there is growing insistence from developed countries that the extracted timber be from "sustainable sources" (ie. there must not be reckless extraction). But then again, if the US economy slows down, durables like furniture would be the first to suffer....

Key players: Jaya Tiasa, WTK, Ta Ann, Subur Tiasa

Rubber
It is clear from the above that the natural resources industries are vertically integrated through to the downstream products, which ensures maximum income is captured within the country's borders. This model is most clear in the case of rubber, where Malaysia is among the top three rubber producers (the other two being Indonesia and Thailand), but actually has to import latex to produce its key product: rubber gloves. It also exports substantial amounts of rubber tyres.

Rubber plantation acerage has decreased over the years in Malaysia and Indonesia, as many owners have switched to the more lucrative oil palm crop. This switch is set to accelerate with the aggressive biodiesel drive by both governments. At the same time, Thailand's southern provinces, which produces much of Thailand's rubber crop, has been embroiled in civil unrest, potentially disrupting distribution channels. The main substitute for natural rubber --- synthetic rubber --- will continue to suffer from high oil prices. All this suggests a strong medium-term outlook for natural rubber until new trees in other emerging countries (eg. India) mature sometime in 2010 and beyond.

Key players: KL Kepong, Top Glove, Kossan (the last two are rubber glove producers)

Tin
Once a mainstay of the Malaysian economy, tin mining has been on the decline for a good part of the past 15-20 years as falling prices took a toll on the industry.

Tin is a key component in electronics products such as mobile phones and televisions, due to its use in soldering applications. With the rise of China, it has enjoyed a revival in recent years.

Perak is the country's biggest tin producing state.

Key players: Perstima

References:
(1) Sahamas forum
(2) Malaysia 3rd Industrial Master Plan: 2006-2020
(3) The Star article Mar 2007: Analysts give oil and gas sector top marks
(4) The Star article Mar 2007: Analysts’ four favoured sectors

Malaysia Series: Part 1

2007-03-17T21:39:00.000-07:00

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Sustained volatility is one of the signs of increasing risk (or equivalently, the perception of it) and it is possible that there could be a cyclical slowdown in the US economy (see "US Consumption Slowdown"), if not the world. Yet all is not lost for long-only investors. There are certain economies where structural-driven dynamics might be interesting against the backdrop of the long-term emerging Asia story. And increasingly, I have come to believe that Malaysia is one of the best structural stories hitherto underneath most institutional investors' radar (until early this year when there was a good-sized rally, which I believe might resume soon).

It'll probably take several parts to cover the various interesting themes associated with Malaysia. Clearly, it is not a new market for most veteran investors. Unforunately, my impression is that many retail investors have shunned it due to terrible experiences in the CLOB debacle where many lost nearly all their money. My writeups will be based on my limited experiences and readings on the Malaysia economy, and many will be more knowledgeable than me on this market. Please feel free to contribute insights.

Below will be several observations on the Malaysian economy and market which I believe show promise for investors on the Bursa. They are grouped under Base (the incumbent baseline) and Growth Drivers (what will catalyse growth and investor attention). Specific themes will be examined in later parts.

The Base

Reasonable fundamentals
It was considered as one of the Tiger economies of Asia, enjoying 7-8% annual growth, before the 1997-98 currency crisis hit. Today, it grows at a rate of 5-6%. It is considered one of the more developed "developing countries", has low unemployment rate of 3%-odd, has a historically resilient domestic consumption base with relatively high per-capita income (as reflected in their being Southeast-Asia's biggest car market), and traditionally strong government spending. It has, however, been able to attract less FDI (foreign domestic investments) in recent years.

Erstwhile investor cynicism
And it is a good thing, because it ensures that market valuations and hopes are not excessive. As mentioned above, the CLOB saga scared away many retail investors from Singapore, while capital controls imposed during the height of the currency crisis alienated foreign institutions. Recently, there is market evidence that the latter are returning to bargain-hunt.

The Growth Drivers

Political commitment to change
The Mahathir era is over and under Abdullah Badawi the government appears to take a more centrist and moderate approach than before, for example in foreign relations towards Singapore, as well as Badawi's promotion of "progressive Islam". With regard to foreign investments, it is possible that the Bumiputra policy enshrined in the NEP (New Economic Policy) may be diluted under the new regime, in particular concerning compulsory Bumiputra equity ownership of companies. With regard to land controls, government regulations over foreign purchases of luxury homes have also been relaxed. Probably most importantly, there is a move toward GLC restructuring to improve efficiencies: stories in progress include Proton, MAS, and the government-backed giant merger of Sime Darby+Kumpulan Guthrie+Golden Hope (all three government-linked). Consolidation of the banking sector is already largely done in the aftermath of the Asian flu.

Arab money
I had written about the flow of petrodollar investments out of the Middle-East. Historically much of this has gone to the West but now the Arabs feel less welcome. It is also common knowledge that Asia is the world's fastest growing region. So where does the Arab money flow? Through Islamic-friendly financial centres in Asia. Malaysia has a well-established Islamic finance infrastructure, shares similar religious roots and convictions, and as a gateway to Asia for Middle-East investors appears a natural destination. Already there is anecdotal evidence of consumption being buoyed by wealthy Arab tourists. Malaysian construction companies get plum building contracts in the Middle-east. And just look at the recent tussle to acquire Islamic bank RHB (Rashid Hussain Bhd) with rival consortium bids by Qatar Investment Authority and Kuwait Finance House.

Various resource-based themes
The world economy has been kind to resources-rich countries these few years. This should continue as the twin Asian engines of China and India continue to develop. Oil and gas , palm oil, timber, rubber, tin --- with the first two being hot global themes, the first three contributing significantly to Malaysia's GDP, and in many of these resources Malaysia is one of the global market leaders.

The bottomline: It may be time to look at active investing in KLSE stocks.

Useful sites
Highly recommended sites for further reading:

Forum: Moolah's Bursa Malaysia Stock Forum

Blog: Salvador Dali's Malaysia Finance- Blogspot

References:
(1) The Star article Dec 2006: Interest in selective laggards
(2) The Star article Feb 2007: Three-cornered ‘fight’ for RHB

Rise in construction costs

2007-01-26T19:38:00.000-08:00

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Anything that looks too good to be true will eventually show its bad side. This law of nature manifests itself in economics through the laws of supply and demand; where demand rises strongly, supply experiences a tightening which eventually leads to higher prices crimping the margins.

Singapore's construction industry is poised to enter a boom period. Value of contruction works for 2007 is estimated to be ~S$19B, up strongly from previous years of sub-$15B. Demand is strong from the private sector due to upcoming condominium and commercial developments especially in the prime areas, the IR developments extending all the way to 2009-10, as well as oil and gas infrastructure construction on Jurong Island and selected industrial facilities construction (especially semiconductor and disk drive facilities). Those interested in the dynamics leading up to the current construction boom can refer to a previous writeup a year and a half back: Recovery of Singapore construction industry.

Yet, as mentioned earlier, it is important to look at the feedback of strong demand into rising factor costs.

The Indonesian sand ban is the most widely-talked about issue this past week and has allegedly been responsible for the market crash on Thursday. Sand is an important component of concrete, comprising 1/3 of the total (as "fine aggregate"), with the rest comprising granite ("coarse aggregate"; 40-45%) and cement (15%). It is unwise to just laugh this off; the ban is likely to be revoked but with readjustment to higher selling prices (already there is talk of sand prices rising 100% or more). There have been sand bans in the past from Indonesia in the late 1990s-early 2000s which were then reversed; it is worth noting that Sembcorp Construction ran into the red because of such bans. It is also worth noting that such building materials price hikes are not confined to Singapore: in December 2006 the Malaysian government also raised its ceiling price for cement by 10% though due to different dynamics (higher production costs eg. energy, transportation).

The sand ban is a precursor of things to come. It may or may not have strong cost impact (our government insists it will not) but it is a symptom of imminent rising building materials costs.

Building materials are not the only factor costs to see potentially strong inflation. Given the industry's labour-intensive nature, the issue of lack of skilled labour for the high number of construction projects coming up has also been highlighted several times by the government, leading to relaxation of labour laws to allow contractors to hire more foreign labour. The reason is the lack of local supply as most Singaporeans shun the construction industry. 50,000 new foreign workers are expected to join the Singapore job market in the next few years as major construction projects get underway. Such a high influx of foreign labour, while alleviating the labour supply shortage, might destabilise margins because foreign labour is typically lower-educated, implying high training costs; and less adaptable, meaning any switches to alternative and better building methods may be difficult (such as switching to the steel-based dry construction method from cement-based wet construction due to the sand ban).

It is instructive to look at the most recent gross margins of some locally-listed construction companies for a view of how important direct costs (ie. raw materials, direct labour) are. Gross margins are typically <10% for companies like Chip Eng Seng and Lian Beng, suggesting direct costs form >90% of total revenue. And these are the better construction companies.

The incidence of rising materials and labour costs, however, is not likely to fall strongly on builders, given the strong demand for their services and the tight supply given that many poorly-managed builders have dropped out over the lean years. Any rising costs will be shared by the property developers, who will be trying to launch their developments ASAP in the current boom market before it falters (as it inevitably will) and therefore will be willing to pay higher prices for construction works. Hence, any rise in factor prices will filter its way downwards through the entire value chain and affect both builders and property developers. It is worth noting that the property index on the SGX has fallen more substantially than the construction index since the announcement of the Indonesia sand ban.

A trend in recent years has been for construction companies to venture into property development, making them integrated property developers, where they integrate their core competence in construction with the very closely related field of property development. This enables them to undertake design-and-build projects, and pass construction costs directly to consumers (property buyers) through higher selling prices that factor in higher construction costs. This business model shields these companies partially from rising construction costs.

Companies to avoid must be poorly-financed construction companies with thin margins. Why buy into companies with loss-making or unstable track records which have basically shown their inability to manage costs well (albeit in the lean years)? A rise in material costs could easily put them into the red given the incumbent thinness of their gross margins as it is; poor finances will exacerbate the situation through lack of working capital to deal with rising costs. This is what caused smaller construction companies to collapse in the years following the last mini-construction boom of 1998-99.

References:
(1) Channelnewsasia Jan 25 2007: 50,000 more foreign workers needed in construction sector

Fundamental trends to watch for 2007

2007-01-01T17:53:00.000-08:00

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Happy 2007! It has been a great 2006 but if I remember correctly, at the start of last year analysts were predicting that 2006 would see the easing of the global markets and that only truly good stockpickers would do well. How wrong they were. It may be fair to say that 2006 was the year when good money could be made by anyone willing to put his money into stocks (any kind).

In the stock market there are always themes that will dominate the attention such that even when the broad market is stagnant there will be sectors that outperform (there has to be). Broadly speaking, late 2003 (when the bull market started) was the technology bull; 2004 was the shipping/commodities bull; 2005 was the oil & gas bull; 2006 was the China stocks & property bull. What is palpable is a gradual shift in dominant themes from cyclicals-related themes to investment expenditure-related themes to consumption-related themes ---- in the same way that the benefits of a strong economy spread and filter through the masses.

Here I venture some personal views on likely trends for 2007. Some may be already mentioned in previous blog articles, in which case I include the link as well. For the new ones, I will probably writeup on some of them in the future.

Domestic
1. Construction recovery (theme of the year)
2. Oil & gas infrastructure buildup
3. Continued strength in high-end properties and shortage of premium office space
4. Rise of aerospace manufacturing/engineering
5. Strength in retail sector
6. Development as an educational/R&D hub and buildup of related infrastructure
7. Section 44 tax credits theme
8. Interest in unique Singapore brands (esp. consumer goods)

Regional(ASEAN)
1. Plantations
2. Energy exploration in Southeast Asia
3. Consumer demand recovery in Indonesia
4. GLC (government-linked company) restructuring in Malaysia
5. Emerging strength and interest in Malaysia property sector
6. Mass investor exodus out of Thailand
7. Rise of Vietnam as a low-cost manufacturing hub

Asia-Pacific
1. Basic infrastructure construction across Asia
2. Beijing Olympics
3. "Harmonious society" theme in China
4. Weakness in traditional export economies
5. Tourism in Asia
6. Rise of alternative power sources: nuclear power, natural gas, clean coal power

Global
1. Middle-East petrodollars as key global liquidity source
2. Middle-East basic infrastructure development
3. Russia as an economic superpower
4. Domestic economy expansion of India (eg. retail sector)
5. Rise of soft commodities
6. Multiple currency crises (domino effect)

Hopefully the last one won't materialise but it is a distinct possibility.

Be imaginative about playing the various themes and good luck to all of us!

US consumption slowdown

2006-12-06T18:13:00.000-08:00

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This may be a trend that has been running full-blast in the press for the last month but it is worth reiterating, for the sheer scale of its impact on the global economy.

Consider the impact of the US on world trade. From 2005 WTO statistics, it is the world's leading merchandise importer (ie. interpret this as demand generator) with a 20% share by value, about 2.5 times that of the next largest individual country (China). Consumption expenditure accounts for about 70% of the total US economy (they're a nation of spenders), and this manifests itself in its share of world private consumption (ie. end-demand, non-governmental, non-investment) expenditures: North America, with 5% of the world's population, accounts for >30% of total world private consumption expenditure (see below, year 2000 figures). One can take the US to account for ~80% of the North American share, which means the US alone generates the demand for about a quarter of the world's consumption goods.

Consider the recent major consumption trends in the US. Housing prices down, squeezing the sources of liquidity for American consumers (they have traditionally borrowed against the rising values of their homes). Growing evidence of weakening consumer sentiment and sales data. Slowing manufacturing activity, reflecting itself in slowing orders. Unintended finished goods inventory accumulation across certain sectors, such as automobiles and electronics --- evidence of unexpected slowdown and possibly excess production capacity in the future. In terms of fundamentals, liquidity and sentiment, the outlook for US consumption does not look good.

So what if inflation is down and the US is likely not to have further rate hikes? This is due to demand slowdown removing the need for it, and the context for Asian exporters should be to look at the slowing demand, not the US Federal Reserve's counter-response to it.

A possible factor that might jolt the world into sudden realisation of this situation is a drop in the US dollar. Finally, the US dollar is beginning to react to the ballooning trade deficit that has been accumulating for years. There are signs that China is looking to diversify its foreign reserves investments away from US Treasuries, which had hitherto been supporting the US capital balance. In recent weeks, the US dollar has been plunging against all major currencies: the Euro, the pound, the yen, even the renminbi (albeit less because the float is managed). Look out for the US Treasury + Federal Reserve delegation to China sometime this month. It is seldom that the fiscal and monetary regulators, who are supposed to operate independently, go on a trip together. It is possible that major discussions could be planned regarding the future direction of the mutual exchange rates and foreign reserves. Any currency revaluations could have major implications for US consumption, and ultimately the global demand.

That is why the general outlook for exporters is bad. The general hope is that the handoff in demand growth from the US to the rest of the world (eg. Europe, a recovering Japan, maybe China) will be smooth. But how can it be, considering the general tendencies of these second-tier countries to protect domestic producers, and to themselves rely on exporting to the US to drive economic growth?

Key sectors to avoid must be export-oriented industries that depend on low production costs as a competitive strength, or which have volatile industry dynamics. The former would be manufacturers with low value-add that are based in China and which supply to the US (one sector that comes to mind is the furniture manufacturing industry). Any currency revaluation would erode this competitiveness, and weak end demand exacerbates the situation, especially for high-ticket, and therefore price elastic, items. An obvious example of the latter category would be the electronics exporters, where inventory overbuild and production overcapacity are perpetual cyclical problems (even in boom times) that often lead to sharp drops in average selling prices. Perhaps that is why there has been no Christmas stock market boom relating to the technology sector in the SGX this year.

References:
(1) WTO World Trade in 2005 Overview: Leading exporters and importers in world merchandise trade
(2) Worldwatch Institute: State of the World 2004: Consumption By the Numbers

Russia as an energy superpower

2006-11-19T07:18:00.000-08:00

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Oil and gas has been THE story of the last 2-3 years and oil producers have been the prime beneficiaries of the petrodollars. We all know this industry moves in cycles; structural trends however will emerge that persist over the longer-term. In the 1970s it was the rise of an oil cartel centering on the Middle East; in the 2000s it could well be the rise of Russia as an energy superpower.

Firstly, the reserves and production capacity. Russia is the world's second largest oil exporter and has the 7th largest oil reserves. These are spread over the Caucasus in western Russia (the objective of Hitler's eastward push into Russia in 1941), and Siberian fields that would be more difficult to exploit. Russia is the top swing producer on supply crunches in the Middle East. The reserves as shown below:

Most quarters, however, see natural gas as being Russia's chief energy resource that will have the world clamouring for its favours. Natural gas, as noted in an earlier article ("Natural Gas- Alternative Energy Source"), is the most natural energy substitute for crude oil outside transportation use. Russia has about one-third of the world's gas reserves (twice that of the next largest -- Iran), and obviously is the world's largest gas producer and exporter. The whole of Europe depends on Russian natural gas for their energy and heating --- an enormous political lever that Russia tested earlier this year when it shut off supply to Ukraine and mainland Europe was also affected.

The geopolitics of Russia accentuate its strengths in oil and gas reserves. Russia is a huge country, its western end reaching into Europe and the eastern end adjoining China and Japan. It appears perfectly logical to run oil and gas pipelines to supply the demand from these huge economies. To the west, as has been mentioned, pipelines already supply gas to Europe, and Russia is targeting to export to the US east coast from its Shtokman natural gas field in Western Russia. To the east, construction has begun on the East Siberia-Pacific Ocean oil pipeline, which will run from Siberia to Russia’s Far East for export to the Asia-Pacific region, particularly China, and also Japan. In other words, Russia's energy strategy encompasses both Atlantic and Pacific facets. China has been drawing closer to Russia partially because of its need for energy security, in addition to the intent to act as counterweights to the US. A trans-Russia oil and gas pipeline would change global oil/gas transportation routes drastically, providing an intercontinental land route in addition to the sea route that passes through the Straits of Malacca from the Persian Gulf. Under such a scenario, the potential for Russia becoming an energy superpower are not limited to its own resources; its extensive land spread will mean that it will exercise great influence over any land-based oil/gas infrastructure. As it is, Russia already monopolises over the Central Asian export infrastructure.

It is also noted that the continued instability in the Middle East has boosted Russia’s position as the aspiring centre of energy geopolitics. In particular, Russia has historically exercised great influence over Iran (whom they supported in the Iran-Iraq war, for example); Iran holds the world's second largest oil reserves and also the world's second gas reserves ..... so there!

Economic nationalisation of strategic industries has been taking place especially in the oil and gas sector of major producers, such as Venezuela. The pioneer is probably Russia, and it has been ruthless. There is strong political will in consolidating the country's energy resources under the control of the state, where most gas reserves have been consolidated under Gazprom and oil reserves under Lukoil and Rosneft (formerly Yukos) --- all undoubtedly heavily state-controlled though some being floated (eg. Rosneft). While acting as a key producer independent of OPEC, global consumers are likely to see increasing leverage of Russian oil and gas as a powerful political tool.

Although there is political risk, widespread corruption and a declining Russian population, the global need for oil and supply line diversification can only mean more foreign direct investment in the country in the coming years, and with it the benefits trickling down to the masses. Russian theme plays are rare, though not non-existent on the SGX. The most important sector, however, is oil and gas, and companies supplying materials and building pipelines across Russia will do very well in the coming years. The key, ironically, is for oil/gas prices not to surge so high as to render various alternative energy projects viable.

References:
(1) Russian profile.org Jan 06: The re-emerging Russian superpower
(2) Russian profile.org Mar 06: Building a Sustainable Energy Superpower
(3) Russian profile.org Sep 06: Supply and Demand
(4) International Herald Tribune Apr 06: Russia re-energized by its natural resources
(5) Untimely Thoughts Nov 05: Russia Profile’s Weekly Experts’ Panel: Russia as an “Energy Superpower”

The developments at Harbourfront

2006-10-26T07:09:00.000-07:00

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Originally my intention was to write an article about an emerging preference for waterfront luxury living in Singapore, centering on Sentosa and the bayfront condominium and bungalow projects that have been selling like hot cakes recently. However, I decided to subsume it within the broader theme of the development of Harbourfront, one of the most exciting precinct developments in years.

Below is a map of the area's developments extracted from Tuesday's Business Times (it was similarly a writeup on the promise of the Harbourfront region by a Colliers property analyst):

The development of the area has been a long time in the making. Sentosa embarked on a strategic plan to rejuvenate Sentosa and the Southern Islands in 2002, and according to its website is now in its final phase with most other planned developments in place. The strategic vision foresaw Sentosa-HarbourFront as a single integrated tourism hub, forming a so-called Central Leisure District. The building of the Sentosa IR by 2010 would complete the final piece in the jigsaw (probably not anticipated in the original plan --- a bonus nonetheless).

The past year has witnessed the successful marketing of waterfront luxury housing development along Sentosa Cove; a measure of its success is that housing prices are forecast to even approach incumbent prime district (Orchard Road) luxury housing prices in the future. In fact the idea of waterfront living was pioneered by the Caribbean@Keppel Bay condominium development across Keppel Harbour. These would not be the last of the residential developments in the area, though bayside frontage would be limited given the presence of other developments.

These other developments currently are commercial and retail, of a scale sufficient to attract critical mass. The office towers of Harbourfront Centre and the various office towers are already in place, and the precinct now also boasts Singapore's largest retail mall right at the gateway to Sentosa. Entertainment will easily be found across in Sentosa in the future with the IR development of course, but St James Powerstation could provide a separate centre of nightlife entertainment. If one wishes to stretch the point, he could look down the road towards Keppel Country Club and its golf links (of course, there's also Sentosa Golf Club); this is an old club which could easily become more important in coming years due to its proximity and facilities.

The transport infrastructure is planned well in advance, signalling the government's high hopes for this area from the start. The new Circle Line will have three stations in the area: Labrador Park down the stretch, Telok Blangah, and to the existing Harbourfront MRT station. A Light Rail System will transit between Sentosa and the mainland. There is already an international cruise centre to bring in tourists. The area is close to the Central Business District, hence further enhancing its attractiveness and connectivity.

The above descriptions serve as a grounding in order to comprehend my basic view that the area is able to attract a critical mass of residents, tourists and funseekers that will establish the Harbourfront area as a major new precinct in the coming years, if it is not already evident to anybody taking a bus ride along Telok Blangah Road and passing by these developments. It is a no-brainer that the waterside frontage is the most valuable and will be maximised in usage, a stretch of it possibly forming a promenade similar to overseas developments like Canary Wharf or Fisherman's Wharf. The next promising developments are seen to be across the road from Harbourfront, in the existing bus interchange/food centre area and Mount Faber further up. Looking down Telok Blangah Road, the stretch of shophouses and miscellaneous industrial/religious buildings also possess redevelopment potential.

Keppel Land and Mapletree Investments (the real estate arm hived out from PSA) own large undeveloped plots along the entire waterfront stretch, while across the bay at Sentosa Ho Bee and City Developments are poised to be key players in the luxury housing segment. As the area sees further development, more companies are poised to take a stake in it in one way or another. Watch for it. This area, together with Marina Bay (where the other IR will be built), is where the action will be in the future.

References:
(1) Busines Times article Oct 24: Harbouring huge changes

The Special Economic Zone model

2006-10-20T20:27:00.000-07:00

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The rise of Asia is touted to be the great big economic story over the next few decades, and billions of dollars are being poured into this story. However, it might as well be seen as the rise of the big emerging markets: vast in geography and therefore possessing huge reserves of natural resources, populous in citizens and therefore possessing abundant cheap labour and a consumer market with untapped potential. Besides China, we have India, Russia, Brazil (these four make up the popular BRIC theme), Indonesia, Pakistan, Vietnam, Mexico --- all these are huge countries that possess the above characteristics and are now seeking to emulate the rise of China.

The biggest problem with growing a large country economically is that capital can be spread thin if attempts are made to homogeneously distribute them. Being erstwhile developing nations, infrastructure is typically underdeveloped -- communication (telcommunications) and transport links (road, rail, airport) are often backward, and power and water shortages are routine (a big example is India). Hence the idea of special economic zones: privately-run zones usually under private-public equity ownership, typically coastal areas, intended to be oases of world class infrastructure, offering duty-free incentives and streamlined procedures. In China, they were developed as "special economic zones" (the title of this article) ---- India's and Indonesia's upcoming developments follow this concept; in Mexico they named it "maquiladora" (or border industrial parks, since they were set up along the border, separating the USA from Mexico); in Pakistan and Vietnam, as export processing zones.

This concept is obviously not new, but the success with which China has been able to mobilise foreign investment into the surrounding areas of its SEZs and multiply their effect is going to popularise this developmental framework in coming years. For China, SEZ development started with 6 SEZ cities following 1978 with the most successful being the regions of the Pearl River Delta (Guangdong province), the model was extended to the Yangtze River Delta (Shanghai) and Tianjin, and recently with the "Go West" economic development programs centering around Chongqing and the Western regions. (As an aside, I would compare the framework to the German warfare concept of blitzkrieg --- concentrate resources at great speed to acquire critical mass, then encircle and attack). Some of the more visible global developments include the passing of the SEZ Act in India in 2005 to promote development of special economic zones, hailed as one of the biggest pushes for industrial expansion in post-independence India; the recent push by Indonesia to develop potentially >10 SEZs for the future; legislation allowing for the establishment of "special economic zones" introduced in mid-2005 in Russia and its subsequent plans for 6 SEZs.

