The year-on-year (y-o-y) EPS change for the KLCI moderated from a hefty 58% jump in 1QFY10 to 30% in 2QFY10. On quarter-on-quarter (q-o-q) basis, the EPS growth strengthened from 4% to 8%. The still-robust y-o-y and q-o-q earnings growth means that our forecasts could have run ahead of expectations and that despite the relatively good earnings performance in 2Q10, it was still below our projection.
The three-month period including the August results season was positive as we raised our core CY10 EPS by 2.1% while upping CY11 by 2.7%. The strong performance during the results season came mainly from the media, utilities, automotive, gaming and banking sectors. Shortfalls came from stocks in the industrial, insurance, oil and gas, and telcos.
The number of companies which saw earnings downgrades increased from 16 in May to 18, namely Bursa Malaysia Bhd, Lafarge Malayan Cement Bhd, Berjaya Sports Toto Bhd, RGB International Bhd, Adventa Bhd, Guinness Anchor Bhd, Tomypak Holdings Bhd, Wellcall Holdings Bhd, MTD ACPI Engineering Bhd, Kurnia Setia Bhd, Petra Perdana Bhd, Wah Seong Corporation Bhd, Notion Vtec Bhd, JCY International Bhd, Maxis Bhd, Telekom Malaysia Bhd, MISC Bhd and Malaysian Airline System Bhd.
The number of earnings upgrades, meanwhile, slipped from 23 to 19, ie Proton Holdings Bhd, UMW Holdings Bhd, AMMB Holdings Bhd, Malayan Banking Bhd, Ann Joo Resources Bhd, Fraser & Neave Holdings Bhd, Genting Bhd, Genting Malaysia Bhd, PLUS Expressways Bhd, Media Chinese International Ltd, Star Publications (Malaysia) Bhd, KL Kepong Bhd, JobStreet Corporation Bhd, Uchi Technologies Bhd, Unisem (M) Bhd, DiGi.Com Bhd, AirAsia Bhd, Suria Capital Holdings Bhd and YTL Power International Bhd.
Looking at the sectoral changes for reported profits, the numbers were relatively positive in absolute terms. CY10 reported earnings were cut for five (eight previously) out of 18 categories.
Earnings were reduced most for the insurance, oil and gas, technology and telco sectors. We upped our forecasts for 10 sectors, against five previously, with the upgrades coming mainly from the gaming, auto, conglo and F&B sectors. For CY11, we scaled back our earnings numbers for five sectors (seven previously) while raising them for eight categories (seven previously).
Since the big jump in profit forecast in November 2009, earnings estimates have been creeping up for CY10 and spiked up again in August 2010. Consensus forecasts were similar but August EPS still trails behind that of May. For CY11, both our and consensus forecasts have shown a gradual upgrade in recent months.
We expect EPS to rebound a strong 30% in CY10, still higher than consensus growth estimate which has bounced back from 14% three months back to 24%. Our CY11/12 growth forecast of 13% is also ahead of consensus. Our EPS forecasts are 1%-6% above consensus estimates.
The KLCI net profit growth to nominal GDP growth ratio for 2010/11 is in positive territory. We still believe that the figures are achievable as we are coming out of an economic recession, and the same pattern was seen in 1999 after two consecutive years of earnings contraction. However, the ratio should be declining for future years as growth moderates.
The Malaysian economy grew, albeit at a slower pace of 8.9% y-o-y in 2Q (10.1% in 1Q), thanks to continuing high domestic consumption, investment amid slower exports. The 2Q10 GDP growth was a shade higher than our estimate of 8.6% but markedly above consensus (7.9%). On q-o-q basis, real GDP growth was 3.5% in 2Q (-2.6% in 1Q). In 1H10, real GDP strengthened 9.5% (-5.1% in 1H09). Domestic demand continued to propel growth, with private consumption providing a strong lift to 2Q10 GDP. Consumer spending rose 7.9%, much higher than 5.1% in 1Q. Total fixed investment also picked up steam, expanding 12.9% in 2Q (5.4% in 1Q) largely on continuing fiscal support while private investment activity also increased.
Net trade had a negative impact on 2Q10 GDP growth as import growth outpaced that of exports. Gross exports grew at a slower pace of 13.8% y-o-y in 2Q (19.3% in 1Q), lower than import growth of 21.9% (27.5% in 1Q). As such, net trade contributed to a pullback in GDP growth, subtracting 5.3% percentage points (ppts) from 2Q10’s GDP growth (-2.7 ppts in 1Q). Also, inventory restocking added 6.3 ppts to overall growth (+8.1 ppts in 1Q).
We expect inventory correction to weigh down GDP growth in 2H10. The services sector showed 7.3% expansion in 2Q (8.5% in 1Q) while the manufacturing sector grew 15.9% (17% in 1Q), followed by the construction (4.1%), agriculture (2.4%) and mining (1.9%) sectors.
The 2Q10 GDP data underscore our view that the strong rebound peaked in 1Q as the effects of fiscal measures and inventory restocking fade in 2H10. The bottom line remains that the growth outlook for the Malaysian economy is still positive but growth will be at a more sustainable pace in 2H10. A softer global environment, coupled with the diminishing low-base effect, is expected to restrain export growth in 2H10. Higher interest rates are expected to cool household demand. As such, we estimate real GDP growth to slow to around 5% in 2H10 from 9.5% in 1H10, taking this year’s GDP estimate to 7%. For 2011, we maintain our real GDP growth estimate of 5.5%.
