CLSA: Red flags in Asia

CLSA issued the following report to its customers:

Some snippets:


One of the long-term themes that we have discussed at length is the strength of Asian balance sheets and how this manifests into a growing dividend culture among corporates with substantial cash hoards. While these companies steal the limelight, there are also a growing number that stay under the radar while trying to succeed through unconventional means. Sadly, this is further fuelled by a new breed of analysts whose imagination doesn’t stretch beyond quarterly forecasts and analysis that mirrors company guidance. Over the past decade, cases of accounting manipulation have multiplied, and this year, the proportion of value destroyers in Asia has also reached an all-time high of 38%. In the current low-return environment, avoiding such accounting blow-ups overwhelms all other considerations. With capital preservation becoming the focus, we create our earnings-quality and balance-sheet-quality risk scores, using ideas from the CLSA U Blue Book on forensic accounting, titled Financial fingerprints.
 
This report highlights two sets of scores including the earnings-quality risk score (EQRS) and balance-sheet-quality risk score (BQRS), which use 10 financial indicators each to identify issues related to earnings and balancesheet quality. Our backtests show that companies with high EQRS scores have underperformed by 7% per annum since 2000, while those with high BQRS have underperformed by 18% per annum.
 
Ownership issues add to the complexity as Asia is marred by an unusually high insider-holding ratio (53% on average), which could lead to numerous instances of related-party transactions as majority shareholders retain strong management control. High government ownership is also common, and while such companies are less likely to enter bankruptcy, they are dominated by value destroyers.

 

Companies flagged under the EQRS score are:

• Olam (SG), "Consistently negative FCF with high debt"
• Gamuda (MY), "Companies with rising inventory days"
• Yanlord (SG)
• Yinson (MY)

AirAsia (MY) was flagged under the BQRS score.

Separately, companies flagged under a single criteria where:

• Noble Group (SG), "Companies with diverging profit and cashflow"
• Petronas Chemicals, "Capex indiscipline"
• Sembcorp Ind (SG), "Dividends funded through debt"
• Maxis (MY), "High and rising leverage"
• Malaysia Airports (MY), "Value destroyers with high government ownership"
• Golden Agri (SG), "Value destroyers with high insider holding, low independence"
• SapuraKen (MY), "Key management changes over last one year"

Needless to say, a single indicator might not mean that much, the company has to be analysed in its totality. Also, the above companies are from the universe that CLSA tracks, in general the larger listed companies in Asia. The fact that a company is not mentioned doesn't mean anything, CLSA might not track it.

ACGA: CG in Malaysia improving

I have written before about the highly regarded country reports by ACGA-CLSA:

• "Asean: Virtue and Vice"
• "Malaysia’s perennial problem: enforcement".

The new report "CG Watch 2014" has been published, I have not yet read the full report, but this is what MSWG wrote about it in their weekly newsletter:


Malaysia is on the 4th position out of 10 in the ACGA-CLSA CG Watch 2014.  The Report mentioned that Malaysia was the only country that had consistently edged up in the score from 49% in 2007 to 58% in 2014. The improvements were largely through a mix of government-driven reforms in the corporate sector such as the implementation of CG Blueprint 2011, a state-grandfathered push to require domestic institutional investors to take up CG seriously through the Malaysia Code of Institutional Investors and the creation of one of the region’s better independent Audit Oversight Board (AOB). The Report also recognised the emergence of some aspect of culture emanating through the development of the Institutional Investors Code, and elements of voluntary poll voting with improved communications by PLCs.

The Report highlighted that the Asian region as a whole often gets caught up in politics making legislative changes tough and thus would depend upon strong government support which normally is not forthcoming.  Securities commissions are beginning to take enforcement seriously, but the disclosure of these efforts can be improved.  The Report also highlighted the conflicts of interest in the role of stock exchanges. Shareholder rights in the different markets were said to be weak, especially relating to takeover and major or related-party transactions.

The CG Watch 2014 reported that our country began promoting corporate social responsibility (CSR) well ahead of many other Asian markets, however, the implementation stopped at the aspect of CG financial reporting.

The Report had suggested that PLCs in Malaysia should disclose more details in the AGM agendas and should provide commentary on services covered by non- audit fees.

Lastly, the Report also highlighted several sure ways to be downgraded in the next rating. One; is the continuation of voting by show of hand at AGMs/EGMs and two; if the implementation of the Malaysian Code of Institutional Investors is weak.


While I do agree that in general CG seems to have improved over the last years, there is still the lingering fear that "corporate governance [is] lacking substance".

The real test would be the next recession, "Only when the tide goes out do you discover who's been swimming naked" (a quote from Warren Buffett).