The reason why I include this trend in my writeups is because there is great potential for Singapore property development and construction companies to capture a piece of this pie. There has already been extensive past experience in exporting our industrial park development experience to places like the Batam Industrial park and the Singapore-Vietnam Industrial Park, and of course the outstanding Suzhou Industrial Park (which became successful only after the Chinese got a majority stake --- one of their little idiosyncracies). It is worth noticing that in the trade missions abroad, one of the value-adds the Singapore delegation always proposes is that of urban/industrial planning and development --- there is great respect for the Singapore industrial development experience. There are plans to develop a large SEZ the size of the Batam Industrial park (typically SEZs have been very small in India) in India to bring in a range of industries, to help set up two of the six Russian economic zones, to develop Batam, Bintan and Karimun as the spearheads for Indonesia's SEZ plans, and recently an emerging colossal market in a Middle East keen to implement sustainable development on their petrodollars.

The obvious beneficiaries would be property and urban developers with experience in doing urban and industrial park/economic zone planning, such as public-turned-private Surbana (formerly HDB) and CPG (formerly PWD) for example. Sembcorp has extensive experience in industrial parks. Keppel Land is already developing townships in China. At the same time, tag-on sectors like Singapore construction companies (eg. Lee Kim Tah, BBR) and equipment/service providers (eg. construction equipment rental companies like Tat Hong) are poised to benefit. This is because the popular operational mode of Singapore private enterprises in going abroad now is in consortium mode, providing a vertically-integrated range of services from planning to construction and maintenance. For example, companies have banded themselves into a Singapore Building and Infrastructure Consortium in bidding for Middle-East mega-projects. The Japanese construction companies have done this to great effect in the past.

References:
(1) Dawn.com article Nov 2002: Economic zoning: strategy for development
(2) Economist article Oct 2006: India's Special Economic Zones
(3) SAWF News article Oct 2006: Row brews in India over Special Economic Zones
(4) Channelnewsasia report Jan 2006: Singapore exploring possibility of developing SEZ in India
(5) Outsourcing Russia.com Dec 2005: Six Special Economic Areas To Be Created In Russia
(6) EE Times article Aug 2006: Singapore will help launch Russian economic zones
(7) Lawandtax-news.com article Jun 2006: Singapore And Indonesia To Establish Special Economic Zones
(8) Lawandtax-news.com article Jun 2006: Singapore And Indonesia To Establish Special Economic Zones

Middle East Series: Oil and Gas Infrastructure

2006-10-10T08:16:00.000-07:00

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It may seem clear that of the four articles (including this one and excluding the introductory article) I've written on this region, three are on construction and infrastructure development. This is exactly my intention because construction and engineering are the prime areas for foreign participation; the Middle East is primarily an investment-driven boom. And what's more appropriate to end this series than with what the region is known for: oil and gas?

The Middle East countries form the core of the infamous OPEC cartel which supplies ~40% of the world's oil and effectively dictate world supply. A main reason for their dominance is that world supply is peaking (North Sea and Gulf of Mexico oil past their peaks) while Middle East oil reserves form >50% of the world's total and gas reserves form ~40% of the world's total. Indeed, in the medium term, they are likely to be the most important producers because there exist significant infrastructural (drilling equipment shortages eg. rigs, as well as transport infrastructure) constraints and even regulatory constraints due to economic nationalism being increasingly practised by countries like Russia and Venezuela. Middle East oilfields are mostly onshore and relatively easy to develop (a significant example being Saudi Arabia) and have incumbent government support and existing frameworks of cooperation with the big IOCs (integrated oil companies). The figure below shows how economically cheap Middle East oil is to exploit in relation to the rest of the options (viability measured by selling price of crude oil)

Saudi Arabia dominates crude oil production, and its national oil company (NOC) Saudi Aramco possesses the technological abilities to extract their oil. Their planned expenditure for oil and gas infrastructure is the top item among all infrastructure expenditure (including electricity and water --- see earlier article); not surprising since this is their critical sector. The bulk of Saudi expansions will come from onshore fields, for which prevailing global tightness in drilling capacity is less pronounced, so delays in obtaining rigs may be less prevalent than for other, notably non-OPEC, producers. Sustained production capacity increases are also seen in Algeria, Qatar (also gas-liquid investments to tap its huge gas reserves), the UAE (both onshore and offshore), and Kuwait, with active foreign company involvement. Iran, as the second largest oil producer, may see plateauing production due to technological difficulties, while Iraq still faces political problems. However, this of course suggests opportunities for more technically competent foreign operators should geopolitical tensions ease.

One of the bottlenecks in the global oil supply chain are the refineries and this is one of the key areas of oil and gas infrastructure development targeted by the Middle-East countries. In fact, the region is the largest contributor to refinery expansions over the next five years, driven by the aggressive expansion plans of national oil companies.

Given that Middle East oil is typically sour crude which means complex refineries are needed for processing, I initially thought these would be the type primarily planned for construction. It turns out a combination of both crude distillation refineries (less complex) and complex hydrocracking refineries (complex) are planned for construction. The former are for domestic power generation for rapidly growing populations, while the latter are for international export. Major additions are planned across the region, from Oman, Yemen and Iran before 2010 and a number of world-class facilities in Saudi Arabia, Kuwait, the UAE and Qatar post-2010 (hence explaining the figure above). It is worth noting that the near-term refinery expenditure is mainly in the form of upgrading and environmental compliance (desuphurisation), while after 2008 the real new refinery additions will start building/coming onstream (for those timing the refinery build cycles).

The third main area of investment would be in distribution facilities, with investments in oil terminals and pipelines. Given the tightness in the export market, the charter rates for oil tankers and VLCCs (Very Large Crude Carriers) have remained strong even as bulk and container shipping rates have foundered; some Middle East countries are building new oil tankers to ease transportation constraints (eg. Kuwait Oil Tanker Company) and also LNG carriers are being built in Asian shipyards.

The theme is one of Middle East countries investing aggressively to expand capacity and ease bottlenecks along the entire supply chain, and those companies with exposure to the oil and gas industries in this region are set to benefit, particularly in the areas above which have proven to be major areas of planned expenditure.

As an indication of the growing economic importance of the Middle East, the Business Times is now covering it as a separate region. It will pay to track the news in this region, because it is likely to be where the liquidity is coming from in the near to medium-term. As it is, the export surplus of these countries have already grown comparable to Asia's on a region-to-region basis as a result of high oil prices.

References:
(1) IEA report Jul 2006: Medium-Term Oil Market Report
(2) BusinessWeek Online Mar 2006: The New Middle East Oil Bonanza
(3) MEES article Mar 2002: World Energy Outlook: A Middle East Perspective
(4) Middle East Online article Dec 2005: Kuwait to pump 44 billion dollars into oil
(5) Gulfnews.com Jun 2006 report: Arabian Gulf VLCC rates rise sharply

Middle East Series: Finance and Investments

2006-09-25T03:12:00.000-07:00

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SM Goh was quoted recently as stating that he was disappointed at Singapore's inability to gain a larger share of the investment funds coming out of the Middle East..... and when you consider that this segment of the local banking industry has been growing at 20-30% per year, it gives a hint of how prodigiously the liquidity in the Middle East must be growing.

This segment centres around three main themes (in my view), which will be outlined below. It is worth noting that the liquidity relating to these themes mainly relate to the six richer GCC (Gulf Cooperation Council) countries: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates, which are relatively more stable politically, foreigner-friendly, and boast strong services industries due to their affluence and consequent strong soft capital --- all necessary ingredients for a strong financial industry infrastructure. Equally importantly, they are strong direct beneficiaries of high oil prices --- with the probable exception of Bahrain.

The first thread is the development of the domestic financial markets. The booming regional economy has boosted the profits of banks, with tailwinds in the form of huge and growing business volumes and a low cost of funds and labor (due to high liquidity as a result of easy oil money) providing the momentum. Given the excellent demographics (one of the fastest growing regional populations) and oil money, foreign banks have been fast getting into the act by setting up branches in the region, leading to rapid growth of assets under management, a phenomenal increase in debt issuance; and accelerated innovation of new products, especially in the area of Islamic finance, with the creation of new Islamic banks. In the capital markets, the stock exchanges in Saudi Arabia and the UAE grew >100% in 2005, and that in Kuwait and Qatar grew >60%; this was due to high oil prices, entry of foreign funds (private equity, hedge funds) as well as a private sector investment boom in areas such as real estate, financial services, industrials and telco infrastructure. In recognition of global interest coming into the region, the UAE launched the Dubai International Financial Exchange (DIFX), the first exchange in its region created to list securities from many different countries, targeted to attract large numbers of international brokers and investment banks and hence establish the city as a regional financial hub. The first theme is one of expanding and liberalising local capital markets and financial services industries in the region.

In particular, Islamic finance has become the largest growth sector within banking globally - growing by 10 to 15 per cent a year. It is worth US$300-500B as of September 2006. This is the second major theme. This banking concept is based on interpretations from the Qur'an, and its two central tenets are that no interest can be earned on loans, and socially responsible investing. The first is self-explanatory, the second means investing responsibly to assure that the money does not go for "bad" purposes, such as investments in drugs, weapons, alcohol, pornography, and terrorism --- not much different from the Western concepts of ethical investing. Islamic financial instruments are not only available within the Middle East bond markets; they are increasingly being made available in foreign markets eager to attract Arab money. There are now Sukuk (Islamic) bonds listed on the London Stock Exchange, and Islamic countries like Malaysia, with decade-long experience in Islamic funds and with legal infrastructure in place, are looking to capture the market with their Islamic credentials. Key Islamic finance instruments include Sukok bonds (Islamic bonds, mentioned above), takaful insurance (cooperative insurance compliant with Islamic beliefs), and Islamic investment funds. Given the need to raise foreign capital (through infrastructure bonds) to invest in new infrastructure projects in the Middle East (oil money not enough) as well as offshore banking services to manage their burgeoning petrodollar assets, Middle East demand for Islamic banking services are expected to grow further.

The third theme relates to the overseas investments being made by the Middle East nations, especially the GCC member states. This is mainly done through their cash-rich state investment agencies, and also partly by corporates looking at other markets outside the GCC region to diversify and hedge market risk (of operating in a single market facing increasing foreign competition). Generally, their investment markets may be divided into several categories: stable Western markets, including the US (less so since Sep 11) and Europe (their old colonial masters and also in close proximity), moderate/relatively stable Muslim countries like Pakistan, Malaysia and Indonesia, high-potential/hotspots such as China (especially their banks) and India, and neighbouring countries like Jordan, Egypt and North Africa. Investments can be portfolio-type (ie. no controlling interest) or direct investments, which tend to be strategic (eg. Dubai Ports' port acquisitions in Hong Kong and P&O in Europe); real estate is a major preference, especially Asian property. Again, the rules apply: no companies that traffic in alcohol, pork, pornography or gambling, and also Islamic financing is typically used to avoid violating religious rules. This trend also partly explains the growth in Islamic financing.

In the Singapore stock market, the most obvious beneficiary from growth in the Middle East financial and investments sector are not banks, but real estate. The former has not achieved any significant penetration into the Middle East nor developed any strong exposure to outflowing Middle Eastern funds, while the latter fit the profile for the investment preferences of Middle East investors: Asian, prime real estate, key regional hub, friendly population and Muslim neighbours. One may note the ease with which large placements by Ho Bee and SC Global were taken up as evidence of interest in the local real estate sector.

References:
(1) Arab News Sep 06: Prospects Are Good for Banks in Gulf
(2) Bahrain Tribune: Islamic finance set to continue prodigious growth - Bahrain
(3) Arab News Aug 06: Sukuk Assumes Greater Complexity
(4) BusinessWeek Oct 05: A Bourse Is Born In Dubai
(5) Washington Post Aug 06: The Real 'New Middle East'
(6) Washington Post Mar 06: Mideast Investment Up in U.S.
(7) Wikipedia entry: Islamic finance
(8) RUSD Investment Bank presentation: Accelerating Investment Funds from the Middle East

Middle East Series: Infrastructure development

2006-09-14T21:44:00.000-07:00

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Development of the infrastructure in the Middle East has been a regional focus for international organisations like the World Bank and the IMF, judging from the number of documents generated. This region has been relatively underinvested with a large portion of the rural population being completely unserved by electricity and telecommunications, while services in urban areas often experience high distribution losses, frequent service interruptions, and weak financial performance.

When countries in the Middle-East talk about "adopting the Singapore model", you know that one focus has to be infrastructure, for that is one of Singapore's key strengths. Given the oil money flowing into the Middle-East, there have been large public infrastructure projects executed and new ones being planned for at least the next decade, with amounts running into the hundreds of billions. Infrastructure development is not only crucial in meeting the region’s social challenge, but has an essential contribution to make towards improving business competitiveness in the Middle East.

By infrastructure I mean public infrastructure, which can be classified into water, electricity, transport, sewerage, telecommunications, sanitation. Given that the region is now characterised by high monetary inflows (due to oil exports) and a rapidly growing population (more than doubled to about 270 million in the past 30 years, could double again in the next 30 years --- an annual growth rate of ~2.5%), the growth in infrastructure investments will obviously outperform most other areas of the world. The strategy has been shifting to more emphasis on private sector participation; an example is shown in today's Business Times which reports the Saudis seeking US$1 trillion from private sector investments to carry out various infrastructure projects (top four being oil & gas, petrochemicals, electricity and water, telecommunications) --- which offers tremendous opportunities for global engineering and construction companies (see Partnership Models Part 1 & Part 2 for various public-private partnership models).

I will choose to focus on two aspects of the infrastructure development which appear to offer the most opportunities for Singapore companies so far, by the track record of contracts offered/explored.

The water sector is a unique problem to the Middle East more than anywhere else, and it is evident from an examination of demand and supply. In terms of supply, the water availability per capita is historically the lowest among all the world's major regions, and this is expected to remain similar in the future.

Among the various Middle-East countries, it is interesting to note that the rich Gulf countries are the ones that lack renewable (ie. natural) water the most: Bahrain, Saudi Arabia, UAE, Qatar, Kuwait --- suggestive because this implies that these countries offer the greatest opportunities for water infrastructure development.

On the demand side, many Middle-East countries have some of the highest consumption rates per capita in the world (eg. in UAE, consumption per capita is >3X the world average). High consumption rates are mainly driven by aggressive agricultural policies, which can account for >80% of a country's water usage, and further accentuated by high technical and commercial losses in the water systems, also referred to as unaccounted for water(UFW). Kuwait, Saudi Arabia and the UAE actually provide water for free.

Approaches to increasing water supply (over and above natural/renewable water sources) include tapping into groundwater, desalinating seawater, or by reusing wastewater. The first poses long-term environmental problems, the third only allows limited usage of the recycled water; the second option is expensive but is the top technological approach for increasing water supplies in the region for the richer countries, and is practised on a large scale in Saudi Arabia and in the Gulf countries (esp. UAE & Kuwait), where it contributes substantially to municipal and industrial water supplies. The Middle East nations operate 60% of the world's desalination plants, and it is estimated they will need to invest a $100 billion on desalination over the next decade if demand for water keeps growing at the current pace, especially in the Gulf region. To give a perspective, water infrastructure is probably the third most important infrastructural investment in Saudi Arabia for the coming years (US$80B over the next 20 years), after oil and gas (to be covered in a separate article) and electricity.

The second sub-sector is electricity and power. The IMF’s prediction is that the regional power sector will remain very buoyant for the coming year, in contrast to other parts of the world where demand is stagnant or growing slowly. This is due to continued strong regional economic growth. Demand in these richer GCC (Gulf Cooperation Council) countries is expected to experience double digit growth in the foreseeable future. In addition, reconstruction of Iraq’s electricity generation and distribution sector also provides promise.

Recent estimates are that $57 billion will be spent over the next six years in the Middle East & North African region on the installation of new capacity alone. where about half of this will be spent solely in the GCC (the richer Gulf countries), with the private sector to provide the majority of this. Among these, Saudi Arabia and the UAE are expected to provide the bulk of the contracts.

An overview of the current/future power/electricity investments as of early 2006:
- Different sectors within the energy industry in the Middle East will require investments of more than $1 trillion over the next 20 years
- The UAE’s power sector needs more than $10 billion investment to meet growing energy consumption demand
- The government of Saudi Arabia plans to increase generation capacity from 17,000MW to 66,000MW by 2023, requiring investments of $17 billion
- Investments required in other Middle East countries are estimated to be: $3.6 billion in Kuwait; $800 million in Oman; and $1 billion in Bahrain

Projected Additional Capacity needed by 2010
Bahrain - 1200MW at an estimated cost of US$900 million
Iran - 20,000MW at an estimated cost of US$10 billion
Jordan - 750MW at an estimated cost of US$445 million
Kuwait - 3,400MW at an estimated cost of US$2.5 billion
Lebanon - 350MW at an estimated cost of US$175 million
Oman - 1,100MW at an estimated cost of US$900 million
Qatar - 800MW at an estimated cost of US$600 million
Saudi Arabia - 20,000MW at an estimated cost of US$15 billion
United Arab Emirates - 6,600MW at an estimated cost of US$5.1 billion

These power/electricity generation projects tend to be huge. An example is the Dolphin Project, which involves the production and processing of natural gas from Qatar’s North Field, and transportation of the dry gas by pipeline to the UAE for electricity generation. Intended to fuel the UAE’s long-term industrial growth, it is worth billions of dollars. Another significant project is the GCC power grid --- a $3B project --- which is intended to serve as a common power grid to join the GCC nations: Saudi Arabia, Kuwait, Bahrain, Qatar, the UAE and Oman.

Due to the size of these contracts and the growing focus on public-private partnerships, foreign utilities players are vying for a piece of the pie. An example is Sembcorp Utilities, which recently had a bidding tussle with Suez Energy over a UAE power plant (it eventually went Sembcorp's way).

References:
(1) World Bank report Jan 2000: Urban Water and Sanitation in the Middle East and North Africa Region: The Way Forward
(2) Booz Allen Hamilton: Public-private partnerships keep Middle East water flowing
(3) Threat of water shortages sees Middle East governments focusing on increasing supply
(4) World Bank May 2005 Speech to World Economic Forum on Infrastructure Challenges
(5) Sep 03 report: Saudi to invest USD700 billion in infrastructure projects
(6) Jun 03 report: Middle East gears up for increased power demand and infrastructure development
(7) Sep 03 report: Inaugural ‘Middle East Infrastructure Innovation’ award goes to Dolphin Energy CEO
(8) Middle East Electricity Exhibition and Conference

Middle East Series: Construction boom

2006-09-03T07:57:00.000-07:00

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It is difficult to figure out where to start in a discussion of the construction boom in the Middle-East. There has been so much written on this sector in the past 2-3 years, in particular on the UAE by virtue of their ambitious developments, that many might probably be already familiar on this theme.

This is a liquidity-driven boom of course, and the key reason for that liquidity is petrodollars as oil prices remain stubbornly high these few years. As mentioned in my last article, the Arabs have learnt from their last boom in the 1970s and are looking to diversify their economy as the oil boom will not last forever: firstly oil prices undergo cyclical moves in conjunction with the global economy, and secondly there is the fear that Peak Oil may already be on us, with supply plateauing in a few years, if not now.

The construction boom looks to me to be taking emphasis along different lines for various key nations in the Middle-East, and I'll start with the UAE. Dubai in particular has developed a reputation as the hottest new playground for the super-wealthy, with its grand developments such as the Palm (a man-made island in the shape of a palm tree), the Burj Al Arab (reputed to be the world's only seven-star hotel) and the World (a series of reclaimed islands that will form the shape of the world). Surely the most Westernised country city in the Gulf, it has marketed itself successfuly as the tourist destination to head for; massive developments, mostly tourism-related, are under construction everywhere, each vying to outdo the other as the biggest, tallest or most luxurious. Hotel occupancy rates are >90%. It is the conference and exhibition hub for the region and a leader in the MICE industry, hosting the World Bank and IMF conference in 2003 (the same one that Singapore is having soon). Its sister city, Abu Dhabi, also the capital of the UAE, has also been focusing on mega construction projects, typically mixed developments comprising residential, commercial and tourism complexes as well as providing elaborate and highly sophisticated infrastructure developments.

Although rents have been rising and still remain strong, supported by revamped property laws that allow for property ownership and investment by locals as well as opening of the market further to foreigners which has seen foreign funds starting to come in, the real estate market is seen to slow down by the end of 2006. The effects of the completion of various construction projects over the coming few years will increase supply, and will exert a downward pressure on prices. This pressure is seen to have less of an effect on commercial and industrial real estate, in comparison with residential property. It is worth noting that the major UAE developers are moving abroad; indeed, the largest, Emaar Properties, has for the most part sold ts developments in the UAE.

In actual fact, the largest construction market in the whole of the Middle East would be Saudi Arabia, with the UAE probably coming in second. The focus is different in the largest of the Gulf states: construction of public infrastructure, which include expansion of infrastructure, transport and municipal services, and expansion of the country's electricity network and water supplies. Public housing is also an area of expected strong future demand given the strong population growth.

Two countries which have come in for less mention but have also experienced high construction growth, going by the growth in demand for cement, are Qatar and Bahrain. Their target audience are still foreigners but they are not just concentrating on tourism, but also as financial hubs. Doha, capital of Qatar, for example, is seen to be taking a different direction from Dubai in its property development focus ---- less of a resort approach. Given that Qatar is set to become the world capital of the gas-to-liquids industry by 2010 and the single largest supplier of liquefied natural gas to the United States, by virtue of its huge natural gas reserves, the coffers are overflowing and some actually see this as a hotter region than the UAE for the future. Bahrain is the incumbent financial hub for the Gulf, and probably draws the best comparison case to Singapore --- it will always draw in capital and will benefit from the booming Gulf economies through capital flows. For Singapore's construction and real estate firms, these two countries, together with the requisite UAE, are seen to offer the most opportunities for project participation (probably also because they are the most open and foreigner-friendly economies).

Some also see long-term potential in the Iraqi reconstruction sector, though these would obviously not be in the areas of luxury housing and more along the lines of basic infrastructure construction.

Beneficiaries of a buoyant construction industry are not hard to conceptualise: sectors which provide the basic building materials will benefit, such as paint, ceramics, glass, cement and steel industries --- the basic materials industries. Bulk shipping traffic transporting these materials to the Gulf apparently command higher rates compared to global benchmarks, which have led to some shippers focusing on the area in search of higher margins(eg. Courage Marine recently). Construction and infrastructure companies with strong presence in the Middle East will obviously benefit as well. For those who believe in emerging markets, the construction sector is one that must not be missed, given the high population growth and relatively backward infrastructure that offers plenty of room for investment.

References:
(1) Canada.com: Boom-town Middle-East
(2) Middle East Times Dec 05: Petrodollar overflow produces Dubai construction boom
(3) Khaleej Times Aug 06: UAE real estate developers target projects in India
(4) Oxford Business Group Aug 06: Abu Dhabi: More Demand
(5) Emirates Today Aug 06: UAE: Funds are deploying cash cushions into value stocks
(6) Ameinfo.com Oct 05: Saudi Arabia's $35 billion construction boom
(7) MenaFN.com Nov 06: A continuing construction boom in Qatar may see the demand for cement go up steeply over the next two years
(8) MenaFN.com Jan 06: Real estate boom stirs investments - Bahrain
(9) Ameinfo.com Dec 04: Doha's strategy for success
(10) Gulf Daily News Oct 05: GCC construction boom in spotlight
(11) Khaleej Times Jan 06: Construction boom in the UAE supports secondary industries

Middle East Series: Part 1

2006-08-26T18:07:00.000-07:00

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The newspapers have been trumpeting the rise of the Middle-East across all sectors, a pretty obvious theme to all who have observed the sustained rise of oil prices. This is seen as the second great boom of the Middle-East after the heady OPEC-cartel days of the 1970s, but many have observed that the distribution of the oil money has been far more responsible this time round, with money not just flowing abroad to buy foreign assets (eg. US Treasuries, luxury hotels and retail assets), but also domestically along various avenues: construction of crucial infrastructure (communications, roads, water), oil-and-gas and petrochemical projects, services-related industries (finance, tourism) --- in order to ensure long-term sustainability of revenue streams as well as to diversify them. The Middle-East theme has been touted as one of the key investment themes to watch for the next few years; locally I remember at least one well-known analyst highlighting it as a strong theme for 2006 (Gabriel Yap).

This is such a broad and interesting theme that it'll probably take several parts to cover it. From a standing start, with limited knowledge of the key cities save for the politics of the region and the main countries involved, I'll look at them from an economic angle, with a focus on where key investments and money flow could go in the future. Please contribute if you know more about the region.

