FOR a start, the market is aware that earnings expectation for this year is extremely bullish, mainly driven by the low base effect from last year.
Hence, on a year-on-year (y-o-y) basis, earnings momentum for the year is expected to be strong based on the assumption that Malaysia will move away from lockdowns as the vaccination drive takes precedence, and Malaysia reaches the much-talked-about herd immunity by next month.
As we know, the Q2’2021 economic performance was much better than expected as the nation’s economic output expanded by 16.1% y-o-y, reversing the deep dive of 17.1% economic contraction a year ago.
Nevertheless, the Q2’2021 performance was somewhat deflated by the announcement by the government to enter into full movement control order since the beginning of June, although essential services were allowed to operate.
Hence, it was of no surprise that on a seasonally adjusted basis, the Q2’2021 period experienced a gross domestic product (GDP) contraction of 2% on a quarter-on-quarter (q-o-q) basis.
Worse, June saw economic activities reversing the positive momentum with a drop of 4.4% y-o-y.
With Q2’2021 GDP data coming in well above market forecast of a 14.1% y-o-y expansion as compiled by Bloomberg from a survey of 19 economists, Q2 earnings momentum too kept up with the recovery of the domestic economy.
Of course, as the Q2 period of last year was a low point, we saw Q2 earnings leapfrogging strongly as earnings expanded by 157.2% y-o-y but just higher by 3.7% on a q-o-q basis.
Compared with the preceding Q1’2021 reporting season, the Q2 performance was much stronger on a y-o-y basis as the Q1’2021 period had earnings growth of 66% on a y-o-y basis.
Nevertheless, the q-o-q momentum was slower as the Q2 growth of 3.9% trailed the stronger 18.5% q-o-q growth in the preceding quarter.
However, despite the strong earnings momentum, the ratio of companies’ earnings that surprised the market against disappointment fell again as some 30% of companies reported earnings that were below expectations against 24% that was above.
This translates to an earnings disappointment ratio of 1.28 times, which is larger than the preceding quarter’s 1.07 times and Q4 2020’s reading of just 0.48 times.
After the strong quarterly performance in Q4’2020 and Q12020, the momentum of earnings surprises are waning, judging by more disappointments than surprises in the Q2 results season.
The recent Q2 period saw big surprises among commodity-based companies, led by our plantation sector as crude palm oil prices maintained their rally.
Although the sector was affected by labour issues, which impacted productions, almost all companies managed to show a strong quarterly report card.
This was also seen among other commodity-based companies like Press Metal, due to higher aluminium prices, and Petronas Chemical, which saw the company having a better refining margin.
The much-unloved sector, our glovemakers, did not disappoint, with spectacular earnings growth, driven by respectable average selling prices (ASP).
However, the sector is now perceived to be heading towards headwinds as ASPs have peaked and trending lower while capacity build-up is beginning to add to the supply side of the equation.
The Q2 performance among the top four glovemakers remained relatively strong with revenue higher by 3.3% q-o-q to RM12.2bil, while net earnings expanded by 4.7% q-o-q to RM6.3bil. The technology sector too did very well with good earnings momentum while selected banking stocks showed stellar quarterly results.
Sentiment driven rally
Post the Q2 report card, there has been a mixed response from brokers in terms of earnings revision or the fair value of the FBM KLCI. In fact, before the Q2 earnings season, some brokers had already lowered the market expectations in terms of earnings momentum and the FBM KLCI’s fair value, mainly due to the prolonged lockdown period and to a certain extent the political impasse.
With the Q2’2021 earnings coming in surprisingly strong on a y-o-y and respectable q-o-q growth, the earnings forecast for the year has generally been higher.
Nevertheless, the revision is rather small and insignificant. For this year, from the earlier forecasted earnings growth of 48.7% at the end of the Q1’2021 quarterly reporting period, the revised estimate is now at 49.5% y-o-y growth, which is just 0.8 percentage points (pps) higher.
For 2022, brokers are projecting an earnings growth of 3.3% which is 1.2 pps higher than the previous growth forecast of 2.1%.
However, a word is caution is warranted from these data as they include the earnings performance of the glovemakers too, which is expected to be significantly higher y-o-y this year but drastically lower next year.
Hence, if one were to remove the impact from this gyrating performance from the glovemakers, the earnings momentum for this year will be much lower, at about 40%, while for next year, the market’s earnings momentum will be much stronger instead, with a growth of about 16%.
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 higher FBM KLCI fair value this time around.
Broking firms have now set targets that range between 1,590 pts and as high as 1,780 pts for next year’s forecast based on a Price Earnings Ratio (PER) multiple of between 14.2 times and 16.2 times.
On average, the fair value for the FBM KLCI is seen at 1,675 pts based on a 15.3x PER multiple. This is lower than the level pegged at the end of Q1 reporting season three months ago of 1,718 pts which was based on a PER of 15.9x.
Positioning for recovery and into 2022
With the hope that the political temperature has now been lowered with the appointment of Datuk Seri Ismail Sabri Yaakob as the nation’s ninth Prime Minister, it is hoped that we can move forward in tackling the incidence of Covid-19 cases by flattening the curve, reaching the 80% vaccination rate soon and moving towards Phase Two, Three and finally Phase Four.
We also hope that economic matters can be addressed and the government has a chance to do so when it tables two important documents later this month and next month – the 12th Malaysia Plan (12MP) on Sept 27, and the Budget 2022 on Oct 29.
The 12MP will give investors a glimpse of Malaysia’s focus over the next four years plus or so as the nation takes a step closer towards achieving the Shared Prosperity Vision 2030 while Budget 2022 is expected to lay down the government’s plan to kick start the economic recovery process that is much needed to go back to pre-pandemic levels.
With the anticipated higher debt-to-GDP ceiling of 65%, the government will now have more firepower to provide financial assistance to the needy and to make sure we are able to crawl back to the growth path on a sustainable basis from 2022 onwards, with nominal GDP surpassing the level we saw in 2019.
As for markets, we have seen the return on foreign funds over the past four weeks or so as Malaysia plays catch-up with the regional markets, being one of the most underperforming year-to-date and relatively cheap when measured against Asia ex-Japan.
Over the last four weeks, the net buying interest among foreign portfolio fund managers reached RM2.14bil and it is surely a sign that the market is riding on positive market sentiment and more so, driven by relatively inexpensive valuations.
Hence between now and the end of October, and into the 3Q reporting season, the market has several events to look forward to and this will likely dictate the market’s direction over the near term.
By then, investors will begin to discount this year’s earnings as the market looks forward to next year’s earnings, which, if we exclude the volatile glove earnings, will be growing at a decent 16% y-o-y growth.
Applying a 16 times PER for 2022 earnings, which is based on five-year mean FBM KLCI PER, and based on market earnings growth expectation of 3.3%, the FBM KLCI is seen to be fairly valued at about 1,810 pts.
Based on Thursday’s FBM KLCI’s close of 1,579 pts, the market’s fair value for next year gives a good 14.6% upside to investors and they should position themselves for this recovery momentum and positive market sentiment over the next 12-15 months.