The overall corporate earnings performance for fourth quarter 2014 (4Q14) ended December 2014 were lacklustre.
In spite of that, analysts expect companies to deliver better financial performance for upcoming quarters supported by measures to improve their financials.
The research arm of Kenanga Investment Bank Bhd (Kenanga Research) believes that there could be ‘silver lining’ for listed companies to register better earnings in the later part of the year judging from their corporate earnings forecast.
Nonetheless, the research house does not foresee large improvement for the recovery of corporate earnings in the near future, especially before the Goods and Services Tax (GST) implementation, due to lack of immediate catalysts.
Kenanga Research head Chan Ken Yew said, “The recently concluded corporate results season appears to be better in contrast to the previous quarter.
“The ‘disappointment ratio’ has improved to 38 per cent after registered a multi-quarter low of 40 per cent in 3Q14 and 37.4 per cent in 2Q14 and 32 per cent in 1Q14.
“Based on 129 stocks under our coverage, there were 49 and 31 of them either within or above expectations.
“In other words, 49 of them or 38 per cent, still performed lower than expected.”
“However, this set of results is considered uninspiring after significant revisions during the previous results reporting season,” he told BizHive Weekly in an e-mail interview.
Concurring with Chan’s view is the research division of CIMB Investment Bank Bhd (CIMB Research) which observed the latest corporate results provide a glimpse of hope for companies to post better figures ahead despite the challenging operating environment.
CIMB Research head Terence Wong said, “The 4Q14 results showed encouraging signs.
“It was not as bad as we had feared with the percentage of companies that beat forecasts increased to 19 per cent from 13 per cent.
“As a result, our revision ratio (number of forecasts upgraded against number of forecasts downgraded) improved significantly to 0.62 times from 0.36 times.
“Although the ratio remained below one time, which means there could be more earnings downgrades than upgrades, the higher ratio is encouraging,” he observed.
With improved percentage of companies posted better-than expected figures as compared with the previous quarter, analysts opined that it could be one of the signs that future earnings have room to recover further in subsequently quarters.
Moving on, analysts believe initiatives and commitments to be undertaken by companies to put them on stronger financial footing will eventually be reflected in their accounts in the later part of the year.
They expect corporate earnings to improve further supported by corporates which leverage on investments in new capacity and technology to boost turnover and profit as well as the implementation of cost control and cost cutting initiatives.
Initiatives to improve results
For instance, CIMB Group Holdings Bhd (CIMB Group) had recently announced that the banking group is set to reduce its workforce across Asia as part of its cost restructuring exercise.
The banking group was understood to be cutting its investment banking cost by as much as 30 per cent, one of its efforts to enable the group to achieve its return on equity (ROE) target of more than 15 per cent by 2018.
CIMB Group added the company is embarking on a medium term strategy plan to put the banking group in a stronger financial footing known as Target 2018 (T18).
Apart from that, the financial institution highlighted its key area focus ahead is costs while the banking group is also looking to streamline some of its businesses to improve operational efficiencies.
Meanwhile, CIMB Group told Bursa Malaysia last February its quarterly earnings for 4Q14 dropped 77 per cent quarter-on-quarter (q-o-q) and plunged 81 per cent year-on-year (y-o-y) to RM200.32 million, the lowest in the last nine years and since the 4Q05 ended December 2005.
Similarly, Alliance Financial Group Bhd (AFG) registered lower q-o-q and y-o-y net profit for the third quarter financial year 2015 (3QFY15) ended December 2014.
The banking group in a filing to Bursa Malaysia in February said its 3QFY15 net profit dropped by 30 per cent q-o-q and 7.4 per cent y-o-y to RM126.37 million.
AFG group chief executive officer Joel Kornreich said, “The group continues to pay heed to initiatives relating to streamlining of processes, productivity improvement and cost management as part of its strategic priorities in the year.
“Operating expenses for the nine-month period (9MFY15) increased by 3.4 per cent y-o-y attributed to marketing expenses.
“Concurrently, the group continued with its investments in human capital and infrastructure, as well as initiatives to re-engineer operations, transform branches and expand channels to deliver superior customer service.
“Given the external headwinds, we do expect top line revenue growth to remain a challenge with intensified competition for funding and increased volatility in financial markets.
