AFTER the end of the fourth quarter 2018 results season three months ago and due to the poor set of results, we entered into earnings recession, which is defined as back-to-back negative earnings growth for the two consecutive quarters measured on a year-on-year (y-o-y) basis.
As we had just completed the first quarter 2019 earnings season, has corporate Malaysia’s earnings improved or worsen?
The only good news is that based on the data reported by 10 brokers covering Bursa Malaysia listed companies, earnings growth has turned positive on a quarter-on-quarter (q-o-q) basis as the first quarter 2019 earnings expanded by 7.4%, reversing the fourth quarter 2018 and third quarter 2018 q-o-q contraction of 7.2% and 6.1%, respectively.
Now the bad news. Firstly, Malaysian corporates are still bleeding, as earnings contraction measured on a y-o-y basis fell by 8.3%. Nevertheless, the negative growth in earnings has been reduced compared with the larger 15.3% y-o-y contraction in the fourth quarter 2018, but still much worse than the pullback we saw in the third quarter 2018 when earnings dropped by 7.8% y-o-y.
Secondly, earnings continue to disappoint in terms of meeting expectations, as this is quite typical for the first quarter reporting period. Some 35% companies reported earnings that were below expectations in the first quarter against 31% in the preceding quarter.
Among companies that surprised the market, just 12% managed to do so in the first quarter 2019 against 20% in the fourth quarter 2018. Hence, the disappointing ratio, as widely expected, dropped from 1.56 times to 2.92 times – a ratio that suggests analysts were too bullish in their estimates and hence the cut in earnings, fair values and market call that follows naturally thereafter.
One of the factors that determine market’s poor earnings report card was poor commodity prices, especially for planters, while the banking sector – with the exception of RHB Bank – showed slightly disappointing set of results mainly due to lower income and tighter net interest margins while the adoption of new accounting rule MFRS16 gave some surprises too, both negative and positive.
What does this mean for markets? With the first quarter 2019 y-o-y earnings contraction and as corporate earnings remain disconnected with the real economy, which expanded by 4.5%, analysts have lowered their 2019 earnings growth forecast for the market as a whole. On average, from the earlier estimated earnings growth of 6.7% in 2019, the revised estimate is now at 4%, a drop of 2.7 percentage points.
For 2020, brokers are now projecting an earnings expansion of 7.4%, which in actual fact is 0.4 percentage points higher than the previous forecast of 6.9% growth. This is mainly on the back of lower base effect for this year’s earnings and expectations of better performance next year.
Lower earnings for this year suggest that the market as a whole is actually trading at a much higher price-earnings ratio (PER) multiple than initially thought as earnings were actually much lower than forecast.
What is interesting this time compared with the fourth quarter 2018 is that due to the poor set of results, most brokers have not only cut their earnings forecast for the current year, but along with it, a lower FBM KLCI target.
Based on 10 brokers that were polled, the FBM KLCI target level for 2019 is now at an average of 1,697 points at a PER of 16.9 times against a fair FBM KLCI value of 1,740 points based on PER of 16.7 times previously – a reduction of 43 points on average or down by 2.5%.
Individually, two brokers have left their forecast for this year unchanged at 1,820 and 1,700 points, respectively. One broker only reduced targeted FBM KLCI by 5 points (why bother even?) while four others reduced their forecasts by between 35 and 42 points. One other broker reduced by 60 points and another by 80 points, but the most aggressive cut was a whopping 131-point cut to the FBM KLCI fair value for this year to just 1,679 points from 1,810 points three months ago.
Interestingly, no broking house dared this time to raise their respective FBM KLCI target due to the poor reporting quarter. The current fair value of the FBM KLCI now ranges between a low of 1,596 points to a high 1,820 points – some 224-point differential between the two extremes. The wide range of the market’s fair values is mainly due to the PER multiple assigned to the estimated target values which range between a low of 15.5 times to a high of 19.0 times.
As we are in the month of June now, the first half of 2019 is coming to a close. Corporates will be busy again to close their books for the quarter and start reporting their performance from mid-July onward. Question on everyone’s mind would likely be will the second quarter be any different that the preceding two quarterly periods? Will we finally see a reversal in the earnings recession that we have seen in the past three quarters?
With the reversal in earnings momentum observed on a q-o-q basis as well as brokers largely cutting their index target levels, the level of market expectations on earnings and valuation has indeed dropped and it is more reasonable now. This gives an even chance for corporates to finally deliver earnings that can perhaps match expectations, finally.
Having said that, it is perhaps an opportune time to re-look at the market now. In fact, since its recent closing low of about 1,598 points on May 24, the FBM KLCI has performed reasonably well with the benchmark index gaining some 2.8% over the past three weeks alone. It is widely expected that we may see a much better second quarter performance among corporates due to lowered market expectations and perhaps its time to re-visit your individual portfolio as the time to buy is now.
In fact, net foreign buying, which is another factor that is correlated to the FBM KLCI’s dismal performance since GE14, has turned positive with net foreign inflow of about RM551mil, turning net buyers in six out of the last 10 trading days. Looks like the market has found its bottom at around the 1,600-point mark and the time to buy is now.