IT’S that time of the year again when the Government is going to announce its annual budget plan.
The market is losing its stamina and desperately in search of a growth story. So far this year, the FBM KLCI has been flat despite the volatility, which some might even say is “a positive” considering the global anaemic growth.
Stocks have been less than inspiring.
Oil and gas (O&G) stocks have been decimated. Export-oriented counters are flailing and property stocks are in search of a catalyst.
Market observers reckon that fear continues to breed, fuelled by Germany’s Deutsche Bank woes, interest rate decisions by the Federal Reserve (Fed) and the United States presidential elections on Nov 8. Despite all these, there are little signs of a looming bear in the Malaysian market, perhaps due to the fact that most of the bad news has already been discounted in the market.
Malaysia’s economic growth was at its slowest in seven years at 4% during the April-to-June quarter of 2016 from 4.2% in the preceding quarter.
While Bank Negara is confident that Malaysia’s economy will be able to achieve a 4% gross domestic product (GDP) growth, some economists have cut their forecast to below 4% due to global woes.
Its fiscal deficit commitment target for this year is 3.1% of the GDP from 3.2% in 2015. Economists are expecting it to improve further to 3% in 2017.
Malaysia’s July exports declined more than expected on a slump in electrical and electronic exports and a drop in shipments to China, the country’s largest trade partner.
Exports slumped 5.3% year-on-year to RM59.9bil compared to a survey of a 2.5% gain, while imports fell 4.8% to RM57.9bil compared to a survey for a 1.5% slide.
Data showed that exports were at its weakest in 15 months.
The International Monetary Fund, meanwhile, expects the global economic growth to stay weak and maintains its growth forecast at 3.1% for 2016 and 3.4% for 2017 after cutting its outlook for five straight quarters.
It had cut its economic outlook for the US to a 1.6% growth this year, down from 2.2%, citing weak business investment and lower demand for goods. It also cautioned the Fed to hold off raising benchmark interest rates until it sees “clear signs that wages and prices are firming durably”.
It is under this scenario that Budget 2017 is seen as a tough one. With oil prices remaining low, half from its heyday of US$100 a barrel, and a tough economic outlook, the Government will need to find a balance in its commitments to address the country’s fiscal deficit without compromising growth.
Although oil prices have improved significantly, rising by 52% from their lowest of US$33.89 a barrel in January, the price sustainability is still a major concern, as new technologies along with a very real oversupply issue will continue to cap the upside.
Recall that in January, the Government had to recalibrate its Budget 2016 by lowering its average-price assumption for Brent to US$30-US$35 per barrel, compared with US$48 per barrel under the original Budget 2016 when it was unveiled in October last year.
The slump in oil prices last year had reduced the government revenue by RM30bil last year, according to Second Finance Minister Datuk Johari Abdul Ghani.
The Government is going to table its budget on Oct 21 with most experts suggesting that it will be a modest one, promoting new economic growth aside from construction and a push for more affordable housing projects.
Another thing to consider is that the goods and services tax (GST) collection was down 30% to RM7.1bil in the second quarter of 2016 from RM10.2bil in the first quarter due to higher refunds.
“The target of RM39bil collections for 2016 could be difficult,” said MIDF Research in a report dated Sept 2.
The Government’s revenue for the first half of this year fell by 9.8% to RM96.3bil.
MIDF said during the period, the Government’s petroleum corporate tax was at RM2.9bil, lower than the RM3.4bil forecast and lower consumption tax collected.
It fiscal deficit has reached RM32.7bil in the first half of 2016, almost reaching its RM38bil full-year target because of higher development expenditure by 31% to RM20bil from RM15bil in the first half of last year.
What sort of budget?
TA Securities research head Kaladher Govindan said that Budget 2017 is expected to be a pragmatic budget that contains growth accelerators to achieve developed nation status without compromising on fiscal prudence and the well-being of Malaysians.
“To do this at a time when external demand and the ringgit are showing simultaneous weakness is challenging. More so if Malaysians expect it to be an election budget packed with goodies to attract the man on the street,” says Kaladher.
He said that Budget 2017 should remain as an expansionary budget with an allocation of RM261bil, which is 2% higher than last year’s RM256bil. About 82% or RM215bil of it will go for operating expenses and the remaining RM47bil for net development expenditure.
“Despite the higher allocation, the budget deficit could trend lower to 3% in 2017 as opposed to an expected 3.1% in 2016, thanks to the expanding revenue base after the implementation of the GST and the Inland Revenue Board’s improvised tax collection methods,” says Kaladher.
Stimulating domestic demand and minimising the impact of the high cost of living on the B40 and M40 segments could be the key focus of Budget 2017. The Government is expected to play its role in boosting consumption and private investment through fiscal measures and incentives that will stimulate domestic activities.
