Cost of living going up and up in Malaysia

THE cost of living has been escalating over the last 10 years, as reflected by the following indicators. On average, over the 10 years, domestic consumer prices have gone up by 2.5% per annum, while asset prices (eg residential properties) have gone up by 6.1% per annum.

This was largely due to cost push factors from rising global commodity prices over the period – rice up 47.4%; wheat 61.5%; crude palm oil 46.6%; crude oil 142.6%. 

The rising cost of living poses an immediate challenge to the domestic economy and it must be addressed appropriately.

Since September 2013, inflation has jumped 3.2%. The rise was largely due to cost-push pressures, after the Government emphasised subsidy rationalisation plans, with a first hike of 20 sen on petrol and diesel as well as abolition of subsidies on sugar. 

In early January this year, new power tariffs for residential users were introduced, while the Government decided to raise gas prices for non-power users beginning May 1 from an average of RM16.07/MMBtu to RM19.32/MMBtu. 

While the Government focuses on targeted subsidies with a gradual phasing-out of subsidies on petrol (RON95), the unpleasant reality is the general rise in overall inflation in recent months. 

The issue at stake is, how will our economy and Malaysian households cope with this rising inflation at large, and especially the cost of living? 

Fortunately, our macroeconomic performances seem to be on track thus far: firm unemployment rate at 3% and a robust growth of 6.2% in 1Q14, despite some noises from major economies like China, the United States and Europe. 

However, the resilience is only half-truth of the story. Clearly, inflation has eaten into household consumption. Close to 40% of Malaysian households have a combined monthly income of less than RM3,000. 

These households and the middle income bracket of just above the threshold have had their budgets squeezed. 

In this regard, incidents of bankruptcy have also risen in the past few years, from 13,238 in 2007 to 21,987 in 2013.

How to cope 

To alleviate the hardships of the low income bracket, the Government opted for a fiscal policy choice. Bantuan Rakyat 1Malaysia (BR1M) cash handouts is a targeted effort to assist those in the low income group. 

However, if cash handouts are made a permanent feature, the rakyat will start to expect and rely on this policy for their economic wellbeing. The endowment effect of BR1M will eventually be no different from the mentality of long-term dependency on subsidies for fuel and energy. 

For sustainable economic wellbeing, households should take proactive measures to safe guard themselves of economic hardships.

When the going gets tough, the tough starts saving. The virtue of saving for a rainy day is a relief to weather the inflationary storm. Therefore, to save is to first budget. 

A guide to efficient budget planning is the 50/30/20 thumb rule, coined by Harvard bankruptcy expert Elizabeth Warren and her daughter, Amelia Warren Tyagi in their book, All Your Money Worth: The Ultimate Lifetime Plan. 

According to the rule, one should spend 50% of net income on “needs” such as groceries, insurance, utilities, and housing; 30% on their “wants” or non-essential items, such as gadgets, cable TV, and coffee; and 20% on savings and retirement accounts. 

Maintaining a household balance sheet is the first step to responsible financial management and taking charge of your money. With discipline, maintaining monthly financial targets will be more transparent. 

Long-term budget requires setting apart savings for short-term, mid-term and long-term financial goals. Besides these goals, you should always factor in inflation too. 

To beat inflation and protect your savings, you should invest part of your savings in assets that have higher returns that the anticipated inflation rate. Currently, as inflation rises above interest rates, consumers should be concerned about the decreasing value of their money saved in banks. 

Perhaps, what is even more worrisome than your money losing value is to owe money – debt. Indebtedness among Malaysian household debts is currently one of the highest in the region. 

According to Bank Negara, household debts in Malaysia have risen at an average rate of 12% annually over the last five years. 

In fact, household borrowing last year has risen to 86.6% of the total value of the economy, compared with 81% in 2012. 

Unfortunately, financial literacy is still lacking in certain quarters and poor money management has led to over 20,000 Malaysians being declared bankrupt last year, a 12% increase from the previous year. 

