Tuesday 25 February 2014

Fried sweet potato starch

My dinner last night was at an interesting restaurant in Old Klang Road. Pu Yuan's address is 112, Batu 4 ½, Jalan Klang Lama.

Looking for the place is an adventure in itself. Coming from Mid Valley, look out for SJK (C) Choong Wen on your left and turn left immediately.

The fried sweet potato starch is unique and very good. A meal of five dishes, including deep fried wheat chicken, vegetables and noodles cost RM40 in total. I thought it was rather good value.

You need to walk a short distance of a narrow back lane to get to the front door. And it does not look much of a front door, nor a back door. A bit scary actually. But once inside, it is surprisingly clean, comfortable and air-conditioned.

Well worth the effort… good food, comfortable and value for money.

Saturday 22 February 2014

Turbulence in the skies — the options left for MAS

Malaysian Airline System Bhd’s (MAS) latest earnings results for the last quarter of 2013 underscore our previous opinion that simply boosting capacity and load factor without a concurrent — and huge — cut in operating costs would not be sufficient to turn the company around.

MAS reported a net loss of RM343 million in 4Q2013 and a cumulative loss of RM1.17 billion for the whole of 2013, compared with a net loss of RM432.6 million in the previous year.

This is despite the company raising the available seat kilometres (ASK) and revenue passenger kilometres (RPK) by 17% and 27% respectively. Its load factor also increased to 81% from 74.7%.

These statistics show that MAS flew more flights and passengers, and filled more of its seats. And yet, it lost money big time.

So, what needs to be done for MAS to break even?

We analysed its latest earnings results, ran the numbers and came up with three options, including one that is rather interesting, plausible and, most certainly, controversial.

Option 1: Boosting load factor to 96.7% on current capacity

For all our scenarios, we assumed a consistent 40:60 fixed-to-variable cost structure (excluding interest expense), and average yield based on total revenue per RPK for the sake of simplicity.

In the first scenario, we conclude that MAS can achieve breakeven at the pre-tax level if it boosts its load factor to 96.7% on its existing capacity (ASK) of 58,381 million seat kilometres.

Casting aside the practical impossibility for any airline to maintain such a high load factor, this scenario also requires that the average revenue or yield remains unchanged at 31.74 sen per RPK. This is highly doubtful.

Consider this — MAS’ yield fell from 36.87 sen per RPK in 2012 to 31.74 sen last year in order to lift its load factor from 74.7% to 81%. That is a load factor increase of 6.3%.

To raise the load factor further to 96.7% means another hefty increase of 15.7%. It is safe to say that to attract this many more customers, MAS would have to reduce its pricing. But as prices (yield) fall, even a load factor of 96.7% would not return the company to the black.

More importantly, AirAsia Bhd, one of MAS’ biggest competitors, has a much lower cost structure. Its operating cost per RPK is almost half that of MAS’ — about 17.5 sen compared with MAS’ 33.3 sen. Thus, even if MAS decides to reduce prices, AirAsia could well match it — and still come out ahead.

Option 2: Cut cost by RM1.1 billion

A more viable option is to cut cost. To be fair, MAS has been doing this over the past year, except that it was just not deep and fast enough to outpace the even steeper decline in yields. The average operating cost per RPK fell 12% while average yield fell an outsized 14% in 2013. In absolute terms, total operating costs rose by RM1.7 billion or 11.7%.

Based on last year’s earnings results, the company would need to shave off another RM1.1 billion in total operating cost (excluding interest expense) — equivalent to a roughly 7% reduction across the board — to break even.

While the figure does not appear too daunting, it should be noted that a good portion of its costs is beyond its control. This includes fuel costs, and handling and landing charges. Others such as depreciation and amortisation are, by and large, fixed. For those costs that are somewhat more flexible, we did a back-of-the- envelope calculation of the quantum of reduction required for one possible combination.

To save RM1.1 billion, MAS could cut staff and aircraft maintenance costs by an average of 11%, and commission and all other expenses by an average of 25%.

To say this is a tough task would be putting it mildly. The quantum of cost cutting required is certainly not impossible but the political will to execute and see through such a painful exercise is highly questionable. Indeed, this option has been articulated in the past but never fully implemented.

To be sure, there are many other possible permutations to lower costs. For the current year, MAS is focusing on increasing assets utilisation (reducing the aircraft downtime) and swapping older planes for more fuel-efficient ones. But these are longer-term solutions that would require time before any material impact is felt.

Another option would be to reduce net interest expense — which totalled RM323 million in 2013 — either by refinancing its loans at a lower rate or raising equity through another cash call. Both alternatives appear unlikely. Globally, interest rates are on the rise and MAS had just raised some RM3.1 billion in rights issue in July last year.

Option 3: Dumping the competition out of the skies

MAS’ latest results underscore the fact that boosting the load factor without any major new investments is not a solution.

Our calculations show that it would have to raise its load factor all the way to 96.7% just to break even. This is practically impossible and yields will keep falling anyway as competitors such as AirAsia have lower cost structures. Slashing cost deeply may work but if history is any guide, the political will to execute such a plan is weak.

This leaves us with one last possible scenario — dumping the competitors out of the skies, for good.

MAS could go on an expansion binge. Armed with the increased capacity, it could then move aggressively to capture market share by throwing prices. It would suffer greatly in the near term as losses would balloon — although the average cost will drop with expenses spread over a larger capacity, yields will fall even faster.

But it would outlast its competitors in the bloodshed because it is funded by cheap government money. After it has finished off its main competitors, the company would be free to raise prices again and start making money.

By any definition, this option will qualify as an anti-competitive practice subsidised by the government. But it is nonetheless, a plausible move.

