We believe small-cap stocks will outperform large caps in the post-Covid recovery phase for two reasons. First, small caps were hit harder during the crisis sell-off. Second, as a riskier area of the market, they often perform well in an upcycle led by risk-on sentiment and ample market liquidity.
The sSET index comprising shares outside the SET50 and SET100 has rebounded by 50% from the low reached on March 23 when authorities announced the first major coronavirus lockdown. That compares with a 20% recovery for the broad SET index and 14% for the SET50. The SET index underperformed the SET50 by 18% when the US Federal Reserve tightened monetary policy from 2004 to 2007. The figure was 5% amid similar tightening in 2013-14 and 8% in 2016-19.
Now, with the Fed signalling that interest rates will stay near zero through 2022, and with more accommodative measures to support a US economic recovery, we expect small caps to continue outperforming large caps.
As analysts begin previewing second-half earnings in October and some companies begin to announce third-quarter earnings, we expect share prices of companies with a solid second-half earnings outlook to outperform the market on speculative trading.
Earnings momentum plays will be sectors that are key beneficiaries of or seeing less impact from Covid-19 (Electronics, Paper, Packaging, Agriculture, Food & Beverage, Rubber Gloves) and sectors poised for a strong turnaround after business reopening (Finance, Commerce, Transport, Auto).
We recommend selective buying of small-cap stocks with strong earnings momentum in the second half with the following preferred themes and top picks:
1. Beneficiaries of increasing non-performing loans in the banking sector (JMT, CHAYO): We like JMT because we expect its earnings momentum to remain solid. Key growth drivers will be a higher proportion of fully amortised loans in its portfolio and an expansion of loans to NPLs. Cash collection should improve year-on-year and quarter-to-quarter in the third quarter, given the easing of lockdown measures and improving private consumption compared with the second quarter.
We also expect CHAYO to deliver the strongest earnings growth among asset management companies during 2020-22 at a compound annual growth rate (CAGR) of 32%, due to its sector-leading NPL acquisition growth. We expect its second-half earnings to grow by 54% year-on-year.
2. Beneficiaries of government stimulus measures (DOHOME and SYNEX): We expect more government stimulus measures aimed at boosting domestic spending, given that officials have 750 billion baht available from the annual budget and the prospect of borrowing up to 1 trillion baht. As a result, the Commerce sector will be a key beneficiary.
DOHOME is our preferred stock on this theme, as we expect it to post strong third-quarter earnings growth sequentially and year-on-year. In July and August, same-store sales growth was positive at 7-8%.
We like SYNEX for its cheaper valuation relative to its peers and a good near-term earnings outlook, which will support sector earnings. We expect higher earnings in the second half and 2021 for the electronic device sector, driven by new products such as the iPad, Apple Watch and iPhone 12. We expect SYNEX to post strong second-half earnings growth of 32% year-on-year.
3. Turnaround play (SRICHA): We believe SRICHA will generate market-beating returns in the second half, driven by a turnaround story on the back of its record-high construction backlog. Despite some earnings slippage in the second quarter, we still believe SRICHA will improve from a loss of 48 million baht in 2019 to profits of 178 million baht in 2020 and 404 million baht in 2021.
Improvement will be led by a high-quality project backlog worth 2.1 billion baht that is near its all-time high, and high profit margins on that backlog, which comprises mainly mining, petrochemical and refinery projects. Strong revenue growth in the first half of 47% year-on-year confirms an uptrend in SRICHA's earnings upcycle.
4. Profitability to reach new heights (ASIAN): Since 2016, ASIAN has increased its proportion of high-margin, value-added food products and reduced the proportion of low-margin, commodity-like products. We thus believe the stock should trade at a higher multiple than its historical mean.
However, shares are currently trading at a discount of around -1 standard deviation from its historical 12-month forward price/earnings ratio. Given the strong second-half outlook, we believe this is an opportunity to accumulate ASIAN shares.
5. Safe auto recovery play (SAT): We believe SAT, a major parts supplier, will be the key beneficiary of an auto production turnaround in the second half after a sharp drop in total vehicle output of 70% in the second quarter. We have seen an improvement in its monthly production, which has risen from 25,000 units in April (-83.6% year-on-year) to 117,000 (-29.5%) in August.
We expect SAT's earnings to turn around from a loss of 143 million baht in the second quarter to show a profit from the third quarter onwards. We expect 2021 earnings will grow by 23% and 2022 earnings by 38% on a recovery in auto production and an improvement in gross product margin to 14-15% from an estimated 13% in 2020, thanks to higher operating leverage.
Moreover, the stock is trading at around -1 standard deviation from its historical mean price to book value, which is lower than in 2011 when Thailand was hit by widespread flooding. Given our expectations of an auto production recovery to 1.1 million units this year, 1.4 million next year and 1.8 million in 2022, we believe the time is right to accumulate SAT shares on a recovery theme.
6. The golden goose (TVO): We believe TVO will generate market-beating returns in the second half, supported by positive earnings momentum and a high dividend yield. The key earnings driver should be an uptrend in soybean prices supported by strong Chinese demand and the impact of the La Nina weather pattern.
We expect earnings to grow by 24% year-on-year in the second half and lift 2020 profit to 1.8 billion baht, or 2.20 baht a share (up 27% year-on-year) in light of three factors: sales growth of 10% year-on-year in the second half on demand for restocking by domestic feed mills and higher selling prices; a higher gross profit margin from a stock gain (11-12% in H2 versus 10-12% in H1); and a better outlook for soybean oil prices in the fourth quarter on seasonally higher demand during the vegetarian festival.
TVO could also benefit from a possible increase in the price of crude palm oil (CPO), a product substitute for soybean oil, as Thailand will adopt B10 as the standard diesel formulation from Oct 1, resulting in stronger demand for CPO to produce biodiesel.
Sunthorn Thongthip is the senior vice-president of Kasikorn Securities Plc.
