Thursday, January 21

Mismatch in 2Q17’s economy, but hope remains


Economic indicators this year have confused observers so far. The economy grew at a faster pace to date, but this was not reflected in corporate results across key Malaysian sectors.

A beacon of light came as Malaysia’s economy grew at a faster pace of 5.8 per cent in the second quarter ended June 2017 – the quickest since the first quarter of 2015 – exceeding economists’ forecast of a 5.4 per cent expansion, underpinned by the services and manufacturing sectors.

Bank Negara Malaysia (BNM) said given the strong growth in the first half of 2017 at 5.7 per cent, the economy is expected to expand by more than 4.8 per cent in 2017.

Governor Datuk Muhammad Ibrahim said the data looked good, with reference to the outlook for the third and fourth quarters.

He expected the growth outlook for 2017 to be revised when the Budget 2017/2018 proposals are presented on October 27.

In spite of this, businesses felt there was only a slight improvement in the economy in the first half of 2017, evidenced by the lower percentage of respondents who felt that the economy deteriorated in the first half.

According to a survey on first-half performance and second-half outlook by the Associated Chinese Chambers of Commerce and Industry of Malaysia (ACCCIM), a sum of 45.1 per cent respondents of Chinese businesses opined that the economy deteriorated in the first half of 2017, a drop from 56 per cent in the previous survey.

Meanwhile, close to 40 per cent of respondents believe that the economy had remained unchanged for the said period, up from 33 per cent in the previous survey.

Based on these survey results, 70 per cent of the respondents, compared with 72 per cent in the second half of 2016, replied that their firms’ sales performance for the first half was either good or satisfactory.

However, the number of respondents with poor sales performance went up two percentage points to 30 per cent. Poor sales were seen mainly from the manufacturing and wholesale and retail sectors.

ACCCIM said this came as a surprise given the improvement in Malaysia’s economic growth during the survey period of first half of 2017 at 5.7 per cent.

“It also suggests that some businesses have yet to benefit from the improvement in economic growth that was largely driven by exports and supported by private sector demand. Private sector activity continues to be the main engine and contributor for growth in the Malaysian economy.

“As such, attention should therefore be focused on assisting businesses to overcome these challenges, as their adverse performance could have a significant impact on the Malaysian economy,” it opined.


2Q17 reporting season a letdown

Researchers said that first-half 2017 growth was strong, but the sentiment on the ground did not reflect this growth.

This is seen as Corporate Malaysia delivered a disappointing set of results in 2Q. Take AmInvestment Bank Bhd (AmInvestment Bank) for example, whose portfolio saw 11 per cent of companies beating and 57 per cent meeting with projections, and 32 per cent coming in below.

This compares with 12 per cent, 63 per cent and 25 per cent for ‘above’, ‘within’ and ‘below’ respectively in 1Q 2017.

Against the market consensus, the numbers were equally uninspiring with ‘above’, ‘within’and ‘below’ at six, 54 and 40 per cent respectively, as compared with 13 per cent, 54 per cent and 33 per cent in 1Q 2017.

“FBM KLCI 2017 earnings growth lowered to 4.3 per cent from 7.2 per cent,” “ it detailled in a results review.

“After factoring the earnings changes, we tweak our FBM KLCI earnings growth forecasts for 2017F and 2018F down to 4.3 per cent and 8.7 per cent respectively, from 7.2 per cent and 8.9 per cent previously.

“Meanwhile, in terms of earnings growth forecasts of “all sectors” – a broader but slightly more volatile earnings gauge encompassing the entire universe of our stock coverage – the numbers for 2017F and 2018F have been adjusted to 6.4 per cent and 15.1 per cent respectively, from 10.8 per cent and 13.2 per cent previously.”

Similarly, MIDF Amanah Investment Bank Bhd (MIDF Research), also shared its observations whereby aggregate reported earnings of FBM KLCI 30 constituents totalled RM14.88b in 2Q17, lower sequentially at 5.7 per cent quarter on quarter but higher year on year at 1.9 per cent.

However, the aggregate reported earnings figure requires some adjustments in order for the sequential and on-year growth numbers to reflect a fairer picture of the benchmark’s earnings performance.