Extreme measures in extreme circumstances, when all else have failed?

We can already hear Tony Fernandes screaming his head off!

Thursday 20 February 2014

From fish market to stock market

Last week, we highlighted the fact that retail investors were net buyers in Bursa Malaysia, the first time since August last year.  Using the latest data up to 18 February, the share of transaction value of small cap stocks rose to over 25% of the total value of transactions on Bursa, from an average of about 10% since January.

With retail investors turning net buyer with higher volume turnover, it pushes up the performance of small cap stocks. Since early February, the small cap stock index has substantially outperformed, rising by 7.3% against 2.6% for the FBM KLCI.

What does this mean?

Widening risk bandwidth, underperformance of premium assets, higher interest rates and inflation, generally leads to higher risk appetite to catch up on returns. I think this is exactly what is happening. Small, unknown and illiquid stocks are pushed. The warnings signs are everywhere. Please be careful.

It reminds me of a story told by an elderly friend. When people go to the stock brokerages after they have finished their shopping at the wet markets, it may be time for the smart investors to go home and take a rest.

The Edge Malaysia this week has a more insightful analysis of the above and other recent trends, including on whether Malaysia’s credit rating is already effectively discounted. What is the bond market trying to tell us?

Saturday 15 February 2014

Let’s have GOOD disagreements

Honest people will always have disagreements, as we hold differing views, opinions and interests. How we resolve our disagreements reflects our individual maturity and values as well as those of the society in general.

I first heard of the terminology GOOD and BAD disagreements used by the Archbishop of Canterbury. How appropriate it is for Malaysians today to understand how we can disagree, but in a positive manner.

We have managed to politicise and polarize everything, from education to economics and issues of race and religion. We do so to seek popularity, to shield our ignorance or to further our own vested interests.

Literally, anything that someone says or does that we disagree with, we issue threats or resort to name-calling, labelling and bullying. We use intimidation (by abusing the system or through lies and slander) to silence what we do not want to hear. This is BAD disagreement.

A GOOD disagreement allows room for differing voices to be heard. Where debates are won on the basis of facts, discoveries and articulation of ideas and opinions. It allows for the possibility that there is no one answer, no one truth, where accommodating differing views and needs may be necessary.

I like to use the example of the revocation of FZ daily permit as an example. Clearly, I have a disagreement with the Government. I believe FZ should be granted the printing permit while the Government obviously now thinks otherwise, after first agreeing to issue it.

A BAD disagreement would be to allow our differences of views to be politicised. It also means to make accusations of intent without reasonable evidence or to resort to any form of intimidation.

One popular view expressed for the revocation is that FZ is anti-establishment and I am a friend of Datuk Seri Anwar Ibrahim and his family. This only serves to politicise the issue, and I do not believe this to be the reason.

I have known Datuk Seri Najib Razak and his family, as well as Datuk Seri Zahid Hamidi, the Home Minister, for as long as I have known Anwar.  For those who see everything through a political lens, let me add to your confusion. The printing permits for The Edge and The Edge Financial Daily were granted some 20 years ago when Tun Dr Mahathir Mohamad was the Prime Minister and Home Minister.

Another popular view is that the revocation shows that the Government is rolling back on the press freedom it had promised. Again, I would be totally surprised if this is indeed the case. It only serves to cast everyone into “my camp or your camp”.

The days when the print media industry is the aggregator and distributor of news are long gone. We have moved from scarcity of information to an overload. Reading habits have changed. The only place where news is still contained is in North Korea. Even there, the walls are porous.

Indeed, the contents of FZ are already available online, for free. And its articles are often printed in the pages of The Edge Financial daily.

More importantly, issuance of a print publishing permit and press freedom and a fair and politically neutral media are really quite separate issues in Malaysia. How many of our newspapers, operating with permits, are really free and fair?

I prefer to pursue this disagreement we have with the Home Ministry in a GOOD way and not allow it to be politicised.

Firstly, we must respect the law and the processes. The next step is to go to court for a judicial review of the decision made by the Home Ministry. We have succeeded in obtaining leave from the court to do so before the recent revocation. Our appeal will go through the judicial process.

In court, both the Government and The Edge will be able to present our respective case, respecting the court to make a fair decision.

This is not the first time that I have taken a body of the Government to court. In 1995, I did the same when Phileo Allied took the then Kuala Lumpur Stock Exchange to court after it tried to stop us from implementing PALDIRECT, an innovative platform for online stock trading and banking.  I believe the various vested interests wanted to block us because we were the first to have online financial transactions and have been a threat to them.  

Today, every bank and stock brokerage in Malaysia or Singapore is using a similar system.

Secondly, we will pursue this rationally by articulating to the government and the public our reasons, our vision, our values and why FZ Daily can further the interests of the public at large.

Our vision is to enrich lives, through communicating insights and analysis. We want to contribute to nation building in the process.

Central to this is the need to reject corporate kings and instead, to embrace fair and free competition with greater social and economic inclusion. This will benefit the country through greater efficiency, innovation and producing superior products and services.

Only then will the best minds stay in the country. Only then can we attract knowledge-based companies. Only then will productivity improve.

The solution to achieve a stronger, healthier and fairer economy, with higher wages, greater employment, rising stock market and ringgit, rest squarely on whether we are prepared to have an inclusive economy. This is the economic transformation we desperately need. This is what The Edge stands for.

Whether we get the printing permit for FZ daily is really secondary. Whether, as a businessman, I am able to operate in Malaysia is inconsequential.  The world operates on fairly free capital and human mobility and there are endless opportunities.

I will practise GOOD disagreements. I invite others to join me.