Out of the over 20,000 Malaysians declared insolvent last year, 26.5% were due to defaults in car loans, followed by housing loans, personal loans and business loans. Notably, personal loans saw an annual increase of 21% from 2010 to 2013 and represents 16.8% of total household debts. 

Good debts, bad debts 

However, not all debts are bad apples. One needs to distinguish between good and bad debts. Taking up personal loans and unnecessary car loans are bad debts. Loans that are spent on unproductive matters will only shave off part of your monthly disposable income. It does not add value to your assets other than satisfying your cravings. 

Unmonitored credit card spending is a sure way to accumulate bad debts. During inflation, it might be tempting to stretch your budget by paying through credit. 

Further indebtedness will soon have its consequences.It is also crucial for one to fully settle credit card balances at the end of every month to avoid the 16% charge. 

On the other hand, taking up a housing loan when you are financially capable – and after doing sufficient research - can be a good move, as it is seen as a good debt. After all, the value of properties tends to only appreciates over time. However, you must assess your cash flow to ensure that you are able to service the monthly repayments to avoid a loan default. 

These are only some tips to help battle inflation and cope with rising costs. Inflation is a time for adjustment. 

A gradual long-term economic equilibrium to higher prices will serve well in the future, rather than short-term subsidy plugs to defer the painful adjustment. 

Having weathered through this adjustment, the economy would be able to cut its excesses and the households would be even more resilient to future inflation and also economic shocks. 

With a little discipline, prudent spending goes a long way. 

Manokaran Mottain is chief economist at Alliance Bank Malaysia Bhd

Valuation techniques on stock investment

When I first started investing in the stock market, like most people, I just listened to what the market told me which stocks to buy. You know those days you went to the Broker firm and many punters sitting and standing around and talked about stocks? “This stock can Okam (pass out gold)” and this was the common gossip which I based my investing on. That experience of course didn’t end well for my investments.

Later I started to read some magazines such as Malaysian Business, I learned a couple of simple valuation metrics such as price earnings ratio and price-to-book. So I happily used PE and PB ratios to gauge if a stock is worthwhile to buy after hearing the rumours in the market. That was a big improvement, even in today’s standard. Unfortunately, my those experience did not turn out well too. Gosh, I am not even sure it was good or bad as I didn’t keep track on my investing experience. But one thing I know, I never got rich. In fact as far as I can remember, I was always short of money even though I worked as a professional, who supposed in the higher bracket earnings. How I wish I had learned some fundamental investing at that time.  

The Simple Valuation Metrics

This was what I have done when using some simple techniques to compare companies. Let us look at two confectionery companies listed in Bursa, A and B. I would doubtless bought company B and would never even looked at company A. Table 1 below shows all the reasons why I would buy company B, yes, just based on their market valuations alone.

Table 1:

Company	A	B	Industry
Price	4.85	0.83
Price-to-book	1.7	0.4	3.0
Price-to-earnings	12.1	9.3	22.8
Price-to-sales	1.7	0.4	1.5
Price-earnings growth	2.4	0.9
Price-to-CFFO	12.3	6.4	13.3

All metrics above show company B is much cheaper than company A to invest in. You will be surprised many “investors” think B is much cheaper than A because it is trading at 83 sen compared with RM4.85 of A, no kidding. But of course most of you would know that B is cheaper because of its PE ratio at 9.3 is lower than that of A of 12.1. Assuming an expected growth rate of 10%, the PEG of B is also much cheaper at PEG of less than 1. In other metrics such as price-to-book of just 0.4 would  make company B like one of the best sales in Bursa. The price-to-sales of B is also so cheap. Even when we compare price-to-cash flows from operations, B also appear to be cheaper. So how could you go wrong in choosing to invest in company B over A?

But is company A very expensive to invest in? Compared to B it appears so, but not necessary if you compare with the industry average. For example, its PE ratio of 12 is much lower than the industry average of 22.8. If you flip the PE ratio over, you get an earnings yield of more than 8%, not bad too compared to fixed income return. Actually if you look at A’s dividend yield, it is also not bad at all at 5.2%. Price-to-book wise, A at 1.7 is also very cheap if compared to the industry average of 3.0.

