'Recession-proof' stocks soar but doubts persist

What makes a stock "recession proof"? It depends on who you ask. Some analysts might say consumer staples, telcos and transport companies qualify because food, communication and daily travel will always be needed no matter what the state of the economy is, others may say Reits because of their dividend yields.

Yet other analysts may point to gold-linked companies or healthcare firms, while there also are those who say no sector can be considered completely recession-proof.

Notwithstanding the differing views and despite the weak economy, the market has been rewarding some "recession proof" counters this year - the question being for how much longer.

Among food stocks, supermarket operator Sheng Siong stands out - for the week ended Aug 26, it recorded the biggest jump in volume among actively traded stocks with seven million shares traded on average a day, compared to 2.4 million on average in the last three months.

The counter hit an all-time high of S$1.155 on Aug 24, before closing at S$1.045 last Friday, continuing a rally that gained strength once the firm released second-quarter results on July 26 that included double-digit profit growth. Bloomberg pegged its gross dividend yield at about 3.5 per cent and for the year to date, it has risen a handsome 24.4 per cent.

Similarly, consumer staples giant Dairy Farm International, which operates 7-Eleven convenience stores, Guardian and Mannings health stores, and supermarkets like Cold Storage and Giant, has rallied this month to its highest levels in a year. With a dividend yield of 2.7 per cent, its gain is 22 per cent so far in 2016.

Analysts view "recession proof'' stocks as defensive companies like consumer staples firms and telcos whose earnings do not fluctuate with business cycles. However, as valuations climb, gains may be curbed. "At one time (instant beverage sachet maker) Super Group was like S$3, S$4 (pre-split), over 20 times (price-to-earnings) and people were trumpeting that it's a defensive stock, a consumer staple," said Terence Wong, CEO of Azure Capital.

"Then when things happen, because it has risen so much over the years, it has room to fall," he said.

Super Group then faced higher materials costs along with regional political, economic and currency volatility. The stock has dropped more than half from its 2013 high.

Sheng Siong, in the meantime, may be a recession-proof stock as people buy more house brands when times are bad, Mr Wong said. But its valuation might have run too far ahead, he said.

"I don't know if something is happening, but no matter how defensive (Sheng Siong) is, does it deserve a valuation far richer than the market? I'd say not."

After Sheng Siong reported its second-quarter earnings, Maybank Kim Eng (MKE) issued a report which said even at 20 times earnings, Sheng Siong was not expensive given its yield of more than 4 per cent and superior returns, the broker said.

Its target price then was S$1.13, equivalent to 22 times 2017 expected earnings. "As the economy weakens, we expect it to benefit from consumers trading down. Benign competition also means it should be able to pass on food inflation ... with no impact on margins," it said.

The "sell'' side like MKE may take a positive view, but the "buy" sees things slightly differently. Lai Yeu Huan, senior portfolio manager at fund managers Nikko AM, said as some stocks push into the 20s in terms of earnings ratios, he has been selling even as he still maintains an "overweight" position relative to benchmarks. Stocks he sold include an airport services firm and supermarkets, he said.

Analysts differ on what makes a recession-proof stock. They agree that these are counters that will perform in a low-growth environment or have stable earnings through an economic dip, though they disagree over what these companies are.

Credit Suisse Private Banking head of Southeast Asia research, Kum Soek Ching, said stocks like ComfortDelgro, Sheng Siong, Jumbo Group, Raffles Medical and Q&M are close to being "recession-proof".

Azure's Mr Wong however, only considers telcos like Singtel, StarHub and M1 to be resilient, on top of consumer staples like Sheng Siong.

He does not think all food and beverage stocks should be considered consumer staples.

"In a recession, people eat out less. Rents can also remain high for a while," he said. Real estate investment trusts (Reits), another favourite, will also be affected in a prolonged downturn. Their underlying assets are property, which will be affected in a slowdown, he added.

However, Nikko AM's Mr Lai said that even with a recent rally, Reit valuations are "more fair" compared to early 2013 when they were expensive prior to being hit by worries that the US Federal Reserve would start tapering its monetary stimulus while raising interest rates.

This time, rate hike worries have affected only the short end of the interest rate curve, and not the longer end like the 10-year Singapore government bond yield which he uses to value Reits.

Mr Lai prefers to invest in themes that will thrive in a slow growth scenario, or which are geared to the new Singapore economy. Examples include a logistics player with e-commerce exposure and a contract manufacturer involved in the life sciences. Stocks that facilitate trade and financial flows, and conglomerates that are restructuring also feature in his picks.