“Notwithstanding this, we will continue to stay focused on building strong relationships in key customer segments as well as leverage on the group’s infrastructure and distribution networks for business growth.
“We will also continue to exercise caution, implement vigilant risk management, and stay focus on asset efficiency, liquidity management and capital management as part of our balance sheet optimisation priorities going forward,” Kornreich said.
To note, CIMB Group and AFG were two banking groups that reported large drop in quarterly earnings in 4Q14.
On a larger picture, the prospect for the banking industry remain challenging this year amidst limited growth potential arising from intense competition for net interest income and higher funding costs.
Following the 4Q14 banking results recently, RHB Research Institute Sdn Bhd (RHB Research) in a sectors’ update note said net interest margin (NIM) for banks remains under pressure from rising funding cost.
The research firm said, “We believe the rise in 4Q14 funding cost was due to a combination of re-pricing of fixed deposits following July 2014’s overnight policy rate (OPR) hike (of 25 basis points) and deposit competition to fund the pick-up in loan growth as well as to meet regulatory requirements.
“Also, we believe the deposit competition in 4Q14 was exacerbated by seasonality (year-end window dressing for banks closing off their financial year) as well as tightness in banking system liquidity.
“Hence, we believe the combination of the above factors together with the need to manage margins have led some banks ending 2014 with a loan-to-deposit ratio (LDR) of more than 90 per cent, which is more than the typically-cited LDR comfort level of 85 per cent to 90 per cent, “ RHB Research said.
For this year, the research firm noted some of the banks have hinted at NIM compression of eight to 10 basis points with profit margins to be affected by funding costs.
RHB Research added several large banking groups have also set a lower loan growth target of nine to 10 per cent this year, a reduction from more than 11 per cent in the previous year.
It explained that the lower growth could be attributed to slower lending activities to the household and corporate segments amid various macro prudential measures introduced to control credit and the uncertain external environment.
The research firm explained further that despite major banks targeting the small and medium enterprise (SME) segment, a smaller portion of their loan book portfolio to be their key loan growth driver this year, the stronger growth from the segment might not be sufficient to lift their overall loan book expansion.
Additionally, Kenanga Research said banks’ profitabilities were still affected by higher credit cost or provisioning amid moderating in top-lines growth and lower interest margin.
Despite the subdued outlook for the banking sector this year, analysts believe others sectors such as utility, technology, construction and healthcare will perform well this year.
Outlook on Sectors
Following the 4Q14 corporate results announcement, analysts continued to favour several sectors which are able to register y-o-y and q-o-q earnings growth.
They believe those sectors such as healthcare, construction, technology and utility will remain resilient and continue to maintain their stable earnings ahead in spite of the challenging period.
The research arm of Maybank Investment Bank Bhd (Maybank IB Research) in a report said sectors that reported both y-o-y and q-o-q core earnings growth were technology, glove manufacturers, consumer, property developer and utility.
Maybank IB Research noted that earnings for utility players in 4Q14 were mixed while Tenaga Nasional Bhd’s (TNB) financial performance had beaten expectations due to a combination of low fuel costs and seasonally low non-fuel costs.
The research firm added Petronas Gas Bhd’s results was also above its expectation boosted by savings from tax credits while the results for YTL Power International Bhd was within its expectation but Gas Malaysia Bhd’s results had missed forecast.
Analysing the trend from the latest corporate results, Chan of Kenanga Research said, “As for the various sectors under our coverage, they have been showing either neutral or mixed results in nature with technology and the ‘sin’ sectors delivered better-than-expected results while glove, consumer retail and aviation industry’s results were weaker-than-expected.
He explained that glove manufacturers’ financial performance in 4Q14 were affected by higher-than expected operating expenses arising from new recruitment of labour and start-up costs incurred for new plants despite being one of the export-oriented sector.
Notably, he observed Supermax Corporation Bhd’s (Supermax) results were dragged by lower-than-expected sales volume as well.
As for retail sub-segment, Chan said industry players were hit by lower-than-expected gross margin and higher-than-expected operating expenditure due to aggressive promotional and sales to defend market share amid rising competition.
Apart from that, Kenanga Research noticed certain industry players have started to clear or write down their inventories ahead of the GST implementation.
