Labels

Tuesday, 9 July 2019

PENTAMASTER IS HEADING FOR THE SKIES : BURSA MALAYSIA STOCK ANALYSIS

We, for one, look forward to the robotic, automated apocalypse

We are short term traders, but usually we are willing to bend over to the buy-and-holds of this world. In the background, away from the flashy trades and easy money (not really), we are still first and foremost students of fundamental analysis. Stocks that go up and stay up are backed by good fundamentals; there is no denying this, ever.

Other stocks with more hype than substance will go parabolic: that is, they will go from 50 sen to RM1 before returning to 50 sen. Hype is sentiment, so of course the stock goes up. Yet sentiment is finite; once it is exhausted, the stock price will simply normalise as punters dump their positions. 

But substance AND hype? That's a powerful combo... it's a theme we will delve into with Pentamaster Corp Bhd, our favorite long term pick. Let's say for at least six months and beyond. 

We will make an investment and trading case for Pentamaster as something you can hold for a while. Our thesis is this: the fundamental prospects are intact, as shown by earnings growth. But the stock has transformed itself to turn this into an even more appealing investment opportunity.
 
THE BACKGROUND

We have been lustily gazing at Pentamaster since our voices broke. This goes back at least two years, when the company demonstrated its capabilities to grow its revenue exponentially. By now, it has all the plaudits : it's already among Forbes' top performing companies in Asia.

Two years ago, the stock is about half the price it is trading at now.

 Weekly chart for PENTA, July 2017 to July 2019

 
Back then, due to its steep price (prior to the price adjustment, Pentamaster was trading at near to the RM4 mark, on very low volume) and lack of liquidity, there was simply no way to hold a meaningful position. What we mean by that is; there is no way to optimise returns relative the the amount of capital we have. We would have preferred the stock to have an associated call warrant or three, enabling us to put on a large enough position and realistically target four-to-five figure profits. 

Fast forward to July 2019 and suddenly : PENTA now has call warrants.

 More details on their technical characteristics here.

Fun fact: call warrants are typically issued by investment banks based on several factors: price stability, positive historical performance, and a few others. But the key consideration is market capitalisation : the company needs to have a market cap of at least RM1 billion and above for a certain amount of time for it to be considered warrant-worthy. This criterion reflects the stability of the stock, interest in the stock, and its not-so-bad historical volatility (it doesn't go parabolic, so to speak). In other words, nobody issues call warrants to shitty companies (Editor's Note : this is up for debate).

Being the weirdos that we are, we have always tracked these things. The 'graduation' of a small cap company into a RM1 billion market cap stock indicates many, many positive things. Longevity. Real earnings growth. Long term upside trajectory (for earnings and stock price). Resilience against negative market conditions. Management acumen. Growing cash flows and ideally low borrowings. PENTA has all this and more. 


THE INSTITUTIONAL FACTOR

We know that PENTA is a great small-to-mid cap stock. But this is what will really drive the stock to the heavens: its investability.

Let's go back to the price adjustment: the company undertook a one-for-two bonus issue in a bid to improve liquidity and 'reward shareholders with more shares while not incurring dilution' (commonspeak : we make the stock cheaper so you can buy more of it). Given its status as a small cap champion, it's natural for institutional investors to look into it. By this we mean the PNBs, EPFs, KWAPs, mutual funds, and hedge funds of this world.

Note the fragmented nature of shareholdings by funds according to PENTA's latest annual report. Previously funds can barely get a position going. Aside from the guy who owns the company and three funds, everybody else in the top 30 hold less than a 2% stake.


Institutions can't really come in before in huge numbers because the stock is simply too illiquid. It was very hard to accumulate a position worth RM50 million, for example. No avenue is available to buy that many shares in the open market; a private transaction would be also a risk, precisely because of the lack of liquidity in the stock.

In other words, institutions prefer a good stock that is easy to buy and sell. Yields are narrowing in the blue chips segment; for those with the right mandate (or the freedom to buy whatever the hell they want), they should also be lustily gazing towards a strong growth counter like PENTA.

 From the annual report.

And growth is all the upside potential: PENTA does not pay dividends, and will likely not do so until Najib becomes PM again. This is understandable: the company is conserving cash for an expansion, a noble goal that in itself is an appealing prospect for the long term investor. 

In fact, the company is so fiscally responsible that they are fully in a net cash position. Profits are fully reinvested.

Think about it this way: the major shareholder, who runs the company, believes in his company so much that he does not take the easy approach of declaring fat dividends as a cash reward to himself and shareholders. This is Marvel Cinematic Universe levels of heroism here.


 *not an actual photo of PENTA's management. Source.
The message is clear: Pentamaster is a capital appreciation play, and if you're in, you're in it for the stock to potentially gain 30%, 50% or 100%  in value. No BS,  and no get-rich-quick crowds are welcome.

The timing to consider the new call warrants is impeccable, as evidenced by the following developments:


2) PENTA-CA and PENTA-CB becomes available to trade from 28 June 2019.

3) On 2 July 2019, Pentamaster stock hits RM3, and a new all time high.

4) It looks as if it's revving up for a rally (but really, don't just take our word for it. As of 8 July, it's still trading at an all time high of RM3.14 (Editor's Note : this post came out on 9 July. Any guesses to where the stock is now?).


THE STANDBY TRADE : A SIMPLE APPROACH

All these boil down to a simple trading thesis. Our parameters are so simplistic that even a monkey can understand it.