RHB Investment Bank's head of Singapore research, Ong Kian Lin, said he prefers sectors broadly classified into "health, wealth and happiness". These stocks could be medical or dental companies ("health"), dividend-paying companies ("wealth") with robust operating cash flows, and entertainment and data-related companies ("happiness"), he said.

"We still find opportunities in some of the small-mid cap companies in terms of undervaluation, for example (specialist healthcare provider) Singapore Medical Group and (clean-room operator) Acromec," he said. Larger stocks, however, look increasingly fairly valued or overvalued, Mr Ong said.

Other analysts prefer not to think of companies in terms of whether they are "recession-proof". NRA Capital research head Liu Jinshu, for one, eschews the label.

"In times of tight credit conditions, investors may be forced to liquidate their portfolios and cause the share prices of so-called defensive or recession-proof counters to drop," he said.

"The search for recession-proof or defensive counters may push their share prices excessively high and reduce the upside that investors can make."

Similarly, Herald van der Linde, HSBC's head of Asia-Pacific equity strategy, said that no stocks are completely recession-proof.

"Even if they are somehow insulated from a recession in their home market - for example, they export all products to other countries - they might still see an impact on their operations. In a recession, wages might decline, interest rates could fall or the exchange rate could move. So there are often 'second derivative' impacts on stocks," he said.

NRA's Mr Liu argued that if there is indeed a counter-recession stock in Singapore, it would be gold miner CNMC Goldmine.

Recessions would lead to lower oil prices, which the miner will benefit from. Meanwhile, given constant or higher gold prices, CNMC's earnings might actually go up in a recession, he said.

However, Azure's Mr Wong points out that even if gold prices appreciate, gold miners face operational risks that might affect earnings.

Apart from goldmines, pawnshops present a useful alternative as possibly being "recession-proof".

For example, when pawnbroker Maxi-Cash became the first of its kind to go public in 2012, it argued that people will borrow money and exchange their jewellery and watches for cash in good times and bad. Maxi-Cash's listing was followed by MoneyMax and ValueMax.

However, all three have not done well, with stock prices hovering at around half of their initial public offering (IPO) prices, probably as they had listed at high earnings multiples at a time when their business was booming due to buoyant gold prices in 2012-13.

These pawnshops make their money from charging interest on loans secured by pawned items. As a result, the pawnbroking business is inextricably linked to the price of gold, which might rise in a recession if money-printing measures lead to a destruction of paper currency value.

As pawnbrokers pursue expansion plans amid gold price volatility, earnings have been similarly volatile - not a quality one would associate with a defensive stock. Net profit at MoneyMax, for example, fell from S$5.8 million in 2012 to S$771,000 in 2014 before recovering to S$3.1 million in 2015.

NRA's Mr Liu thinks listed pawnbrokers in Singapore "are generally trading at undemanding multiples of 10 to 12 times earnings, suggesting potential scope for rerating in a recession".

Ultimately, traditional defensive stocks which pay decent dividends remain the favourites of many brokers.

Said DBS Group Research in an Aug 29 strategy report: "Our yield picks are ARA Asset Management, Sheng Siong, ST Engineering and ComfortDelGro."

Real estate fund manager ARA is expected to grow assets under management, DBS said. Sheng Siong is improving operating efficiency and pays most of its earnings as dividends. ST Engineering has a "healthy balance sheet and secure dividend payouts".

Transport play ComfortDelGro will benefit from lower fuel prices and capital expenditures with the new bus contracting model, resulting in potentially higher dividend payouts, DBS said.

But on the question of what is a fair multiple to pay for "recession-proof" stocks, analysts said it depends on fundamentals as well as comparisons to peers, history, and other markets.

Credit Suisse's Ms Kum said it depends on comparisons, as well as a company's return on invested capital and its growth prospects. "There is hardly any undervaluation in this space in Singapore now," she said.

HSBC's Mr van der Linde said one has to look at returns on equity that companies can generate even in a recession, and how valuations moved in previous recessions.

As for Sheng Siong, some point out that premium valuations are justified as quality companies like it that can grow in a slowdown are hard to find.

Nikko AM's Mr Lai said that around the region, multiples can be even higher. Convenience stores or supermarkets in Indonesia can trade at over 30 times earnings, and in the Philippines, even 60 to 70 times.

"We tend to try to give these stocks a bit more room to perform," he said.

RHB's Mr Ong said the broker still has a "buy" rating for Sheng Siong.

"Valuation multiples have been increasing post-quantitative easing, with too much cash chasing too little investment ideas," he said.

"Some healthcare companies, for example, are even trading at 40-50 times earnings this period. In terms of fairness, it also depends arguably on your investment horizon."

This article was first published on September 05, 2016.
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