B40 is the bottom 40% of the population, while the M40 are households with a monthly income of between RM3,860 and RM8,320.
Kenanga Investment research head Chan Ken Yew said that the general expectation is that the forthcoming 2017 budget proposal will definitely be a “rakyat-friendly one”, but may be again corporate neutral.
“It is widely expected that Budget 2017 should see positive measures for the affordable housing segment, Government servants and the lower-income group of people such as a higher pay-out, say RM1,200 per year, for BR1M.
As for big-ticket items such as automobile and housing, Chan says there is talk in the market that auto players are lobbying for excise duty exemption, especially for those with a higher local content or national cars, for first-time car buyers.
Chan adds that for the 2016 budget, the Government has only factored in crude oil prices of US$30 to US$35 per barrel, which has proven conservative given the year-to-date average of more than US$40.
“Should this expectation materialise, this should be good for the consumer food and beverage and retail sub-segments,” says Chan.
What the corporates hope for
SMRT Holdings Bhd chairman and Cyberjaya University College of Medical Sciences pro-chancellor Tan Sri R. Palan is looking forward to a budget that will support the education sector. “Hopefully, PTPTN loans can be enhanced to help youths pursue tertiary education. The gap between the PTPTN loans and the tuition fees are too wide at the moment, leaving many in difficulty. Additionally, interest on student loans can be waived to minimise student burdens.”
He further adds, “Private-sector education has given greater access, more choices and flexibility to our young people to take up the courses they want. The Government could incentivise private-sector education players due to the increased global competition. This is essential, given the Government’s goal to make Malaysia a preferred education hub.”
Secondly, Palan says it would help to boost skills development by funding high-priority skills training and hence increasing the productivity of the Malaysian workforce.
The Human Resource Development Fund (HRDF) was established with the aim of developing quality human capital and a world-class workforce in order to achieve a high-income economy based on knowledge and innovation.
The HRDF collects 1% of the payroll from sectors covered by HRDF and reimburses approved training. Palan says that perhaps the HRDF could give much more allocations for accelerating skills development.
Lastly, to incentivise entrepreneurship, while Palan is aware that the Government needs revenue, it would help if the corporate tax rate was reduced by 1% point.
“While this may appear as if the Government is losing some short-term revenue, over the longer term, the Government will gain so much more when these entrepreneurs have full running businesses and are contributing taxes,” says Palan.
Meanwhile, the local O&G stocks have underperformed the FBM KLCI with a year-to-date (YTD) performance of -14.5% versus the FBM KLCI’s -2.3%, led by Perisai Petroleum Teknologi Bhd, Dayang Enterprise Holdings Bhd and Alam Maritim Resources Bhd despite crude prices recovering by some 25% on a YTD basis.
Consensus numbers are also anticipating an earnings recovery in 2017 and 2018, with expectations of a pick-up in offshore activities.
The earnings outlook of the local services players has been under pressure due to slow contract award flows with slim margins.
President and group chief executive officer of Enra Group Bhd Datuk Mazlin Junid said that O&G contractors and vendors realise that there is a massive contraction of services issued by Petroliam Nasional Bhd (Petronas) this year and in the foreseeable future at the current oil price levels.
“The Government should provide initiatives for contractors to expand in the region. Don’t forget that these very contractors were also the ones that had helped Petronas succeed and become a Fortune 500 company in the good days.
“And the Government also benefited from taxes. It’s the nature of the industry that assets are very costly and need time to recover investments,” says Mazlin.
Kenanga Research analyst Sean Lim Ooi Leong is neutral on the sector while awaiting for stronger contract flows to act as a firm earnings recovery indicator.
“Keep in mind that stronger-than-expected oil prices will definitely serve as a strong catalyst to the sector should a collaboration between the Organisation of the Petroleum Exporting Countries and non-Opec members to prop up prices goes much smoother than expected. Meanwhile, investors should avoid highly leveraged companies with poor earnings outlook. Note that the industry’s average net gearing level is currently at 0.55 times (as of the second quarter of 2016).
Ajiya Bhd managing director Datuk Chan Wah Kiang hopes to see more stimulus policies that involve the strengthening of ownership of affordable houses. More efforts should also be focused on expanding the housing supply and containing cost escalations.
“We hope to see more policies that will further encourage private participation in affordable housing, such as more joint-venture programmes with private developers to build affordable houses. With the young forming the bulk of the Malaysian population, there will be strong demand for starter homes,” he says.
“The price of many of the residential properties available now do not meet this market’s demand. We are pleased with the Government’s direction and initiative to push for PR1MA and other schemes for first-time home buyers.