On the contrary, it highlighted semiconductor manufacturers reported good set of results, underpinned by their better-yielding products amidst the overwhelming demand of new smartphones.
“The encouraging financial performance for the semiconductor sector was also boosted by weaker ringgit against the US dollar.
“We believe this sector should continue to do well in coming quarter, judging from the favourable ringgit trend.
“Besides, the reasonably strong results by Malaysian Pacific Industries Bhd (MPI) has also reaffirmed our bullish recommendation.
“As for other blue-chips, TNB had actually delivered an electrifying set of quarterly results.
“The stronger-than-expected results were attributed to lower fuel cost and lower effective tax rate.
“However, we have revised down our earnings estimate for TNB after the recent announcement of 5.8 per cent (electricity) tariff cut,” he pointed out.
On another note, he observed brewers also reported earnings that were above the research firm’s expectations attributed to better product mix and successful marketing campaigns.
Furthermore, CIMB Research said the research firm is bullish on the utility sector given its stable earnings and steady cash flows generation capability.
It opined that the government will resume its reform agenda for the utility sector this year despite the slower than expected implementation of the fuel cost pass-through (FCPT) mechanism.
The research firm noted weaker commodities prices also provide some relief to power generation fuel costs, which in turn will benefit TNB’s earnings.
Thus, CIMB Research reiterates its belief that the utility sector will perform well in the current weak financial market conditions due to its stable earnings and cash flows which are supported by long-term power agreements.
Wong of CIMB Research is also optimistic on the construction sector.
He outlined, “Public and private sector projects will continue to be the main themes for construction in 2015.
“We continue to expect more progress in the RM150 billion total value of outstanding major infrastructure projects for 2015 and onwards.
“This includes the RM25 billion Mass Rapid Transit Line 2 (MRT2) in the Klang Valley, the tender for which should start in the second half of this year and several more highway infrastructure projects on top of the remaining works for the West Coast Expressway (in Peninsular Malaysia) as highlighted in Budget 2015,” he believes.
Moving on to the healthcare sector, RHB Research opined that the growth of the industry remains ‘attractive’ given its defensive nature of business and long-term growth prospects post expansion by major healthcare players.
Moreover, the research firm said the industry’s growth is also supported by increasing healthcare expenditure, population affluence and more awareness towards health issues.
In the meantime, RHB Research observed healthcare players namely IHH Healthcare Bhd (IHH Healthcare) and KPJ Healthcare Bhd (KPJ Healthcare) which are under its coverage registered strong financial performance during 4Q14.
The research firm noted the stellar results from both the healthcare players were boosted by increased in revenue arising from higher inpatient admissions and intensity per patient due to seasonally strong fourth quarter for hospital operators as well as gain from foreign currency translation to ringgit.
For the oil and gas sector, Kenanga Research observed that industry players experienced challenging period during 4Q14.
“For instance, offshore support vessel (OSV) players, Alam Maritim Resources Bhd (Alam Maritim) and Perdana Petroleum Bhd (Perdana Petroleum) posted weaker-than-expected 4Q14 results due to lower-than-expected utilisation and higher dry docking activities.
“Meanwhile, results of Perisai Petroleum Teknologi Bhd (Perisai Petroleum) and Malaysia Marine and Heavy Engineering Holdings Bhd (MMHE) continued to disappoint due to idling of assets and weak orderbook replenishment,” the research firm said.
As for the prospects of other sectors such as plantation, Kenanga Research said the outlook remain muted as most of the players just registered average crude palm oil (CPO) selling price of RM2,150 to RM2,250 per tonne, which is within the research house’s CPO price assumption of RM2,200 per tonne.
Given the less sanguine picture ahead for a few sectors for instance the oil and gas as well as plantation to rejuvenate with higher growth numbers, analysts have also scaled back their year-end target level of the market barometer, FBM KLCI post 4Q14 earnings.
Concurrently, they have also made some adjustment to their corporate earnings forecast for financial year 2015 (FY15).
Outlook for FBM KLCI movement
Kenanga Research said it has adjusted its FY15 and FY16 earnings growth forecast figure to 6.5 per cent and 5.4 per cent respectively from its earlier projection of 4.7 per cent and 7.4 per cent.
