Light at the end of the tunnel?


Traders and investors monitoring stock prices at RHB Investment Bank on bank interest rate high in Kuala Lumpur. FAIHAN GHANI/The Star

Early signs of a less fragile economy is starting to show

IT’S a wrap for the second quarter result to 2016, and it looks like while earnings may still be weak, early signs of a less fragile economy is starting to show.

This could be one the first signs that corporate Malaysia is finally bottoming, and while it doesn’t signal that the party is about to start, the FTSE Bursa Malaysia KL Composite Index (FBM KLCI) could start inching up considering that earnings have already taken a huge bashing in the last few years.

Earnings of Malaysian companies over the last four years have been contracting, even with expectations already being tempered. What is different this time around is that the ratio of companies that underperformed compared to the outperformers have narrowed.

For the banks, results were met, no doubt on the back of lower expectations. It is not out of the woods though, as moving forward, weaker loans growth and compressed margins as a result of a lower overnight policy rate will continue to be a persistent thorn on its side.

The oil and gas (O&G) sector continues to languish, with remnants of nasty surprises and impairments still rearing its ugly head.

Unexpectedly though, the property sector looks like it could be coming out of its worst, with most analysts now upgrading the sector.

Hong Leong Investment Bank research head Sia Ket Ee says the 2016 reporting season remains a disappointing one, although recording slight improvement over the previous quarter, with the same 42% of Hong Leong’s universe falling short of expectations while a higher percentage 17%, surprised on the upside.

Against consensus, it was almost a similar trend where 46% of the companies were below while 11% were above expectations.

In his strategy piece, Sia says corporate earnings continue on recessionary mode despite resilient gross domestic growth (GDP) growth at 4% in the second quarter.

In the near term, though, Sia expects a squeeze in margins to still persist, given cost pressures and a challenging fiscal position.

Notwithstanding the cautious earnings outlook, he expects the market to walk past weak earnings cycle to focus on the upcoming Budget on Oct 21, and a potential turnaround in corporate profitability in tandem with the bottoming of GDP growth.

Sia is maintaining his end-2016 FBM KLCI target at 1,730 points, based on 15.8 times one-year forward earnings.

“The readiness of Bank Negara to support economic growth via easing is overall positive for the market. Coupled with improved fiscal position, low foreign shareholding and the possibility of snap election, there is potential for the market to recharge to a higher level despite still lacklustre earnings outlook,” says Sia.

Meanwhile, RHB Research head Alexander Chia is less optimistic. He says the subdued June-quarter reporting season provides scant evidence to conclude that the profit recession could soon be behind us.

“Earnings revisions remain in negative territory, with the miss ratio steady at 30%, reflecting persistent underlying earnings weakness. While 2016 earnings growth is now minus 5.1%, 2017 growth has risen to 10.4%, coming off a low base.

“Weak corporate earnings will cap market upside, with valuations still elevated. With the FBM KLCI already at the top end of our 1,590-to-1,700 point trading range, we would take some money off the table and look at re-entering at lower levels. The key risk to our forecasts is a pick-up in foreign capital flows that could drive the market higher,” says Chia.

The majority of companies came in line

For a better picture of how companies did in the second quarter, using Kenanga Research’s universe of stocks, approximately one-third of the stocks in its coverage (or 43 stocks) out of a total of 127 delivered weaker-than-expected results. At the same time, 52% and 14% of them performed within and above expectations, respectively.

Kenanga’s 2016 and 2017 net profit growth estimates are fine-tuned to 1.6% and 7.2% from 2.3% and 7.8%, respectively.

Within MIDF’s universe, 5% of stocks under its coverage reported higher than expected earnings. Of the rest, 23% posted earnings that were lower than expected, versus 72% which came within expectations.

“It is also notable that the ratio of outperformers against underperformers among the FBM KLCI constituents improved somewhat to 1:4 in the second quarter ... Recall that there was zero outperformers in the first quarter of 2016 against 8 underperformers,” says MIDF Research head Syed Muhammed Kifni.

Syed says the aggregate reported earnings of FBM KLCI 30 constituents totalled RM14.59bil in the second quarter of 2016, rising 3.6% from a year ago. However, the aggregate normalised growth figures were more muted at 0.5% from a year ago.

MIDF maintains its year-end 2016 FBM KLCI target at 1,750 points.

Kenanga Research head of research Chan Ken Yew says that in general, the automotive, gloves as well as oil and gas sectors delivered weaker-than-expected results. Auto players experienced tighter margins due to unfavourable forex exposure, coupled with sluggish consumer sentiment.

Chan adds that while the results of banking stocks were well within its expectations, it seems weaker as opposed to consensus estimates.

“For other sectors, they are either neutral or mixed in nature. Nonetheless, it was still a better quarter for the building materials, construction, plantation, and property sectors, which we saw more improvements and less downgrades as opposed to outright underperformances and downgrades in the first-quarter results reporting season,” he says.

Post-results, Kenanga has downgraded the telco sector to “underweight” and has upgraded the property sector to “neutral”.

Despite the lower earnings estimates and further downgrade in consensus index target, Kenanga maintains its end-2016 index target at 1,715, implying 16.1 times price-earnings (PE) for 2016.

RHB’s Chia says he is unable to conclude that the worst is behind us following the June 2016 quarter earnings.

He expects the challenging macro environment to persist going into 2017, and the market to range-trade between 1,590 and 1,700 points.

He also sees trading opportunities in the property and consumer sectors, with one eye on the 2017 Budget announcement in October.

Chia is keeping RHB’s end-2016 index target of 1,620 points, based on an unchanged 15 times target PE on forward earnings.

“Our sole underweight sector is auto, while we remain overweight on utilities, construction, basic materials, Reits and aviation,” he says.

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