In the meantime, I am looking forward to the detailed report regarding Malaysia and Singapore.

Glaucus targets Prince Frog

Glaucus Research (about which we have written before, in the case of  Singapore listed China Minzhong) this time has targeted "Prince Frog International Holdings Ltd" (1259.HK), a Hong Kong listed, China based producer of child care products.

Their report can be found here.

Main issue: Glaucus claims that Prince Frog's revenue is hugely overstated. It does give quite a bit of information to support its claim.

After releasing the report, the share price dropped quickly, about 25%.

HKEX has halted trading in the company, pending a clarification by the company.

The allegations are not new, a blogger has written before about the issue that revenue might be overstated.

However, I have received a research report by CLSA (dated August 24, 2013) which refers to an "in-depth" study done through more than 200 interviews with Chinese parents and found that Prince Frog is the 2nd best known brand behind Johnson & Johnson. This result is very different from the numbers presented by Glaucus.

The question is, was this study by CLSA done in a proper way, 200 is not that high number, and of the group of interviewed people was not chosen random, then the results might be biased.

Prince Frog did a conference call today, to clarify the items raised. However, quite a few answers were rather "evasive" (in my opinion). Two examples:

• Q: Given that the company has the frog cartoon, shouldn’t consumers throughout the country all know of the brand?
• A: The brand survey was based on 15-50 year olds. Children recognize the brand; but parents don’t necessarily. The survey methodology from Nielson was limited to 13,500 people across 30 cities.
• My opinion: 13,500 people is a lot; the answer on parents not knowing the brand is rather strange.

• Q: Clarification on insider Xie’s sell down in the stock?
• A: At the beginning of 2012, Mr Xie sold shares to the market to increase the free float to improve liquidity due to investor demand.
• My opinion: well, that is an "interesting" way to bring it. If a company books stellar results and the free float is limited, then the share price can only go one direction, up. Insiders selling while the company claims to book excellent results will always turn investors jittery.

I guess we have to wait for an official announcement by the company, where they can give a detailed explanation of the situation.

YTL, why the hurry?

From the website of MSWG:

"MSWG completed the attendance of a few AGMs this week. Amongst them were AGMs for YTL Group of companies comprising meetings for YTL Land, YTL Power, YTL Corp and YTL E- Solution. The observations we noted was the speed with which the meetings were carried. It seems rushed how four (4) meetings were conducted on the same day, with very little breathing space both for shareholders and directors. The average interval between the commencement of each meeting was only an hour and seemingly there was an hour constraint imposed for all the businesses to be carried out at each AGM. The tendency is for shareholders to ask very few questions and the response could possibly be a hurried one which may be unsatisfactory. To us it was undoubtedly a whirlwind affair and rather compressed meetings.

Wouldn’t it have been better if the same meetings were spread out over an interval maybe a day each between each AGMs? It would give those attending more time to digest the details provided by the company with greater depth. The Board too would benefit as it would have more time to take questions thoughtfully. AGMs are only held once a year where shareholders get to see their directors and ask the pertinent questions. We do hope that the Board of YTL would consider such suggestion."


All were held on November 27th:

• YTL Land at 11AM
• YTL E-Solutions at 12PM
• YTL Power at 2PM
• YTL Corp at 3PM

AGMs' are only held once a year, why not give the minority shareholders a good presentation what is going on, and ample time to come with questions?

On November 26th, 3.30pm the AGM of YTL Cement was held. But since this company is delisted, I haven't read any information about it, they are not making announcements to Bursa Malaysia anymore.

This is not the first time that the YTL Group seems to have some CG issues. I don't think that the delisting of YTL Cement deserves a medal for good CG.


From CLSA "CG Watch 2012", "Companies that have seen CG deterioration":

Larger-cap companies with an institutional following that have seen CG declines include YTL Power, Genting Malaysia and Genting Berhad.
 
For many years, YTL Power had focused on regulated industries, ie, power generation and water. It has a global presence in regulated industries stretching from the UK to Australia. However it recently ventured into telecommunications, where it has no prior industry knowledge. Competition in this market is stiff and this venture has incurred large startup losses. Our scoring marks negatively for a  company that diversifies into different businesses.
 
The key concern on Genting Malaysia has been related-party transactions. In November 2008, it purchased a 10% stake in Walker Digital for US$69m from the family that controls the Genting group. In July 2010, Genting Malaysia paid Genting Singapore RM1.7bn for Genting UK. Generating positive Ebitda for Genting UK has been an uphill battle, especially with the difficult macro environment in the UK currently. There is also an issue about independence with a chairman who is also CEO, and holding the same two positions at the listed parent. Genting Berhad, meanwhile, has one of the highest ratios of director remuneration to net profit for companies in our Malaysian coverage universe at 4%, which is a drag on its score.

