AMONG the comments that were made at the of second quarter earnings season ended three months ago is that we have probably seen the worse in terms of earnings disappointment and investors should see better performance among our corporates going forward.
Guess what? Sorry guys, corporate Malaysia has disappointed the market yet again and we as investors would need to accept another apology from Malaysian companies for failing to deliver on earnings growth, as the just concluded third quarter earnings season remain as disappointing as before.
The recently concluded Q3 reporting season marked the fifth consecutive quarter of negative year-on-year (y-o-y) earnings contraction, as earnings fell by 6.2% while on a quarter-on-quarter (q-o-q) basis, earnings were lower by 3.1%. With this, Malaysian corporates remain in earnings recession or “ER”.
The only consolation we can take are related to two factors, but they are rather weak. Firstly, based on the data reported by brokers covering the Bursa Malaysia listed companies, earnings growth for the Q3 period was a smaller contraction against the Q2 period’s y-o-y contraction of 7.9%.
Nevertheless, this “positive” take is negated by the larger contraction in earnings in the Q3 period against the Q2 period’s 0.1% q-o-q decline. For the nine months period ended Sept 30, Malaysia corporate earnings fell by 7% on a y-o-y basis and the disconnect between earnings and economic growth remains.
Second plus point is the performance in terms of actual earnings vis-à-vis market expectations. The Q3 earnings season was slightly better as the number of companies that beat expectations was marginally better than the preceding quarter as number of companies reporting disappointing earnings was held steady at 36%.
Among the companies that surprised the market, 15% managed to do so in Q3 against 10% in the Q2 period. Hence, the disappointing ratio improved from 3.52x to 2.4x – a ratio that suggests that the gap between actual and market expectations is narrowing, but not by much.
Earnings disappointment in the current quarter were mainly due to slower loan growth and higher credit cost among banking stocks, lower crude palm oil prices for plantation sector, tough property market for the real estate companies and the impact of negative growth in the real economy for the construction sector.
The automotive sector was great for national marques at the expense of falling sales for non-national cars, some oil and gas stocks saw big misses among Petronas-related companies while accounting treatment related to MFRS 16 continue to impact companies that have large operating leases. Telcos were generally disappointing while consumer companies too were surprisingly weak, led by, as expected, continuous contraction in market share for companies like BAT due to rising illicit cigarettes.
With the disappointing earnings, earnings forecast for 2019 has again been slashed down, along with target prices as well as fair value for the FBM KLCI.
On average, from the earlier estimated negative earnings of 1.4% in 2019, the revised estimate is now at negative 3.1%, which is another drop of 1.7 percentage points.
For 2020, brokers are projecting an earnings expansion of 7.8%, which is 0.7 percentage points higher than previous forecast of 7.1% growth. This stellar growth expectations for next year is driven mainly due to the lower base effect as well as expectations of earnings recovery, which may or may not materialise.
As market is trading near the year’s low and based on eight brokers that were polled, the FBM KLCI target level for 2019 is at an average of 1,613 points at a PER of 16.8x against a fair FBM KLCI value 1,647 points based on PER of 16.9x three months ago – which is another reduction of 34 index points or 2.1%.
Interestingly, the market’s fair value is based on average PER of 16.8x, which is still on the high side given the compression in earnings.
Based on the FBM KLCI’s close of 1,564 points on Thursday, the market forecast of 1,613 points for the KLCI at the end of the year is not too far fetch as its just 49 points or 3.1% upside, which is still possible, if window dressing activities kicks-in among index-linked stocks.
Individually, three brokers have left their forecast for this year unchanged at 1,583 points, 1,620 points and 1,650 points respectively. Six other brokers have reduced their forecast by between 20 point and 70 points while one other broker reduced its estimate on the FBM KLCI by a massive 110 points to just 1,570 points from 1,680 points three months ago. The current fair value of the FBM KLCI now ranges between a low of 1,570 points to a high 1,650 points based on PER multiples that are pegged between 15.9x and 18x.
As we are less than a month away to the New Year, do we have a perfect view of 2020 earnings momentum? With brokers’ average earnings growth of about 7.8% and with the index fair value of 1,666 points, it seems the market’s upside for next year is kind of muted at just over 100 points or 6.5% from its current level.
However, as most investors are aware, the index may not be reflection of where strong investment gains can be made as the Malaysian bourse has always been a market where investors get to pick the right stocks to beat the market’s benchmark.
In fact, most of Bursa’s other indices are higher year-to-date ranging from 2.7% for the Bursa Malaysia Utility Index to as high as 47% for the Bursa Malaysia Energy Index. Only three indices have underperformed the FBM KLCI 7.5% decline year-to-date and they are the Bursa Malaysia Industrial, Property and Finance indices, which are down 10.1%, 10.3% and 11.7% respectively.
As for what the watch out for next year as far as the market is concerned, this column will be exploring further in the year ender article at the end of this month.
For now, while we are earnings in recession, it is hope we won’t be getting into the other Emergency Room or ER – the popular medical TV drama series which was mostly about how medical staff dealt with critical life and death situations which lasted for 15 seasons.
For corporate Malaysia, it is hoped that after five seasons of being in ER, it’s about time to get out of it, i.e. to turn corporate Malaysia’s performance with positive earnings growth momentum on a y-o-y basis.
The views expressed are the writer’s own.
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