The aggregate normalised 2Q17 earnings of FBM KLCI 30 constituents were lower at RM14.57 billion,” it said in a separate report.

“Some of the major non-operational items reported during the review quarter were mainly attributable to a gain of RM497 million from the full disposal of stakes in Hap Seng Logistics Sdn Bhd by Hap Seng Consolidated Bhd, and RM131 million gain on the disposal of equity interest in Sime Darby Property (Alexandra) Private Ltd by Sime Darby Bhd.”

Positive on market still

Despite the disappointing 2Q17 results, AmInvestment Bank maintained its end-2017 KLCI target of 1,745pts and end-2018 KLCI target of 1,900pts, based on 17.5x 2017F and 2018F earnings, at a 1x multiple premium to the 5-year historical average of about 16.5x.

We believe the local equity market is steering into calmer waters in 2H2017, with abated concerns on Trump’s rhetoric, general elections in Europe and a steeper-than-expected rate hike cycle in the US.

As such, the cyclical upturn in corporate earnings will be in focus. We now project FBM KLCI earnings to grow by 4.3 per cent and 8.7 per cent in 2017F and 2018F respectively, underpinned by projected GDP growth of 5.7 to 5.9 per cent and 5.5 to six per cent in 2017F and 2018F.

Against a backdrop of a very gradual rate hike cycle in developed economies, we believe the “risk-on” trade will continue to prevail, which entails: the flow of money from the low-risk-low-return money market funds, to the higher-risk-higher-return equity and bond funds; and the sustained inflows to emerging markets – to both emerging markets equity and bond funds. This is positive to the local equity market.

“We believe the sentiment towards emerging markets will also be buoyed by US President Donald Trump’s protectionist and anti-trade rhetoric which has failed to materialise, emerging markets’ attractive valuation-to-growth matrix versus developed markets; and firming commodity prices.

“We like cyclical sectors such as financial services, property and consumer discretionary. We also like certain large-cap names with strong earnings resilience in the construction and power space. Small- and mid-cap stocks could be in the limelight thanks to government initiatives in Budget 2017.

“Meanwhile, MIDF Research reiterated its FBM KLCI year-end 2017 target at 1,830 points.”


Automakers to gain from ringgit’s rise

The ringgit is gaining strengths of late — even reaching its strongest level in the past ten months — and this is set to benefit automotive players if the currency continues to rise in the second half.

Ringgit watchers rejoiced last week when the currency rebounded from RM4.26 to RM4.19 per US dollar over a three-day period. This week, the currency is expected to continue appreciating in fair value and hover around 4.15-level against the US dollar.

Analysts now anticipate  ringgit appreciation bias to be sustained by a confluence of domestic and external factors.

AmInvestment Bank maintained its positive view on the ringgit due to six factors including stronger economic growth, healthy inflow of foreign funds into the equities market and easing inflation pressure.

Among these factors include the continued weakening pressure on the US Dollar Index due to the ongoing sentiments in the US.

To note, the US Dollar Index is a measure of the value of the dollar relative to a basket of foreign currencies.

AmInvestment Bank expects the index to hover around 90 to 91 in 2017.

“From our estimates, it shows more room for the ringgit to strengthen. Our fair value for the ringgit is around 3.95 against the US dollar.

“However, our year-end target for ringgit is 4.12 while our full year average is 4.33,” it said.

Bearing this in mind, MIDF Research compared the ringgit’s uprising with the recently reported 1H17 earnings which came on the back of still inflated levels of RM4.39 per US dollar.

“The current development underpins our bullish stance on the sector and our view that FY17F earnings will be backloaded on the back of more aggressive launches and the ringgit strength in 2H17.

“Who benefits? Of the auto players under (our) coverage, UMW Toyota has the largest exposure to the US dollar given that all its imported completely knocked-down (CKD) kits and completely built up units (CBUs) from Thailand are transacted in US dollar.

“Given low localisation rates of between 20 per cent to 60 per cent relative to the national makes of 80 per cent to 95 per cent, we estimate around half of total component costs are imported,” it said.

“Tan Chong, meanwhile, is estimated to have circa 80 per cent of total imported cost exposure to US dollar imports with the rest in Japanese yen.”