"Asean: Virtue and Vice"

From CLSA's highly influential CG Watch 2012, the executive summary for Singapore, Malaysia, Thailand, Indonesia and the Philippines is given on pages 11 & 12:

Singapore has the highest CG score of markets we cover ex-Australia
Asean spans markets that in our rankings are the highest as well as those that come at the bottom of CLSA and ACGA’s rankings. Singapore has, on average, the highest score for governance among its corporates. As this report goes to print, there is a battle for corporate control for Asia Pacific Breweries (APB), which owns leading beer brands in the region (Tiger, Anchor, Bintang, etc). The conglomerate F&N looks set to dispose its majority stake in APB to Heineken, with which it has had a partnership arrangement that was disturbed when Thai Beverages made a bid for both a stake in FNN and control of APB. The likely outcome is that F&N disposes of its stake in APB at a premium and might disentangle its current structure that puts brewing and softdrinks together with a large property division. That a battle for corporate control in one of the largest conglomerates is leading to realisation of shareholder value with commercial logic prevailing is a rarity in the region.

But S-chips are an embarrassment
However, Singapore’s embarrassment is the so-called S-chips, mainland companies that have listed in its market. CG standards are shoddy, a number of firms have flouted the listing rules and directors have absconded to China when the exchange pursues them. The case for Chinese companies listing in Singapore has never been clear and investors in these stocks certainly need to weigh seriously the risks. This segment of the market, however, is likely to diminish in significance over time.

Sime Darby takes a hit again
Across the causeway, the largest of Malaysian conglomerates once again disappointed the market. In the Asian crisis, Sime Darby nearly blew up for its poorly managed foray into banking and stockbroking. Over the recent crisis, its balance sheet is much stronger and loses less significant but it took a hit again, this time for cost overruns at Bakun as well as the Middle East power projects, a business where it has little expertise.

Unfavourable optics in Sime’s E&O takeover
An independent director at Sime Darby has recently been charged with insider trading. More embarrassing for the governance perception for the market was Sime’s acquisition of a controlling stake in the property company, E&O. This had been preceded by the chairman of E&O buying shares in the company, before Sime Darby announced it was taking over control at a 60% premium. On the basis that the acquisition of the stake was a private transaction between Sime and the previous significant shareholders (which did not include the chairman), and that the matter had not been discussed by the board of E&O, no charges of insider trading was brought to bear. But unfortunately for the optics of the matter, the E&O chairman was the husband of the then chairperson of the Securities Commission (SC). She has since stepped down when her contract was not renewed earlier this year.

Successful enforcement required to improve perceptions
The now retired SC chairman had been brought to the commission fairly recently in 2006 from outside the agency. The current chairman has been promoted from within and has been a regulator for over 20 years (neither does he have the disadvantage of having a spouse who is a corporate figure). CG issues are nevertheless likely to continue to crop up but the efforts of the SC to take to task directors for insider trading is a positive. The country, though, needs a period without governance accidents at its larger companies and successful enforcement against transgressors to improve the perception of investors on the market.

Little impact from new government in Thailand
Thailand has a new government in place now for slightly more than a year. This has not had much of an impact on the governance outlook for corporates. Related-party transactions remain an issue with certain groups, cropping up again with CP Foods. But as companies get larger we notice improvement in transparency. The stock exchange continues to push for high standards, for instance on voting by poll, which is not mandatory but most companies have been persuaded to adopt this for extraordinary and annual general meetings, a practice that is still relatively uncommon in the region.

Regulatory issues in Indonesia
Indonesian firms have had to deal with regulatory uncertainty with regard to ownership limits on the banks and export restrictions on the mining sector. These impact their ability to maximise shareholder value, which is one of the issues in our CG scoring. Indonesian companies are also the slowest to release full-year results; given the 90-day deadline for releasing full-year numbers, none report within two months which is becoming the norm elsewhere.

Shadow play in the London market
Over in the London market, a shadow play for control of a FTSE constituent that had recently been created to take an interest in an Indonesian mining asset was illuminating. It reveals firstly there is still risk of change in shareholding structure for groups where major shareholders are highly geared. Yet, influential groups will often be able to retain effective control. Other shareholders and investors should expect to go along with the intentions of the effective controlling shareholder.