We feel this trade is better represented with the call warrants. 

1) Pick a range to trade. Avoid exposure to the volatility. Mitigate downside risk and optimise the position to profit greatly on the upside.

Let's say the call warrant is trading below 20 sen. When the warrant hits 20 sen, you already have created a profit buffer. For example, a purchase at 18.5 sen per warrant means you already have a 5% yield and a 1.5 sen per warrant profit once it hits 20 sen (Editor's Note : given that the warrant values have gone up, this is still applicable at above the 20 sen mark, provided you have set aside a reasonable profit buffer).

The expectation is for the warrant to never hit below 20 sen again. This means you can sit and relax. If you're a market timer, let's say the next important date to look out for is Pentamaster's next quarterly earnings announcement - that's about a month and a half away, and it's expected to be good. 

2) Downside mitigation. 

Pick a price you'd be willing to accept losses. If a trade is done at 18.5 sen, we'd be willing to exit at 17-17.5 sen. The maximum downside is 8%, but given that you're trading leveraged call warrants, let's just say your loss potential can be multiples of that.

You must accept potential losses before committing to an exit point.

Similarly, you decision to exit should also be based on the mother share's current trajectory. Let's say that another dumb Donald Trump announcement causes tech stocks to crater. There is no doubt that stocks like Pentamaster or INARI will go down fast; they are the sector leaders after all. In your mind, set a loss threshold for the mother share itself. From its current price of RM3, let's say your forced exit point is RM2.85 (Editor's Note : indeed, we started writing this post when the stock was at the RM2.95-RM3 range. Since then, it's already up by 13%).

Without over-complicating things, you would exit your call warrant position (bought at 18.5 sen) if either the warrant hits 17 sen, or if the mother share drops to RM2.85, whichever comes first. Obviously the stock determines where the warrant goes; what really matters is you're picking your own exit point.

To put it another way : who the hell rides a bus without picking his/her stops? 

3) Exit when downside range is hit; re-enter when necessary.

The last step in the execution stage is simply that. Sell your holdings if the warrant falls below your downside range. But try to buy and accumulate the position when the warrant shows signs of recovering. As it is tracking the PENTA stock price closely, you can reasonably use the warrant as a gauge for the mother share. 


Hard to look at the charts with feeling aroused.
THE ILLIQUIDITY PRINCIPLE 

Despite all this talk about improving liquidity, we'd like to highlight one thing: the stock still isn't all that liquid. This is both good and bad; let's focus on the good part first.

We have stated before that the key to riches is to focus on illiquid mid-to-large cap counters with a solid growth story, strong earnings growth to reflect said growth story, and (crucially) some tradeable cheap call warrants.

Illiquidity means the stock can easily go up by 20 sen in a day if there's a good catalyst. Your downside is protected by the company's continuing growth story. As long as you have this, there will be reasonable support in the share price to a certain extent. 

We particularly love expensive stocks that are trading at RM3 or more, simply because there usually aren't that many shares available to trade. Any positive news and the reaction will be outsized

With the right call warrant trade, you're buying into a cheap position that is linked to an expensive stock. The stock is presumably expensive because it's got a strong earnings record. Your cheap call warrant position will become considerably less cheap the further the mother share goes up. And because of illiquidity, the mother share can go up fast.

The downside of illiquidity is simple: during bad times for the market or sector, the stock may see near zero trading interest. This means it's definitely not for the contra / t+2 punters of this world. Any commitment must be of the buy-and-hold variety.

BUY IN AND STAY INVESTED

We get it; many of you are probably the trigger happy types, eager to chase the next trending stock when the opportunity arises. 

However, from time to time you may be better served by switching your strategy. To do this you'll have to get rid of the trading mindset, but retain the profit mindset.

It's hard for us too; we target hot IPOs to trade all the time, sometimes ridiculously successfully. But the priority of profits take precedence over what we like or dislike. The desired outcome from any investment/trade idea should be profit maximisation, not how much fun you'd have trading things (if that's your real priority, go here).

EXIT THE MARKET AT YOUR OWN TERMS

Of course, the trade has many pitfalls But assuming marginally improving earnings over the next few quarters, your risks are mainly three types : losses arising from opportunity cost, external factors, and technicals.

Opportunity cost here is simply defined (by us) as potential opportunities/trades you could have gone into but didn't because of the need to hold a long term position.

This must be considered at your own discretion : if you think you can make RM30,000 in profits by trading in and out over the next 2 months, compared to making RM25,000 from a buy-and-hold call warrant position, go for it (Editor's Note : most of us will end up with a -RM15,000  loss if we actually do that).

External factors are simple : Trump. Trade war. Fed rates. Jittery global investors. Geopolitical shocks. Back to Trump. Repeat. Also include broader KLCI conditions and sector newsflow.

Technicals : a stock like PENTA is currently at all time highs. There's a good reason for that, but there may be equally good reasons for it to start going down. Our remedy for this is simple: there will always be enough time to exit at a small loss if the stock reverses its course and invalidates our entire thesis. We don't recommend doing the buy-and-hold approach and carrying it into negative equity: it's suicide.

NOW GO DO WHATEVER YOU WANT

This was never meant as an inducement, or enticement, to acquire PENTA call warrants, or PENTA stock. The principles described here can be applied to any similar situations where a good, pricey counter comes along with a good, cheap call warrant.

When you find those - and we have found many such opportunities - try to stick with them. It's worthwhile.




Popular Posts