Investors enjoyed a much needed respite on 24 March after returning from the Easter holidays. Spurred by strong gains on Wall Street as well as bargain hunting, the STI rallied by more than 100 points to close higher at 2,927.79.

For investors who missed out on these gains, not to worry, as volatility is expected to continue. In fact, a number of research houses have concluded that there is probably more downside of about 10-35% before a bottom is reached. So it is not too late to enter the market the next time it goes down.

For investors waiting at the sidelines, it is timely to prepare a strategy so that you are ready to capitalise on opportunities to pick up stocks at a bargain. In this article, we will discuss some considerations for investors interested to enter the market as well as highlight 3 stocks, which offer compelling valuations.

Robust demand for steel

One consideration for investors is to determine the amount of capital set aside for short term trading and long term investing. While both short and long term trading can be effective, an important advantage of a long term strategy is that the investor is less affected by short term volatility.

As Legg Mason Capital Management’s chairman Bill Miller, named as one of the heroes of value investing, puts it: ‘Traders and those with short attention spans may still be fearful, but long-term investors should be well rewarded by taking advantage of the opportunities in today’s market.’

In addition, investors should also bear in mind that in general, short term trading requires superior technical analysis skills and constant monitoring, while long term strategy emphasizes a thorough fundamental analysis of the company and ability to hold on to the stock over a long term horizon.

Next, determine your selection criteria for stocks. For short term trading, liquidity of a stock is important. Therefore look out for the stock’s trading volume and market capitalisation. Technical tools will be useful in determining support and resistance levels.

For long term investing, there are basically two styles of investing: Growth and value. Growth investors focus on the future potential of the company while value investors focus on companies that are trading below their intrinsic value. Value stocks typically trade at relatively low price to earnings ratio or price to book ratio.

During volatile times like these, we prefer to adopt a value approach to investing. Portfolio manager Mary Chris Gay of Legg Mason Capital Management, who works with Bill Miller, said: ‘The bottom line is that for long term investors, buying at a point of great uncertainty – especially for financials, buying at book value or below – has proven historically to be a very good strategy.’

Another factor to look out for in the current credit crisis are companies with low debt. With banks restricting their exposure, funding may become a problem to companies who are not well capitalised. However, those who have access to funds can enjoy lower financing costs. We also like companies with strong return on equity, which reflects the efficient use of capital.

After taking into the consideration the above factors, we have narrowed our search to three value stocks: FerroChina (FC), Koh Brothers Group (KBG) and Lizhong Wheel Group (LWG).

FerroChina
“ To meet this sudden surge of orders in China, we are diverting 5% of our exports for domestic use,” commented She Chun Tai, CEO and chairman of FC in a recent press release.

Unlike other China plays that are reeling from disappointing revenue or squeezed by soaring raw material prices, FC is simply sizzling.

Even the recent snowstorms that wrecked havoc across the Middle Kingdom appears to be a blessing in disguise for the company, with FC chalking up orders for reconstruction.

Unfortunately, the share price of FC could not shrug off the sub-prime storm as easily as the company shrugged off the snowstorm.

After hitting a recent high of $1.66, FC fell to a low of $1.06 on 5 March 2008. The company is presently trading below its 14 and 60 days moving average. FC appears to be caught in a downtrend but is consolidating at the $1.03 to $1.30 level.

FIRING ALL CYLINDERS
Aided by the acquisition of Superb Team, FC reported a record Rmb5.9b in turnover for FY07, an increase of 56.1% year-on-year. In conjunction with the rise in revenue, earnings rose 41.7%.

Sales on the domestic front performed brilliantly, nearly doubling to Rmb4.1b while exports also rose. Concentrating on high-margins products like galvanised steel paid off with profit margins maintaining at respectable level.

On the whole, if consistency is what you are looking for, then FC should be one of the companies that you are looking at. The top and bottom line had grown 50.3% and 36.8% on a CAGR basis from FY04 to FY07.

EXPANDING CAPACITY
FC will be driving earnings through economies of scale, which is important in selling what is essentially a commodity product. Expansion plans are well in progress at Changshu Xingyu and Xinghai. By the end of 2008, at least 900k mt cold rolling capacity will be added to total capacity.

Total capacity is set to increase further. Recently, FC inked a memorandum of understanding to acquire Richsun Steel in Guangzhou and Vietnam-based Zhongyue Steel. The acquisitions are expected to increase 618k mt to overall production capacity. Further, the purchase allows FC to cement a strong foothold in Southern China and Vietnam, areas in which it had little or no presence.

With another year of progress in store for 2008, FC plods ahead towards its goal of becoming a global coated steel manufacturer in 2010.

Lizhong Wheel Group
What is the one thing which every car needs? Wheels of course.

LWG is one of the largest manufacturers of aluminum alloy wheels in China. It recorded a 19% increase in revenue to Rmb905.4m for FY07 due to robust demand from China’s automotive industry. Growth was mainly attributable to the Original Equipment Manufacturing (OEM) segment, recording an increase of about 28% to Rmb643.3m.