An overview of the region must start from the geopolitics. Two maps below, one overlooking the region's neighbours and another focusing on the region proper:

Middle-East overall strategic view

Middle-East region

Geopolitics is especially important in this region because of the historical political uncertainty, which suggests high investment risk. Yet this risk is not even across the region --- the areas around Israel up to Iran have been traditional flashpoints, with the Saudi-Arabian peninsula relatively more stable (where the UAE and Qatar are on), probably because the stretch of water that is the Persian Gulf is where the US can project its naval power upon, to protect against any cross-Gulf threat (obviously from Iran). An overview of the maps also facilitates understanding of why Russian and European influence have traditionally been important here (proximity, in addition to former colonialism), and also the importance of the Persian Gulf, through which most of Arabian oil is shipped to Asia.

(For those interested in reading more about Middle-East geopolitics, you can check out The truth laid bear --- a collection of blogs on the Middle East)

An overview of the main component countries of the Middle-East, with an emphasis on the key economic resource --- oil and gas resources --- that will provide the oil money to propel growth. The Middle-East is said to produce ~20% of the world's oil but 40% of its oil exports (that's the important figure). The countries are listed in descending order of general importance (self-judged):

(Note: oil production and export figures - 2004; oil & gas reserves figures - 2006)

Saudi Arabia
- World's No. 1 oil producer, world's No. 1 oil exporter, world's No. 1 oil reserves, world's No. 4 gas reserves
- Economic summary: (2005 est.): per capita $12,900.
- By labour force: agriculture 12%, industry 25%, services 63%
- By industries: crude oil production, petroleum refining, basic petrochemicals; ammonia, industrial gases, sodium hydroxide (caustic soda), cement, fertilizer, plastics; metals, commercial ship repair, commercial aircraft repair, construction
- Growing banking and financial-services sector; growing emphasis on tourism, especially along the Red Sea coast and pilgrimage tours to Mecca/Medina

Iran
- World's No. 4 oil producer, world's No. 4 oil exporter, world's No. 3 oil reserves, world's No. 2 gas reserves
- Economic summary: (2005 est.): per capita $8,100.
- By labour force: agriculture 30%, industry 25%, services 45% (2001 est.)
- By industries: petroleum, petrochemicals, textiles (2nd most important after petroleum), cement and other construction materials, food processing (particularly sugar refining and vegetable oil production), metal fabrication, armaments

UAE
- World's No. 10 oil producer, world's No. 6 oil exporter, world's No. 6 oil reserves, world's No. 5 gas reserves
- Economic summary: (2005 est.): per capita $29,100.
- By labour force: services 78%, industry 15%, agriculture 7% (2000 est.)
- By industries: petroleum and petrochemicals; fishing, aluminum, cement, fertilizers, commercial ship repair, construction materials, some boat building, handicrafts, textiles
- Important services: international banking, financial services, regional corporate headquarters, tourism

Kuwait
- World's No. 11 oil producer, world's No. 7 oil exporter, world's No. 5 oil reserves, world's No. 20 gas reserves
- Economic summary: (2005 est.): per capita $22,800.
- By industries: petroleum, petrochemicals, cement, shipbuilding and repair, desalination, food processing, construction materials

Iraq
- World's No. 14 oil producer, world's No. 11 oil exporter, world's No. 4 oil reserves, world's No. 10 gas reserves
- Economic summary: (2005 est.): per capita $3,400.
- By industries: petroleum, natural gas, phosphates, sulfur

Turkey
- Economic summary: (2005 est.): per capita $7,900.
- By labour force: agriculture 36%, industry 23%, services 41% (3Q04)
- By industries: textiles, food processing, autos, electronics, mining (coal, chromite, copper, boron), steel, petroleum, construction, lumber, paper
- Substantial tourism
- a traditional link between Europe and Middle-East, with railroad of international importance, Baghdad Railway, linking Europe with Asia Minor and the Middle East

Qatar
- World's No. 14 oil exporter, world's No. 13 oil reserves, world's No. 3 gas reserves
- Economic summary: (2005 est.): per capita $26,100.
- By industries: crude oil production and refining, LNG, ammonia, fertilizers, petrochemicals, steel reinforcing bars, cement, commercial ship repair
- Regional banking center

Israel
- Economic summary: (2005 est.): per capita $22,300.
- By labour force:public services 31.2%, manufacturing 20.2%, finance and business 13.1%, commerce 12.8%, construction 7.5%, personal and other services 6.4%, transport, storage, and communications 6.2%, agriculture, forestry, and fishing 2.6% (1996)
- By industries: high-technology projects (including aviation, communications, computer-aided design and manufactures, medical electronics, fiber optics), wood and paper products, potash and phosphates, food, beverages, and tobacco, caustic soda, cement, construction, metals products, chemical products, plastics, diamond cutting, textiles, footwear
- Doubtful whether it will benefit from neighbours' oil boom given political differences

Bahrain
- Economic summary: (2005 est.): per capita $20,500.
- By labour force:agriculture 1%, industry, commerce, and services 79%, government 20% (1997 est.)
- By industries: petroleum processing and refining, aluminum smelting, iron pelletization, fertilizers, offshore banking, ship repairing, tourism
- Major financial center
- Key Western ally; base for U.S. navy's 5th Fleet, which patrols the Persian Gulf

Egypt
- Economic summary: (2005 est.): per capita $4,400.
- By labour force: agriculture 32%, industry 17%, services 51% (2001 est.)
- By industries: textiles, food processing, tourism, chemicals, pharmaceuticals, hydrocarbons, construction, cement, metals, light manufactures
- Strong foreign aid from Arab neighbours and the West
- Home of the Suez Canal which facilitates East-West trade

Oman
- Economic summary: (2005 est.): per capita $13,400.
- By industries: crude oil production and refining, natural and liquefied natural gas (LNG) production; fishing, construction, cement, copper, steel, chemicals, optic fiber

Lebanon
- Economic summary: (2005 est.): per capita $5,300.
- By industries: banking, tourism, food processing, jewelry, cement, textiles, mineral and chemical products, wood and furniture products, oil refining, metal fabricating
- Best days are behind them since civil strife in 1970s. Lebanon was previously the distribution center for the Middle East, and commerce was its major industry. Beirut, a free port, was the region's financial and commercial hub.

I omit the economically less significant nations of Syria, Jordan and Yemen.

References:
(1) Infoplease: Middle-East Atlas
(2) CIA: The World Factbook
(3) Infoplease: Top oil and gas producers/exporters/reserves

Singapore as a MICE destination

2006-08-20T07:28:00.000-07:00

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The way that the mass media has been advertising the IMF/World Bank convention coming up in September, you'd think that it's the coming-out party for Singapore the way that the 2008 Beijing Olympics is seen as one for China.

Every country which sees itself as a respectable business destination and aspires to build on its services-based income is eyeing a slice of the MICE pie. MICE stands for Meetings, Incentive Travel, Conventions and Exhibitions, and in my view it is suddenly being seen as prime beef for two reasons: (1) business/incentive tourists tend to spend more in the convention cities on their company accounts (ie. other people's money) compared to leisure tourists; but more importantly, (2) because it creates long-term strategic value to become (in the words of STB) "an exchange capital where talent, technology and ideas converge to create synergistic value for both business events and visitors" --- given the current focus on innovation and information to drive growth, it will pay off to be a "hub" (yes, that word again) where people converge and ideas and information are generated. Just as couples have a special attachment to places where their romance bloomed, so executives/academics will develop certain mindshare for places where their ideas were first sprouted/exchanged.

The tailwind is behind Asia to grow this trend. The top 10 convention countries are all in Europe/North America and yet Asia is seen by all major MNCs to be their growth drivers for the next 1-2 decades. As relocation of manufacturing is followed by relocation of higher value-added services components (IT, R&D, design & engineering) and regional headquarters are established in the region, and the major Asian cities grow in sophistication and market size, their share of the business conventions/exhibitions market can only grow. Everyone will converge in the most dynamic region for exchange of ideas because they "need to understand the market". It is a no-brainer.

What may be more arguable is Singapore's ability to grab a growing piece of this pie, given that all major Asian cities are planning expansion of MICE space. For the Asia Pacific region, there is currently 1.9m sqm of available MICE space with another 772,000sqm coming onstream in the next five years, an increase of 40%. The major space additions are in cities like Shanghai, Tokyo, Seoul, Macau, Singapore, and surprisingly, Ho Chi Minh. That is not including investment in Middle-East cities/countries like Dubai, Abu Dhabi, Qatar etc which are also expanding aggressively.

There are a few factors which support Singapore's bid. The most important factor is that it has critical mass; it has been Asia's top convention city for several years and was ranked second (in terms of number of meetings) for the World Top Convention City last year (behind Vienna). The second, linked to the first, is that it is one of the key regional hubs for Asia, a bridge between West and East. Given that the top 10 convention countries are all from the West (Singapore is considered a city), it makes sense that if some should migrate to Asia in the future, they would be seeking "transition" cities where culture shock would not be too great. Thirdly, there is strong governmental support through STB, comprising of clustering, marketing and incentivisation efforts. The Business Travel & MICE sector accounted for approximately 30% of total tourism receipts in 2004, and the aim is to raise it to at least 35% by 2015 --- an average annual growth rate of 15% (in dollar terms) over the next ten years. I always look for governmental support because it takes away a portion of the required investment costs away from the private sector.

Check out the MICE (exhibition/convention) services providers. Given that they already operate on tight margins in a highly competitive and fragmented industry, it is a volume game. And volume growth, as has been highlighted above, is what the Asian/Singaporean MICE industry is all about.

References:
(1) UOB Kay Hian analyst report 25 Jul 06: Cityneon
(2) STB Unveils Key Initiatives to Spur Growth in the MICE Industry 3 Aug 06
(3) ICCA publishes country and city rankings 2005

The coming biodiesel boom in Malaysia and Indonesia

2006-08-10T09:44:00.000-07:00

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I have written about the coming second Green Revolution in an earlier article and it may be worth looking at the manifestation of a growing focus on the alternative fuels sector in two countries in ASEAN -- Malaysia and Indonesia.

Biodiesel is obtained by mixing natural oils (eg. palm oil, jatropha oil) into normal gasoline, and given the incumbent plantations already in existence in Malaysia and Indonesia for the crops in question, it is no surprise that they are looking to cash in on a probable alternative energy boom. Note that even in Europe, hardly the most agricultural of regions, biodiesel production capacity has almost tripled since 2003.

Malaysia, in particular, as the top producer of palm oil in the world, are looking to tap the huge potential in the biodiesel market, particularly in meeting the demand in Europe and the United States. The Malaysian Industrial Development Authority has approved 20 biodiesel projects between Jan 05 to May 06, with total proposed investments of RM1.9bil.

Indonesia is targeting a crash program to build biodiesel plants with production targets equivalent to 3 percent of the country's 2005 total fuel consumption by 2010. Biodiesel is renewable and based on such crops as castor-oil plants, oil palm, cassava and sugarcane, which can all be grown in the country. Most importantly, biodiesel production is highly labor intensive. In short, biodiesel production plays to the country's incumbent strengths.

There is tremendous optimism surrounding the alternative energy aspirations of the two countries. The key beneficiary is the plantations sector, which is set to benefit from a likely permanent upward shift in CPO (crude palm oil) prices. In Malaysia, the plantation index has already outperformed the KLCI by 21% since January 2006. Plantation heavyweights IOI, KL Kepong, Golden Hope are trading at >20X forward FY06PE following a year-long re-rating of the long-term prospects of the plantation sector (statistics taken from a Malaysian site: Sahamas forum Plantation sector.

A key development was a mid-July 2006 announcement by the Malaysian and Indonesian governments that the two countries will set aside 40% (or 6 million tonnes) of their CPO output for biofuel production, which sent CPO futures trading to two-year highs in response.

Siginificant biodiesel capacity is expected to come onstream over 2007-08 and palm oil prices are likely to appreciate over that period. Traditional users of palm oil will be affected -- the food and oleochemicals industries. A May 06 CLSA report predicted that "There is a good chance the edible oil market is at the cusp of a sea change in demand structure and will soon be staring straight into the headlights of a significant inventory destabilisation." That is the extent to which the emergence of a substantial new demand driver in biofuels could cannibalise on incumbent palm oil applications. There is at least one edible oils-linked company traded on the SGX --- clue: it started trading recently.

Below is a list of biodiesel plants being built in the region(taken from forum), for reference.

Soon to Start Production Biodiesel Plant

Annual Production (Tonnes),Material,Operational (Year)

Malaysia
Biotech International,"300,000",Palm Oil,2008
Carotech,"110,000",Palm Oil,2007
Carotino,"60,000",Palm Oil,2007
Golden Hope Plantations,"300,000",Palm Oil,2007
IOI Corporation,"150,000",Palm Oil,2007
Kulim,"200,000",Palm Oil,2007
Kumpulan FIMA,"60,000",Palm Oil,2007
IJM Plantations,"90,000",Palm Oil,2007
POIC (Palm Oil Industrial Cluster) Sabah Sdn Bhd,"300,000",Palm Oil,2007
Mission Biofuels,"100,000",Palm Oil,2007
Peter Cremer GmBH,"120,000",Palm Oil,2007
TSH Resources Bhd,"100,000",Palm Oil,2007
FELDA Group,"150,000 ~ 300,000",Palm Oil,2007
FELCRA,"50,000",Palm Oil,Unknown
Boustead Holdings Bhd,"16,000",Palm Oil,2007
Lereno Sdn Bhd,"60,000",Palm Oil,2007

Singapore
Peter Cremer,"200,000",Palm Oil,2007
Wilmar Group,"150,000",Palm Oil,2006

Thailand
Pamola Ltd,"72,000",Palm Oil,2006

Indonesia
3 BioEthanol,"150,000",Cane,Unknown
8 Biodiesel Plant,"400,000",Palm Oil,Unknown

China
Biodiesel,"400,000",Vege Oil,Unknown

References:
(1) TheStar Online article 29 July 2006: Optimism abounds in the plantation sector
(2) Biodieselnow.com forum
(3) People's Daily article 20 July 2006: Indonesian gov't to build 8 biofuel factories

Steady appreciation of the renminbi

2006-08-02T08:38:00.000-07:00

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There can be little doubt that the managed float of the renminbi is going to lead to a steady upward appreciation of the renminbi. In fact, if the People's Bank of China, the de facto central bank, did not actively intervene, it would have appreciated more rapidly. Nevertheless, since it switched to a managed float system in July last year, the renminbi has appreciated from ~8.1 to the dollar to ~7.95 to the dollar today, or about 2%.

Given that China runs a perpetual trade surplus and now has one of the largest foreign reserves in the world, plus the fact that it has been one of the (or is it THE) world's largest recipient of direct foreign investment, it is natural that its currency should revalue upwards. Speculators betting on this have been disappointed so far. The China government directs its foreign capital to high-quality foreign assets (eg. US Treasuries). But circumstances now look to favour a more accelerated upward edging of the renminbi.

The China government appears to be serious on slowing the economy, looking at the recent slew of moves to curb liquidity (reserve ratios and interest rates raised), restrict foreign speculative capital (eg. property) and foreign acquisitions of local companies (by introducing additional approving authorities), and general directives to various provinces to curb excessive fixed asset investments. Given that the prerogative of sustainable development is to be driven by domestic demand expansion, the purchasing power of locals will be strengthened by a stronger renminbi, boosting imports. At the same time, the cut in rebates to exporters of steel, textiles and other basic goods while export rebates to higher-technology products are increased suggests that the long-term emphasis on exports will shift from quantity to quality, from low value-add to high value-add. To be sure, this has been a stealth trend recently as China companies have been seeking to establish international acceptance by building brands (eg. IT industry), innovating, and setting standards (eg. software & telecoms), while moving away from traditional manufacturing. Assuming this is the future export focus, a renminbi appreciation would prove to be another way to divert resources towards the fulfilment of such an export policy.

What this means is that China companies relying on traditional competitive strengths of low input costs, with little product value-add through innovation and systems design and integration, would be hit due to less competitive export selling prices (unless they have a domestic market). Manufacturers would probably be hit more than brand owners, because they will have less pricing power, while more labour-intensive operations would similarly be hit more than capital intensive ones, because labour is typically local while capital can be imported (at lower renminbi costs if the currency appreciates).

References:
(1) RatesFX: CNY vs USD
(2) People's Daily article Aug 05: Yuan's appreciation by appropriate margin benefits China in general
(3) International Business Times article Jul 06: China to Cut Export Rebates

The second Green Revolution

2006-07-27T08:19:00.000-07:00

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The original Green Revolution was the increase in food production stemming from the improved strains of wheat, rice, maize and other cereals in the 1960s created by technologists, which increased the crop yield in underdeveloped countries across the world and prevented large scale famine. Biotech created the first Green Revolution; it looks like the search for energy will fuel the second.

It is ironic that the age of agriculture was supplanted by the Industrial Revolution, but now we have gone full circle and gone back to agriculture to further sustain our advanced industrial society. I have talked before on alternatives to oil and gas --- nuclear power and natural gas --- but these are only viable substitutes from the point of power generation. The other main use of oil is as transportation fuel, and this is where the hottest topic of the day emerges --- biofuels.

There are two main forms of biofuels --- biodiesel and bio-ethanol. The former is obtained by mixing natural oils (eg. palm oil, jatropha oil) into normal gasoline, while the latter involves deriving ethanol from crops like corn, soybean, sugar-cane. Both types are apparently able to operate in existing car engines. Most major countries have started to go into development of biofuels big-time, with the US and China having big government drives and feisty targets to have a proportion of their vehicles run on ethanol in a matter of several years, while some countries, in particular Brazil, already predominantly run on ethanol-powered vehicles.

My point is not so much on the downstream impact of these biofuels but rather, on the upstream. Given the sudden jump in demand for certain crops which can be harnessed for biofuels, there is true potential for them to become cash crops, or "energy" crops. Yet these have hitherto been food crops, and to divert them for energy will be to deprive the masses of food. Many, including energy experts themselves, have hence found a compelling moral argument against biofuels.

Cellusoic ethanol, which basically can utilise many kinds of natural fibre as feedstock, is still under research, yet most people and governments are unwilling to give up the biofuel alternative. The answer, then, must be a drastic increase in supply of these crops so that their food function will not be compromised. The high prices of agricultural products like palm oil, corn, downstream industrial ethanol etc will send the signal to the private sector eg. Archer Daniels Midland, to undertake investment. On the governmental sector, suddenly agriculture might become part of a strategic industry --- energy.

There is an additional incentive for new emerging powers like China and India to grow their agricultural sector. These two countries are predominantly rural (probably 70-80%) with urban development confined to a few metropolises, and hence have to develop a strong rural agenda to reduce social inequality and alleviate social tensions. Sustainable development is the main agenda of the Chinese government for the next few years, and that includes both the environmental and the social aspects. Energy cash crops might just provide one of the main channels for these countries to direct their rural development plans and to undertake massive modernisation. Indeed, it may not be far-fetched to project in the future that their rural economy might just become a competitive strength, if biofuels enter the mainstream alternative fuel market.

The US has recently announced a massive push for ethanol fuel substitutes (including research on cellusoic ethanol) while China has some ongoing programs for soybean zones in the Northeast (Celestial) and is expected to issue licences for bioethanol production (something that China Sun has been perpetually linked to). In India, the government is less involved but Reliance Group, the private sector behemoth, is embarking on a "second green revolution" (hence my title) in biofuels, through R&D as well as bringing the biomass energy generation concept to the rural areas: it is one of Reliance's three main drives for the future. Nearer to us, Malaysia is already refocusing the use of palm oil to the production of biodiesel to cater for the huge demands from European countries, and has encouraged the building of biodiesel plants. From 2007, all diesel sold in Malaysia must contain 5% palm oil.

It is not difficult to observe that the excitement seems as euphoric as a stock market at its peak, and things might just fall over a cliff suddenly (especially if oil prices suddenly dip). However, the clear trend is that agricultural productivity will become a key buzzword, in view of the new demand drivers for (certain) agricultural crops plus the current limited supply capacity (leading to the abovestated moral argument of food crop-energy crop substitution). Key beneficiaries? Agricultural machinery and tools manufacturers, agricultural technology providers, logistics services providers (logistics is part of productivity). It may sound a cliche, but the big beneficiaries of the 19th century gold rush in California were the pick and shovel providers.

References:
(1) Newsweek article 17 July 06: Bigger, Faster, Better
(2) Ethanol market.com
(3) Wikipedia article: Palm oil

Tapering of China's property boom

2006-07-21T08:15:00.000-07:00

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China has announced another 10% annual growth, which is probably one of the longest sustained booms it has experienced since the booms and busts of the 1990s. Rapid growth has brought with it a different set of problems, and key among them must be social.

Given the increasing income disparity between the rural and urban population, amid a rapidly growing acceptance of capitalism, it is inevitable that there is mass migration into the cities. Add the foreign influx of businesses and their associated white-collar workers. Juxtapose all these to the existing city-dwellers. The real demand for residential housing obviously is there and will keep growing as China's economy continues to develop. Now add the speculative element as foreigners buy up China property in anticipation of prices continuing their stratospheric ascent with the additional plus factor of possible medium-term renminbi appreciation. No wonder the Chinese government is worried, and has been taking steps to curb the speculative element.

Recently the Chinese government has begun raising interest rates, and just this week has followed it up with a series of curbs bordering on administrative controls, including the prohibition of foreigners buying into the residential market, and strict limits on the development of high-end housing, effectively tightening controls on both demand and supply side.

That the China government's moves are so closely watched can partly be attributed to the fact that China is such a growth driver for the global economy. The other reason is that for all the growth of private entrepreneurship these few years, economic control is still top-down. It is difficult to call a peak on the China property market, given that in the past few years the China government has similarly attempted to control property prices to little avail. However regulatory focus on this segment of the economy will constitute a strong headwind --- hence my view that the property boom will taper off. Over the long-term, the government is committed to reducing social inequality --- a corollary of its "sustainable development" policy in its recent Five-Year Plan (see "China looks inward and downward"). Ensuring that Chinese citizens will have affordable housing and are not bid out of their home markets by foreigners will be a key policy focus (those in doubt can look at why the recently departed Lim Kim San was so respected --- he brought affordable housing to the masses).

The property segment most affected should be the residential segment, in particular the high-end which has seen influx of foreign money. Commercial, retail and industrial property should not be hit badly. Losing all these cash cows at one go would hit the municipal governments badly --- they have lost taxing power under the central government, and yet are expected to increase social spending; land sales has been a major money-spinner for them. High and rising commercial and industrial property prices will not generate as much social friction as unaffordable housing (although they do create higher business costs for local entrepreneurs).

It would make sense to avoid property stocks with heavy exposure to the Chinese property market. Capitaland and Keppel Land were downgraded in the wake of these administrative measures but surely these are not the most heavily exposed. There are one or two pure China property plays, some which have listed recently. These are the dangerous ones.

Singapore oil & gas infrastructure construction

2006-07-06T21:28:00.000-07:00

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The oil and gas theme has been in play for the last 2-3 years already, and the optimism surrounding the industry shows no sign of abating. For potential stock picks into this sector, one need not go further than Singapore itself.

The anchor trends suggest that Singapore oil and gas services companies are well-positioned for the sustained upturn. Let's proceed through a top-down view of the hierarchy of trends. Globally, oil prices are maintaining a sustained uptrend, leading analysts to keep revising their 2006 oil price estimates upwards (US$67 at last count) and also oil majors to adjust their long-term price estimates upwards (these figures are for the purpose of planning large capital expenditures). In the Asia-Pacific, Southeast Asia is seen as a potential hotbed of exploration and production activity, which is explained in a previous article "Southeast Asia as an energy resource hotzone". And finally, Singapore has for long been one of the key energy hubs in Asia, being one of the world's top three oil trading hubs and refining hubs. Given the underinvestment in oil and gas infrastructure during the last decade, the scene looks set for Singapore oil services companies to profit greatly from the ongoing and upcoming infrastructure construction.

Let's omit the offshore infrastructure boom which has benefited the shipbuilding industry and the rig construction industry; less prominent but no less capital-intensive are the onshore oil and gas infrastructure itself. There are three big areas where capital expenditure will be huge in the coming years.

The first is oil storage. It is natural that Singapore could develop as Asia's de facto oil storage hub, given its existing strengths in refining and trading. And yet current storage space -- held by refineries and independent storage operators (Vopak, Oiltanking, Tankstore)-- is inadequate. Consequently, there are several private sector investments to build more oil storage terminals -- eg. Vopak's Banyan terminal, Horizon Terminals (a Middle-Eastern venture), Universal Terminal, Titan (planned), and Oiltanking's terminal expansion. These are huge -- eg. Universal Terminal's construction is worth S$500M to Rotary Engineering which secured the contract. Also on the cards is the possibility of the construction of underground oil storage caverns on Jurong island (typically for strategic storage purposes) which would probably be the biggest project of them all if approved.

The second is refinery and petrochemical plant construction. ExxonMobil and Shell are reportedly planning to invest US$3bn in cracker plants on Jurong Island and Pulau Bukom. SPC had also announced that it would be spending $200M to produce clean fuels at its refining arm SRC. This is expected, given the global shortage of refinery capacity.

