Malaysia is facing increasingly tough outlooks. External conditions alone remain less favourable with analysts noting that the US recovery momentum has somewhat lost traction, although the research arm of MIDF Amanah Investment Bank Bhd (MIDF Research) does not expect the economy to slip even further from where it is now.
“While the eurozone’s recovery is picking up, the pace is rather modest and the uncertainty cast by the Greek problem may continue to put a damper on market sentiment,” it said.
The research arm’s mammoth concern is China, where the seven per cent growth in the 1Q15 may easily slide by 50 to 100 basis points (bps) in the following quarters as stock markets – the only part of the economy that had been doing well thus far – began to show signs of lethargy.
MIDF Research had earlier made a call for the US economic growth at 2.7 per cent for 2015 but the research arm is revising it to 2.3 per cent in view of the significant amount of slowdown in the industrial production index (IPI) in the 2Q while the leading indicator suggests growth to stay flattish thereafter.
It noted that the supporting factor to growth in the second half (2H) period would be the gains from the improvement in the labour market that should translate into modest gains in domestic demand.
According to MIDF Research, Malaysia’s April IPI had eased significantly to four per cent from a brisk 6.4 per cent in the first quarter of 2015 (1Q15), indicating growth could lose further m-o-m mentum in the 2Q-3Q.
“Near term future trends as indicated by the forward-looking indicators suggests that there is further downside in IPI in the 2Q which is justified by the further weakness in China and flattish performance in the US manufacturing sector,” it said.
However, the research arm expected real gross domestic product (GDP) would rebound albeit modestly in the 3Q15 on low base factor but this rebound would prove to be weaker if the pullback from net exports is bigger.
Malaysia’s economy had remained resilient with its GDP registering a growth of 5.6 per cent in 1Q15.
Malaysia’s Department of Statistics noted that GDP in current prices amounted to RM277.2 billion in this quarter. In constant 2010 prices, GDP registered a value of RM254.4 billion.
Meanwhile, Bank Negara Malaysia had said in a report that the growth was underpinned mainly by the private sector demand while on the supply side growth was supported by the major economic sectors.
“On a quarter-on-quarter seasonally-adjusted basis, the economy recorded a growth of 1.2 per cent,” BNM said.
Private sector drives growth
BNM further highlighted that private sector activity remained the key driver of growth during the quarter.
Private consumption had expanded at a stronger pace of 8.8 per cent, compared to 7.6 per cent in 4Q14, supported by stable labour market conditions and higher wage growth.
The bank noted that the strong private consumption growth was also contributed by the flood relief efforts early in the year, and the front-loading of household spending prior to the implementation of goods and services tax (GST).
According to the research arm of Kenanga Investment Bank Bhd, private consumption grew 8.8 per cent year on year (y-o-y) in 1Q15, and this appears to be encouraging as it was the highest since 2012.
However, Kenanga Research’s economists attributed the growth to the increased consumer spending leading up to the implementation of GST as consumers brought forward their purchases in anticipation of price increase arising from the consumption tax.
“On the other end, the inflation level has continued to rise in the second month of GST implementation in May,” the research arm said.
Kenanga Research added that it was signalled by the latest consumer price index (CPI) figures which inched up by 2.1 per cent y-o-y, higher than 1.8 per cent in April and the average of 0.7 per cent in 1Q15.
Meanwhile, BNM reported that private investment recorded a growth of 11.7 per cent (4Q14 at 11.1 per cent), underpinned by capital expenditure in the manufacturing and services sectors.
“Growth in public consumption improved in the first quarter (4.1 per cent; 4Q14 at 2.5 per cent), due to higher growth in supplies and services amid moderate growth in emoluments.
“Public investment turned around to register a positive growth of 0.5 per cent (4Q14 at minus 1.9 per cent) following higher capital spending by the Federal Government,” it said.
On the supply side, the bank said that growth in 1Q was supported by the major economic sectors.
It noted that the services sector was underpinned by growth in all subsectors, particularly consumption-related sub-sectors.
“Growth in the manufacturing sector was supported by stronger performance in the export-oriented industries, particularly the electronics and electrical (E&E) cluster.
“The construction sector was supported mainly by the non-residential and residential sub-sectors, while the mining sector continued to record stronger growth amid higher crude oil production.
“Meanwhile, the agriculture sector contracted as a result of lower palm oil production, arising from flood-related disruptions,” it added.
External headwinds
Going into the second half of 2015 (2H15), the research arm of Affin Hwang Investment Bank Bhd (AffinHwang Research) also believed that the country’s IPI will continue to be affected by external headwinds, possibly from the impact of the stock market crash in China and unresolved debt crisis in Greece, which may lead to some slowdown in the global economy.
