Overshadowed by Asean markets
Still expensive — does not deserve a premium rating
Structural and political challenges aside, the market’s near-term obstacle is its stretched valuation. The market is currently trading at a 3%-11% premium to the region at 17.7x and 15.2x PER 2009E and 2010E, respectively.
This appears to be at the upper end of the market’s post-Asian crisis valuation range of 12.5-18x forward PER. On a P/B basis, the market is trading at 2-2.1x for the same period, again at a 5%-11% premium against the region.
Within an Asean context, Malaysia trades at the highest PER valuation and offers the second lowest, after Indonesia, net dividend yield at 3% for 2010.
Not surprising then that Indonesia and Thailand have both enjoyed net fund inflows given a combination of attractive valuations (Thailand at 11.5x PER 2010 and Indonesia at 13.8x PER) and strong revision ratios.
In fact, despite mixed political news flow in Thailand, the market continues to maintain a high level of foreign ownership at c. 33% (vs 21% in Malaysia). The positive news is that earnings risk has abated since 1Q.
However, in a regional context, Malaysia is in sharp contrast to say a market like Korea where earnings revision has been strong. Malaysia lags in EPS and target price revision momentum. This clearly explains why the market is still placed in the region’s low beta “bucket”.
Significant improvement in 2Q; earnings expectations raised
Of the 21 Deutsche Bank-covered stocks which reported, 61% were in line with expectations, 29% above and 10% below. The results were far better than the first quarter.
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Financial sector came through unscathed — positive; PLANTATION [] sector rebounds
The star of the reporting season was the banking sector. Most of the banks reported stronger-than-expected earnings driven largely by higher non-interest income and lower loan loss provisions. Again, this tells us that the Malaysian credit cycle is turning out to be less severe than anticipated.
The plantation sector too had a reasonable quarter after what was a very weak 1Q production season given the effects of severe floods in East Malaysia. 2Q was supported by stronger CPO prices and production lifting, though marginal.
The gaming companies did not have a weak quarter as many had originally expected. Domestic consumption trends held up. There was slight weakness in results from companies like DiGi.Com (RM21.66, hold, target price RM19.80) which had the slowest quarter in more than six years) and KNM (75 sen, buy, target price RM1.10) which faced margin pressure.
The trajectory for earnings recovery is now far more convincing after the 2Q reporting season. We believe the lumpy writedowns as a result of diminution in value of major investments are now largely behind the market. Leading indicators in the economy have also been encouraging with a bottoming in industrial production, electricity sales, and loan approval and applications.
Post-2Q results: EPS growth at -8.6% and 17% for 2009 and 2010
Prior to the reporting season, we were forecasting EPS growth of -7.1% for 2009 and 9.9% for 2010, respectively. Today, these forecasts have been revised to -8.6% and 17.4%, respectively. The stronger growth outlook for 2010 was largely due to EPS revisions for the financial, plantation, CONSTRUCTION [] and gaming sectors.
Domestic liquidity; top-down index target suggests 13% upside
Domestic funds like the Employees Provident Fund (EPF) and PNB have been actively buying in the market, especially where foreign interest has waned. This explains why foreign ownership in the market has stayed flat at around 20%-21% despite the recovery in the market.
This trend is likely to persist in the near term, thereby keeping market valuations lofty. Our 12-month bottom-up index target for Deutsche Bank’s universe of stocks suggests an MSCI target of 453 (0.4% upside) and an FBM KLCI target of 1,213 (+0.4%). This compares against the consensus bottom-up target of 1,234, which suggests upside of 2.2%. We believe the key difference between the Street and our estimates is our slightly more conservative view on GDP growth estimates, currently at -3% and 4% for 2009 and 2010, respectively.
Putting this in the context of Asia, our regional strategist, Niklas Olausson, expects MSCI Asia ex-Japan to reach 522, suggesting upside of 18.2%.
With most markets expected to offer upside of more than 15%, Malaysia is naturally an underweight, along with Hong Kong, India, and the Philippines. The implied top-down valuation of 17.2x 2010 PER is at the upper end of Malaysia’s historical trading range. By using our bottom-up approach, with an implied valuation of 15.3x PER, this puts Malaysia in the “fair” territory, the mid-range of its post-Asian crisis PER band.
Local news flow can drive interest in the market despite demanding valuations
There have been times when the market outperforms the region momentarily on domestic news flow, ignoring valuations. In recent years, market-friendly initiatives, such as the first stage of GLC restructuring, have ushered renewed interest in the market.
Similarly, the property market liberalisation in 2007 prompted a re-rating of the smaller- to mid-cap sectors. We think a similar re-rating is likely to occur if and only when the market is convinced of three key issues.
First, that Barisan Nasional is gaining traction with the voter base, hence providing the market with renewed confidence that the corporate landscape or regulatory environment does not run the risk of significant changes under a new party. Secondly, sustainable signs that structural changes made are bearing fruit. Thirdly, potential sizeable new listings to force attention back into Malaysia, as discussed earlier.
Positioning into the final quarter of 2009/early 2010
We believe most would agree that Malaysia has been a difficult market for most of 2009. Often the market has been referred to as “Asia’s rounding error”, “Asia’s lost child” and “Asia’s most unloved market”, etc. And indeed it has been the worst-performing market in Asia ex-Japan year to date.
But we also argue that it does not mean the entire market is a write-off. Far from it, we believe. In fact, Malaysia has always been a stock-pickers’ market. We believe it is important to select stocks for the final quarter of 2009 or early 2010 with the following pointers in mind:
• To focus on companies with growth prospects outside Malaysia, and especially those with an increasingly strong Asean/regional footprint; for example CIMB, Genting and IJM Corp.
• To focus on companies that have structurally transformed themselves by utilising improved systems and infrastructure to take advantage of a more robust economic environment next year; for example, AMMB.
• Returns being the priority of top management and having the ability to execute on the plans. Many Malaysian companies place significant emphasis on enhancing shareholders’ return but very few actually execute on them with a structured plan. Companies that have articulated their returns policies, and where we have a high degree of comfort of execution are Public Bank (though a hold), KL Kepong (has consistently paid >50% dividend payout ratio in the last four years) and CIMB.
• To focus on companies that continue to generate strong cash flows and are still dominant in their industry, ideally not heavily reliant on the domestic market for growth; for example KLK.
• Avoid companies that are heavily reliant on government contracts — political news flow is likely to stay volatile in the near term.
• Quality stocks tend to hold their valuation premiums, defying fundamentals at times — largely due to scarcity reasons and often, liquidity. These include companies such as Public Bank, IJM Corp and IOI Corp (RM5.21, hold, target price RM5.05).
Risks to our underweight call on the market:
The biggest risks to our Underweight call on the market fall into three areas.
The first risk is better-than-expected macro indicators as a result of the second stimulus package and improvements in domestic consumption trends. The second risk is that market liberalisation/structural change measures surprise the market. The last risk is a sudden collapse in neighbouring markets, such as Indonesia, prompting a sudden surge of liquidity into low-beta markets such as Malaysia.
Written by Financial Daily
Friday, 16 October 2009
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