The third is natural gas infrastructure. Singapore has historically imported all of its natural gas via pipeline from Malaysia and Indonesia, but recently has been looking into LNG as another source of natural gas to diversify. The $500M cost of the required import terminal is probably more viable following rising oil prices and the recent unreliability of piped Indonesian gas. Such LNG import terminals have already received consideration elsewhere in Europe and the US in past years, and should indeed be gaining strength given the viability for natural gas as a credible oil substitute (see "Natural Gas: Alternative Energy Source"). Indeed, an LNG import terminal could be the first step towards a natural gas export/trading terminal and the development of Singapore as a regional gas hub. There are plans for a regional gas grid for ASEAN members, and should this come to fruition, there will be heavy construction of more infrastructure to support the grid.

All these projects are expected to fill order books all the way till 2010 at least, giving great visibility to order books of companies which secure the contracts. Typically, foreign EPCs (eg. from Japan, US) will be the main contractors for these construction jobs but local contractors will receive sub-contracts to fabricate the structures and provide process packages and instrumentation. Just look at Technics and its meteoric share price surge. Check out its peers.

References:
(1) Department of Energy: Singapore Country Analysis brief
(2) OCBC analyst report 16 June 06: Oil and gas support service sector

Demand trends within the shipbuilding industry

2006-06-25T05:44:00.000-07:00

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The marine sector has long been considered a sunset industry but its resurgence over the last three years has shown that sometimes when such perceptions arise, it suggests underinvestment that ultimately will have to be rebalanced through vigorous capacity expansion.

Since late 2003, shipyards locally and abroad have been receiving incessant orders for newbuilds of all varieties. The anchoring trend has been the optimism surrounding the increase in global trade, in particular the rise of China. The key symptom has been rising chartering rates all round for bulk shippers, container shippers, oil tankers, exploration vessels. It is a demand-pull effect: rising end-demand rates pull shipbuilding rates along, benefiting an entire industry across the board.

Yet the signs are clear that this situation is near its end. The charter rates for bulk shippers have gone down substantially since early 2005, as evidenced by the Baltic Dry Index and the poor performances of bulk shippers like STX Pan-Ocean and Noble, while containership charter rates had also peaked around mid-2005(although their decline has not been as drastic compared to bulk), as evidenced by the performance of NOL. Given the looming demand-supply imbalance in the downstream demand, the demand for newbuilds has obviously been affected. This is best reflected in the newbuilding prices, where rates for both bulk carrier and containership newbuilds peaked in mid-2005 and have slowly come down to a plateau since then (see Reference 1). It is inevitable that declining freight/charter rates will have a direct negative impact on prices for future new buildings as well as expansion plans for yards worldwide.

On the other hand, there has been no significant weakness in the oil exploration and transportation market, in line with the huge and steadily growing demand for crude oil and supported by persistently high oil prices. In particular, the more expensive offshore exploration/production segment has been made viable by high oil prices which have led oil majors to revise their long-term oil price projections (on which they base their long-term capex plans). The day rates for deepwater rig and mid-water depth market are at 4 years’ highs, boosted by near-full utilization capacity; Keppel and Sembcorp Marine have of course been beneficiaries of this highly trumpeted development. Also, the offshore exploration/production trend is driving demand for offshore support vessels such as AHTS/AHT vessels, which have been experiencing upward trending chartering rates since 2003, as evidenced by the rising fortunes of Ezra. Indeed, most old AHTS vessels will not be able to support deepwater production; it is estimated that only <15% of the global fleet of >1,800 AHTS can fulfill deepwater operations. This means that the replacement cycle is likely to accelerate as the offshore production trend increasingly develops. On the transportation side, tanker rates have not exhibited any significant sustained downtrend, while LNG vesselbuilding --- reputedly the most complex vessel types --- are increasingly being planned as the importance of natural gas as the most viable alternative fuel is being realised.

The orderbooks of most shipyards are filled all the way till 2008-09, such has been the pent-up demand. However, the above observations suggest that weaknesses in freight rates will have a knock-on effect on new building orders and prices, and weakening demand (due to, for example, tightening US liquidity and hence consumer demand) might exacerbate any such situation. What is most likely is a stratification of demand trends in the various functional shipbuilding segments, with weakening demand in bulk carriers and containerships, and sustained strength in energy-related vessel newbuilds. Singapore shipyards are likely to benefit from the latter trend rather than suffer badly from the former, because the shipyards here have evolved to specialty vessel building due to lack of competitiveness in the mainstream market (as a result of high labour rates locally). It is interesting to note the recent orders received by shipyards such as ASL Marine, Pan-United Marine and Labroy Marine: most have been AHTS vessels, with a smattering of supply vessels, drillships, diving support vessels, maintenance vessels, barges ---- all offshore support-related.

References:
(1) Maxmart Shipping Information
(2) Business Guide to Shanghai and the YRD: World Leader by 2015? - Shipbuilding in the PRC & the YRD
(3) OCBC analyst report 16 June 06: Oil and gas support service sector

High-end residential property boom

2006-06-16T01:59:00.000-07:00

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There is a buzz around the property market these days. High consumer enthusiasm for property usually happens at the mature/late growth stage of a business cycle, where consumer confidence has been strengthened adequately such that they are comfortable with making large purchases. Some skeptics are thus predicting that this will not last, and point to the lack of buyer interest in the mass market for residential properties as a sign that the property market is being talked up.

However, what looks more likely is that there is a stratification of the residential property market: the mass market where lower/mid-end condominiums are suffering from the after-effects of an over-supply of HDB flats plus limited local consumer demand growth, and the high-end property market in prime districts which all observers agree is extremely strong.

There were some studies done to compare Singapore high-end residential property prices with that of major global cities elsewhere (New York, London, Tokyo, Hong Kong etc) which concluded that local prime residential property was undervalued. Ok perhaps it might be the other way, that property in these other cities is overvalued, but there are fundamental reasons that underpin strong prime residential property prices and in my view, will be sustainable through this business cycle.

It basically boils down to demand-supply dynamics. The demand part is clear: Asia is the growth engine for the global economy, and Singapore as a key hub will see high demand for prime office space and also high prime residential property rents and property prices. The shift from manufacturing towards services will attract high-income individuals (especially in the financial industry) who are willing to pay high prices for prime residential property. Also, Singapore is seen as a safe haven in Southeast Asia, and the return of Indonesian money into Southeast Asia is benefiting Singapore --- as exemplified by Lippo purchasing commercial properties around Orchard Road and asset-heavy/"branded" companies like OUE and Robinsons. Indonesians, together with Malaysians, are key buyers of high-end residential property in Singapore, and this trend is showing no signs of abating.

The tight supply is reflected in a few phenomena. The en-bloc fever that has gripped the market in early-2006 is a result of developers seeking to add to their landbanks for new property development, and the sellers' market reflects the developers' desperation/optimism (although it has abated slightly recently). Hotels in prime areas have been torn down previously (Marco Polo, Seaview Hotel and Cockpit Hotel) and condominiums built in their place (a related article: Hotels in Demand), another reflection of the tight supply. It is in anticipation of further such conversion (possibly Hotel Negara coming up) that the Singapore government is releasing more sites from its land bank for hotel construction to meet future tourism demand.

This limited supply of residential land is most apparent in Orchard Road, where the action will be hot for the next few years as it undergoes a remaking with the development of Orchard Turn, the former Gluttons' Square, Somerset Central and probably more coming up (with Lippo a likely key player). The bulk of en-blocs have taken place around this area, in Cairnhill, Grange, Oxley etc. We had the Sail@Marina attracting huge demand last year, followed by strong interest again at Sentosa Cove, while the upcoming St Regis at Tanglin appears to have no difficulty selling off its units while setting a new benchmark of S$3,000 psf; these are manifestations of the strong demand for Singapore high-end residential property. As long as the government continues being stingy in releasing residential land in the prime districts, the demand-supply dynamics should continue to sustain such high rates for prime property developments.

This sector is one of the best plays on Singapore domestic reflation. Resistant in bad times, booming during good times, it is a direct beneficiary of Singapore's long-term positioning as a services and business hub and a "playground of the rich". Generally speaking, it is not just a play on rising income and purchasing power of Singaporeans, but also a play on foreign money entering Singapore from ASEAN, Asia-Pacific, the Western countries and even the Middle-East (in that order) --- a theme that is structurally more robust.

The rise of non-conventional advertising

2006-06-05T15:45:00.000-07:00

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Advertising is a cyclical industry; its fortunes varies with the ups and downs of the business cycle. It is also a significant industry; it forms ~1% of the world's GDP. The relationship between advertising and GDP is very close, such that one of the industry's key ratios is actually the advertising-to-GDP ratio (which is of course, ~1%). The industry was badly hit by the dot-com bust in 2001 but since the economic recovery in 2003 it has rebounded smartly. Worldwide ad spending has been growing at the rate of 5% for the last few years, outpacing GDP growth.

But this is not the story here. There is above-average advertising growth that is defined by two themes: the emerging markets and the rise of non-conventional advertising.

The first is relatively straightforward: given that the emerging markets experience higher growth rates, it is natural that for a fixed advertising/GDP ratio, the growth rates for advertising will be higher in these economies. It is projected that six developing economies (China, Russia, Indonesia, Brazil, Mexico and Poland) will be among the top-ten contributors of new ad dollars over the next few years ie. they will be the industry's growth drivers.

The second is a palpable momentum shift in advertising mindshare from the traditional forms of advertising media. The big two have always been print media (newspapers, magazines) and television, accounting for ~80% of total advertising spending. However, the rise of technology has given rise to increasingly popular alternative mediums, which are taking market share and forcing traditional media monopolies to re-strategise and develop new business divisions to hedge against their rise.

Internet advertising is the most obvious outperformer, and a proxy for its rise has been the ascendancy of Google, whose revenue is derived almost entirely from online advertising (of which its highly-popular contextual ads can be seen on my site). Its rise is facilitated by high Internet popularity and penetration (which explains its popularity in developed markets), its precision targeting (enabled by cookies), and increasing recognition by traditonal media that it complements, and not cannibalises. Comprising 4% of total in 2005, it is projected to grow to 6-7% in three years, overtaking outdoor advertising and eventually radio, generally seen as a declining medium.

Outdoor advertising (~5% market share) is seen to be on the rise in large developing economies, especially China. It is defined mainly by billboards, which is suitable for large expanses of empty space and roads. Other examples include street display boards (such as those seen at bus-stops), and large customisable LCD display panels mounted on the facades of shopping arcades. Outdoor display advertising is what Fung Choi has been diversifying into (which the market was enthusiastic about) and which SPH has invested in recently (through a stake in TOM Outdoor Media Group Limited, China's largest player in outdoor billboard advertising).

It is amazing what technology can do to redefine advertising. Product placements are now common in movies, and one of the most interesting mediums is computer games. There is now a market for ads and product placements inserted inside the scenes of computer games (PC or online), and one of the companies at the forefront of this niche, Massive Inc, which allows marketers to deliver fresh new ads into console and PC games via an online connection, has been acquired by Microsoft recently (presumably for integration with its X-Box).

Technology is what makes me optimistic about the rise of alternative forms of advertising media. Besides looking for companies with new promising advertising concepts to buy, one might also look to avoid the reverse: old-world media companies that fail to recognise the rise of these media and develop new strategies accordingly. SPH might have been stagnant these two years primarily for this reason, despite the economic recovery. Note the new moves it has made recently to capture this trend: through the abovementioned expansion into overseas outdoor advertising, through online classified advertising via ST701, and introduction of new free alternative-language (Chinese) print media.

A last look at the global market share of the various advertising media, courtesy of ZenithOptimedia (note that 2006 figures were projected):

References:
(1) Center for Media research Jun 2006: Internet Ad Spending Outpaces Traditional Media Worldwide
(2) Football World Cup to boost adspend growth in 2006: ZenithOptimedia
(3) AAF Survey of Industry Leaders on Advertising Trends 2004
(4) ABC News report May 2006: Microsoft Acquires Massive
(5) SPH corporate website announcements

The emergence of Eastern Europe

2006-05-16T08:09:00.000-07:00

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In the years after World War 2 the Iron Curtain divided Eastern and Central Europe from the developed Western part of the continent, and although communism in Russia ended in 1991 the countries of Eastern and Central Europe remained relatively backward. However, in recent years they have come into prominence, as a source of cheap (and yet well-educated) labour; one could call them the "factory of Europe" in the same way that China has gained a similar moniker in relation to its role in global production.

The key story is that of "euro-convergence". The EU (European Union) has been in existence since the 1990s but in recent years it has started admitting Eastern European countries, most notably in mid-2004 when a large number of states in Central and Eastern Europe were admitted: Poland, Hungary, Czech Republic, Slovakia, the Baltic states of Estonia, Latvia, Lithuania. The rest of the Balkans (the states of Romania, Bulgaria, Serbia, Croatia, Turkey etc), the traditional powder-keg of Europe, are set to join in the later part of this decade or next.

Singapore has been going big on FTAs (Free-Trade Agreements) these few years, but the EU is mother of all multilateral FTAs. It facilitates and liberalises movement of labour, travel, goods and services across borders of member EU states. It is ironic that pioneer states like France and Germany have suffered the brunt of such liberalisation (high unemployment rates) as their companies are moving production bases eastwards with the admission of Eastern European countries into the EU. These countries boast high educational literacies (hence not just capable of low-cost production; note that automobiles production are increasingly being outsourced there), favourable tax rates (a big plus compared to socialist western European models), and pro-investment policies (everybody realises the way to economic progress is foreign direct investment). Such country environments explain why Western European companies would rather move their capital to Eastern Europe and set up factories there, rather than continue to produce in Western Europe while bringing in cheap Eastern European labour (both options are possible under free movement of labour and capital under EU rules)

At the same time, liberalisation of travel and the ensuing rise of budget airlines (Ryanair, Easyjet) means that Eastern Europe is no longer as remote as before (of course, the death of communism has helped too). Besides facilitating investment and tourism (weekend getaways), development has accelerated around secondary airport sites in the various Eastern European countries.

And who can forget Russia? It is not a member of the EU, but it is one of the key beneficiaries of the resources boom these 2-3 years, in particular oil and gas (among world's top three producers in both), as well as in commodities like metals. All that oil money....

The evidence of the emergence of Eastern Europe is reflected in the MSCI index for Emerging Markets (Eastern Europe); it has probably sextupled from 50 in mid-2001 to ~300 in early-2006 (in comparison, Emerging Markets (Asia) only went up from ~120 to ~350 in that same period). And nowadays we hear about the BRIC theme: Brazil, Russia, India, China --- the four future pillars of world emerging market growth, reflecting the importance of Russia.

Unit trusts specialising in Eastern Europe typically go for energy, materials, utilities, telecommunications --- sectors that play on the investments expenditure and infrastructure construction associated with developing economies. Given the abovementioned benefits of liberalised intra-Europe air tourism and rising domestic incomes due to foreign capital inflows, consumption stocks may also be worth buying. It is possible to find some stocks on the SGX with an Eastern European theme, if one looks hard enough.

References:
(1) Newsweek 13 Mar 06 article: Budget Bonanza
(2) TheStreet.com article Aug 2004: Betting Big on Eastern Europe's Emergence
(3) BBC news article Apr 2004: Eastern Europe's road to the EU

Beijing Olympics

2006-05-11T05:31:00.000-07:00

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The 2008 Beijing Olympics is seen by many as the "coming of age" party for China, as the new major player on the world stage. Historically it has been seen as a loss-making event for the host country but in recent Games it is increasingly being seen as providing a stimulus to the economy, both for the short term and the long term, if managed correctly.

For the short term, the preparation and actual staging of the Games contributes sigificantly to the economy, as new infrastructure and stadiums have to be built in the run-up to the Games, and there is a tourism and consumption boost in the year of the Games. South Korea’s economy grew 12% in the year of the Seoul Olympics. For the long term, the host country and city could use the Games as a platform to raise its profile (such as the Barcelona Olympics), or as the catalyst to undertake long-term infrastructure upgrades (eg. Seoul, in preparation for its Olympics, undertook the expansion of their airport, the construction of new roads and underground stations and enormous improvements to the telecommunications infrastructure), or to position the city as an attractive leisure tourism spot or as a business convention hub, hence building on the momentum post-Games.

From the Chinese government down to the citizens, the feedback is that all are focused on one big goal: keep the economy booming so that by the time the Olympics in Beijing rolls around in 2008, China will be able to stage the biggest international event in its history. There are not likely to be any serious issues with Taiwan till then. The Games is a huge rallying call and mobilises the nationalistic tendencies of the Chinese. But there is talk that underlying problems could start to surface post-Olympics eg. social inequality problems, geopolitical problems (that could be used as the new rallying cry by the Chinese government).

Some people thus see 2008 as the watershed year, in terms of political direction, and therefore, for investing as well. Personally I wouldn't practise this form of market timing (exit before 2008); a better idea is to look at the medium term at the sectors that could benefit the most from the buildup to the Games. The area around Beijing would be key, and infrastructure construction (roads, rails, telecommunications, sports facilities) would be the obvious beneficiaries, together with hotels, business services, retail. These will filter upstream and downstream: construction materials, digital electronics, luxury durables, telecommunications equipment and environmental protection facilities.

One may notice how Chinese companies are trying to build their brands overseas. That drive was behind the takeover of IBM's PC division by Lenovo and Hai-er's attempted acquisition of Maytag. The Olympic Games would provide them the perfect platform to open Chinese companies to the world, and companies performing advertising and media services will ride on this demand for advertising. Fung Choi for example; too expensive now.

With respect to consumer goods, sportswear/sports equipment is the most obvious beneficiary. In Hong Kong, companies like Li-Ning are trading at 30X PE; over here China Hongxing is not far off that valuation, on the strength of its Erke brand. One might even guess that China Sky's price surge and general market optimism recently has partly to do with its exposure to the textiles segment, in particular nylon, which is used to manufacture high-end sportswear and has no direct substitutes. Increasingly, this Olympics theme might play out over the next 1-2 years.

References:
(1) Irish Times article 11 May 06: Is it economically beneficial to host the Olympics?
(2) Asia Times article 24 July 01: Seoul sees windfall from Beijing Games
(3) Investment U: Investing in China in 2006
(4) Moneyweek article 28 Apr 04: Will Greece be an Olympic winner?

Nuclear power as an alternative

2006-04-26T00:15:00.000-07:00

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Today is the 20th anniversary of the 1986 Chernobyl disaster which some argue caused the decline of the Soviet Union five years later, and after two decades in the wilderness as a result of this industrial accident whose fallout affected the whole of Europe, the rise of oil prices has brought about the rise of nuclear power as its most legitimate alternative.

It is ironic that nuclear power is seen today as one of the cleanest forms of energy around: non-greenhouse, non-smoke emitting. The concerns of accidental explosions are reduced with the advent of new fail-safe technology (pebblebed reactor); the main concerns are that of nuclear waste disposal (radioactive and danger of falling into wrong hands) and economics of construction/operation.

The second factor is rapidly being dissipated by the need to diversify out of oil. Natural gas is plentiful but its prices are often tied to oil. Coal is viable, but produces unacceptable pollution. Not just the West, but also countries like China, are committed to environmentally sustainable development. Other energy sources like fuel cells, hydroelectric, biomass (ethanol), solar are either work-in-progress (no critical mass) or substitute fossil fuels in other areas (transport fuels).

That several developed countries have trailblazed the path of using nuclear power as a major source of their energy needs provides a reliable track for other countries to follow. France relies on nuclear power for ~80% of its electricity needs, while amongst the world's top five economic powers, four use nuclear power to produce 20-30% of their electricity (there is still no substitute for transport fuels). The exception is China (2%). That is set to change, because the way that China has been setting about securing strategic oil and gas sources, the energy diversification path of the major powers cannot have failed to escape its attention. The plan is to increase nuclear power generation to 4% of national total in 15 years; considering China's rapid growth rate that amounts to a quadrupling of current nuclear power generation capacity, and entails a building program of nuclear plants probably equal to the rest of the world put together (from my reading of the statistics).

There is tremendous investment potential in this theme. The first sub-sector must be the uranium mines which would supply the raw material, in which two countries stand out: Australia’s share of the world's known uranium resources is about one third and it produces about 22% of the world's mined uranium; Canada's share of known world uranium resources is about 12%, but it produces about one third of the mined uranium.
The second sub-sector must be companies that provide construction services for nuclear power plants, for example Westinghouse Electric (recently acquired by Toshiba) which build these plants. If one is more imaginative he could look to the sub-contractors for these power plants, especially those with exposure to China since that is where growth potential is strongest in the future. There is some reason to suspect that Asia Water's price surge over these few months (and a 20% rise today alone) has something to do with the fact that they secured a water treatment contract for a nuclear power plant in late 2005.

References:
(1) Newsweek 6 Feb 06 article: Another Nuclear Dawn
(2) Uranium mining in Australia and Canada

The impending decline of telecommunications

2006-04-21T04:36:00.000-07:00

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Think back to 2000 during the peak of the dot-com boom when analysts were hyping about the convergence of the holy triumvirate in the New Economy: telcos, Internet and content. All companies related to these industries were bid to the skies: in the brave new world, telco service providers would be providers of the infrastructure and pipelines, Internet companies would provide the software services and business operating models, content providers would hold the key to the creative content that could be delivered over the enhanced pipelines and draw the masses. In particular, telcos jockeyed for positioning in the projected future growth sectors, bidding 3G licences to the skies (billions of dollars in profits to governments granting these licences) and building miles of new fibre optics cables in anticipation of future broadband demand.

Developments since then have brought about a slow but sure decay of the fortunes of the telecommunications industry, first fixed-line providers but probably spreading to mobile service providers soon.

Voice services has always been the bread-and-butter service for telcos, and this is under serious threat from the emergence of digitisation of voice which enables transmission over the Internet --- the now well-known VoIP or Voice-over-IP, of which Mediaring is a key player. In the same way that budget airlines have brought regional airfares, a traditional money-spinner for the incumbent airlines, into a downward spiral, so these VoIP service providers have brought international calls, a top income generator for telcos, into commodity-like pricing and squeezed all the juice out of their operating models. What had been a near-monopoly/oligopoly situation has become one where the savvy user can use VoIP software like Skype, easily accessible over the Internet, to call friends in other countries virtually for free (and with new VoIP phones, one need not be too Internet-savvy). What is needed is an Internet connection in both countries, and with high and rising Internet penetration rates in Western countries and in Asia, a critical mass for VoIP has already been reached long ago.

The big players have started providing VoIP services: Google, Microsoft, AT&T, eBay, AOL, British Telecom: note the last few are telcos which have had to succumb to market demand at the risk of cannibalisation of existing revenue: a case of damned if you do, damned if you don't. But there is a trend which threatens to make Internet calls even more ubiquitous and hence commoditise voice calls: retailers getting in on the act. In the UK, the top supermarket Tesco and the largest electronics retailer Dixons are offering VoIP services to their customers as well. If everyone who can provide Internet services can offer phone services, the leverage that telcos used to enjoy will be dissipated. And that includes mobile phone operators, not just fixed line operators. Already, European phone companies, both fixed line and mobile, have announced profit warnings recently and are projecting grim futures (France Telecom, Deutsche Telekom, Vodafone).

People have talked about Asian emerging economies skipping a generation of telecom evolution and going straight to mobile phones; this will be true but at the same time, it is very likely that these mobile phones will not be operating voice calls per se, but through disruptive mobile VoIP technology platforms like Wi-Fi (although these would still probably be operated by the existing telcos).

On the data services side, the Internet services that telcos can provide (eg. Singtel's Magix) through their fixed line infrastructure still faces stiff competition from other broadband service providers, most obviously cable broadband in Singapore's context (Starhub) but also satellite, third-party leasors of their fixed-line infrastructure (eg. Pacific Internet) and wireless broadband (Starhub, but limited to hotspots currently). And what about the land-based and undersea fibre optic networks that were built during the dot-com boom, which now provide an alternative (and cheaply-bought) network in competition with the incumbent infrastructure?

Given the ease of entry (in both voice calls and data services), numerous substitutes and emerging new players, the telecommunications industry would probably score an F on Michael Porter's Five Forces industry evaluation model. Add to that one final element: the liberalisation trend of the telecommunication industry, a move to stimulate competition and innovation and requiring incumbent telcos to lease out their infrastructure to new players at regulated rates. This liberalisation policy in Singapore is what has forced Singtel to diversify externally in search of other growth drivers (eg. Optus), given that new players freed to emerge in the fixed-line voice calls and fixed-line Internet broadband market leasing its fixed-line infrastructure would eventually crimp the market and its margins.

References:
(1) Newsweek 6 Feb 06 article: The Call's on the House
(2) Telco Encyclopedia

The coming global consolidation of stock exchanges

2006-04-10T00:12:00.000-07:00

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Local investors would have observed the meteoric rise in share price of the SGX over the last few months and wondered what was brewing. It turned out that fundamental reasons (increase in trading volume --> higher fees to SGX) constituted only part of the explanation, as market rumours swirled about a possible bid by NASDAQ(!) for the SGX. This was later dispelled by the SGX on promptings from MAS, but it just highlights a key emerging global trend -- consolidation of stock exchanges.