MIDF Research explained that every one per cent change in the US dollar impacts its FY18F by 4.7 per cent for UMW Group and 16 per cent for Tan Chong.

“As Tan Chong is loss making — relative to the steady state earnings of RM200 million to RM300 million annum prior to the downcycle — it is more sensitive to forex changes now.”


Japanese yen-exposed beneficiaries

The ringgit had also strengthened against the Japanese yen over the past six months and currently stands at RM3.88 per 100 yen.

Bermaz Auto is a key beneficiary of the Ringgit strength against the yen as its imports are 100 per cent exposed to the latter.

To note, Bermaz Auto is exposed to the yen via CBU imports, whereas CKDs such as the CX5 and Mazda 3 models are purchased at a fixed ringgit price from 30 per cent-owned Mazda Malaysia Sdn Bhd (MMSB), which is the importer of Mazda CKD kits and assembler.

“To make this possible, MMSB absorbs yen volatilities from CKD imports; which means that MMSB also benefits from the current ringgit’s strength,” it added. “ We estimate that every one per cent strengthening of the Ringgit against the yen impacts BAuto’s FY18F earnings by three per cent.

“Perodua is another beneficiary given its exposure to the yen, and partly, US dollar.”

MIDF Research saw that automotive players’ earnings in 2Q already showed signs of improvements.

For example, UMW autos’ pretax improved 14 per cent q-o-q to RM99 million while Tan Chong’s losses narrowed 35 per cent q-o-q to a net loss of RM23 million in 2Q17 on the back of improved volumes and slight improvement in forex.


Aggressive campaigns roll out   

Looking at campaign roll-outs, the research firm saw that non-nationals marquees were turning more aggressive.

Volume recovery has been healthy with year to date (YTD) total industry volume (TIV) growth of 4.7 per cent; Honda (29 per cent YTD) and Toyota (22 per cent YTD) are leading this TIV growth.

“Given the strong performance, Honda will be launching two additional models on top of the four – Honda BRV, Jazz Hybrid, City Hybrid, CRV – that were planned and already launched.

Toyota is launching four facelifts – the Vios, Fortuner, Hilux and Camry models – in 2H17. Toyota has also opened registration of interest for the popular CH-R model (B-segment SUV, competes with the CX3 and HRV) and is currently touring the Klang Valley to showcase the model prior to an expected launch in FY18.

“Our recent visit to a CH-R showbooth suggests a possible 3Q18 launch of the CBU-spec CH-R, to be available in two specs, namely the 1.8 litre and 2 litre hybrid with indicative initial import batch of 500 units.

“The first round of showcase at Setia City Convention Centre back in May already generated registration of interest by over 3,000 potential buyers. CKD of the CH-R is likely after UMWT’s Bukit Raja plant is completed by early FY19F, which could bring down cost of the CH-R substantially.

“The new Camry and the CH-R are expected to be Toyota’s key models for FY18F. On the national car front, Perodua which is 38 per cent-owned by UMW is speculated to launch the new MyVi in 2H17.”


Slower half ahead for banks

All seven of the banks’ under AmInvestment Bank Bhd’s (AmInvestment Bank) coverage were within expectation for the second quarter of 2017 (2Q17) which led to analysts trimming the banking sector’s core earnings growth for current year 2017 (CY17).

According to the research arm of Kenanga Investment Bank Bhd (Kenanga Research), all seven banks’  earnings were within expectation for 2Q17.

The results of Malayan Banking Bhd (Maybank), Public Bank Bhd (Public Bank), RHB Bank Bhd (RHB Bank), Hong Leong Bank Bhd (Hong Leong Bank), CIMB Group Holdings Bhd (CIMB) and Alliance Financial Group Bhd came in within Kenanga Research’s expectation while AMMB Holdings Bhd’s earnings met consensus expectation.

After the conclusion of the 2Q17 results, Kenanga Research trimmed the sector’s core earnings growth for CY17 to 6.4 per cent from 8.6 per cent.

This was after the research arm’s adjustment of earnings to Hong Leong Bank net profit estimates by factoring in higher cost-income (CI) ratio and credit cost assumptions.

“For Maybank, we have also tweaked our credit cost and CI ratio estimates higher as well as fine-tuned our projection of its operating income,” the research arm said.