AffinHwang Research noted that Malaysia’s manufacturing Purchasing Managers Index (PMI) has already trended lower by 1.9 percentage points at 47.6 in June, suggesting slower growth m-o-m momentum in the economy.
It further noted that this was also in line with global manufacturing PMI, which slowed further to 51 in June (51.3 in May), as well as the monthly Organisation for Economic Cooperaton and Development (OECD) composite leading indicator (CLI) which has eased from 100.3 in January to 100 in May 2015.
The research arm added that the International Monetary Fund (IMF) has also trimmed its 2015 growth projection by 0.2 percentage points to 3.3 per cent, attributed to lower growth projections for advanced economies.
On a quarterly basis, with slower growth in the manufacturing and services sectors, AffinHwang Research estimated that real GDP growth is likely to have grown at a slower pace of 4.5 per cent y-o-y in 2Q15, from 5.6 per cent in 1Q15.
The research arm maintained its long-held GDP growth forecast of five per cent for 2015, which is at the mid-point of the official projection of 4.5 to 5.5 per cent (six per cent in 2014).
“However, if global economic growth deteriorates leading to slower demand from China for Malaysia’s manufactured goods in 2H15, we believe the country’s real GDP growth will be slightly lower than our current forecast.
With that, BizHive Weekly delves into analysts’ second half outlook for Malaysia’s major economic sectors.
Automotive: Neutral
Analysts are generally positive that auto sales, which took a hit in the first half of 2015 (1H15) due to weaker consumer sentiment, will improve in the 2H, on the back of marketing activities and festivities, among others.
The research arm of Kenanga Investment Bank Bhd (Kenanga Research) believed that auto sales will pick up in the 2H underpinned by aggressive advertising and promotion (A&P) activities, festivities and stronger seasonal patterns.
It recalled that the 2H auto sales for the past three years accounted for 51 to 52 per cent of the full year total industry volume (TIV) numbers.
The research arm believed auto companies will be more aggressive on A&P activities this year, to make up for the shortfall in 1H which was caused by weaker consumer sentiment on the back of goods and services tax (GST) implementation.
Hence, it viewed that the stronger sales in the 2H are very likely to be at the expense of margins erosion.
Another headwind, in Kenanga Research’s view, that will suppress margins is the old issue of unfavourable exchange rates, particularly auto players (in the research arm’s portfolio universe: UMW Holdings Bhd and Tan Chong Motor Holdings Bhd) with highly denominated US dollar costs due to the import of completely built up (CBU) vehicles, completely knocked down (CKD) packs and other components.
“Hence, we remain selective in our picks and prefer players that are less vulnerable to the weakening of the ringgit with its targeted customer base in the middle-income to high-income brackets that are less sensitive to the rising cost of living,” it said.
As for AffinHwang Research, it expected softer sales for the auto players in 2Q15 as it believed that consumers are still trying to come to terms with the increase in the overall cost of living post-GST.
“While we believe that auto sales will fare better in 2H15 post the GST lull period, the highly competitive and difficult operating environment may still prove a challenge for auto players without a strong product line-up,” it said.
AffinHwang Research noted that while a handful of mass market models showed a decline on a month-on-month basis (namely Honda and Perodua), luxury car brands such as BMW which was up 21 per cent month on month (m-o-m), Lexus (up 14 per cent m-o-m), Audi (an increase of three per cent m-o-m) and Mercedes (up 23.2 per cent m-o-m) still registered strong positive growth in sales in May 2015.
This reaffirmed the research arm’s belief that consumers in the higher income bracket have been least affected by the increase in prices post-GST versus the lower- and middle-income groups.
Thus, AffinHwang Research maintained its 2015 TIV forecast of 680,000 units and ‘neutral’ recommendation on the auto and auto parts sector.
Kenanga Research also maintained its ‘neutral’ rating on the automotive sector with an unchanged 2015 TIV forecast of 667,000 units (flat growth assumption).
Healthcare: Overweight/Underweight
Demand in the healthcare sector has remained resilient and analysts are expecting the industry in Malaysia to continue enjoying stable growth.
In its June sector report, AffinHwang Research had noted that over the past decade, demand for private healthcare has been on the rise, in tandem with rising health awareness and increased affluence.
AffinHwang Research further noted that Malaysia’s private healthcare demand has also grown due to favourable demographics as the population ages, insufficient public healthcare facilities and improving insurance and employee medical benefits.