The research firm explained that the higher FY15 estimate growth number was due to lower earnings base in FY14 and they have yet to see significant downgrades in FY15 earnings estimates.
However, the research firm observed that its earnings forecast numbers still appear more conservative compared to consensus estimates of 7.6 per cent and 9.2 per cent.
With such revisions, Kenanga Research said its year-end FBM KLCI target is also being revised lower to 1,865 points from 1,905 points earlier.
In spite of that, the research firm believes there could be some upside potential from its Index forecast level compared to the current level.
It explained that the scenario is derived from the valuation of the Index which suggests a price-earnings-ratio (PER) of 19.1 times and 17.4 times compared to consensus’ current year and next year earnings estimates respectively.
“While market sentiment could improve in the future, as the small capitalisation PER multiple discount against the FBMKLCI PER has bottomed, we still prefer a ‘Buy on Weakness’ strategy when the Index is below the 1,800 points level.
“Stocks wise, the strong earnings turnaround of MMC Corporation Bhd (MMC) and good financial performance shown by Pharmaniaga Bhd (Pharmaniaga) have reinforced their selection as preferred counters for investment, “ Kenanga Research said.
Similarly, UOB Kay Hian Research also favours MMC as a theme investment strategy due to the upcoming listing of its power subsidiary Malakoff Bhd which could stir some excitement for the equity market in the short term.
The research firm advised investors to adopt a defensive strategy towards investment by investing in fundamentally strong large capitalisation companies such as IJM Corporation Bhd (IJM Corp), Malayan Banking Bhd (Maybank), SapuraKencana Petroleum Bhd (SapuraKencana) and TNB.
Going forward, UOB Kay Hian Research believes that the movement of the FBM KLCI could have upside limited potential in the first half of this year due to lack of external and domestic catalysts.
Therefore, the research house expects the benchmark index to ease towards the lower level of its trading range of 1,700 points to 1,810 points before staging a more sustainable recovery towards 1,810 points by end of the year when crude oil prices are expected to recover towards a new long-term ‘norm’ of around US$70 to US$80 per barrel.
Besides that, the research firm also expects corporate earnings to regain its recovery momentum in the subsequent quarters of 2015.
Affin Hwang Investment Bank Bhd (Affin Hwang) on the other hand expects the Malaysian equities market to move in range-bound especially in the first half of the year.
The research firm believes positive factors that are favourable and supportive for the equities market include Malaysia’s healthy economic growth projection of five per cent this year supported by consumer spending and investments as well as the country’s current account remain in surplus.
On a positive note, Kenanga Research observed the excess liquidity in the banking system remains supportive for the domestic equity market.
The research firm noted as at end of January 2015, excess liquidity stood at about RM300 billion, which was just RM20 billion off its highest level.
At the same time, the research firm believes Brent crude oil price has found a bottom recently and is poised to stage a consolidation judging from its historical volatility study.
Kenanga Research noted the volatility of Brent crude oil price has registered a three-year high some weeks ago.
Statistically speaking, the research firm believes the high volatility for Brent crude oil price is not sustainable and the price could potentially stage a reversion and move back to its average price level in the future.
Thus, the research firm opined that in the event Brent crude oil price is going to reverse its downward trend, this development will be positive for oil and gas companies.
Aside from that, Affin Hwang said potential catalysts for the benchmark FBM KLCI to move higher include the strengthening of oil price that may lead to stronger ringgit and a spillover of liquidity from Europe’s quantitative easing (QE) into the Southeast Asia region.
On the flip side, the research firm pointed out risks for its recommendation include further downgrades of corporate earnings that will have an effect on the stock market, a downgrade of Malaysia’s sovereign ratings that could cause the ringgit to depreciate further and significant geopolitical events.
Among the stocks which Affin Hwang prefers for investment are Astro Malaysia Holdings Bhd (Astro), IJM Corp, Kossan Rubber Industries Bhd (Kossan Rubber), Public Bank Bhd (Public Bank), Hong Leong Bank Bhd (HLBB) and TNB.
The research firm added the least preferred stocks include AMMB Holdings Bhd (AMMB), UMW Oil and Gas Corporation Bhd (UMW-OG), MMHE and AirAsia X Bhd (AirAsia X) as it does not expect those companies to register a turnaround for their financial results in the near term.