No real CG change yet in the Philippines
In the Philippines, President Aquino has been in power since 2010 and sets a positive backdrop for clean governance nationally. At the corporate level, however, there is little evidence of much change as yet. Companies continue to issue new equity when the purposes are unclear, eg, Ayala Corp, or
sometimes surprising the market with the size, eg, Banco de Oro. Inter-group transaction of assets within the First Philippine Holdings listed companies raised questions over pricing.

CG in Malaysia: enforcement and culture are still the main problem areas

CLSA has published its highly influential corporate governance survey 2012 that examined 11 markets and more than 800 listed companies across Asia.

A posting about the previous 2010 survey can be found here.

I could not yet locate the report (which often has a lot of interesting detail), but the main findings can be found in the below table from this source:

It should be noted that the scores are relative, and that Singapore and Hong Kong (globally considered to be Grade B) score tops in Asia, but that better CG is to be found in certain Western countries (Grade A), although nowhere it will be really ideal. Thailand, Japan, Malaysia, Taiwan, India and Korea are considered to be in Grade C.

Total score for Malaysia improved, from 52 to 55.

CG Rules & Practices improved from 49 to 52.

Enforcement improved from 38 to 39.

Political & Regulatory improved from 60 to 63.

Accounting standards remained the same, on 80.

CG Culture improved from 32 to 36.

Malaysia has done a lot of work on CG, organising seminars, publishing booklets and its CG blueprint, hence the improvement in the CG Culture.

However, if not accompanied by a clear increase in enforcement (which is still so much lacking), the effects will only be limited, in my opinion.

My main grouses:

• much more enforcement is needed on rampant insider trading and market manipulation
• handling of complaints by minority investors should be hugely improved
• the standard of independent reports should be higher, independent advisors who write biased reports should be adequately punished
• minority investors should be better protected in delisting exercises and related party transactions
• companies that are delisted should not be allowed to be relisted again, at least not within a certain time frame (say 5 or 10 years); if they relist, they should be transparent about the reasons for the delisting, the change in valuation, etc.
• companies that post very disappointing results immediately after they are listed should be investigated, together with their bankers, advisors etc;

CLSA: Corporate Governance Watch 2010

CLSA regularly publishes a report about Corporate Governance standards in Asia. Their latest report was published in 2010, it is a very interesting read:

https://www.clsa.com/pdf.cfm?link=/assets/files/reports/CLSA-CG-Watch-2010.pdf

The chapter about Malaysia starts at page 87. Some snippets:

"Malaysia retained its sixth spot in our rankings this year, but with a higher overall score of 52% compared to 49% in 2007. Regulators have been making steady progress in the past three years and appear more open to listening to the market. Yet doubts remain. A major issue we have is how much of this is window dressing and how much is genuine change? Will this take corporate-governance practices beyond box-ticking? These uncertainties for CG culture are why Malaysia’s CG culture score recorded a one-percentage drop this year, where as all other categories saw improvement.  

An area that has improved is enforcement. The Securities Commission (SC), in particular, has been active. The score for the section increased from 35% in 2007 to 38% this year. Yet, we find that securities laws have not proved to be a meaningful deterrent against insider trading and market manipulation, as enforcement statistics show.

The two categories that showed a marked improvement this year were CG rules and practices, and political and regulatory environment, which increased by five percentage points and four percentage points respectively.

IGAAP (accounting and auditing) recorded a modest two-percentage-point increase.  

In most markets, it is government efforts that lead corporate-governance reforms, but nowhere is this more obvious than in Malaysia. Looking at our table comparing the scores for political and regulatory environment with CG culture for all 11 markets, the 28% gap for Malaysia is easily the widest. It is this weakness in local CG culture that is holding the market back.

The SC brought three market-manipulation cases to court in the past three years - one in 2008; one in 2009; and one in 2010. The case in 2010 dated back to 2005 and the sentence imposed is being appealed by the SC, as is the acquittal of the defendants in another case in 2009. We find it hard to believe that insider trading and market manipulation happens so rarely in Malaysia, unlike the rest of Asia."  

Singapore and Hong Kong have the highest CG score, however, globally disappointing, for CG they only score tier 2 while they definitely should be in Tier 1 given their high GDP per capita. Malaysia is in Tier 3, together with countries like Japan, Taiwan, Thailand, India, China and Korea.

I agree that enforcement has indeed increased in Malaysia:

• Bursa Malaysia however is still shooting with a water pistol, giving small fines where much bigger deterrents are required. And then there is the market-manipulation and insider trading which is not dealt with.
• The Securities Commission is more active and has increased its fire power: some managers of listed companies have been jailed, the only sentence that would-be perpetrators will fear. It is now time to unleash the big guns and to go after the Major Players who went scot free so far.