RCECap- caught in a tight spot

Background

RCE Capital Bhd ('RCECap') is a non-financial institution player in the niche credit cooperative market. Its core business is in the provision of personal loans through strategic tie-ups with cooperatives. It also provides short-term financial solutions, such as factoring and confirming facilities, to corporate clients. In addition to its financing business, RCECap also has investments in AmFIRST Real Estate Investment Trust and properties, which allows it to enjoy some recurring income.

Recent Financial Results

For QE31/3/2011, RCECap's net profit dropped by 49% q-o-q or 27% y-o-y to RM16.6 million while turnover declined by 24% q-o-q or 10% y-o-y to RM59 million. The lower top-line & bottom-line was attributable to lower disbursements by the loan financing division. Loan & receivables dropped by RM60.9 million, from RM1.147 billion as at 31/12/2010 to RM1.086 billion as at 31/3/2011. Could a drop of 5.3% in loan outstanding contributed to such a severe impact on the bottom-line as well as the top-line? Look at Chart 1 below. I believe two things happened:

1) To compete effectively against new comers, such as MBSB, RCECap lower the interest rate chargeable on its clients. This explained why its turnover, which is interest receivable, dropped faster than the decline in loan outstanding; and

2) At the same time, RCECap experienced higher interest cost from funds borrowed. This led to a squeeze in its profit margin, which explained why its bottom-line dropped faster than its top-line. Unlike banks, even MBSB which can accept Savings & Fixed Deposits, RCECap has to source its funding from the money markets. As such, its interest cost is slightly higher than other players in its core business of lending to cooperative members.

Unless the interest rate regime & the competitive environment changes, I expect this same pattern to persist, resulting in further decline in RCECap's bottom-line.


Table 1: RCECap's past 8 quarterly results



Chart 1: RCECap's last 16 quarterly results (plus profit margin trend)

Financial Position

RCECap's financial position is deemed satisfactory as at 31/3/2011, as reflected in its current ratio of 1.30 times & debts to equity of 2.64 times. RCECap, being a finance company, is expected to operate with a leverage of 2-3 times.

Valuation

RCECap (closed at RM0.53 yesterday) is trading at a PE of 6.2 times (based on annualized EPS of 8.48 sen). While this PE multiple looks attractive, I believe the market is expecting further deterioration in RCECap's earning and is pricing this into the share price. As such, I believe that RCECap could be a value trap- a stock that looks relatively cheap but it will stay cheap. Others may hold differing opinion, such as RHB research which valued the stock at RM1.10 (here).

Technical Outlook

I drew a price band onto the price chart of RCECap. For the near term, I expect RCECap to trade within a band of RM0.40 & RM0.60.


Chart 2: RCECap's weekly chart as at June 15, 2011 (Source: Quickcharts)

Conclusion

Based on concern for further deterioration in its financial performance & poor technical Outlook, I believe RCECap is a stock to be avoided. If you are presently holding this stock, I would recommend a sell into strength when the share price approaches the RM0.60 level.