After a washout second quarter, a better second half?


By Pankaj CKumar

FM KLCI fair value

AS expected, Corporate Malaysia’s second quarter earnings were extremely disappointing as most corporates, other than the glove sector and, to a certain extent, the plantation and technology sectors, were lashed by the tsunami of movement control order (MCO) and recovery MCO period that followed thereafter.

However, the saving grace is as we are now in the third quarter period and soon into the final quarter, most investors have already factored in the earnings’ whitewash for this year as all eyes are now focusing on 2021 expectations. So, just how bad was the second quarter results?

Based on data from 12 brokers, the percentage of companies that reported disappointing earnings dropped to 34% in the second quarter against 46% in the preceding quarter while companies that surprised the market jumped to 20% in the latest quarter against 11% in the first quarter period.

Hence, the disappointing ratio improved to 1.7x from 4.15x. The jump in the total number of companies that surprised the market and lower number of disappointments perhaps came from the mellowed down expectations from analysts due to the MCO period and this was already reflective in the earnings growth projection of -15% for 2020 at the end of the first quarter results period and before the current reporting period.In terms of earnings, second quarter earnings came in at 37.8% lower quarter-on-quarter (q-o-q) and an astonishing 53.2% drop on a year-on-year (y-o-y) basis. The decline in earnings was almost 3x the 18.6% y-o-y contraction in economic activity in nominal value and about twice the 17.8% q-o-q fall in economic output.

For the first half period, earnings fell by 39.6% y-o-y as economic output fell by 8.7% in nominal terms.

As second quarter earnings remain disappointing, earnings forecast for 2020 has again been cut, but this did not cause a drop in the FBM KLCI fair values as the market is now pricing in FBM KLCI fair value based on 2021 earnings. As a matter of fact, due to the deep cut for the year 2020, earnings are now expected to rebound strongly next year.

For this year, earnings had been forecast to contract 15% at the end of the first quarter but have now been revised to a staggering contraction of 20.4%. For 2021, brokers are now projecting an earnings expansion of 30.2%, much higher than the earlier estimate of a 19.7% increase.

The jump in earnings forecast for 2021 is mainly driven by the lower base effect due to earnings contraction this year. In essence, earnings growth in 2021 basically suggests that as far as earnings are concerned, the market is looking at a sharp V-shaped recovery. Based on current estimates, total earnings of companies under brokerage in 2021 will be about 4% higher than the absolute level seen in 2019.

Over the past few months, thanks largely to the spectacular rally among glove stocks, the market fair value of the FBM KLCI has steadily been rising in line with the higher target prices for Top Glove and Hartalega.

From just 1,421 points three months ago, the market fair value was raised to as high as 1,537 points just before the current reporting season, an increase of 116 points. Post-second quarter results, three brokers lowered their FBM KLCI fair value by between 28 points and 50 points while three others raised it by between 20 points and 80 points.

On average, the market fair value has been raised by just six points to 1,543 points from 1,537 points prior to the results season. The current fair value of the FBM KLCI now ranges between a low of 1,400 points to a high 1,650 points based on PER multiples that are pegged between 15x and 19x 2021 earnings and on average PER of 17.1x 2021 earnings.

With the FBM KLCI at 1,515 points as at Thursday’s close, the market is now trading at just 28 points discount to consensus fair value for the FBM KLCI.

Over the past seven quarters, analysts have been cutting estimates every quarter mainly due to the disappointing earnings from Corporate Malaysia. However, in the last reporting quarter, due to the improved momentum in terms of number of companies that reported better than expected earnings, we are finally seeing an uptick in the FBM KLCI’s fair value on a q-o-q basis as can be seen in the chart.

Of course, the change in q-o-q is also brought about by the significant contribution from the two index-linked glove manufacturers.

With just four months to 2021, the stock market is now looking at next year’s earnings momentum, which at 30% growth, is attractive given the deep dive in numbers this year.

Over the next few months, the key to the market’s outlook would be the performance of other regional markets, liquidity factors, the end of the banking sector moratorium, tabling of Budget 2021 and potentially, the 15th General Election.

Investors are also expected to keep a close eye on development in relation to Covid-19 cases and deaths, development on vaccine, and of course, whether the glove boys would be able to deliver earnings that are now cast in the minds of investors.

All in, we are in for a better second half of 2020 and into 2021, as fear and greed has now been replaced by hope and confidence.

After all, even the pace of selling pressure from foreign shareholders has eased with the August 2020 net outflow reduced to about RM1.49bil, which was the lowest since January 2020, when net outflow stood at RM138mil.

Pankaj C. Kumar is a long-time investment analyst. The views expressed here are the writer’s own.

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