WHEEL WELL
LWG’s chairman, Zang Ligen, said, “The past year has presented us with challenges and also new opportunities. Aluminium prices continued to fluctuate while our customers’ demands remain strong. In light of these challenges, we commence the construction of our new Tianjin facility, systematically evaluated our operations in an effort to contain costs, while we were also able to command higher margins with a better customer and product mix. We are pleased to say we have successfully achieved good results as compared to our industry peers.”

LWG maximises its production efficiency by locating its factories near its suppliers of aluminium alloy. Super hot molten aluminium alloy, instead of solid ingots, is transported to LWG’s factories using tankertrucks. This is amazing when you consider the melting point of aluminium is 660 degree Celsius.

The heavier a car is, the more petrol it consumes. So to cut down on the weight of its aluminum alloy wheels, LWG has been focusing its research and development efforts on producing alloy wheels that are lighter.

NEW JOINT VENTURE
To increase the company’s technological edge while lowering costs by making the moulds in-house, LWG set up a 51:49 joint venture company, Tianjin Nano Machinery Manufacturing Co (TNM) with Citi-China (Hong Kong). TNM has a registered share capital of US$1m and will require a total investment of US$1.4m. This investment will be funded by internal resources and bank borrowings of TNM and Citi-China. TNM will do Research and Development (R&D), manufacturing and sale of aluminium alloy wheel moulds, ancillary automated equipment and provision of relevant technical consultation and services. It will have an annual production capacity of 240 moulds.

OPTIMISTIC OUTLOOK
According to the China Association of Automobile Manufacturers (CAAM), 6.38m units of passenger vehicles were produced in China in 2007. To date, demand has shown no signs of abating, with a 32% increase for year-on-year production figures in January 2008. Despite experiencing the most severe winter storm in 50 years, vehicle sales of as many as 630k units were recorded in January, up 6.7% from December 2007. February sales that should have been affected by the long Spring Festival holiday, has been reported to be high at 400k units by the China Passenger Car Association. With international automotive makers such as Volkswagen China and Ford Motor committing to increasing their investment in China for the next couple of years, the outlook for the PRC car market continues to remain bright.

One of the basic fundamentals of long-term value investing is to look for stocks of companies like LWG that are making profits consistently. Such a fundamental should not be thrown out the window in times of market meltdown when retail investors go into panic-selling mode.

Koh Brothers Group
In Issue 326, we featured Chip Eng Seng Corporation. This issue we will again look at another established construction company, KBG. If you are wondering why we have featured construction companies again, let us take this opportunity to tell you the reasons.

The construction sector has started to recover since 2007, aided by the government mega-projects that will boost Singapore’s tourism industry, foreign direct investment and construction activities. Although the US economy has slowed down significantly due to the sub-prime crisis or in fact, as what Warren Buffett has said, the US is already in recession, we remain very positive on Singapore’s future. KBG will be one of them to leverage from the government’s aggressiveness to make Singapore into a tourists’ wonderland.

ALL DIVISIONS ON A ROLL
KBG has reported strong growth across all its business divisions in its FY07 results. Its revenue from real estate division increased 7% attributed to the new sales from Bungalow@Caldecott and rental income from the Alocassia Apartments and the Sun Plaza. Excluding revaluation surplus for investment properties, its profit before tax (PBT) from real estate division was upped by 33.3%.

On the other hand, KBG’s construction and building materials division’s PBT more than doubled due to higher demand for building materials and higher recognition of work done from Marina Barrage and Common Service Tunnel 2 projects. Its leisure and hospitality division managed to turn around into the black on the back of 11% increase in revenue compared
with FY06.

FUTURE LOOKS BRIGHT
With the government’s megaprojects coming up, this will create more jobs, which means more expatriates coming here to work. Logically, this will lead to an increase in demand for apartments, pushing up rents and property prices once again. Moreover, with the government officially targeting to increase Singapore’s population to 6.5m and Singaporeans getting richer, this could trigger higher private housing demand and translate into higher property prices, which spells great opportunities for KBG’s real estate division.

Due to the government’s mega-projects, you can see construction activities everywhere in Singapore. We understand that construction costs may have doubled but we believe that KBG’s prudent and cautionary approach in cost management, efficient allocation of resources, as well as exploring more sources of supplies can offset some of these high costs. The increase in construction and building activities has also brought a positive spillover effect to its building materials division. Moreover, KBG has achieved total contracts in hand of $849m up to 2011.

Over at KBG’s leisure and hospitality division, this sector definitely looks promising. The government’s effort in promoting tourism, exhibition and convention activities has led to an increase in demand for hotel rooms. In addition, KBG sold off its prime freehold hotel site along Changi Road for a gain of $20.4m and this is going to be realised in FY08 results.

As at 25 March 2008, KBG is trading at $0.30 and at a historial PE of a mere 3.6x. Based on what have been discussed above, don’t you think that KBG’s shares are way undervalued?

-Angeline Cheong, Donavan Lim, Michael Chua, Xavier Lim

Exposure to growing sectors