The research arm believed scarcity of syariah-compliant healthcare stocks like IHH Healthcare Bhd and KPJ Healthcare Bhd justify their current premium valuations, supported by current demand for defensive and resilient stocks in a volatile Malaysian market.
“Furthermore, we believe that Malaysian healthcare stocks have higher potential earnings growth compared to their regional peers.
“As demand for private healthcare rises in Asia, Malaysian healthcare players are at the forefront in capitalising on this market with their expansion plans,” it said.
Meanwhile, the research arm of Kenanga Research noted speculation has been rife that the Health Ministry may prohibit doctors from dispensing drugs to their patients and hence restrict their roles to only prescribing.
“It was also reported that organisations representing doctors and pharmacists have agreed, in principle, for the dispensing function to be served by pharmacists.
“If this materialises, pharmacy operators will be the winners of the new system as their sales would be boosted considerably,” Kenanga Research said.
The research arm has however noted that pharmaceutical players being the source suppliers to both the medical fraternity and pharmacies are unlikely to enjoy any new impact.
Specifically, revenue generated by Pharmaniaga Bhd, under its coverage, is supported by government concession agreements, nongovernment purchasers and exports to a smaller extent.
Overall, Kenanga Research believed that the healthcare industry in Malaysia will continue to enjoy stable growth supported by growing healthcare expenditure, rising medical insurance and aging population demographics.
The research arm noted that looking ahead, the implementation of the GST and further subsidy rationalisation programme could dampen private hospitals’ margins and volume growth while pharmaceutical products are more stable.
“From our channels check, we understand that several private hospital players are expected to raise prices in order to mitigate the higher operating cost due to the implementation of GST which could ultimately exert a negative impact on their margins.
“Generally, healthcare services providers’ operating expenses are expected to increase as they have to pay for GST on business purchases or raw material costs before selling but are unable to claim credit for the GST paid on the inputs.
“Similarly, higher prices charged by hospitals as well as further subsidy rationalisation programme could potentially dampen purchasing power of consumers leading to lower volume in patients,” it said.
Consumer: Neutral
The implementation of the goods and services tax (GST) on April 1 has had quite an impact on the consumer sector, with the retail and multi level marketing (MLM) sub-sectors affected the most while the food and beverage (F&B) segment remained solid.
Analyst Soong Wei Siang of the research arm of Kenanga Investment Bank Bhd (Kenanga Research) noted that 1Q15 results showed that the F&B sector is still able to register growth in spite of the challenging market environment with consumer sentiment collapsing to a six-year low.
Soong said that all the F&B stocks with the exception of Dutch Lady Milk Industries Bhd recorded earnings within Kenanga Research’s expectations and they observed that volume growth was still intact as compared to other sub-sectors in the consumer space.
The research arm however, noted that the retail and multi level marketing (MLM) sectors delivered uninspiring results as the worsening consumer sentiment took its toll on demand.
An interesting trend that Kenanga Research observed during the quarter was the stocking up activities in anticipation of the GST implementation on April 1.
“The trend was very obvious in the MLM industry as distributors were seen front-loading products before the GST implementation but was milder in other sub-sectors.
“We were not surprised by such behaviour as big-ticket products or items with more durability were being stocked up before the GST inflation.
“Thus, we foresee the sales of companies that benefited from the pre-loading stocking up to normalise in coming quarters,” the analyst said.
Meanwhile, the research arm expected a transition period of six to nine months subsequent to the GST implementation for the consumers to adapt and acclimatise to the new costing environment.
It noted that prior to that, sales growth is expected to be subdued.
Kenanga Research foresaw the consumer sentiment to remain subdued in near term as consumers take time to adapt and acclimatise to the new costing environment as well as to the global uncertainties.
“Thus, we expect the retail and MLM sectors to suffer in view of the persistently weak sentiment as we think that consumers are likely to tighten their spending budget, particularly for discretionary expenditures,” Soong said.
Moving forward, the research arm’s economists are forecasting slower private consumption growth of 6.8 per cent in 2015 (2014:7.6 per cent) to be in line with the slower GDP growth.
Meanwhile, Kenanga Research said that inflation is expected to be lower at two per cent to 2.5 per cent as compared to 3.2 per cent in 2014 with the strict enforcement of anti-profiteering laws to keep the prices stable despite the GST.
“In a nutshell, we view the macro environment to be supportive for the consumer sector with healthy private consumption growth and manageable inflation rate,” the analyst said.
While Kenanga Research still favoured the F&B subsector in the consumer space, the research arm reckoned that the valuation of the F&B stocks under its coverage have peaked with most of them trading at above plus one standard deviation (SD) over mean.