In Europe, the London Stock Exchange (LSE) has been the target of several takeover attempts, starting with the Deutsche Borse AG (German stock exchange)/Euronext (London) in early 2005, Macquarie Bank in late 2005, and recently NASDAQ, all of which turned to be fruitless (primarily due to anti-competition concerns for the first and valuation differences for the last two). LSE, as reported in today's Business Times, is now planning a merger of equals with Euronext to create a European super-exchange.

The consolidation of Europe's stock exchanges is a natural progression as they now share a common market and a common political body; the resulting liberalisation of restrictions as well as a common currency have facilitated the emergence of cross-border trading. Prior to the attention focused currently on the LSE, the Paris Bourse, the Amsterdam Exchange, and the Brussels Exchange had consolidated to form Euronext, while a Nordic exchange had been created by the Stockholm and Copenhagen stock exchanges. A pan-European stock exchange in the future is not out of the question.

The argument for combining stock exchanges under a single trading platform is strong, both on the consumer side, the listed companies side and the service provider side. The retail investor/trader would be able to access multiple markets on one single platform with resultant lower costs; the listed companies need not maintain multiple listings (eg. Creative on NASDAQ through ADRs and on the SGX); the consolidated stock exchanges need only maintain one single trading platform with resultant lower system operating and maintenance costs that can translate to fantastic profits. Also, like online games or Ebay, the more users an exchange attracts, the more valuable it becomes to other customers (ie. bigger is better), a critical mass phenomenon known as the network effect. Thus it makes sense to build scale in the way that dot-com companies were building "eyeballs" during the dot-com boom.

The key barriers to stock exchange consolidation are what would probably deter exchanges in Asia from consolidating any time soon. These include legal and regulatory differences; for example Malaysia has a legacy of capital controls which make any merger with neighbouring countries (an obvious one is SGX) difficult. Most Asian countries would also consider their stock exchanges as strategic to the development of their capital markets and therefore unwelcome to outsiders, even though some of these exchanges are themselves public listed entities. The American and European exchanges are, on the other hand, considered as purely for-profit entities given that they have developed capital markets and financial institutions capable of providing checks and balances. Cultural differences will also prevent any kind of large-scale consolidation: can you imagine the North Asian exchanges (Shanghai, Tokyo, Seoul) merging for example, given that the countries are generally homogeneous cultures with strong nationalistic tendencies?

Although exchange mergers do not look likely within Asia at the moment, tie-ups between exchanges present a distinct set of business opportunities. Given the potential exponential growth in investor base possible from tie-ups with exchanges in other countries, the SGX is looking to link up with Bursa Malaysia in the near future (and I'm looking forward to that), and has already established integrated equities and derivatives trading links with the ASX (Australian Stock Exchange). That could well explain why investors are so bullish on the SGX these days, given the network effect that such links generate.

References:
(1) US Federal Reserve report June 2002: The Consolidation of European Stock Exchanges
(2) Financial Times report 31 Mar 06: LSE remains a bid target for stateside suitors

Existing link: Niversphere the Savvy Investor

2006-04-07T17:44:00.000-07:00

Niversphere's blog is purely fundamentals-based, which would be quite similar to mine, except that he provides research on Singapore stocks that are worth buying. Those looking for extensive coverage of many stocks would be disappointed because he prefers to cover those in his stock portfolio only, an understandable position because it probably takes the least effort to cover these (I notice that he does not "commercialise" his site at all unlike other sites (including mine). But for those interested in the same stocks as him you would find a substantial amount of coverage and follow-through on them. I personally have benefited from a number of his stock research on several stocks, knowledge-wise, although I am not vested in the stocks. One learns to appreciate serious and well-researched views from fellow investors.

So far, Niversphere appears to have covered in detail the following:
UTAC
Hongguo (which has since run to the moon)
Ace Achieve
Tat Hong
Noble Group
Want Want

One significant point about his views is that they tend not to be valuation-driven, but business-driven. That is, his investing horizon might be longer.

You can check out the link on my sidebar on the left (Local Blogs section).

The rise of economic nationalism

2006-04-06T06:58:00.000-07:00

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I first read of this term several weeks back in our national papers and it aptly sums up the increasing politicisation of cross-border M&A (merger & acquisition) activity nowadays.

Those who follow the news would be aware of the national passions that have become entangled with what were hitherto business transations between two parties, simply because one of them was foreign. China has been seen as engaging in expanding overseas assets through proxy companies, in particular securing strategic long-term energy and mineral resource supplies, and has therefore often experienced political opposition to their attempted overseas M&A deals. The prime example would be CNOOC's failed bid for Unocal last year, which drew heavy grassroots and political criticism in America (they probably didn't do their lobbying well). Other recent cases involving other parties would be Mittal Steel's bid for France's Arcelor, the No. 2 steel player, which drew similar widespread opposition within France, Dubai Ports' bid for several American ports which sparked security concerns, and of course Temasek Holdings active acquisition strategy which have single-handedly triggered worries about state-financed, state-influenced investment funds.

Of course, such nationalistic worries about foreigners taking over the country's crown jewels are not new. They are usually associated with the rise of new world powers and the strategic concerns associated with their rise. In the mid-late 1980s it was Japan, now in the new millenium it is China. Hence much attention is given to bids for what are viewed as strategic national assets --- energy, telecommunications, banks are seen as three key ones. One may remember Singtel's bids for Cable & Wireless (Hong Kong, top telco provider) and Time Engineering (Malaysia, fibre optics) failed partly because of the importance of the telco assets in question; similarly, problems are currently being faced in DBS's bid for a stake in Korea Exchange Bank and Temasek's bid for a stake in Bank of China. Investment companies with a state-funded kitty can never shake off the tag, whether justified or not, of having a state-driven agenda in their acquisitions, and in politically volatile countries, popular opposition disporportionate to the perceived "foreign threat" can arise: cue Temasek's acquisition of Shincorp which has dragged it into a political mess in Thailand.

The other main driving force of economic nationalism is the fear of the side-effects of globalisation, which is an inevitable phenomenon in this age of outsourcing and IT. This fear is especially palpable in the Western nations whose jobs are at stake post-takeover. Hence the strong opposition to Arcelor being acquired by Mittal --- the former is a big employer of thousands in France, and mergers almost always lead to consolidation and trimming of fat. European and US cultures also incorporate unionism which can be a powerful force in galvanising mass local opinion against the "foreign invaders". Occasionally the sugar-coated reason is "for security reasons", such as Dubai Ports' failed bid for the US ports recently.

And of course, in the most interesting manifestation of economic nationalism, the state nationalises the economic assets and reaps the benefits itself. That is the route that Russia has taken, with the sidelining (or even conviction) of the big oil oligarchs and nationalising of the country's oil and gas reserves.

What implications does this have for the investor? Well firstly, he should perhaps be aware of what are the key strategic industries to a country that are not likely to be ever divested: defence, energy, telecommunications, banking (the top few) etc. A second take-home point would be that such politically-driven opposition to business deals gives potential acquirors a bad impression of the investment climate which would cause them to divert their funds elsewhere in the future --- this is what analysts are predicting the Middle East will do with their oil money after observing how unwelcome they are in the US --- and surely countries like Malaysia and Turkey would benefit. Thirdly, it teaches us that besides the hard-nosed quantitative valuations of an acquisition, there is also the political --- and social --- aspects to consider, which might ultimately scupper the whole deal.

References:
(1) Wikipedia article: Economic nationalism

New Link: Lloyd's Investment Blog

2006-03-26T00:28:00.000-08:00

I was surfing the Web and came across this very interesting US investment site, with great articles on the US stock market. The blogger doesn't update it that often, about once every 1-2 weeks, but look at the quality of his writing. That is what matters.

I've realised that there's no point just adding new links quietly to my sidebar, since most readers probably won't notice. So from now on, every link added will be simultaneously broadcast as a new post across all my blogs, starting with this one. I will probably cover the existing ones as well.

You can check out the new link on my sidebar on the left.

China looks inward and downward

2006-03-15T15:15:00.000-08:00

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The chief winner in the new millenium so far must be China. Its economic opening up brought to an abrupt halt in 1989 by the Tiananmen "incident" (to put it euphemistically), it spent the 1990s in diplomatic recovery mode while building up domestic foreign investment quietly as the IT, technology and dot-com industries boomed elsewhere. Now in the 2000s it has finally realised its potential as a critical mass of foreign domestic investment and labour supply have made it the factory of the world. China is growing at a steady rate of ~10% per annum, a pace of growth that Singapore enjoyed in its golden years in the 1980s. And this is for a country a zillion times Singapore's size!

The most common class of problems with rapid economic growth are social problems, and the unequal distribution of income has long been recognised as one of the most pressing issues. China's growth has been driven by investment, and these have tended to congregate around the eastern coastline of China: a normal development as ports and external links usually emanate from these coastal cities. The original special economic zones (SEZs) were chosen from cities along the coast: Shenzhen, Xiamen, Shantou, Hainan, Zhuhai. Later other cities along the coast began to open up, most successfully Shanghai, which has a long economic legacy from the past.

The dangers of a poor majority rising up against a well-to-do minority are well-documented: communist China herself was formed from such a mass movement of opinion. Of course, today a great proportion of the population are congregated around the coastal regions, most significantly the Pearl River Delta centred around Hong Kong-Guangzhou, and the Yangtze River Delta centred around Shanghai. However the Chinese government remains cautious of the huge disparity in income between the rural regions in the interior and the urban developed coastal cities.

For a central government-driven country such as China, where quotas and restrictions can have a huge impact on investments overnight (they did it in the "soft landing" policy, affecting property, automobiles, cement in 2004), one would do well to watch the government's future plans and priorities. The recent National People's Congress (NPC), the top decision-making forum, laid down the next five-year plan commencing 2006 till 2010. In the words of their spokesman, it "signifies a major shift in China's economic policies: from urban development and heavy investment in billion-dollar projects to increasing rural and sci-tech investment in the interest of sustainable development...... Infrastructure investment will be shifted from the urban areas to the countryside, with a focus on farmland, roads, safe drinking water, methane facilities, power grids and telecommunications networks."

My guess is that allied to this policy will be incentives to foreign MNCs (and local companies as well) to invest in the inner regions. Already there are companies relocating their production bases further inland, as wage inflation starts to take hold in the coastal cities where living costs have risen (just look at their skyrocketing property costs). Chief among them would be automobile makers (eg. Ford) and technology companies (eg. Intel) in second-tier cities, themselves the capital cities of the inland provinces, such as Chengdu and Xi'an. The traditional heavy mnaufacturing base in the Northeast which have lagged economic expansion --- the provinces of Heilongjiang, Jilin, Liaoning --- are also set to benefit from renewed government attention.

As in stock investing, the investor must decide whether to "follow the winners" (the hot coastal regions) or "chase the laggards" (the less developed regions which are the government's new medium-term focus) . There are two main sub-themes here in the latter category: one would be infrastructure construction, chief of which must be (1)logistics and commmunication links to link them to the developed regions, (2)basic infrastructure like power and clean water, (3)development of better farming facilities to enhance the incumbent main economic activity -- agriculture. The second theme would be a geographical investment focus on the second-tier cities which are coming in for foreign investment attention as they boast decent infrastructure (being the most developed city in their particular province) and yet low labour costs (the original competitive advantage that drove FDI into the coastal cities several years back). Among the current crop of China stocks and new ones which are IPOing with alarming frequency this year, there should be quite a number from which one can pick to play these themes.

References:
(1) China.org article Mar 14 2006: NPC Endorses Five-Year Economic and Social Plans
(2) The US-China Business Council: Foreign Investment in China

Chinese funds flow overseas

2006-03-01T07:17:00.000-08:00

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The attention so frar has been on foreign domestic investment flowing into China, which has become the "factory of the world". However, in this span of time China's foreign reserves have burgeoned so much from external trade that it is now in a position to invest the excess funds overseas.

In fact, this has been done for the last few years in the US capital markets as a strategic measure to shore up the US dollar, and by direct relation keep the China renminbi weak to facilitate its export-driven growth. Hence the phenomenon of China financing the buying habits of the US consumers by mopping up bonds and bills on the US markets ie. lending to the US government. This has had the added advantage for as long as US consumers keep spending, China's factories will keep running to churn out the supply line of goods --- a win-win situation if there ever was one.

At the same time, Chinese businesses have been trying to expand their presence overseas, sometimes with stiff foreign opposition. The balance of power is still more unequal than all the press hype over China and India will have us believe. It is still tilted towards the West. The latter was the chief provider of FDI that drove China's workshop economy to what it is today, and the MNCs in the home countries are loath to have the Chinese countries try to take them on their home turfs instead. So as far as acquisitions are concerned (a main way by which China companies are trying to expand overseas), there have been successes and failures. The former would include the merger of Lenovo with IBM's PC division, while the latter would include Hai-er's unsuccessful bid for Maytag, owner of the venerable Hoover vacuum cleaner brand. And where strategic resources, in particular oil and gas, are concerned, acquisitions have been even more difficult and the competition fierce: witness CNOOC's futile bid for Unocal and CNPC's tight battle with India's ONGC over Petrokazakhstan (the former ultimately prevailed).

Yet, to share investors nowadays, what must be the most interesting overseas funds flows by Chinese investors would be the gradual relaxation of regulations on Chinese financial units that allow them to invest in overseas markets. Insurers have been a key beneficiary of such capital control relaxations, in part because they faced imminent competition from foreign insurers who would be progressively allowed access to the China market under the WTO agreement. Thus, their hitherto narrow investment scope was expanded to Chinese government or corporate bonds issued in overseas markets as well as overseas bank bills, certificates of deposits or other money market instruments with an AAA rating, in late 2004. Then in late 2005 this was further expanded to include stocks of Chinese enterprises listed in selected securities exchanges: New York, London, Frankfurt, Tokyo, Singapore and Hong Kong.

Now this might shed some light on the recent rally of China stocks. Given that most China companies list either in Hong Kong or Singapore (very rare in the Western markets, only the most elite) and that Singapore-listed China companies were rather cheaply-priced, it was no wonder that the rally at the start of 2006 was so sharp for these stocks. This was a liquidity-driven rally if there ever was one, and as China further relaxes its foreign investment guidelines, there may be more market instruments, not necessarily China-linked, that see inflow of Chinese hot money. In a way, that might be how the rest of Asia shares in the fruits of China's red-hot growth.

References:
(1) People's Daily Online article Aug 19 2004: Insurers allowed to invest overseas
(2) China Daily article Sep 12 2005: Overseas investment rules boost insurers

Consolidation of the steel industry

2006-02-08T07:58:00.000-08:00

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The proposed acquisition of France's Arcelor Steel, the world's No.2 steel producer, by Mittal Steel, the No.1 steel producer, if materialised (subject to anti-trust approval I think) will probably signal a massive shift in power within the steel supply chain, in favour of a rapidly consolidating steel producing industry.

The world's three biggest iron ore producers, BHP Billiton,(BHP) CVRD & Rio Tinto (RTP), control about 75% of production of steel's major raw material and the top 3 car companies have about 30% of global sales. By contrast, Mittal, Arcelor and the next biggest steel maker have about 13% of the steel market. What this means, of course, is a disadvantaged situation where steel producers are squeezed by oligopolistic suppliers and customers at both ends. Economics 101 tells us that such a case of near-perfect competition produces minimal profits (known as normal profit).

One of the surest signs of inadequate pricing power and bargaining power is volatile earnings driven by supply and demand dynamics on either side of the producers. Indeed, steel prices fluctuate greatly, causing their producers to make massive profits during upswings and losses during down periods. This has been experienced by companies such as HG Metal, which experienced the former over 2004 to mid-05 and then the latter after mid-05. Such change of fortune over 2 years.

Consolidation in the US has been proceeding since the early 2000s, driven by United Steelworkers (a union) which also managed to lobby George Bush to adopt protectionist policies for the local steel industry. Nearly 20 mergers or acquisitions in the steel industry were negotiated involving ~30% of domestic steel-making capacity: eg. U.S. Steel purchasing National Steel to combine 2 of the USA's 4 largest producers.

Steel-making used to be seen as a strategic industry and a symbol of a nation's industrial strength, such as US Steel in the early 20th century. However, such thinking has become backdated and governments are no longer averse to outsiders acquiring their steel plants. Some might remember Natsteel has recently sold its steel operations to Tata Steel. Such a change in view has in turn facilitated a global consolidation as that championed by Mittal Steel over the last few years, in addition to the intra-national consolidations such as that within the US mentioned above.

Mittal which grew from a local steel plant in Calcutta to the world's No. 1 producer by acquiring distressed steel plants all over the world, across Europe, Central Asia and North America (the largest so far being International Steel Group, itself hitherto a major consolidator in the US as mentioned above). The timing of their consolidation process was truly outstanding, for it was in time to catch the massive wave of global (especially China) demand for steel in 2004-05 that catapulted Lakshmi Mittal to the world's 3rd richest man.

The trend for the major steel producers is to seek low-cost producers in new markets, or acquisitions which consolidate their positions in existing markets. That is why Mittal is seeking to acquire Arcelor: Mittal's footprint is mainly in the US and Asia, while Arcelor's stronghold is Europe, hence their operations complement each other.

Surely the next region for steel industry consolidation would be China. The steel industry in China has burgeoned these few years and made China a net crude steel exporter over the space of two years (hence causing steel prices to collapse). If the aim is to organise the steel industry into an oligopoly of producers and create an equal playing field with the ore producers and major steel consumers, China's steel industry would be one for major consolidation. The problem, of course, will be regulatory restrictions from their central government. There has been some attention over Delong Steel as a result of Mittal's Arcelor bid but indeed betting on they being a target of such consolidation is a shot in the dark: there are many more bigger steel producers in China which would interest the big players much more.

References:
(1) USWA: Steel Industry Consolidation
(2) Mittal-Arcelor Deal would create steel powerhouse

(3) Industry Consolidation Promises Stable Steel Prices
(4) New #1 in steel

Growth of private healthcare in Singapore

2006-01-29T19:19:00.000-08:00

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Given the renewed focus on the services sector in Singapore, it is no surprise that education and healthcare --- the prime concerns of the individual at the early and late stages of his life --- have been given strong focus in the drive to restructure the domestic economy.

A lot of press space have been devoted to the drive to make medical tourism a growth sector of the economy in the coming years, drawing on patients from the burgeoning Asian economies. I have often wondered where the term medical tourism derives from, until recently I realised that hospitals operate on quite a similar basis as hotels: they also have occupancy rates (bed occupancy), length of stay, and of course bed rates: quite similar to how hotels analyse their operational performance, although of course services offered are different. There is a government target of serving 1 million foreign patients by 2012, which would raise the healthcare sector's contribution to GDP to 3% by then from 0.2% in 2004.

There are underlying trends that support such optimistic projections. Firstly, the emerging economies of Asia are among the fastest growing economies in the world, and the second phase of the economic expansion, hitherto driven by exports and investments, is likely to be consumption-propelled. Secondly, Singapore has competitive advantages in the area of healthcare, having been the medical hub for Southeast-Asia which competes not on cost but on quality and complexity of medical treatment. Upstream, the biomedical sector will be a recurring source of new R&D projects and innovative medical treatments, while downstream, the integrity and professionalism hallmarks of the Singapore brand serve it well particularly in this segment. Thirdly, cross-border travel are now increasingly facilitated by improved travel links --- the likes of budget airlines, as well as relaxed travel restrictions (China, for example).

The healthcare market, of course, may be broadly split into the public and private sectors, where the former is subsidised by the government using public funds while the latter operates on a for-profit basis. Although we often hear about healthcare stocks being the classic defensive stocks on the premise that we still need medical care when sick regardless of whether the economy is doing fine or not, the fact is that this might apply more to public hospitals which typically cater to the masses (due to their affordability) and less to the private healthcare groups which are known more for specialist services, elective surgery and a general higher level of service, care and prestige. Thus the private hospitals exhibit a higher degree of cyclicality that one might expect --- one might even link them directly to consumer discretionary expenditure trends.

The MOH website has quite a good collection of articles discussing healthcare trends. To get a feel of the higher value-add services that private hospitals typically provide, consider: in 2002, private hospitals accounted for 16% of inpatient workload (counted by number of discharges) but 37% of inpatient revenue,; a similar trend was exhibited in day surgery where private healthcare workload amounted to 17% but recorded 37% by total market revenue share. These suggest much higher average charges for private healthcare (and obviously higher margins). To get a feel for whom medical tourism would benefit most, one can look at the foreign patient admission trends: the private sector have served 80% of foreign patients over the last decade (obviously, since public healthcare won't be subsidised for foreigners), with most foreigners being Indonesian and Malaysian. To get a feel of the cyclicality of the private healthcare industry, consider the effect of the 1997 Asian financial crisis on patient load: private market share (in inpatient and day surgery) had been gaining at the expense of public hospitals from 1993-96, with revenue share in particular close to converging at 50% each; but then the trend swung the other way from 1997 to 2002: with public healthcare workload remaining largely stable while private healthcare workload dropping steadily due to poor economic sentiment, the latter lost 6-7% market share by workload and ~10% by revenue share to the former over the next five years (of course, in large part due to the acute loss of foreign patients).

With the global economy now on a steady growth footing and Asian consumerism rising,
the trend must therefore benefit private healthcare groups more than public hospitals. A wildcard lies in the form of government regulations which have in recent years exhibited the trend of favouring decreased public subsidies for those who can afford it: in particular means testing must shift the preference towards private hospitals for more affluent individuals whose public healthcare subsidies might be cut. The private healthcare groups have been highly priced all these years, such as the two main groups Raffles Medical and Parkway Holdings which are priced at ~20X PE. But more intensive searches for other undervalued medical and healthcare stocks on the SGX may still yield some reward: those that satisfy niches in private healthcare, for example.

References:
(1) MOH article Jan 2004: Singapore Healthcare Market-Share Analysis
(2) MOH article Nov 2003: Trends in Foreign Patient Admission in Singapore

(3) CIMB-GK Goh analyst report 22 Nov 2005: Healthcare sector

Restructuring Singapore series: Promoting domestic consumption

2006-01-14T16:37:00.000-08:00

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As had been mentioned in the earlier blog, any country trying to build up its service sector has to have a strong domestic base. This is because services and manufacturing are different in their nature of end product delivery: service providers have to be close to the customer, while manufactured goods can be exported overseas. With the advent of IT the need for proximity has somewhat been mitigated (eg call centre outsourcing in India) but by and large the distinction remains (eg. healthcare, education).

At the same time, it is generally the case that developed nations, besides transforming from being manufacturing-based to services-based, also become consumption-based as opposed to investment- or export-based (considering GDP components). The initial phase of expansion of supply capabilities has been built up: hard capital such as infrastructure (transportation and communication links, utilities) and fixed capital (factories and buildings). Export growth is bound to taper off. To build higher value-add manufacturing and services one needs ideas and innovation, and for ideas to flourish they need support: that is the gap a strong domestic consumption sector fills. At the same time, the consumption model can tap on substantial national savings accumulated over the earlier years, providing a ready flow of liquidity that ultimately drives a benign rate of asset inflation (eg property prices) that is sustainable. This is the model that the US and Europe a generation earlier, has tracked. Consumption forms as much as 60-70% of the US economy today.

If one has been observing the Singapore government's moves these few years, they will have noted a few broad moves to generally stimulate domestic consumption. Generally, they can be classed into three categories: (1)relaxation of consumption-related rules, (2)stimulating tourism and encouraging immigration, (3)building an economic hinterland. It is no complex model: in a sense it is similar to how one maximises income from say, the Google Adsense program (employed on my blogs) where website owners get paid when readers click on the advertisements shown. The idea is: drive web traffic to your site hence increasing the overall readership base (compare to points 2 and 3 above), and then try to increase the click rate (ie. total advert clicks / total readership) by customising the site and adverts (compare with point 1 above).

Just some examples. Point 1 is illustrated by the relaxation on downpayment rules for purchases of cars (in 2003, from 30% to 0%) and property (in 2005, from 10% to 5%), the two single biggest consumption items of households typically. In a way the planned building of casinos (sorry IRs) can also be seen as increasing taxable consumption that would otherwise have leaked away (to Genting and cruise ships). Point 2 is well-documented: annual tourism figures is targeted to double to 15M (from 8M today) within 10 years, with a plethora of attractions being planned, the most significant being the abovementioned IRs and the revamping of Orchard Road retail properties. Immigrants provide a new source of consumption: I believe about a quarter of Singapore's population today are non-citizens. That is the value of a developed country: you can attract people to move to your shores in search of a quality lifestyle. Even so, a population of say 5 million is inadequate to provide to critical mass of domestic consumption. Hence Point 3, which is illustrated by the multitudes of FTAs that have been signed these few years to facilitate easy passage of goods and services. In particular, an ASEAN free trade area would effectively open up the entire ASEAN market to flow of goods and services. With a combined population of ~500 million, that would surely provide the consumption hinterland needed, albeit with lesser spending power.