The 2Q10 results season disappointed as the revision ratio fell from 1.1 times to 0.9 time. This was a negative surprise for us as it comes on top of the relatively uninspiring major results seasons in February and May. This means that positive earnings surprises for the broader market could be dissipating and market EPS remains driven primarily by the larger caps, particularly the banks. The banking sector has largely topped expectations and lifted market EPS for four-five quarters in a row.
In view of the mixed August results season, we are keeping our end-2010 KLCI target of 1,450 points which is based on an unchanged 2011 P/E of around 14 times. The strong YTD performance of the KLCI, stoked in recent weeks by foreign funds, could take a pause before picking up pace later in the year. We now introduce our end-2011 KLCI target of 1,520 points, based on 13 times 2012 EPS or a 15% discount to the three-year moving average P/E of 15.3 times to factor in global uncertainties as well as a gradual slowdown in the domestic economy and market EPS growth.
The 1,520-point target implies a P/BV of 2.2 times, close to the mid-cycle P/BV of 2.3 times. We maintain our Overweight stance on Malaysia in light of the potential catalysts of 1) the disclosure of Part 2 of the New Economic Model, 2) the award of 10th Malaysia Plan construction contracts, especially the mammoth RM36 billion MRT project, and 3) the announcement of the 2011 Budget in 4Q.
Nonetheless, we remain optimistic about stockmarket prospects for 2H10 as domestic newsflow on policy liberalisation and transformation programmes will remain strong. There should be low-lying fruits for the reaping during the period and potentially spilling over to 1H2011 as well. Also, Malaysia’s low-beta defensive qualities, strengthening ringgit (US$:RM exchange forecast to hit 3.05 by end-2010) and recent inclusion in China’s QDII are factors that should encourage continued inflows for the market. Already, we have seen net foreign purchases of Malaysian equities boosting foreign ownership in July to 20.8%, the highest level since October 2009. This is positive as slight inflows could have a significant impact on stock prices given the market’s relatively low liquidity.
Longer term, however, the true test of the government’s ability to deliver on transformation promises made is likely to be seen only from 2H2011 onwards. Any misses on this front could be a sore disappointment for the market. Although progress made so far has been encouraging, particularly on the Government Transformation Programme, we should not underestimate resistance to change from certain quarters. Already, there is frustration over changes in policy on sports betting, GST and petrol price hike. It is imperative that the government’s efforts to liberalise the economy and transform both the government and the economy yield results as the next general elections must be held by mid-2013.
We have removed the oil and gas sector from our preferred sector picks after downgrading Petra Perdana and Wah Seong due to their poor results. We continue to like the banking sector for its heavy weighting in the market and its stronger-than-expected performance over the past year. The sector continues to anchor earnings growth for the broader market. The rubber glove sector has come under some selling pressure of late due to hiccups in earnings as a result of high latex prices. We believe the earnings hiccup is temporary and weakness in share prices provide investors with a cheaper entry point.
Banking — We maintain our Overweight rating on the banking sector given the positive earnings outlook. Banks rank among the key beneficiaries of the economic recovery, which will lead to increased business activities and investment banking deal flow. We envisage a better operating environment in 2010, with projected loan growth of 11%-12% (versus 7.8% in 2009) and stable gross NPL ratios of 3.7%-3.8%. This, coupled with healthy growth in non-interest income, will help banks to achieve our projected net profit growth of about 26% in 2010. The potential share price triggers are (1) strong earnings growth, (2) increase in investment banking income, (3) stronger growth potential for overseas operations, especially in Indonesia, and (4) potential GP write-backs.
Construction — Investor sentiment on the construction sector is likely to remain positive in the coming months. This is backed by recent news-flow suggesting that the implementation of projects (public and PFI) is underway, which also addresses concerns over execution. Several tenders have closed since the beginning of the year, suggesting that project awards, both public and private sector jobs, will be a key theme for the sector in 2H10. We expect the government to press ahead with the award of rural infrastructure projects (East Malaysia), IWTS, and PFI jobs, ahead of mega projects like the LRT extension/upgrade. The likely approval and rollout of the proposed RM36 billion MRT project will be a bonus for the sector. We continue to Overweight the construction sector, with WCT and Gamuda as our top picks.
Rubber gloves — We remain positive on the rubber glove sector in view of the sustainability of demand and the manufacturers’ pricing power. The Malaysian rubber glove sector is advancing well ahead of its competitors from other countries, thanks to continuous innovations in glove technology and manufacturing process. We retain our Overweight stance on the rubber glove sector as demand remains resilient regardless of the condition of the global economy. All the glove stocks under our coverage remain as Outperforms.
Potential re-rating catalysts include the continuing uptick in demand from the healthcare industry, ongoing capacity expansion and strong earnings growth. Supermax and Latexx remain our top picks. We like Supermax as prospects for the company are improving thanks to its growing OBM segment as well as potential earnings growth from upcoming capacity expansion plans. Potential share price triggers for Latexx include improving earnings ability, driven by its major expansion plans and move towards premium products.
In the past three months, we had far more downgrades than upgrades. We upgraded several media companies and downgraded quite a few plantation stocks. All in all, the number of stocks we upgraded edged up to eight (seven leading up to May) while the number downgraded rose to 14 (eight leading up to May). The downgrade-to-upgrade ratio was 1.75:1 in August against 1.1:1 in May. The greater number of downgrades is due to a combination of weaker-than-expected results and strong share price performances which stretched valuations.
This article appeared in The Edge Financial Daily, September 3 2010.
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