Thus, the research arm switched its focus to mid-and-small cap F&B counters to tap their steady growth in a challenging market environment, ability to preserve or improve earnings margins on the back of favorable raw material prices, and the exposure to the strengthening of US$ with exports sales.
Kenanga Research reaffirmed its ‘neutral’ stance on the consumer sector as the research arm was cautious on the growth in retail and MLM industries in view of the worsening local consumer sentiment.
On the flipside, the research arm favoured the F&B sector as it has shown resilience and defensive nature amid the challenging times.
“We also think that investors should look at small to mid-cap F&B stocks with the gradual pick-up in interest due to their defensive and resilient nature while the valuation of large caps have peaked,” Soong said.
Plantation: Neutral
The plantation sector, which saw Malaysia’s production decline month on month (m-o-m) in June, is expected by analysts to see stronger palm oil prices in the second half (2H).
According to RHB Research Institute Sdn Bhd (RHB Research), Malaysia’s production fell by 2.6 per cent m-o-m to 1.763 million tonnes, mainly due to Sabah’s 7.7 per cent decline.
“Sabah has been unusually dry this year since February. Until recently, trees were found to display as many as six unopened spears,” it said.
The research house expected a seasonal upcycle to lift production in the months ahead, noting that year to date (YTD) production was flat at 9.045 million tonnes.
RHB Research said that Malaysia’s local palm oil consumption rose to 267,500 tonnes in June, the highest in the past five months.
The research house believed there will be further growth in the months ahead as Sarawak’s fifth biodiesel blending facility becomes fully operational in September.
So far, this year has seen total local usage of 1.546 million tonnes, representing a growth of 8.1 per cent.
RHB Research noted that inventory fell back by 4.3 per cent m-o-m to 2.151 million tonnes on stronger demand and weaker production.
“Amidst the current production upcycle, we expect some further increase in stockpile, although India’s strong demand will likely keep the increase in check,” it said.
The research house noted that Malaysia’s June palm oil exports were lifted almost single-handedly by India.
“We expect India’s strong demand to continue as its monsoon has faltered, with likely poor crop this season,” RHB Research said, adding that it expects palm oil prices to strengthen in 2H.
According to TA Research, US National Oceanic and Atmospheric Administration’s (NOAA) Climate Prediction Center in its July 9 statement had said that “there is a greater than 90 per cent chance that El Niño will continue through Northern Hemisphere in winter 2015 – 16, and around an 80 per cent chance it will last into early spring 2016”.
It noted that on the downside, the potential near term risks are another round of rout in the global equity markets and an extended weakness in the crude oil price.
Given that first five months of 2015 (5M15) exports at 6.14 million metric tonne (MT) is eight per cent lower than 5M14 at 6.65 million MT, it said that “there is a good chance we will see demand playing catch-up in the latter half of the year”.
“Hence, we expect 2H15 CPO exports at 9.96 million MT, or 28 per cent above our 1H15 CPO export forecast of 7.78 million MT, and this should help offset the negative price pressure from seasonally higher 2H production,” it added.
Despite increasing its CPO price forecast, Kenanga Research retained its ‘neutral’ call on the sector as the research arm though that although the demand outlook is improving, near-term supply remains more than ample and this could limit immediate CPO’s price upside. Similarly, TA Research and RHB Research remained ‘neutral’ on the sector, with the latter adding that it was ‘overweight’ on Singapore/Indonesian plantation.
Shipping and ports: Neutral
The limitations on the overall growth in the shipping industry has led analysts to be generally neutral on the shipping and ports sector, as they note a mixed outlook in the shipping industry while the ports industry is “still awaiting catalysts”.
According to analyst Soong Wei Siang of Kenanga Research, the outlook of the shipping industry is mixed with LNG still falling due to the lacklustre demand and overcapacity of vessels, while the situation is not expected to improve much with new vessels (eight per cent of the current fleet) coming on-stream in 2015.
Soong said that chemical charter rate also remained lacklustre on the back of weak demand.
“The saving grace was the petroleum charter, which continued the resurgence into 2015 while the momentum should be sustained in view of the steady demand on the back of low crude oil prices and slow new ships delivery,” the analyst added.
As for the ports sector, Kenanga Research noted that the much-anticipated tariff hike has not materialised so far, with the exact timeline and quantum still unknown at this juncture.
“However, we do not think that tariff ceiling upwards revision can translate into a linear positive increment in revenue for the port operators as some of them may be charging their core clients at lower rates than the ceiling tariff.
“We believe a tariff ceiling hike is imminent despite timing uncertainty given that the tariff ceiling has not been lifted for 10 years despite rising fuel and electricity costs,” Soong said.