Restructuring Singapore series: Renewed focus on services

2006-01-04T06:29:00.000-08:00

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As mentioned in my last post, the services sector is clearly where Singapore is restructuring towards, although manufacturing continues to be seen as a pillar due to its incumbent importance as a revenue driver and jobs provider.

One only has to look at the US (or any of the Western economies) to perceive the reasons for such an evolutional strategy. What drives the US nowadays since the 1980s when Japan (and followed by the rest of Asia who followed its export-oriented strategy) acquired the manufacturing edge? It is software (or more generally, IT ---> cue Microsoft, Oracle, and all the hardware industries that have benefited immensely from alliances with successful software eg the 1990s Wintelpaq alliance), entertainment (Hollywood, what else?), finance. All these are services, with high intellectual and creative content, which captures the competitive advantage of the developed nations.

Frankly, it doesn't take great intellect to formulate such a strategy, since one can just read the history books and look towards the Western economies, as mentioned above. I guess that is how the newly formed National Research Council has decided on digital and interactive media as one of the two growth sectors to pour billions in over the next few years (the other being water technologies, a potentially lucrative sector as highlighted in my earlier article). What is digital media, but just a cross between software and entertainment?

Just a short discussion on what I think it takes to succeed in software and entertainment (and from there, decide whether the big-budget foray into digital media is likely to succeed). The important factors for software industry growth would be high intellectual content, strong complementary hardware industry, and strong domestic base. The first is self-explanatory; the second is because bundling of software and hardware as an integrated package is what works, in addition to the fact that major research and standardisation efforts need software/hardware collaboration; the third is because software acceptance typically needs to be worked from within before it can be successfully exported. Singapore would struggle in all three areas, especially the third where the domestic economy is too small to provide a support base (unless the government decides on a major local software adoption by the civil service sector). As for the entertainment industry, the important factors: creative talent and cultural content/strength are quite lacking. Singapore doesn't have the critical mass of creative talent. Our environment has often been accused of not being supportive of creativity, a reputation that often precedes itself in repelling creative talent. We do not really have a unique culture that is attractive to other countries, in the way that Japan and Korea have managed to project their soft power and export their entertainment programs overseas in recent years.

In fact, the services that Singapore will do well in are those that it already excels and on which its strengths lie. The financial sector --- which emphasises efficiency, integrity and regional connectivity. Regional hub management (headquartering services like marketing and sales, legal, corporate finance, research and design services, management) --- which emphasises high education and professional training. The logistics sector --- which again emphasises efficiency and regional linkages. In fact, two service sectors which have also been covered extensively in the papers in recent years suit this profile --- service sectors serving for the young (education) and for the old (healthcare). The success of the education industry depends on academic recognition globally, which Singapore enjoys by virtue of the routine strong performances in the sciences by her students. We already have hordes of mainland Chinese students coming to Singapore to study, whether in public or private schools. The attraction of Singapore as a place to find work for these students after they finish their studies is also a less-recognised factor that I think is just as strong a pull factor for Singapore as an education destination. As for the medical and healthcare industry, those familiar with the private hospitals would know that a large proportion of their patients are from neighbouring countries, particularly Indonesia and Malaysia. This is by virtue of Singapore's reputation for quality outpatient and inpatient (surgery) care. The growth of the pharmaceutical and biomedical cluster in recent years could well be leveraged on to build further capabilities in medical research and grow the healthcare sector. The jobs it can offer should not be underestimated: in addition to doctors and nurses, there're also researchers, administrators, pharmacists, chemists and laboratory technicians, even workers for non-profit organisations (ie. charities).

Why else is the government trying to encourage a "service culture" these days? Customer orientation and a commitment to value creation for the client are more important in the abovesaid service sector, compared to say, the manufacturing sector where the worker might as well be a faceless digit producing the goods for the faceless cusomer thousands of miles away. One of the drawbacks of the service sector is that the delivery of the service has to be done in close proximity to the customer, and hence there is high leakage of income if the service is performed overseas (compared to manufacturing which can be done locally while customer is overseas). Hence it is important to keep the service delivery local and get the customer to come instead; that is why the education and healthcare industry are such great service sectors in my eyes.

Restructuring Singapore series: Targeting high-end engineering / manufacturing

2005-12-26T20:37:00.000-08:00

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Any discussion of the economy restructuring process cannot be complete without an overview of the manufacturing sector, which employs about one-tenth of Singapore's population and contributes one-quarter of its GDP.

The manufacturing sector is divided into a few clusters: electronics, chemicals, transport engineering, precision engineering, biomedical engineering and general manufacturing. Electronics has always been recognised as the mainstay of the manufacturing sector, contributing about 40% of its output; however this is set to change with the rise of low-cost production centres, hence the recent push to drive growth in other manufacturing sectors.

In particular, the rise of China as the factory of the world and the impending threat of India as another alternative has meant that manufacturing work with a high labour component will be increasingly outsourced to these regions. Electronics, high-tech though it may sound, is actually rather labour-intensive in its manufacturing process, involving mainly manual assembly of electronic components. That is why local electronics companies are following their customers (Seagate/Maxtor, HP etc)and increasingly moving manufacturing operations overseas: it is a matter of do-or-die. One might remember that in the 1990s Singapore used to be a hub for electronics manufacturing. Veteran investors would remember the likes of Omni Industries, JIT, Natsteel Electronics, Natsteel Broadway: each of these had mega-scale electronics manufacturing operations in excess of S$300M (Natsteel Elec had $3B). These have since been taken over by MNC manufacturing operations like Celestica and Solectron; consequently the local electronics manufacturing base has been hollowed out: the factories are still around, but these foreign MNCs have no roots in Singapore and hence are likely to move out when they perceive costs to outweigh benefits.

In recognition of this trend, the government embarked on initiatives to increase the perceived value-add of Singapore as a manufacturing centre (it is too great a revenue driver and jobs employer to scale down). I would see these as constituting a multi-pronged approach: (1) targeting higher value-add manufacturing sectors; (2)increasing R&D investment; and (3) promoting the regional hub status of Singapore.

The biomedical cluster has been a result of (1) above. From a standing start of nil in the late 1990s it is now contributing 10% of Singapore's industrial output and 20% of the value-add in 2004. One can not only see how important it is as a growth driver, but also the high value-add nature of the sector from the above figures. However, as a jobs provider it only employs <3% of the total under manufacturing sector: such is the problem with high value-add manufacturing: it is usually capital intensive.

Another means of increasing value-add is to move upstream ie. to design engineering and innovation through R&D. That is the reason why A-Star was formed and also why high-powered civil servants like Philip Yeo and Dr Tony Tan are driving the national R&D effort. Why is Chartered Semicon still in existence despite years of red-ink? It undertakes intensive R&D, is at the forefront of electronics developments and hopefully one day it can drive the development of downstream electronics manufacturing. Such a vision has come true for Samsung, which leveraged technology from its world-leading semiconductor arm to drive innovation and branding for its consumer electronics brand to great effect. One may have heard of the trend of outsourcing: the first wave is manufacturing, then non-core services like IT and after-market support, and possibly R&D and design engineering (the rise of ODMs) in the future (leaving the brand owners to focus on building their brand and manging their supply chain). Singapore does not have competitive advantages in the first two, but it would be wise to position ourselves for the next outsourcing wave.

And for (3), I guess we have been pushing our hub status for the last two decades. Transport hub, logistics hub, finance hub, preferred regional headquarters for MNCs. I remember reading an article about the Indian founder of eSys, the budget PC manufacturer which is based in Singapore but operates worldwide (billion-dollar revenue I believe), and he said after surveying all the countries for his manufacturing operations he found that Singapore was the best, on a total cost basis, because the high labour costs were offset by the efficient and reliable infrastructure compared to say, China where logistics was still a problem. Now, his opinions might well have been tempered by the fact that he was speaking to a Singapore newspaper, but my view is that as a production centre Singapore suffers from high costs in the mid-stream (manufacturing) while possessing strengths on the upstream (the above-mentioned R&D and design, together with high national educational qualifications) and downstream (last-mile supply chain management, post-manufacturing transport and distribution).

It is interesting to note that some of the most promising sectors were not ostensibly targeted as growth sectors by the government until recently when it became clear that they had emerged as possible world leaders in their respective industries. In particular, I am talking about the offshore rigs and marine industry, where Keppel Fels and Sembcorp Marine are between them building 80% of the world's offshore rig platforms, KS Energy is rapidly expanding its rig refurbishment business in the region, while shipbuilders in Singapore like Labroy and Jaya are getting fresh shipbuilding contracts every other month. They have driven the transport engineering sector which has outperformed the other manufacturing sectors significantly over the las two years. Environmental engineering has also come into the picture, in particular water engineering. Wastewater treatment has become a major focus of municipal governments in China, while Middle-East countries flush with oil money look to build up water resources through advanced techniques like desalination. Singapore, in its paranoid years where water from Johor was so critical to survival, has now developed four different sources of water that it can depend on: the domestic reservoirs, water from Johor, Newater, and water from desalination. The weakness has been turned into a strength. Just look at the number of companies listing on the SGX that do water treatment: Hyflux, Biotreat, Asiawater, United Envirotech, Sinomem, Dayen, Darco etc. In a manner analogous to top tech companies choosing to list on the Nasdaq, I would think this is an acknowledgment of the reputation of Singapore as a potential "water engineering hub".

One may well classify the above-mentioned engineering sectors as more of services than manufacturing (in its original "mass production" sense); it is simply indicative of the way Singapore's manufacturing sector have to restructure to add value. Typically, since the 1970s, developed nations worldwide have witnessed their labor move from agriculture to manufacturing, and then from manufacturing to services. Although Singapore is looking to develop the services sector, the manufacturing sector is too big a job employer to ignore in this transitionary period. Promoting our strong integrated support for manufacturing (infrastructure, logistics, design and R&D) and low country risk is the way to go, to keep current manufacturers locally as well as to attract new investments.

References:
(1) Statistics Singapore: Principal statistics of manufacturing by industry cluster 2004

Restructuring Singapore series: Banking opens up

2005-12-17T22:35:00.000-08:00

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Following my last article on Singapore business going global, I thought a series of writeups on where Singapore appears to be heading would do justice to the topic, instead of just one or two. The rise of China and India has created the urgency for economic restructuring that was sorely lacking in the 1990s, given their intrusion into the core export sector (of most Asian countries). In particular, Singapore runs the danger of losing its status as a trading and business hub, given that it is not exactly near Northeast Asia where all the action is.

One of Singapore's core strengths, built up over the 1980s, has been its financial centre status. It is intimately linked to our status as a trading and regional business hub, given the importance of financing and credit to business. Fairness, efficiency, liquidity and transparency are all key attributes for a top banking system, and these have all been key features driving Singapore's rise as a financial centre. It is to MAS's credit (and also a follow-through to the dominant late-twentieth century trends of globalisation, deregulation and liberalisation) that they have recognised since the 1990s that to drive the next phase of growth (towards the Swiss standard, to employ Goh Chok Tong-speak) the Singapore banking sector has to open up to foreign competition.

The banking landscape is already morphing as we speak. MAS issued full qualifying banking licences to six foreign banks (Citibank, ABN Amro, Maybank, HSBC, BNP, Stanchart) through 1999-2002, the most privileged status for foreign banks that allows them to open new branches locally and to develop their ATM network. At the same time new wholesale licences (the next most privileged status) were given to banks from Switzerland, Japan, France, Australia etc. The number of branches that these banks can open, and the number of ATMs that they can operate, both key measures of permitted penetration into the local commercial banking sector, are set to rise further (you might have read of Citibank's intention to expand its presence into the heartlands).

The local banks have responded to the coming foreign competition by a process of consolidation to achieve the necessary operational scale: DBS with POSB, UOB with OUB, OCBC with Keppel-Tat Lee. On the investment banking side, there are the less-publicised acquisitions of Vickers Ballas by DBS and Kay Hian by UOB. The three main local banks are also required by the government to dispose of non-core assets by 2006: a measure probably designed to prevent conflicts of interest and abuses of the great power bankers wield over their clients, and presumably also to give greater focus to the core banking business. Additionally, we have seen a wave of expansion overseas: DBS bought Dao Heng Bank in Hong Kong to establish a Northeast-Asia presence, UOB established a strong presence in Malaysia (long-standing) and Thailand (through Bank of Asia), while OCBC built on its traditional presence in Malaysia. Trust the banks to diversify their revenue sources and risks in view of the coming foreign threat onto local shores.

Over the years, local retail banking has opened up to a new range of services, some with not entirely welcome consequences: insurance products and fund management services have burgeoned, credit card banking has become a major segment of consumer banking, and the new hot sectors now are wealth management and private banking. All this ties up with Singapore's transition from developing to developed nation status: the trend of high savings in the developing years is turning to an environment of high consumer demand (credit-driven) and investments (shares, unit trusts) typical of developed countries like the US.

Businesses, in particular SMEs, need access to funds for growth, and such financing is typically achieved by loans through commercial banks. An increase in competition (through a rise in number of banks) can only mean better financing rates for private enterprises, a sector the government is trying to encourage. The currency crisis of 1997-98 when the danger of excessive leverage was illustrated clearly also shifted the emphasis towards equity financing for many, and this is where investment banking comes in -- a traditional strength of foreign banks, in particular those of the Anglo-Saxon variety where equity financing has tradtionally been preferred. Foreign banks bring in foreign fund managers and private equity -- a source of new liquidity to absorb new share and corporate bond issues. They also bring in new instruments and methods: observe the new investment instruments springing up these few years or being planned for the future: REITs, structured warrants, index futures, single-stock futures, commodity futures.

Seen in such a context, the liberalisation of the banking sector is crucial to the transition process of the Singapore economy. Having acquired the critical mass of wealth, technological expertise and economic goodwill, the priority now is on how to manage it ie. capital allocation. Not only would banking sector liberalisation provide the competitive jolt to the local banks and eliminate unfair practices due to their hitherto protected status, it would also allow the new foreign banks to bring in their established expertise and best practices in consumer credit, investments and equity financing, banking segments which are crucial (and which local banks, long accustomed to traditional lending, might be lacking in) as Singapore seeks to boost domestic consumption, local entrepreneurship and foreign investments in local assets. A vibrant banking sector would further secure Singapore's position as Southeast Asia's financial hub.

References:
(1) MAS press releases
(2) ATM Marketplace news article Apr 17 2002: Singapore opens banking market, more ATMs follow

Restructuring Singapore series: Singapore business goes global

2005-12-03T19:32:00.000-08:00

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When you see our Prime Minister making state visits to foreign countries all the time (latest being Europe) and our Senior Minister (Middle-East) and Minister Mentor (latest being India) chipping in, you know that Singapore is embarking on a renewed globalisation drive right from the top.

This is not to say that we were not globalised before. As a trade-dependent and export-oriented economy Singapore's fortunes have always been tied to global business cycles. But it is clear that the trend of increasing local affluence and consequently costs (land, labour) together with the rising production capabilities of mega-economies of China, India and even Vietnam are likely to provide major obstacles to the long-term growth of our export sector.

There is a multi-pronged approach being developed to counter this threat. (1) The development of higher-end manufacturing ie. a continuation of the export strategy, albeit in new high-margin sectors like pharmaceuticals; (2) The stimulation of domestic consumption, where attracting tourists is sort of an "out-of-the-box" thinking to increase consumer base; (3) Investment in overseas assets, which is what Temasek and GIC have been up to aggressively in recent months; (4) Expansion of operations overseas, such as manufacturing and engineering services.

In particular, Temasek has espoused its 1/3-1/3-1/3 strategy: 1/3 in Singapore, 1/3 in developed economies, 1/3 in rest of Asia. In short, exposure to the local economy would be trimmed down to generate funds for overseas asset purchases. GLCs (government-linked companies) have taken the hint and expanded operations overseas (for some years now) to generate Singapore's "external economy", especially in major economies like Australia (Optus), China (mainly property, through Keppel Land and Capitaland), and the latest flavour of the month, the Middle East (Surbana, CPG).

It has also been natural for private companies to venture overseas to capture the comparative advantages offered there, in terms of cost and consumer base. Electronics contract manufacturers have had to build plants overseas to support their customers that have relocated to China (eg. Brilliant moved to China to support Maxtor), resulting in the recognition for a restructuring of local jobs. Higher-margin service-based companies are, in particular, doing a roaring business overseas, as they build on the Singapore brand of quality, integrity and technical knowledge to deliver solutions to a previously-untapped gargantuan consumer base: think Raffles Education in China, Hyflux in the Middle East, Inter-Roller for airports across the Asia-Pacific and Middle-East.

Previously the expansion overseas had been undertaken with seemingly half-hearted and sporadic endeavours (think Suzhou Industrial Park), in view of the buoyant global economy throughout the 1990s providing a strong tailwind for Singapore's export sectors. However, the need for a structural shift in Singapore's economic model has emerged with the rise of China and India as production and service outsourcing hubs, creating urgency for the development of a significant external arm to Singapore's economy. Hardly a week passes nowadays without hearing of a stake increase in some major overseas asset by one of the GLCs, Temasek or GIC.

There is a way to ride this trend for the investor. The government has been pledging strong support to help companies expand overseas, through its chief agency IE Singapore. Business entourages following ministerial state visits overseas are now common, such as that following SM Goh to the Middle-East; government-to-government interactions and business-to-business contact take place concurrently and often reinforce each other. Temasek itself has taken stakes in local companies which it believes have strong potential: Hyflux, Osim and KS Energy have been beneficiaries. It is no surprise that these companies embody key competitive sectors and strengths of Singapore: Hyflux in water, KS Energy in oil rigs, Osim in brand management (as distinct from manufacturing per se). Look out for service companies with significant overseas scale and contacts and enjoying comparative advantage in operation (perhaps as a result of being from Singapore). They may well be the next vehicle for Temasek to drive private sector expansion overseas. Even if not, strong governmental support for overseas expansion will provide a favourable environment (possibly in terms of taxation) for businesses looking to go global.

References:
(1) Newsweek article Nov 8 2005: Singapore's Bling
(2) Bloomberg news article Aug 6 2004: Temasek goes shopping to build a new Singapore

The rise of flash memory

2005-11-29T06:58:00.000-08:00

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Five months ago in one of my first blog articles (has it been five months already?!) I wrote about the Future of Mobile Phones and discussed the tussle for ascendancy between flash and hard disk drives to become the storage form of choice on mobile phones, or indeed on most personal electronic devices, currently the hottest sector in technology.

It looked more likely then that HDDs might just gain the upper hand, given their success on the Apple Ipod, and observing the miniaturisation trend that was giving birth to 1" and 0.85" HDDs. However, several events have occurred since then to swing the trend, probably decisively, towards flash memory. The chief trigger was the adoption of Samsung's NAND flash memory by Apple in its latest version of the Ipod, the Nano. Apple also more or less declared that flash was its choice for the future. The second event is rather, a combination of events involving the main vendors of both storage platforms. Samsung announced that it was committed to growing the market for flash, revealing its 16GB prototype and plans to expand to 100GB in a few years. Given its financial strength, top ranking in global flash memory compared to only being 4th or 5th in HDD, and its strong and growing downstream Samsung electronics brand, one cannot doubt its commitment nor its ability to bring fruition to that promise. Over on the HDD side, Seagate, the world's top HDD supplier, announced it would cut back on capacity expansion plans, revealing attentuated optimism; Maxtor, probably the 2nd or 3rd largest, announced it was ditching its 1-inch drive development altogether.

As usual, the economics of the options decides the contest. Flash is still much more expensive per unit megabyte compared to HDDs but its price is dropping rapidly; it had fallen about 40% in 2004-5; in general they are declining in prices faster than for HDDs (~20% annually). It will not be surprising, as well, to see the flash vendors, led by Samsung, make a concerted push, at the cost of short-term margins, to drive mass adoption of flash in personal consumer electronics. There are three key personal electronics items: the digital camera, the music player, and the holy grail of the mobile phone. The first two have more or less embraced flash; it is likely that the key vendors of the last will do so as well.

The key advantages of flash are that it is more robust (since it has no moving parts) and consumes less power; these are key advantages in personal devices which are often operating on the go, and the battery unit forms a significant portion of the cost as well as its weight. For mobile phones, the adoption of flash as the standard might be less straightforward: a key problem is that flash has a limited write/erase cycle; on mobile phones where such operations will take place many times daily (projecting into the future when a phone becomes a personal data-organisation device) this will be a serious technical drawback. But I wouldn't bet on this problem remaining unresolved; too often the case is that when the creative human encounters a difficult technological problem, it is the reputation of the former that remains intact.

Don't sound the death knell for hard disk drives. In terms of cost per megabyte HDDs will take some beating, and on static devices such as desktops they will remain the de facto choice. It may be interesting to note that flash vendors are now planning to encroach on the laptop domain; if they do succeed it would be time to dump all your HDD-related shares.

References:
(1) IDG news article May 23: Samsung develops flash-based 'disk' for PCs
(2) Yahoo news article Nov 16: Maxtor Inches Away From Small Drives

Organisation of the contents in this blog

2005-11-23T08:28:00.000-08:00

You may find it difficult to get an overview of what articles are in this blog. Just scroll down and there is a "Contents" post showing all the postings done up to October. The postings are organised by months on the LHS sidebar, so click on the appropriate month of the posting you want to read.

Natural Gas: Alternative Energy Source

2005-10-31T18:25:00.000-08:00

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So much attention has been paid to the discussion of exotic alternative sources of fuel such as ethanol, hydrogen etc that the most economical crude oil alternative has receded into the background. Yet natural gas is what is being used today in the most efficient power plants in the world, the combined cycle gas turbine plants. This is incumbent technology that has already proven itself.

The fact is that alternative fuels that power transport (ie. diesel or petrol substitutes) tend to receive more attention since this sector provides the highest profit margins. Natural gas is mainly used for two main purposes: power generation and home use (heating/cooking) (in a ratio of about 70-30 in the US). Although rare, there are already vehicles running on natural gas/CNG (compressed natural gas), even in Singapore, the so-called hybrid cars.

Natural gas is available through two main modes of transport, similar to crude oil. It can be run through gas pipelines (even across seas) or it can be liquefied into LNG (liquefied natural gas) for transportation by LNG carriers. The former is obviously a better choice if the source supply and demand catchment area are in close proximity, but LNG is fast becoming a more feasible source due to geographical mismatch between the two.

Key producers of natural gas are the Middle East (again), Indonesia, Australia, Russia; there is some distance of these main sources from the key demand centres. Traditionally Northeast Asia, in particular Japan, Korea and Taiwan, have been dominant consumers of the LNG market. The supply situation for crude oil is undoubtedly tight now but natural gas, apparently, is in abundant supply; the implication that natural gas could become an increasingly economical fuel alternative has not been lost on key demand markets and has led them to invest in LNG infrastructure and to secure long-term natural gas supplies. These include the US, China, India and western Europe.

The infrastructure in question would be LNG production and offloading(at source) facilities and receiving(at destination) terminals, storage facilities, and of course the LNG carriers that would transport the LNG. There are many signs that investment in such infrastructure is accelerating. Middle East countries and Southeast Asian producers (Indonesia, the world's largest LNG exporter, and Malaysia) have been expanding existing and building new export terminals, the US may finally be embarking on plans shelved earlier (due to environmental concerns) to build new receiving terminals on its West Coast, several Western European countries are actively exploring building and expanding receiving terminal facilities. For LNG carriers, the world fleet of LNG carriers is about 200 in total (see The World Fleet of LNG Carriers) but the order book for new LNG carriers over the last 2 years alone has been about 150 (see The Order Book of LNG Carriers). That suggests an explosion of supply which would not be good for the margins of existing LNG carriers but is strongly suggestive of the optimism surrounding the long-term demand for LNG. Even Singapore is getting in on the act, with its recent announcements on feasibility studies to build an LNG receiving terminal, storage facilities, as well as new pipelines to bring in natural gas (awarded to Keppel Gas).

References:
(1) International LNG
(2) News article Nov 15 05: New Direction for Natural Gas
(3) News article Apr 12 05: Too Late in Singapore LNG Race?
(4) Wikipedia entry: Combined cycle

Contents up to end Oct 2005

2005-10-28T16:28:00.000-07:00

Contents up to end Oct 2005

Growing ASEAN automotive industry

2005-10-27T07:26:00.000-07:00

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Two pieces of recent news stand out in my mind in relation to the automotive industry. Firstly, there has been much furore recently in Malaysia over the issuance of APs to favoured individuals and implicating its Trade Minister Rafidah; allied to this are plans to end the special treatment of the national carmaker Proton and to develop several areas in North and Central Peninsular Malaysia as automotive hubs. Secondly, the US automotive sector continues to be in deep trouble, with Delphi filing for bankruptcy while General Motors reported huge losses due to high labour costs.

The former piece of news reflects the Malaysian realisation that the ASEAN automotive industry has strong potential, but the way to grab a piece of the pie is through foreign investment and not developing one's nationally subsidised vehicle. The latter reflects the high costs of production in Western countries, not least the ridiculous pay packages the powerful automotive unions negotiate (it was reported that retrenched GM workers were paid in full, as much as US$5K per month, for idling at home), which suggests the centre of gravity for car manufacturing must surely shift to economical Asia (which also happens to be the region with the fastest growing consumer demand).