“Lastly, we hope the Government will introduce measures to help companies address the issue of the rising cost of business arising from the manpower shortage, such as providing more funds and especially tax incentives for affordable housing to encourage large-scale and even compulsory industrialised building systems in their job scopes,” says Chan,
Meanwhile, Ekovest Bhd’s managing director Datuk Seri Lim Keng Cheng hopes the Government will look into the corporate tax rate to ensure it is similar to neighbouring countries.
“This lower rate will definitely appeal to foreign investors and with large sums of investment coming into Malaysia, the spillover effect will definitely be felt by the rakyat,” says Lim.
He adds that Ekovest supports the recent announcement to allow developers to lend money to purchasers. However, this policy and its mechanism need to be studied in detail to ensure that it is not abused and the scheme will ultimately benefit purchasers, especially first-time home owners.
“I also hope that the developers’ interest-bearing scheme (DIBS) can be reinvented and reintroduced to further boost the property market. Its mechanism needs to be improved to ensure that speculators do not benefit,” he says.
Property developers have reiterated their wish list for Budget 2017, mostly centred on relaxing guidelines for first-time home buyers.
> The reintroduction of DIBS for first-time home buyers;
> Financing flexibility of 95% loan for first home buyers, 90% for second homes, followed by 70% for third homes;
> A higher debt service ratio from 70% to 80% for first home buyers and the loan tenure to be extended from 35 years to 40 years;
> Increasing the funds in Employees Provident Fund (EPF) Account 2 from the current 30% to 40% of total balances to allow for higher mortgage down payments; and
> Lowering or removing the real property gains tax or RPGT.
Credit Suisse notes that most developers are now focused on “affordable housing”. However, the demand-supply gap in the market remains unmet, judging from the uninspiring mortgage loan approval rate (42% in August 2016).
“We do not believe there will be a broad-based relaxation of cooling measures for the property market, which could fuel speculative purchases once again. Household debt as a percentage of GDP is at a record high of 89%. Milder measures to increase home ownership and dishing out affordable housing projects seems more likely, in our view,” says Credit Suisse.
All that could fuel speculative purchases once again, which Credit Suisse believes is against Bank Negara’s priority to keep household debt controlled (currently 89% of GDP).
“To increase home ownership substantially, what we believe could work is to raise financing only for first home buyers to 95%, and allow for an increase in the withdrawal limit from EPF Account 2.
“However, the latter could require further studies by the EPF due to the long-term repercussions on future retirees.
“What is more certain is that Budget 2017 will continue to focus on affordable housing projects. We expect updates on the progress of government housing initiatives such as PR1MA, SPNB and PPA1M with new allocations made, and developers could also be given more incentives to encourage the building of more affordable homes,” adds Credit Suisse.
The FBM KLCI has generally displayed a strong tendency to rally prior to the budget, with the excitement typically fizzling out post-budget, as killjoy sets in for the lack of strong catalysts.
Kaladher is anticipating similar behaviour this time around due to economic reality and the necessity to keep a tight rein on the budget deficit.
“In the last 19 years, the benchmark index has shown a strong tendency to rally in the two-week period prior to the budget with a probability of 78.9% and an average gain of 2.8%.
“Chances for post-budget corrections for the same duration are 57.9% with an average return of -3.6%,” Kaladher notes.
He notes that from a total average return perspective, the FBM KLCI tends to underperform during the first two months of the post-budget announcement before bouncing back for a year-end or New Year rally.
Kaladher is not changing his 2016 year-end target of 1,705 based on the 2017 price earnings ratio (PER) of 15.8 times. Market jitteriness over the impact of a US rate hike and its presidential election will cap further upside due to current high foreign shareholdings in our capital market.
Kaladher is positive on the construction, building materials and consumer sectors. Multi-billion-ringgit projects in the pipeline will ensure long-term earnings visibility for the first two sectors, while the consumer-related sector will reap the benefit from cash handouts and measures implemented to enhance the disposable income of the B40 and M40.
Looking at the market, Chan says that the market pricing of the FBM KLCI seems mixed in nature. One market-positive observation is that the consensus downgrades in the index target could be nearing its tail-end. As such, a strong turnaround or upgrade in the consensus index target will be the long-awaited market catalyst.
“Fundamentally speaking, we believe a broad-based earnings growth story is still missing despite our net earnings growth rates of 1.6% and 7.2% for 2016 and 2017, respectively.
“The FBM KLCI is now trading at 16.1 times and 15 times of Kenanga’s 2016 and 2017 earnings forecasts. Historically, the FBM KLCI has traded between 15.5 times and 17.0 times for the period of 2011-2015.
“We maintain our end-2016 index target of 1,715, implying a 2016 and 2017 PER of 16.6 times and 15.5 times. We have also introduced an end-2017 index target of 1,755.”