That said, the research arm was not factoring in any potential impact from the tariff ceiling revision due to uncertainties in timing of implementation and quantum.
Nonetheless, it still expected robust growth considering the sustainability of the Malaysian economy and also local ports to slightly benefit from the cheaper rate advantage as compared to the nearest competition in Singapore.
While Kenanga Research was neutral on the mentioned core sectors above, the research arm favoured the local logistics sector as it believed the sector is poised for re-rating thanks to the resilient growth moving forward, with the industry projected to grow by compound annual growth rate (CAGR) of 11.2 per cent over the next five years.
The research arm believed the logistics sector in Malaysia offers a good shelter in these volatile times, as well as providing good opportunity for investors to tap into the resilient growth of the sector.
All in, Kenanga Research reiterated ‘neutral’ on the shipping and ports sector.
“We think that the positives in petroleum charter rate resurgence will be offset by the weakness in LNG and chemical charter rates, while the slowing global economic growth will also limit the overall growth in the shipping industry,” the analyst said.
“Meanwhile for the ports’ operators, while we think that the sentiment could potentially be buoyed by the tariff hike, the actual financial impact would be limited due to the reasons mentioned above but the growth will be supported by the sustainability of the Malaysian economy.”
Telcos: Neutral/Overweight
The telecommunications sector has recently displayed a highly competitive environment among its biggest players, leading most to find that the sector’s outlook appears challenging but manageable.
According to Kenanga Research, all the mobile players have adopted aggressive marketing approaches in both the prepaid and postpaid segments recently.
Kenanga Research noted that on the prepaid segment, incumbents tend to differentiate themselves through fast changing offerings and unique features to keep subscribers’ loyal.
In the research arm’s view, while these complicated ‘customised’ plans could draw subscribers’ attentions, it could also lead for higher operating and marketing costs moving forward.
“On the postpaid segment front, incumbents tend to lower their offer price on top of bundling with higher values.
“Thus, these could potentially lead to short-term margin’s pressure or even trigger a price war under the worst-case scenario,” it said.
While Kenanga Research believed the sector could face some margin pressures as a result of the lower broadband entry prices, it noted that the impact is likely to be short-lived given consumers’ tendencies to upgrade to higher connection speeds as well as subscribing to more valued-added and Internet-related services once they have more Internet experience.
On the other hand, Lim Tee Yang of AffinHwang Research believed the celcos’ focus will be on sustaining earnings before interest, tax, depreciation and amortisation (EBITDA) margins in the second half of 2015 (2H15), given the relatively soft figures seen in the first quarter of 2015 (1Q15).
“Amid a more competitive landscape, we think that sales and marketing efforts would likely remain extensive in 2H15 as the celcos seek to defend their market share,” Lim said.
So far, AffinHwang Research noted there is no change in EBITDA margin guidance by the celcos.
In the analyst’s view, other than higher-than-expected sales and marketing expenses, they see a stronger US dollar as a possible downside risk to their 2015 EBITDA margin estimates.
While not a major component of a celco’s overall cost structure, the research arm noted that international direct dialling (IDD) costs are mostly denominated in US dollar.
“Therefore a weak ringgit could inflate IDD costs and squeeze margins if cost management initiatives are not in place.
“The celcos do not disclose actual IDD costs separately and therefore it is difficult to gauge the actual impact,” Lim said.
AffinHwang Research thus remained ‘neutral’ on the sector, as it thought positive surprises in earnings are unlikely.
Nonetheless, the research arm believed the sector will continue to offer relatively resilient earnings and decent dividend yields.
“We prefer the pure domestic celcos to avoid exposure to the highly volatile RM and heightened risks in regional markets,” the analyst added.
Despite Kenanga Research admitting that the sector’s outlook appears challenging in view of the challenging economic outlook during the post GST transition period as well as intense competition (especially in the mobile space), the research arm believed the incumbents will be able to sail through the challenging wave under the cluster management strategy (which allow operators to response instantly and enhance operational efficiency).
It noted that heightened competition is not a new issue to the incumbents.
¡°In fact, the battle has been intensifying every year but yet most of the incumbents still managed to sustain their normalised EBITDA margin at reasonable range.
¡°Thus, so long as there is no irrational price war between the players as well as drastic changes on regulations, we believe, the incumbents’ EBITDA margin may likely to drift at their historical range over the short-to-medium term,” the research arm said.
All in, Kenanga Research maintained ‘overweight’ on the telecommunication sector given that value buys are emerging following the recent sell-down, decent dividend yield of circa four per cent and being a defensive sector, it could provide a good shelter to investors under the current volatile market.