Consider: ASEAN as a free trading bloc (under the AFTA agreement) is comparable to any other major economy in the world, even China or India, in terms of population (several hundred million, think it is 400M combined) and potential consumer demand growth. In terms of geography, it is well-placed for product distribution to other main demand centres in Asia. In terms of supply, it has already achieved critical manufacturing mass with Thailand's Rayong as the acknowledged regional hub for auto and auto-components manufacturing, and home to many global car manufacturers, such as Toyota, Ford and our familiar General Motors (profitable here, I believe); in addition to first-tier car assemblers, the automotive subsystems and automotive components industries in Southeast Asia have also developed as strong supporting acts.

This momentum looks set to continue; Japan is one of the major investors in the car manufacturing industry in ASEAN (particularly Thailand) through such heavyweights as Nissan, Honda, Toyota. It recently showed greater interest in expanding its car manufacturing in ASEAN, in view of the abovementioned factors and the fact that many Japanese companies now adopt a "China plus one" policy with regard to manufacturing; this is a long-term strategy to reduce manufacturing risk exposure to China due to political troubles. As governments in ASEAN become more receptive to foreign investment in the industry like Malaysia recently, the environment is likely to grow even more attractive to foreign carmakers.

Singapore, of course, is never slow to spot emerging regional opportunities. EDB is pushing for yet another "hub" in automotive operations, but come on, we have better chances in other areas. However, high value-add specialised components manufacturing are strengths of Singapore manufacturing, more specifically, Singapore's precision engineering industry. Companies like Innovalues Precision (precision parts), First Engineering and Sunningdale Tech(plastic parts), Jackspeed (automotive leather), Armstrong (rubber and foam components) are likely beneficiaries of increased investments in the automotive industry. In addition, increased consumer demand would probably provide tailwinds for companies like Jardine Cycle & Carriage (owner of Astra, Indonesia's largest car distributor) and Stamford Tyres (regional tyre distributor).

References:
(1) Business Times report: Plenty to Catch Up on in Malaysia's auto policy

Rising Singapore food industry

2005-10-13T07:19:00.000-07:00

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One of the often overlooked growth sectors in Singapore is the food and beverage manufacturing industry. If one were to look at the monthly manufacturing performance report released by EDB, this sector, classified (unfairly) under the General Manufacturing group, has been growing at about 7% year-on-year for the last few months. That is quite strong growth (remember, we're talking about a large number of companies, so averages tend to attentuate growth figures) and also very steady growth, compared to the volatile biomedical cluster or even the electronics cluster.

For some time now, Singapore has been the regional headquarters of a number of international food corporations, companies like Nestle, Danone, Unilever. Some companies have also been in the news recently for setting up base in Singapore: Barry Callebaut (a leading global chocolate manufacturer), and Danisco, a leading food ingredients manufacturer (in papers today). Additionally, we have large F&B manufacturers locally ourselves, companies such as Singapore Food Industries, Asia Pacific Breweries, Tee Yee Jia, Prima. And if one looks at the SGX he will find many listed companies there doing the food manufacturing/processing business.

To me, there are quite a number of underlying factors supporting the continued long-term growth of the food manufacturing industry in Singapore. Firstly, there is of course the burgeoning Asian consumer market, which Western companies cannot afford to ignore. One can be sure high-tech, and hence higher margin, Western food companies will continue to build their presence here in the future.

The next few reasons relate directly to Singapore's strengths. Firstly, Singapore's strengths in R&D. The government has actively brought in foreign food companies to set up R&D facilities here, while also encouraging R&D locally. The rapidly growing biotech sector also provides research that can probably be commercialised in the food sector; organic food products are a result of biotechnology. The food industry can be a high-margin business; probably the food ingredients industry, rather than the food manufacturing industry, would benefit most from such R&D. Secondly, Singapore has a strong national brand for quality control and integrity, a quality nowhere more important than in food products. That would mean consumers are ready to pay a premium for food products originating in Singapore, or even those made by Singapore-based companies. Thirdly, Singapore has long been a logistics and distribution base for Southeast Asia, with many products entering Singapore to be re-exported. It is a base for many global trading houses.

Hence, although the local population could never provide the critical mass for a domestic consumption market supporting the growth of the food processing/manufacturing sector, the "hinterland" of Southeast Asia, or even Asia, surely can. Add to that the availability and growth of key supporting services (R&D, quality control, logistics, distribution, trading operations) throughout the supply chain and one has to be optimistic about this industry.

References:
(1) USDA Report: Singapore's Food Manufacturing Industry 1998

Economic recovery in Japan

2005-10-05T08:07:00.000-07:00

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Japan's economy has been in the doldrums since its fall from grace in the early 1990s following the asset and property bubble of the 1980s (see my blog The Japanese bubble economy). Some call the 1990s Japan's "lost decade". Deflation has been the chief economic problem hounding the world's second largest economy, as the excesses of the 1980s worked themselves off slowly through a vicious spiral of declining prices causing a "poverty effect" (as opposed to the "wealth effect" where enriched masses spend more during bull markets) which in turn further dampened demand.

This deflationary process has progressed on to this day but there are signs that Japan's domestic economy might finally turn the corner. A recent survey in September showed Tokyo residential and commercial land prices rising year-on-year for the first time in more than 15 years. Elsewhere, outside Tokyo, land prices still continued to fall, albeit at a decelerating rate. The recovery in Tokyo's land prices was attributed to better business optimism and higher investments, and does suggest that the property market might be turning the corner. Incidentally, this trend of high-end property prices leading the recovery is similar to Singapore's market, where prime downtown condominium developments have been snapped up eagerly in recent months while the HDB flat market remains stagnant.

One can look at other indicators for clues. The stock market is often a leading economic indicator; Japan's Nikkei has risen about 14% since the start of the year. The economy grew at an annualised 3.3% in the April-June quarter. Given such signs of an end to the deflationary spiral, there seems to be a strong case for an upturn in domestic consumer sentiment, especially when near-0% interest rates provide loose credit. On the investments side, the rise of the two Asian giants China and India, particularly China, must surely be beneficial economically for Japan's manufacturers and exporters, despite all the overblown political troubles with the former; the external business environment looks optimistic enough for Japan's big electronics and industrial machinery firms to increase capital investments further.

The long-term picture looks good. Japan's government under Koizumi has obtained a decisive mandate to go ahead with reforms starting with the postal office, which locks up a large proportion of savings and allegedly serves as a source of funds for politicians to do favours for business associates. This has distorted resource allocation and many foreign investors view the planned privatisation of Japan Post as a positive first step in unravelling the incestuous links between government and big business, leading to more optimal investments in the long term. Already, the drive for reform has led to plans to trim 10% of the government's work force over the next 5 years in a bid for leaner government. All this suggests the government's determination to restructure the Japanese economy.

Given the recovering consumer sentiment and business optimism, supported by ample liquidity and a restructuring story, and it being the second largest economy in the world, I would pounce at the chance to buy Japan if it were a stock in itself. In this case, I would of course buy a country fund specialising in the country.

References:
(1) CNN report Sep 20 2005: Tokyo Land Prices in Rare Rise

RFID Techonology Adoption

2005-09-28T08:13:00.000-07:00

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RFID, or Radio Frequency Identification, is one of the most-talked about technologies in the US nowadays. In fact, I remember that it was actually included as one of the top 100 inventions over the past century in some magazine poll recently. It has not yet caught on in Asia but I believe it might soon, as consumer trends tend to fan out from the West; the widespread adoption of RFID technology is, incidentally, driven by the consumer goods industry in the US.

At its core, RFID technology simply refers to simple tags which can be attached or incorporated into any object, with the ability to be read by RFID receivers via radio waves; they can provide product identification and facilitate logistical tracking. They are an improvement on the ubiquitous bar codes as moving objects can be tracked easily, while still being relatively cheap compared to contactless Smart cards which have better security features and are used to store more personalised information.

The adoption of RFID technology has been driven by Walmart, the largest retailer in the world, who announced in 2003 that it expected that its top 100 suppliers would be RFID-compliant by the end of 2004. Indeed, now they are 100% RFID compliant, which means their suppliers, all top brand names, have adopted the technology (albeit mainly in the US). It is not surprising why Walmart wanted to adopt RFID. On the supply side it would allow them to press their longstanding strengths in inventory management and enhance supply chain efficiency by allowing tracking of every item in every shipment and instant access to important groups of product data: expiry date, country of manufacture, OEM etc. On the customer side, it allows faster checkout at the aisles and better security against shoplifting.

Indeed, the technology has been used in many industries. It has been embedded in tires to allow tracking, in airports to track luggage, in bookstores to track books, and can even be implanted in pets or prison inmates to track their locations. Singapore, as always, is quick to adopt new technologies; the new NLB library book returning/borrowing systems makes use of RFID technology facilitated by RFID tags on all library books. And I wouldn't be surprised if RFID-enabled chips are used in the new casinos that are coming up 3-4 years later; that seems like a natural application for RFID.

References:
(1) RFID's growing presence in the marketplace
(2) Radio Frequency Identification news and commentary
(3) Wikipedia: RFID

Southeast Asia as an energy resource hotzone

2005-09-20T08:15:00.000-07:00

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Increasingly, it looks like a key pillar of Southeast Asia'a economic future could well be in resources exploration and processing, as its strength as a manufacturing base is gradually lost to most cost-effective countries with abundant and increasingly well-educated labour supply.

Indonesia has to be the starting point for any discussion of natural resources in Southeast Asia. Long recognised to have potentially huge unexplored oil and natural gas resources in its territory, its slowness in capital investment to increase exploration has led to it being embarassingly the only country in OPEC to be a net importer of oil, the high domestic consumption partly due to its petrol being heavily subsidised. All this is set to change, as the country faces currency problems due to having to buy in highly-priced oil. They have been relaxing foreign investment regulations over these few years, and this current difficulty looks set to accelerate the process. Already China has been quick to tie up investment cooperation agreements with Indonesia. We all know what China has been doing: its relentless efforts to ensure energy security are well-documented.

Of course, oil and gas exploration is not confined to Indonesia. There have been drillings all over Southeast Asia; for those who follow SPC and Pearl Energy, they will for example know about the PSCs in Indo-China and Thailand. Malaysia, I read, has recently revived the idea of setting up a second national oil exploration company to complement (and provide competition for) Petronas, given the attraction of high oil revenues.

And again, the energy resources are not confined to oil. It is clear that coal mining is also a major growth sector. That's why Chuan Hup was purchased by Habib (whose substantial shareholder is Scomi, a listed Malaysian oil and gas services firm with strong connections), and that's why Sembawang Kimtrans has shown strong earnings growth and analyst reratings leading to a share price surge. For poorer countries with less developed infrastructure, coal is still the primary fuel, especially given the high oil prices now.

Look at how Singapore is positioning herself. Already we are a world-leading builder of offshore rigs and platforms, and one of the three key oil trading hubs (the others being Rotterdam and New York). Now there are plans to set up energy derivatives trading infrastructure, to build substantial oil storage facilities (including plans for underground storage like what the US has), and government-linked SPC is actively providing consultancy services to Indonesian oil refineries and explorers. I won't be surprised to see quite a number of oil services and exploration companies in the SGX's IPO pipeline in the near future too. As always, Singapore is looking to capture the downstream and supporting services pie. And hey presto, we would experience the oil boom too, even though we have no natural resources.

Actually, one should not be surprised by this trend. Just over half a century ago, Japan invaded Southeast Asia precisely because it found the available natural resources, especially oil, too hard to resist.

Consolidation of the airline industry

2005-09-15T07:46:00.000-07:00

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The latest US airlines to be haunted by bankruptcy fears are Delta Airlines and Northwest Airlines, the No. 3 and No. 4 US carriers respectively. If they do indeed file for Chapter 11, it would mean four of the seven major airlines would be operating under court protection (the other two being US Airways and United Airlines).

Ok so US bankruptcy laws are much more forgiving compared to Asia's, but this is nevertheless a quite startling situation given the importance of aviation to the modern economy. No wonder Warren Buffett singled it out as an industry where long-term net profit to investors has been zero or negative.

We have seen a consolidation of the major airlines going on worldwide over the past few years and this trend looks likely to continue given the financial difficulties epitomised by the US major carriers as described above. We have had the mergers of KLM-Air France and Lufthansa-Swissair in Europe, Qantas-Air New Zealand in Australia, America West-US Airways in the US; even in Singapore we have recently had the merger of the presumably loss-making budget carriers Valuair and Jetstar Asia.

In this sector, one interesting difference between the West and Asia is the type of airline which generally outperforms the industry. In the West, budget carriers such as Southwest in the US and Easyjet and Ryanair in Europe have done excellently compared to the national carriers, while in Asia it is the reverse: national carriers like Qantas and Singapore Airlines have maintained strong performance while budget carriers have generally struggled. This difference is probably accounted for by the large size and high affluence of the domestic markets in the Western countries (European Community, US domestic routes) which makes the high-frequency short-haul flights business model of the budget carriers in these regions viable. In Asia the lucrative market is in long-haul flights where national carriers have existing agreements in landing rights and generally have advantages in securing new ones (hence enabling them to subsidise short-hauls to counter the threat of the budget carriers).

What is clear is that the high oil prices is taking its toll on all carriers big and small. Fuel costs account for a large proportion of airlines' raw material costs and the doubling of oil prices over this two years must be a page out of their worst nightmares. It is thus natural that further consolidation of the airline industry is likely to continue, given the advantages of doing so: (1) combination of air routes/landing rights and hence more comprehensive coverage making the business model more viable; (2) combination of financial resources thus improving financial stability and enabling options like fuel hedging (not efficient if done on a small scale); (3) greater negotiation power especially if the merger partner has strong governmental links.

Another thing is clear: I wouldn't be in a hurry to buy any transport stocks, airline or otherwise, in the near future!

Infrastructure boom

2005-09-05T07:46:00.000-07:00

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This is not just a knee-jerk post after seeing the damage that Katrina has caused in the US. The infrastructure boom I am talking about is geographically different; it is in Asia, it is happening now, and it is likely to be a long-term trend going into the medium term.

Those investing in the stock market would not have failed to notice this trend. Most obvious of course is the offshore infrastructure segment, which of course has a lot to do with high oil prices. We have seen the rise of the water plays like Hyflux and recently Biotreat, both beneficiaries of governmental drives to improve the supply of a key necessity to their large populations. Inter-Roller has benefited tremendously from the sudden rush of contracts from various airports to expand their baggage handling capacity. Utilities are enjoying a tailwind due to high energy demand -- just look at China and their annual summer power shortage in the big cities like Shanghai. And telco infrastructure providers are starting to come out of the doldrums, due to the growing need by the developing economies to connect their populations.

This trend is not difficult to foresee. Firstly, it's a case of supply catching up to meet demand. The global economy has been on an uptrend since 2003, and both an increase in income (growing global GDP) and an increased willingness to spend it (better consumer sentiment) has led to steady growth in spending these two years. Certain industries have been quick to adjust, such as electronics industries which can usually ramp up production by adding more lines. However, heavy industries typically need longer lead times to increase production, and a supply crunch results leading to a sudden need to invest huge amounts to increase supply. The best example is of course the refining industry, an issue which has come to the fore after the Katrina hurricane.

Secondly, that China and India are probably the two most rapidly growing economies is a happy trend for providers of land-based infrastructure, such as roads, power and communications. The two countries are geographically huge, and as their economy grows they will be inclined to spend large proportions of their GDP on improving the standards of living and connectivity of their populations. In particular, China's government is committed to reducing economic disparity between the rich eastern coastal regions and the western interior; I can foresee heavy funding for infrastructural development of the interior for many years to come.

What does all this mean? It means bumper contracts are in the pipeline for many years to come for engineering companies with the right credentials and connections. Just look at Halliburton and how it has secured rebuilding contracts with its connections to the US government, for example. And closer to home, one can look at KS Tech and Hyflux and how they have expanded operations overseas successfully with the probably strong help of Temasek Holdings, a substantial shareholder in each case.

The rising M&A trend

2005-08-24T08:18:00.000-07:00

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Hardly a week passes by now without the papers reporting a mega-merger or major acquisition globally. We have in the oil industry, the much-discussed CNOOC bid for Unocal that was ultimately trumped by Chevron, and the probably successful acquisition of PetroKazakhstan by CNPC (with some competition from India's ONGC); in the shipping industry, the key one must be Maersk acquiring P&O Nedlloyd; in the consumer appliances industry, China's Hai-er sought to acquire Maytag but ultimately lost out to Whirlpool; while in the Internet realm we have had quite a number of mergers as the industry continues to consolidate, with Yahoo buying over Alibaba.com being the main talking point (see Return of the Internet stocks). And of course in Singapore we have just had the acquisition of Raffles Group's hotel assets by a US investment group. The above is just a cross-section of the increasingly buoyant global M&A activity.

To me, these M&As can be generally divided into two categories. The first is a global push by MNCs to cultivate new growth drivers by acquiring assets in "hot" regions (eg. Yahoo's acquisition of Alibaba to penetrate the China online auction market, PSA's acquisition of HK's port assets, Osim's purchase of Brookstone to enter the US market) or in synergistic industries (Whirlpool's acquisition of Maytag, BenQ's acquisition of Siemen's handphone division, TPV's acquisition of Philip's LCD TV division). Why do these companies buy when the economy is good and price tags are high? That's because the buying companies have themselves had good results as a result of the booming economy and their management might be finding it difficult to grow further organically; hence they look to stimulate growth through acquisitions. A case of Accounting 101, increasing efficiency of capital management (and hence return on equity).

The second is a relatively new phenomenon, that of the global push by rapidly developing China and increasingly, India, with strong support from their relative governments. This has been most prominent in the energy sphere where the country's strategic future is seen to be at stake. But increasingly, major Chinese companies with strong cash holdings and a solid domestic base have also been looking abroad for Western companies to purchase, likely for the strong brand equity associated with Western companies that will enable these China companies to grow their export markets. Hence it was that Hai-er sought to buy Maytag (owner of the Hoover brand) and Lenovo paid a ransom to buy IBM's computer division.

Who benefits from these M&A deals? The shareholders of the companies being purchased are usually big winners, however the individual investor is seldom so lucky to be invested in one of such companies. Less obvious beneficiaries would be those parties involved in the value chain lubricating the final transactions. Investment bankers and brokers who underwrite these deals will benefit from professional fees. Corporate secretarial services will be needed for the heavy administration work associated with M&As. And printers with exposure to the financial industry gain from all the documentation needed to be sent to the shareholders. A buoyant M&A scene often lends strength to a stock market but might also portend a peaking of the market as expectations and consequently valuations grow higher and higher. Hopefully it does not end up like 1999-2000, when tears followed the frantic acquisition of EMS companies like Omni Industries, JIT, Natsteel Electronics and Natsteel Broadway.

Ethanol: The Alternative Fuel

2005-08-16T06:30:00.000-07:00

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Everybody knows about the high and still rising oil prices nowadays, and some, especially drivers, are being hurt financially by it. There are doomsday projections of US$100 oil, and these have scared governments into accelerating programs to explore alternative sources of energy.

The August 8 edition of Newsweek highlighted such a source --- ethanol. Already, Brazil is embarking on a major program to supplant oil with ethanol as the fuel in cars and even aircraft, and its many ethanol production plants have led to some even calling them "the Saudi Arabia of ethanol". Major economies including the US and Germany are promoting the use of ethanol in vehicles, and crops are being grown for production of such fuel -- so-called "energy crops".

There are several strong points of ethanol as a fuel, as pointed out in the article. Firstly, it can be processed from a variety of crops, including corn, sugar-cane, rice husks, sugar beet and possibly even sweet potato. It belongs to a class of what is known as biomass fuels. This also leads to the second advantage, which is that conventional engines can run on it without much ill effects. After all, oil is also a type of biofuel (fossils compressed under high pressure turn to oil over millions of years). Hence, ethanol can be mixed with oil in car engines for normal operation, hence cutting the fuel bill (an equivalent barrel of ethanol costs US$25, less than half the price of oil now). Indeed, this is being practised in Brazil and Germany (where it is known as biodiesel). These advantages put it ahead of completely new alternative energies like fuel cells, which involve reinventing machines and reinvesting a great deal of money.

So it is that ironically, after having progressed from an agricultural economy to industrial economy to information economy, we are now going full circle and looking to agriculture to solve the biggest problem in modern society -- energy. Indeed, if the price of oil remains high and progress continues to be made on the supply side (more efficient production and refining techniques) and demand side (additional areas where it could replace oil as a fuel, eg. heating and power generation) for ethanol as a fuel, ethanol as an alternative energy source could well be a megatrend for the future.

References:
(1) Newsweek Aug 8 issue: The Next Petroleum

Return of the Internet stocks

2005-08-09T07:53:00.000-07:00

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The Nasdaq IPO of Baidu.com, a popular search engine company from China, was a tremendous success, its share price quadrupling from the offer price as of today (and PE of >2000!). It was probably the second recent Internet IPO success story, following Google's own IPO last year; Google's share price itself has tripled to its current price at around US$300, valuing it at about 80 times earnings.

The euphoria surrounding these new Internet IPOs smells of Internet fever all over again. But nowadays people are more rational; many are still reeling financially from the burst of the Internet bubble five years back. The valuations might be a bit on the high side, but Baidu, although likely to correct from its price surge, captures the essence of a rising China with potentially explosive Internet-based business growth (given China's population and high popularity of the Internet among the young --- one only has to go to a typical LAN centre in China --- always full ---to find out), while Google, of course, is king of the search engines with consistently outperforming earnings growth to match.

The burst of the bubble has led to a process of natural selection, with those having poor business models falling aside while the stronger ones like Yahoo!, E-bay and Amazon have survived and become beacons of the Internet sector. The sector itself has grown more mainstream, with models like e-commerce, Internet banking and online music downloads now becoming commonplace and more importantly, commercially viable. Security was a big issue, in the areas of payment and confidentiality of personal information; nowadays public acceptance of Internet transactions has grown together with the improvements made in enhancing online security. It appears that the promise the Internet held has indeed materialised in many arenas.

To me, there are two probable trends that will anchor a further rise of the Internet sector. Firstly, the continued strengthening in the global economy will lead to consumption growth and with it, increased advertising by companies. Advertising is arguably one of the most cyclical sectors, and will do well in a consumption boom. With it, online advertising rates will continue to rise; online search ad rates rose an average of 25-30% last year. That is the bread and butter of most Internet stocks, and thus bodes well for their future earnings.

Secondly, there is a likely consolidation of the sector. Both the big Internet companies and "bricks-and-mortar" companies are looking to acquire smaller Internet companies that could be synergistic to their business. Some significant deals this year include IAC/Interactive, a big interactive commerce player formerly owned by Vivendi, purchasing search site Askjeeves.com; the New York Times buying an information site About.com; Dow Jones & Co. buying investing site Marketwatch.com. Yahoo is reportedly considering buying Alibaba.com, a China search portal. This spate of deals has led to analysts predicting more acquisitions down the road, most likely involving second-liner Internet companies being acquired. And of course, don't forget Microsoft and its ever-ready checkbook, particularly as they are looking to hedge on the Internet as an alternative future of computing.

More activity in the sector will always mean greater investor attention, higher trading liquidity and ultimately rising prices. This is one sector to look out for.

References:
(1) Why Second-Tier Sites May Be Worth Top Dollar

The need for security installations

2005-08-01T08:02:00.000-07:00

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The recent London blasts have once again highlighted the dangers that terrorism pose to our normal way of life. Western societies and those allied with them now find that improving public security is a major issue that has to be implemented.

Singapore already has a Coordinating Minister for Security and the fact that he is a Deputy Prime Minister fully illustrates the importance placed on this issue. The new ministry has been in existence for the last two years and it is likely that a host of recommendations to improve public security will be introduced, jolted by the London bombings.

One of the key drives that has involved regional cooperation is the push to strengthen security along the Straits of Malacca. This was to be expected given the importance of seaborne trading to Singapore, and indeed the region's, fortunes. There are discussions to increase ship patrols and recently, even air patrols. Armed security guards are also provided onboard commercial ships now. And of course Singapore was one of the first to adopt the US anti-terror ship and port facility security code, which include requirements for onboard security officers, alarm systems, and automatic identification systems for ships.

Recent talk has also centred around the installation of security cameras on public vehicles and locations. Already there are such cameras installed in places like Geylang, and also at the MRT stations (albeit perhaps also for other reasons). It would be useful to note the high density of such cameras in Western countries like Britain, which have supposedly helped to facilitate investigations into the recent bombings.

These are but two of the many areas that I would expect security to be tightened (albeit surreptitously) through the use of technology. Think about aviation, strategic infrastructure such as the utilities and telco installations, cybersecurity, personal identification (eg. biometrics) etc, and it is clear the security issue cuts across a slew of areas. Given the global concern about terrorism, security is likely to be a new growth sector with a continual churn of new products that will fill gaps in various public operations.

