A strong start

DESPITE the extension granted by Bursa Malaysia to report the quarterly results for the period ended March 31, 2021 to the end of this month, most corporates have been diligent enough to meet the original dateline, and hence, we have a good picture of corporate Malaysia’s performance for the recently concluded earnings season.

For the first quarter (Q1) itself, the economy as a whole performed better than expected, as the Q1 gross domestic product (GDP) came in at a 0.5% year-on-year (y-o-y) contraction against a forecast of a 1.9% decline, as the pace of economic recovery gathered momentum. This was despite the MCO 2.0 period that was imposed for about two months, especially in the Klang Valley and selected other states.

Due to a large extent of a low base effect, we saw the Q1 earnings rebounding rather strongly as they expanded by 66.3% y-o-y and 19.2% quarter-on-quarter (q-o-q). Compared with the preceding Q4 of 2020 reporting season, the Q1 performance was much stronger as the Q4 of 2020 period had y-o-y and q-o-q earnings growth of 16.3% and 15.3%, respectively.

However, the ratio of earnings that surprised the market against disappointment fell for the quarter under review as some 29.3% of companies reported earnings that were below expectations against 24.7% that were above. This translates to an earnings disappointment ratio of 1.16 times against the preceding quarter’s strong momentum, whereby disappointment was only from about 18.2% of the stock universe, while 38.0% were surprises.

In other words, the earnings disappointment ratio then was only 0.48 times. As this is still an early stage of the 2021 reporting season, earnings misses are rather common in the Malaysian context when one is comparing the Q1 period against the full-year forecast.

Notable sectors that showed earnings that were above expectations were mainly from the banking sector, which has the highest weightage on the FBM KLCI, and companies linked to the Petronas group of companies, but except for MISC Bhd. Strong momentum was also seen from Telekom Malaysia Bhd.

The plantation sector too outperformed, driven by higher crude palm oil (CPO) prices, while semiconductors showed stellar performance. Disappointments were again from sectors that are exposed to the pandemic, in particular the aviation sector, especially for AirAsia X Bhd, which posted a net loss of RM5.67bil for the quarter alone. The gaming sector too was poor, and this was from both the casino and numbers forecasting operators (NFOs).

A good 8.7% upside on the KLCI

Despite the Q1 earnings coming in surprisingly strong on a y-o-y and q-o-q basis, the earnings forecast for the year has been generally revised lower, as the earnings disappointment ratio had surged significantly. Nevertheless, the revision is rather small and insignificant.

For this year, from the earlier forecast earnings growth of 48.6% at the end of the Q4 of 2020 quarterly reporting period, the revised estimate is now at 47.7%, which is just 0.9 percentage points (pps) lower. For 2022, brokers are now projecting an earnings growth of 1.8% which is another one pps higher than the previous growth forecast of 0.8%.

With the small revision, we are also seeing the market’s projected fair value for the year-end relatively unchanged too. Only two broking firms had a lower KLCI fair value this time around while one firm raised the forecast by just 10pts on the index.

Broking firms have now set targets that range between 1,660pts to as high as 1,830pts for next year’s forecast based on a price earnings ratio (PER) multiple of between 15.2 times and 16.5 times. On average, the fair value for the KLCI is seen at 1,718pts based on a 15.9 times PER multiple. With the KLCI last seen at about 1,580pts as of Thursday’s close, the KLCI has some good 8.7% upside.

Positioning for the post-pandemic momentum

As Malaysia is now in the full MCO period, the time spent in economic hibernation for selected sectors is necessary as the nation attempts to bring down the number of cases and flatten the curve. As seen in the experience of other nations, this process will take time but the end result is that we will overcome the pandemic and be able to open up the economy fully, hopefully in Q3 of 2021.

Hence, as far as economic and earnings momentum is concerned, some wind has been taken out of the sail and it is likely the much anticipated strong economic growth momentum of about 20% y-o-y that is expected for Q2 of 2021, will now likely be at between a high single-digit and low double-digit y-o-y growth. However, if we can return to some form of normality by the end of August, Malaysia is in for a strong growth momentum for the rest of the year. This will likely see the country posting a modest GDP growth of between 4% and 4.5% for 2021.

As the market is always forward-looking, should this base case scenario materialise, it is time for investors to accumulate strong fundamental stocks that will ride the economic recovery and growth momentum. For now, the big winners this year have been the technology sector, the larger capitalised banking stocks, selected consumer names, and the telco sector. Clear laggards have been the glove sector, namely due to expectations of unfavourable demand/supply dynamics and falling average selling prices, and surprisingly, the plantation sector, despite the soaring earnings and higher record high CPO prices.

With that in mind and the likelihood that Malaysia will maintain the current interest rates level for the rest of the year, as the current rate remains appropriate and accommodative, the equity market should do well in the second half of the year as investors will start to position their portfolio for 2022 earnings expectations.

Commodities and cyclical will be the next winners

As the economy opens up, and borders begin to see the movement of Malaysians and tourist arrivals begin to see some sort of recovery, the early beneficiaries of this momentum will be the directly exposed sectors, ie, the aviation, tourism, and leisure service providers and retailers. Next on the list will be the cyclical sectors, the likes of building materials, construction or even the property names as economic normalcy brings greater certainty.

Of course, with headline inflationary pressure rising mainly due to a surge in commodity prices, we will also see key Malaysian exporters benefiting from the rally seen in crude oil palm, oil, and metal prices.

This includes the plantation sector, oil and gas sector as well as selected exporters who are beneficiaries of rising metal prices.

Given the positives of the market over the next few quarters there are also challenges, and of course, this includes the pandemic itself, the spread and the mutating nature of the virus, and the rate of inoculation of the vaccine.

Any departure from the current timeline of vaccination will further delay the expected recovery that we are pencilling now.

The other concern is the Malaysian topsy-turvy political scene which could turn out to be a headwind for the market especially if general elections are called. This will leave policy options cold for the time being.

However, the biggest challenge for markets is not only just factors within Malaysia but what is the direction of the US interest rates and the Fed’s trigger to start quantitative tightening.

While US Treasury Secretary, Janet Yellen, was quoted as saying higher inflation and interest rates are good for the US, the market will react negatively to rate hikes and the pace of increase as well as any measures that will pullback the market’s liquidity.

With the core inflation rate now well above Fed’s comfort zone, mainly due to the low base effect from last year and pressure from rising commodity prices, it is hoped that these headline numbers remain transitory and not a sustained shift towards higher prices.

Pankaj C. Kumar is a long-time investment analyst. The views expressed here are his own.

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