But wait a minute, there are so many participants in the stock market, and how come nobody seems to see that the stock price of B is so attractive that everybody would buy stock B, and in turn bid up its share price? I didn’t know the answer 30 years ago.

Growth of profit

The chart below shows the high growth of steady earnings of company A compared to the down trending earnings of company B. In the last two years, you can actually see the good growth of A’s earnings in contrast with the deterioration of B’s earnings. Hence the stable and growth in earnings plays an important part in the valuation of stock such as PE and PEG ratio.

Figure 1: Growth in earnings of company A and B.

Quality of assets

Figure 2 below shows that the quality of assets of A is much higher as 25% of its assets are in hard cash whereas for B, the major portion of its assets is its extremely high 77% in property, plant and equipment. This will definitely has a huge impact on the valuation using price-to-book ratio.

Figure 2: Assets distributions of A and B

Balance sheet

Looking at the balance sheets of company A and B, A is debt free with plenty of excess cash, while B is laden with increasing debts every year and negative net working capital. The solvency and long-term financial strength ratio below shows the vast difference in their financial health. In fact company B  is at high solvency risk with current ratio and quick ratio well below 1 as shown in Table 2 below.

Table 2: Financial health

Company	A	B
Current ratio	13.8	0.6
Quick ratio	11.5	0.5

Cash flow

While B’s price-to-cash flow from operations appear to be lower than A, the more important metric should be the price-to-free cash flow. Figure 3 below tells the whole story. While company always has positive FCF and slightly trending up, company B has no positive FCF at all for most of  the years.

Without FCF, the company continues to need cash injection from shareholders and bank loans for capital expenses and its continue operations, and paying dividends. 

Efficiency comparison

The comparisons of return on equity and return of invested capitals as shown in Figure 4 below shows that there is vast difference in their returns on capitals; A’s returns on capitals is easily above its costs, while that of B is way below its costs of capital, and clearly trending  downwards. Clearly a more efficient company like A deserves much higher market valuation than B.

So is company B really cheap compared to A? Or it is cheap for good reasons? The metrics we used to compared company A and B as shown in Table 1 above is clearly not good enough. Table 3 below shows the right metrics to be used instead of those shown in Table 1 above.

Table 3 below shows that company A is in fact cheaper than B using the more appropriate enterprise value which includes all stakeholders, equity and debt holders. Company A with its earnings yield of the whole firm as 13.1% is clearly a better buy compared to 5.8% of B. In terms of Price-to-FCF and enterprise value over sales, A is also cheaper.

Table 3: Enterprise valuation

Company	A	B	Benchmark
EY=Ebit/EV	13.1%	5.8%
P/FCF	15.4	23.9	77.0
EV/Revenue	1.5	1.9

Which valuation metric to use?

The choice of which of these valuation ratios to use will come down to the situation at hand. Some companies are cheap for good reasons. Good companies are not cheap. In general, the quality of earnings and its assets are very important when comparing companies. Some companies are laden with debts and some have excess cash and many ratios do not show these distinctions. Hence it is important to be able to compare apple and apple.

Five years ago the share price of Company A and B were RM2.50 and 80 sen respectively. B’s share price was RM2.60 ten years ago before it retreated to its lowest at 56 sen in 2008. Its share price was rammed up again to RM1.38 4 years ago. Today, the share price of company A has risen steadily to RM4.91, not forgetting the more than 5% dividend yield yearly, while the share price of company B is still languishing at 88 sen. The results clearly shown that picking the right company to invest is the way to go to build long-term wealth.

Will the future shows the same pattern? Well after analyzing the past and recent financial statements of A and B, and the actions of the same management, do you foresee any change in the trend for the future? I personally do not see any change so far, absolutely nothing,  and hence do not expect me to think that this time will be different.

Valuation does matter.

K C Chong in Auckland (22 June 2014)