I am interested in this probable trend in two ways: firstly, there is likely local demand for security technology and products from the public sector in the next few years as the terrorism threat becomes something all Western-allied countries have to deal with; secondly, as always Singapore will try to position herself at the cusp of a rising trend (see biotechnology) and I think security might well be seen as one of those that could be leveraged on; it has a high services component requiring specialised skills, and provides high profit margins and growth. One might wish to note that our Coordinating Minister for Security is also in charge of the nation's R&D planning.

A key beneficiary of China's currency repegging

2005-07-27T08:10:00.000-07:00

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China has finally allowed its renminbi to operate on a managed float. This was always inevitable, and might have been delayed until now precisely because of foreign pressure; China's government wants to show that it does not bow to ang-mohs.

And again, no matter how many times the Chinese deny that this revaluation move is just the start, it is very likely that there is going to be further upward move of the currency as its volume of trade and trade balance continue to grow.

There has been a great deal written about Chinese companies operating in the domestic market benefiting from this, due to asset appreciation and higher earnings (when converted to US$) but I think one of the greatest beneficiaries has to be global exporters of capital equipment. These are the machinery and equipment used to manufacture products in wafer plants, EMS companies, automotive companies, consumer products factories etc. The effects of the renminbi revaluation on domestic consumption in China might be overestimated because the majority of mainland Chinese are hardly affluent by any means; those who can afford to spend now would have been able to spend before the revaluation, while the poorer ones are not going to spend much more because of it. On the other hand, it is clear that economic growth is a key target of the Chinese government, and I suspect part of the reason for the revaluation is to allow local companies to import foreign machinery at cheaper costs. It ties in with the drive to produce more China companies that can compete globally, as the next step following the successful import of foreign investment capital that has made China the workshop of the world.

Japanese companies are likely to be the chief exporters of such capital goods, given their close trade links with the mainland (despite all that tension over WW2 recently) and their strong expertise in this area. At the same time, it appears they are seeking alternative production bases (a so-called "China plus one" policy) for outsourcing given the poor political relations. Thus it looks like they will be importing capital equipment into China but withdrawing capital at the same time. This could be the true legacy of the currency revaluation, and it might include not just Japan.

Hotels in demand

2005-07-19T07:08:00.001-07:00

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The acquisition of nearly all the hotels under the Raffles Group by an American investment company, which was announced yesterday, has put the Singapore hotel industry in focus for once in a long while. The hotel sector used to be hot during the late 1980s and early 1990s when Singapore was in a property boom, the retail sector was strong and tourism was growing. However, in recent years, it has receded into the background as other growth pillars like manufacturing have taken over.

Yet the hotel industry in Singapore looks set to perform well for the next few years. It is at the confluence of three secular themes which I will outline below.

Firstly, the recovery of Singapore's tourism industry since SARS has been strong. Last year we achieved a record 8 million tourists, and this number is set to grow as discount carriers increase linkages at low cost, and as consumerism in Asia grows (see an earlier blog Consumer discretionary expenditure in a recovering economy) in tandem with their national economies. Already many hotels in Singapore are optimistic about occupancy rates growing for the next few years, and have raised their average room rates this year. This suggests higher profit margins in the coming years, especially since new supply of hotel rooms are limited for the next few years until the new IRs are built.

This brings us to the second trend which sees the Singapore government making a renewed effort to bring tourists into Singapore. It is clear that they now recognise that Singapore needs to create more service-based jobs and create strong domestic consumption, to keep jobs in view of the inevitable outflow of manufacturing jobs to cheaper locations; this transition has been seen in other developed economies like the US and the UK in the past. However since Singapore has a small population which has stubbornly refused to grow organically, a rise in domestic consumption can be achieved through more permanent immigration and of course, temporary tourists. Thus the huge investments made in the Esplanade and the planned (not one, but two) casinos (oops Integrated Resorts) coming up. The buzz surrounding the latter is likely to bring further attention to hotel stocks within the coming 2-3 years, although the expected increase in toursists might be offset partially by the increase in hotel room supply created by the new mega-hotels in the IRs.

Some might also remember reading about the third trend in the papers several days back. Because hotels are generally sitting on expensive land in the premium city area, developers are now looking at them with a renewed interest towards converting them into high-end residential apartments that can be sold off to interested buyers which does not seem to be in short supply despite the general stagnant housing market (one observes that the rich get richer). Already, hotels like The Marco Polo, Seaview Hotel and Cockpit Hotel have been bought over, torn down, and condominiums built in their place. Basically, this is a conversion from the yield-based earnings of hotels to the capital gains earnings associated with residential property developments. In addition, there are people who speculate that the current red-hot REITs theme in the Singapore market might spread to the hotel sector, allowing hotel owners to realise their property value and to concentrate on their hotel management competency. One should note that Singapore hotel stocks are typically trading way below their NTA, which means any such value realisation will potentially bring a windfall for the lucky investor.

It is possible that the American investor was eying the real estate that Raffles' hotels are lying on rather than the hotels themselves (of course, note that Raffles does not own some of the hotels, it just manages them). This is quite likely given the global property boom. Whatever it is, it definitely brings welcome attention back to the long-neglected Singapore hotel sector.

Strong tourism in Hong Kong

2005-07-18T07:04:00.000-07:00

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The Hong Kong economy has recovered strongly since being stricken by SARS in mid-2003. A major factor has been its strong linkage with its hinterland of China, who have given Hong Kong a strong boost with its CEPA (Closer Economic Partnership Agreement), effective since 2004, which has facilitated easy tariff-free movement of goods, services and people across the China-HK SAR border. One of the primary beneficiaries has been tourism in Hong Kong.

According to statistics, China tourists now form more than half of Hong Kong's record 22 million tourist arrivals in 2004. The Mainland Individual Tourist Visit Arrangement that was introduced by the Chinese government, allowing mainlanders from several cities (the main coastal ones) to travel to Hong Kong as individuals rather than in tour groups as previously allowed, has contributed strongly to this trend. It is not hard to see why Hong Kong is seen as the favourite destination of Mainland Chinese; it is cheap to travel there, there are little restrictions, and it is a cosmopolitan global city. The biggest beneficiaries of this tourism trend would arguably be hotels in Hong Kong, which have enjoyed 80-100% occupancy rates over the last two years. Retail and property have also enjoyed booms, together with the stock market.

Clearly the steady growth of the global economy has also contributed to the recovery of Hong Kong tourism, but more than anything the strong tourist influx from China and the continuing growth of the Chinese economy is likely to buttress the tourism growth in Hong Kong for the next few years. The next stimulus to Hong Kong tourism will be the Hong Kong Disneyland opening in September 2005; this is expected to bring in another surge in the tourist arrivals.

References:
(1) Hong Kong Tourism Commission: Tourism Performance in 2004

Energy conservation in China

2005-07-14T07:03:00.000-07:00

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In recent years, power shortages in China during the hot summer season and the cold winter season have become an annual phenomenon, due to massive use of air conditioners in the former and heating appliances during the latter. They can hardly be considered one-time occurences, and are indicative of China's huge demand for power.

Indeed, China is now the world's second largest consumer of energy, after the United States. As its economy continues to grow and development progresses further inland, the trend can only point upwards with regard to its energy needs. The Chinese government has been quick in recognising this potential bottleneck and has been active in securing new supplies of oil (for power generation) and even looking to buy into foreign oil assets.

It is to their credit that they recognise not only does the supply issue need to be tackled, but demand must also be managed. It is well-known that one of the main reasons for the country's high energy consumption, besides its red-hot economy, is that it is extremely inefficient in using energy. There is tremendous wastage and the problem is not helped by heavy government subsidies on various petroleum products. The papers today reported renewed efforts to cut down on power consumption through "green buildings" which cut down electricity consumption by use of various electronic sensors to detect and switch off unnecessary appliances, and the government plans to introduce these designs across government departments, one of the greatest culprits in energy wastage. This move will not only cut down power consumption of the buildings but will also have the important long-term effect of educating people about the importance of energy conservation.

We only have to look to Europe for the model of such a "green" society. Over there, they stress not only energy conservation, but also renewable energy sources, recycling, environmental air and noise pollution control, and now even environmentally-friendly "green manufacturing". As China becomes increasingly plugged into the world through such organisations as the WTO and various free-trade agreements, it will have further incentive to adopt more stringent environmental standards. And coming back to the issue of supply, don't forget the rising price of oil as an additional driving force for change in the way energy demand is managed.

There are no really strong China energy conservation plays of a sufficient scale right now on the SGX but one might want to watch this development of this trend in the future and see which firms might look to take advantage of it. One possibility might be construction/property development firms that have such "green building" capabilities looking to spread their wings abroad.

Indonesia's economic recovery

2005-07-11T06:45:00.000-07:00

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Since the 1997 Asian financial crisis where Indonesia emerged as one of the biggest losers in thw aftermath, its economy has been languishing in the doldrums as a series of mediocre presidents have tried, mostly in vain, to restore it to its former glory days in the 1980s and early 1990s when she was the fulcrum about which ASEAN operated. It seems likely that the process is now steadily underway with a new well-respected President holding a strong mandate and with the winds of political and economic investment in its sails.

Of course, much of the economic momentum is due to the upsurge in the global economy since late 2003. Indonesia has clearly benefited from the increase in world trade, since much of the world's shipping traffic (and most of Asia's imported oil) passes through the Straits of Malacca. Feeder shippers that operate within the region, such as Samudera Shipping, have seen massive growth in volume in addition to margins. Operators of Indonesian ports, such as Portek, have also seen strong growth in terminal handling operations over the past year.

Much of my optimism is due to recent political events where it is clear that both the US and China are jostling for influence in what they now recognise as a strategic region: Southeast Asia. China sees a need to secure its oil route, and also sees potential in oil exploration in the ASEAN region (check out CNOOC's aggressive bidding for Unocal, which holds many oil assets in Southeast Asia). The US strategically will look to counter-balance China and also sees a (security) need to cultivate good relations with the key Muslim countries in the region, chief among them Indonesia. Indonesia is already taking advantage of such an evolving political landscape. It is opening up new PSCs(Production Sharing Contracts), allowing foreign investment in oil exploration. And their President agreed to preferential trade agreements with both the US and China earlier this year. New foreign investment is set to flow in in the coming years.

One might also see Japan as a future source of foreign investment. In particular, Japanese automotive companies like Nissan and Toyota are looking increasingly to South-east Asia for car assembly and parts production. Indonesia has a low-cost base and must be seen as a key beneficiary of such outsourcing by the Japanese. In addition, their large population is a strong plus since the Japanese will view it as a strong potential customer base to sell the production models directly to. Just look at how Jardine Cycle and Carriage has been growing its vehicle sales volume (through Astra) over the last 2-3 years. This is also an indication that consumer demand in Indonesia is alive and well (and many Chinese businessmen have started to return after fleeing during the 1997 racial riots).

The Jakarta stock market has symbolised the growing market confidence in the future of Indonesia's domestic economy. Its composite index is probably one of the best-performing over the last two years, jumping from about 700 points in Jan 2004 to above 1100 points as of today, a jump of more than 50%. It looks poised to grow further provided that no major force majeure or human-inflicted disasters occur in the next few years.

Upgrading of port infrastructure

2005-07-05T08:01:00.000-07:00

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World trade has recovered spectacularly in line with economic recovery since 2003, in particular in the Asia-Pacific, where basic materials move from resource-rich countries like Indonesia, Australia and South America, to rapidly developing behemoths like China and India. Consequently, the demand for container ships and bulk carriers has raised charter and freight rates spectacularly, and sparked investment on new ships that are expected to come on stream in 2006.

Yet if we consider the supply chain, it appears that there might be an impending need to upgrade or augment the port infrastructure which will handle the first (export) and last mile (import) of the transport process. Already, there have been numerous cases in China over the past year where bottlenecks formed at the ports with ships waiting to unload. Even the US faced such problems last year. This has highlighted the erstwhile underinvestment in upgrading port infrastructure which I am not sure is being addressed adequately even now given the large number of new ships being commissioned next year and with the economic recovery continuing.

Furthermore, there is a trend of ships growing larger in size. For example, for container ships, previously we had Panamax container ships, and then we had Post-Panamax, then now even the Super Post-Panamax. This tendency towards larger vessels can also be seen in the aerospace industry with Airbus introducing the huge A380. The reason is that the unit cost of transportation goes down due to economies of scale. This trend is likely to continue due to rising oil prices putting more pressure on shippers to be more cost-efficient in fuel usage. As ships increase in size, the port infrastructure such as cranes and shipping berths might have to be upgraded/replaced to handle these larger ships.

Anchored by booming demand throughout the supply chain for its services and overworked due to tight supply, port infrastructure might well be due for further investment sooner rather than later.

Recovery of Singapore construction industry

2005-06-29T20:51:00.000-07:00

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The construction industry in Singapore has been in the doldrums since the bursting of the property bubble after the 1997 Asian financial crisis. Over the last few years, many construction firms have gone belly-up or into deep financial trouble, including many listed ones (L&M, Chew Eu Hock, Econ etc). Today the industry is seen as a sunset industry, where contribution to GDP has been consistently declining year after year.

Yet as with all things, recovery rises from the deepest pessimism. And I am not just
talking about stock market prices of construction companies, but the fundamentals of the construction industry itself.

On the supply side, one can say that the decline over the last few years has purged the industry of its excesses: the weaker companies that have poor balance sheets, high operational costs, questionable product quality and insufficient operational scale. In effect, consolidation of the industry has occurred, with existing players now more able to control costs better, avoid overbidding (a myopic practice of the past) and having potential to grow profit margins in the future.

On the demand side, there are three areas where there is strong promise. Firstly, retail and commercial construction and upgrading. This is going to be supported by rising tourism in Singapore. One increasing focus of the Singapore government has been to increase domestic consumption expenditure, given that investment expenditure might plateau; a sympton of transition from developing to developed economy. And to attract foreign consumption (ie. tourism), major revamping of key areas like Orchard Road and construction of new ones eg. the BFC (Business and Financial Centre), the casinos (oops the Integrated Resorts) and mega retail malls like Vivocity. Secondly, construction of niche industrial properties. To quote from a DBS Vickers report recently, for industrial properties, there has been a trend of "more developments being built for a specific end-user’s needs rather than strata-titled units. This is evident among logistics service providers and the hi-tech sector where the end-user has specific business requirements." Thirdly, exporting construction expertise overseas. There is strong demand for fixed asset investment in growing economies such as India and China especially in the current benign economic climate, as well as oil-rich regions like the Middle East which are reaping massive windfalls from oil these two years and are now looking to diversify away from oil. Local construction companies can look to Japanese construction companies as an example and go global (look at how fast Japanese construction companies were in responding to reconstruction of Aceh after the tsunami).

Residential housing is apparently in a long-term decline and we have heard stories of HDB having an oversupply of flats which are now lying empty. Meanwhile there seems to be high take-up rates for high-end condominiums in plum areas such as Orchard Road. Besides suggesting rising income discrepancy, it also means the demand picture for residential housing in Singapore is intact.

It is difficult to pick the bottom of any industry but one only has to look towards the marine industry to see how a "sunset" industry has transformed itself into an acclaimed sunrise industry (especially in offshore rigs) in just a few years.

New Luxury

2005-06-15T09:00:00.000-07:00

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Market strategists have long pointed out that there are primarily three sorts of competitive advantage: price, differentiation and focus. It is clear that commodity-like pricing (competitive advantage based on price) squeezes margins and profits, and to earn supernormal profits differentiation and focus is the way to go.

How do we spot companies that can differentiate their products successfully? Some BCG (Boston Consulting Group) guys wrote a book called "Trading Up" which was very illuminating on today's consumer psychology. Drawing on their deep experience in retail consulting, they identified a rapidly developing socio-economic trend: America's (and indeed, developed countries') middle-market consumers are trading up to "products and services which possess higher levels of quality, taste, and aspiration than [other] goods in the [same] category but are not so expensive as to be out of reach...[trading up to products and services which] sell at much higher prices than conventional goods and in much higher volumes than traditional luxury goods"--- these are the New Luxury goods. They deliver key benefits that are increasingly appreciated by the well-educated, comfort-seeking and individualistic consumer of today: innovation, quality, a flawless experience; affordability by a wide range of consumers (by having extended product ranges priced at different levels), customisation, and consistent branding.

I had first-hand understanding of this consumer psychology when doing research for Meiban, which does plastic moulds for Dyson, a British vacuum cleaner OEM which had broken into the US market. It was surprising that Dyson was able to capture about 20% of the US market within two years of its entry, for it was priced at least twice that of the other brands in the market. But it turned out it had techno-chic appeal; their advertisements got the founder to explain its patented cyclone technology (which ensured consistent suction force) and consumers convinced of its technological superiority flocked to it. Apparently the men started taking over the women to vacuum the house after buying a Dyson, and got sufficiently excited to dedicate entire websites to their Dyson vacuum cleaner (emotional engagement: a key feature of the "trading up" phenomenon). This was a prime example of a New Luxury product.

More familiar to many is the Apple I-Pod which has taken the world by storm. It was hardly the first to launch a portable MP3 player (I think Creative was one of the first), but its trademark scroll wheel interface and soft white platform captured the imagination of techno-geeks like no other before it. By creating a cultural phenomenon of people being able to bring their music (a deeply personal thing) everywhere with them, and coupled with their past record of innovation, Apple had secured an emotional link with music lovers everywhere that would be hard to break. Even after two years of relentless competition from new MP3 players made by rivals, Apple still owns a majority of the MP3 player market and is able to retain strong pricing power.

For the small investor, his visits to the shopping centres are opportunities to identify which could be the "New Luxury" items of tomorrow. They should not be difficult to spot. Their counters will have many people crowding around waiting to try the demo or just gawking at the product. And if the product is expensive and still clears the shelves well, then it's time to pay more attention.

References:
(1) Trading Up (by Michael Silverstein, Neil Fiske)
(2) Against the Odds: An Autobiography (by James Dyson)

Rise of "sin" industries in Asia

2005-06-11T17:20:00.000-07:00

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The recent casino debate in Singapore put the spotlight on the gaming industry, and many realised that this was a rising trend in Asia which arguably Singapore would have to follow or be left behind. Countries in the Asia-PAcific are reportedly considering building casinos as well, including Hong Kong and Thailand, in addition to those which already have them, particularly Macau but also Japan and South Korea.

What is this casino fever about? It is linked to the rise of Asian consumerism and the resulting scramble to make money off them through tourism, and gaming is seen as a key attraction to increase the country's entertainment value.

Western gaming companies are also eying a share of this pie, which is why the big Las Vegas and Atlantic City gaming companies like Caesars, Wynn and Harrah's have recently been expanding in Asia in a big way, in particular in Macau, where a series of casino developments are being planned following further industry liberalisation in 2001/02. These gaming giants have also been facing increasing industry regulation and competition in their home countries, and are clearly looking to Asia as their next engine of growth.

These moves in the gaming industry form part of a bigger trend, that of export of "sin" industries into the Asia-Pacific in search of better profit margins. Another example of this trend is the forays planned by cigarette companies like Philip Morris and British American Tobacco into China and Indonesia. Increasing regulatory action (bans on smoking in public places) and taxes, looming class action lawsuits with heavy payouts (in the US) and rise of discount brands are squeezing margins in the developed countries and forcing the big players to move to less-developed countries which have big populations, more lenient regulatory environments and rising consumerism.

The biggest deal in recent months has been the acquisition of Indonesia's No.3 cigarette manufacturer Sampoerna by Philip Morris, a big move indicating the latter's seriousness in expanding in the region. British American Tobacco has long been active in Vietnam, another big nation of cigarette smokers. It is useful to note that these target countries are less developed economies containing large portions of less educated smokers who are likely to care less about the health risks associated with smoking, and hence there is little political pressure to cast a heavy hand over the tobacco industry. China is another country viewed as the holy grail of Big Tobacco companies, with its immense population and relatively backward social attitudes.

A standard template of these "sin" industries has been to offset difficult conditions in home countries with strides in other parts of the globe. It is probable that these "other parts" will include large parts of Asia, where on the supply side, governments are relatively compliant and legal infrastructure is not antagonistic; while on the demand side, large populations with rising disposable income and less developed attitudes towards "sin" industries (hence lack of social lobby groups) provide ideal operating conditions.

An Asian "Playboy" regional headquarters anytime soon?

References:
(1) Chronology of Macau's gaming industry
(2) UK Guardian report: US tobacco companies fall on hard times
(3) Bloomberg report: Altria completes takeover of Indonesia's Sampoerna

Rising global protectionism

2005-06-08T19:38:00.000-07:00

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The Straits Times reported today that the EU has just warned China that it may erect trade barriers (in the form of tariffs) against shoes made in China, following a similar move against textiles. This is the latest in a series of moves by the developed nations to protect their home industries.

The US has also been active in such trade protectionism. Besides the much publicised tariffs against highly competitive Chinese textile imports, it has in recent years also put up barriers against steel, colour television sets and miscellaneous agricultural imports. US politicians have spoken out against outsourcing operations of their big-name companies, and demanded for jobs to be kept home.

Much of this is understandable. A main reason is that the West sees China as imposing an invisible trade tariff itself through its undervalued renminbi which lowers competitiveness of US exports to China's domestic market. The US, in particular, has been running massive trade deficits with China for years. Big US MNCs prefer to manufacture in China because of the lower labour costs, causing domestic jobs to be lost; the EU increasingly so as their rigid labour laws similarly drive manufacturers overseas.

Outsourcing is a secular phenomenon which has been facilitated by the advanced information technology that has allowed easy communication, coordination and specialisation; it is not likely to go away in a capitalist world. However, specific industries might come in for greater scrutiny by national trade authorities. Those that have come in for special attention fit the following mould: relatively low-tech products whose cost structures are highly pegged to labour costs, employers of many low-wage workers in the home countries, strong local lobby groups arguing against loss of jobs in that particular industry, lack of strong interest groups (such as MNCs) which have a special stake in outsourcing jobs overseas. This is why companies like HP and Motorola will continue to produce their consumer technology products in China and export it to the US without much domestic complaints while more fragmented industries whose products have more political sensitivities (such as agricultural products) will have problems doing the same. This trend is likely to extend into the future as outsourcing takes further hold.

Investors would need to be careful of victims of such protectionism. China's biggest exporter of television sets announced major losses in 2004 stemming, in part, from the US tariffs on television sets.

References:
(1) US-China trade tensions rise
(2) Scandal undermines China's big electronics exporter

Oil and China

2005-06-06T18:21:00.000-07:00

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The economic boom in China in recent years has led to a surge in prices of most basic industrial commodities such as metals, coal and oil. How sustainable is this, many might ask?

China has had a history of booms and busts, its GDP growth characterised by a trend line zig-zagging crazily up and down since Deng Xiaoping initiated economic reform for China in 1978. This is a symptom of a developing capitalist economy and suggests that it will be difficult to manage "soft landings" for booms such as the one currently.

However, over the long-term, oil demand in China is likely to sustain on a secular growth path. There are clear development trends anchoring this. To ensure that the China interior do not lag too far behind the coastal areas (resulting in social unrest), the Chinese government is committed to constructing linkages such as roads and telecomunications; that fuel needs for commercial(truck) and passenger transport will rise is almost a given. Energy shortages at factories during the summer season are common, a sign that there is upward pressure for industrial fuel and associated power generation facilities.

It is clear that coal, the primary source of energy in China now, is likely to be supplanted increasingly by oil as a cleaner and more efficient fuel in the future. Heating fuel is also likely to trend towards oil instead of biomass/coal as electricity is increasingly adopted as a primary delivery channel of energy.

On the supply side, unlike other commodities like metals which are less in demand by other developed countries (due to their already developed infrastructure) and whose supply elasticity is higher, oil is needed for run all industrial economies and is considered a strategic resource by governments, due to its scarcity. The supply problems are of course exacerbated by the OPEC cartel control.

China has identified the securing of its future oil supplies as a key target, and recent developments suggest their committment in this area. China vied with Japan to finance Russia's construction of the trans-Siberian oil pipeline, in order to ensure that the pipeline would fork to China (ultimately Japan won the bid; another reason why China's government implicitly supported nationalist rallies against Japan lately?). It has increasingly sought to strengthen relations with Indonesia lately, the latter being the biggest country in South-east Asia and controlling access to the Straits of Malacca where most of China's imported oil passes along (from the Middle East), and also a key exporter of oil. State-linked oil companies has also sought to buy stakes in foreign counterparts; they were planning to take a stake in Singapore Petroleum through China Aviation Oil before the latter ran into a quagmire of financial problems. Exploration for domestic oil is also accelerating; our own KS Energy Services is a key beneficiary of China oil companies going offshore to drill for oil.

As oil prices continue rising, it is likely to be in focus more and more by all countries because the need for this commodity cannot be substituted easily in the short-term. It is a long-term trend which is not likely to go away even as the economy slows, with the resulting tussles over and heavy investments in energy-related assets, such as oil resources, refineries and distribution channels (pipelines/tankers/trading routes).

References:
(1) Oil in Asia (by Paul Horsnell)