Defensive stocks to the rescue

Malaysian Business, Feb 16, 2008 by James S

IS THE BLOOD OUT ON THE streets? The recent volatile equity investing environment worldwide has definitely shaken the confidence of investors, and despite what most analysts believe as to the country being on solid economic footing still, the Malaysian equity market is, nonetheless, not likely to be spared the carnage in stock markets outside the country. In tandem with the sharp falls in the US and regional markets recently, the Kuala Lumpur Composite Index (KLCI) has also followed suit, albeit on a lesser degree from its high of 1,525 points to its recent low of 1,340 points within a week.

With growth and thematic investing likely to be shunned by investors in a climate of fear and uncertainty, many conservative analysts have recently started to promote low-risk investment strategies, such as switching to low-beta or high-dividend stocks. Some prudent strategists also now prefer investors to park their money this year in companies with strong cash positions or are debt- free in case the US economy goes into a recession and affects the rest of the world.

With capital preservation now being the buzzword, some analysts think it may be time for investors to take a serious look at stocks that could actually ride out the possibility of a bear market emerging. That means stocks that have done so in the past and will still likely do well in scenarios of an economic slowdown or an outright recession. While there is no need to press the panic button, the expected volatile equity markets for this year mean that investors certainly need to have the right stock picks to withstand a sharp fall in the value of their portfolios in the worst-case scenario.

Searching for low-risk stocks

Given the above scenario, it may be interesting to look at such low-risk stocks. Table 1 shows the top-50 stocks listed on Bursa Malaysia that have the properties of lower investment risks such as those having low betas, high dividend yields and low financial debts. The list is compiled based on available data from Bloomberg and include only stocks that are members of FTSE Bursa Emas Index.

Capital preservation the key?

While the above list of stocks could be seen as defensive in nature and thus have the ability to outperform the KLCI on the way down, investors should realise that they could still suffer losses in a bearish market environment or in a panic selling situation. To further minimise the downside and preserve their investment portfolio value, investors may want to look at only stocks in the list that have exhibited strong defensive returns in the past.

Accordingly, a new methodology can be used to further select companies or stocks that have recorded no (or minimum) negative total returns (capital gains plus dividend yields) in the last ten years (from 1998 to 2007). In other words, these are companies or stocks that have been able to consistently generate positive returns (or only minor losses) in any kind of market conditions in the last ten years (see Table 2).

From the list, it can be seen that AEON Co (M), IOI Corp, IOI Prop and Public Bank are at the top of the list with unbreakable solid capital preservation track records in the last ten years. Meanwhile, the list shows that Nestle (M), Amway (M), Asiatic Development, Keck Seng (M), Lion Diversified, LPI Capital, Negeri Sembilan Oil Palms, Panasonic Manufacturing, Petronas Dagangan, Selangor Properties and United Plantations only registered one negative total return between 1998 and 2007.

It is also worth noting that while KLCC Property, the KNM Group and NPC Resources have no track records for the whole ten years since they are only three to five years old on the bourse, these stocks, nonetheless, have generally established remarkable total return track records since they were listed. For the benefit of readers, we will look at the actual fundamentals of some of the top stocks on the above list:

AEON CO (M) (RM9.90)

In a recent update report on the company by Affin Investment Bank Research, the research unit notes that AEON's same store sales (SSS) has recently grown a robust 10% versus that of a low single digit (around 3%- 4%) a year ago. As such, it believes that the company's FY07 SSS growth is now poised to exceed its current forecast underpinned by:

* stronger consumer spending - thanks to budgetary measures, in particular, the pay hike for civil servants (AEON's Malay customers account for about 35%-38% of sales), and

* a seasonally stronger 2H coinciding with the Hari Raya, Deepavali, Christmas and `Back To School' festive holidays.

Apart from stronger SSS growth, the earnings of the group could also be boosted by stronger contributions from its new stores/ supermarkets in FY07. According to Affin Research, there were four new Jusco stores and D'Hati supermarkets in 2007, located in Bandar Sunway, Bukit Tinggi - Klang, Kota Kemuning - Shah Alam, and Desa Park City - Kepong. These stores began commercial operations from September 2007 onwards and should, thus, contribute positively to the top and bottom lines of AEON from FY08 onwards. The research unit has maintained its `buy' call on AEON with an upgraded target price of RM13.52 based on a calendar year 2008 price to earnings multiple of 18.0x. It says that it remains upbeat on AEON, given its excellent growth prospects, strong management and branding as well as healthy balance sheet (with a net cash of RM87.7 million).