Meanwhile, Kenanga Research’s CY18 earnings growth estimate was at 10.2 per cent, up from 10 per cent previously.

The research arm will refine its projection of CY18 earnings after the release of further guidance by banks on the impact of the Malaysian Financial Reporting Standard (MFRS) 9 closer to the implementation date of January,1 2018.

Kenanga Research expected the ability of banks to utilise regulatory reserves to be crucial as this will knock off some provisions that banks will be required to raise under the new accounting standard, leaving a milder impact on their respective common equity Tier 1 (CET 1) ratios.

The research arm also expected the impact of MFRS 9 to be more on banks’ balance sheet than profit and loss (P&L) as all increase in provisions on day one of the implementation will be charged off directly to banks’ shareholders’ funds, hence this will affect capital ratios, particularly CET 1 ratio of banks.

“After day one of the implementation, banks have yet to provide guidance on the run-rate of their credit cost,” it said.

Nevertheless, Kenanga Research expected the P&L (if any) from the MFRS 9 implementation to be significantly lower than the balance sheet impact on day one implementation of the new standard.

The research arm noted that the larger capitalised banks, Maybank and CIMB, appeared to be comfortable with their early assessment impact of MFRS 9.

It further noted that on the early assessment impact of MFRS 9, Maybank indicated a decline of 60 to 90 basis points (bps) to the group’s CET 1 ratio (without utilising regulatory reserves to offset against the potentially higher provisions from the new accounting standard).

“Meanwhile, CIMB Group hinted an early assessment impact of a 50bps drop on its CET 1 ratio on the basis that its regulatory reserves be allowed to offset against the higher provisions under MFRS 9,” the research arm said.

Overall, Kenanga Research maintained ‘overweight’ on the sector with ‘buy’ calls on RHB Bank and Public Bank.


O&G: Tough times persist but more contracts expected in 2H

A low number of outperformers in the eyes of Kenanga Investment Bank Bhd (kenanga Research) for 2Q17 led it to peg a dull outlok for oil and gas (O&G).

“In the recently concluded 2QCY17 result season, we saw lower number of outperformers, at only four companies out of nine in the previous quarter.

“Note that these four counters — namely Coastal Contracts Bhd, Dialog Group Bhd, Pantech Group Holdings Bhd and Yinson Holdings Bhd — had registered positive earnings surprises for at least the consecutive two quarters.”

On the flipside, Kenanga Research said the disappointment ratio stayed flattish at 27 per cent in 2Q17, whereby within the upstream space, these disappointments largely came from offshore services players such as Malaysia Marine and Heavy Engineering Bhd, Uzma Bhd, Wah Seong Corporation Bhd, and Dayang Enterprise Holdings Bhd, dragged by lower-than-expected work orders and delay of contract award by oil majors.

Following that, we cut our two-year forward earnings by 24 per cent/3 per cent given our less optimistic view on 2H17’s earnings outlook.


Challenging operating environment

This comes on the back of challenging operating environments as examplified in 2Q17. Despite recording 16 per cent quarterly growth due to seasonality, the aggregate revenue from upstream space deteriorated 11 per cent y-o-y across most sub-segments.

Asset-heavy players such as drillers, Kenanga Research said, managed to narrow their operating losses helped by higher rig utilisation resulting from a higher number of short-term contracts and lower depreciation post impairment while offshore support vessel (OSV) charterers widened their operating losses dragged by poor vessel utilisation with no reprieve in charter rates despite spot charter space still active.

“What caught us by surprise was the aggregate earnings for oilfield services players falling 67 per cent q-o-q even though the aggregate revenue improved by 16 per cent q-o-q,” it said.

“On a closer look, the poorer performance is marred by Barakah Offshore Petroleum Bhd which sank into massive operating losses of RM77 million in 2Q17 as a result of project cost overrun.

“We understand that this is because the oil major has become more stringent in terms of claiming variation orders suggesting that service providers/ contractors are exposed to higher operating risk going forward.”


Better contract flow in 2H17

Within the local scene, the recent portfolio reshuffling by Petronas may not be seen benefiting the local upstream space as not much attention is given as far as the local services players are concerned.

This could be due to the pullback in capital expenditure and operating expenditure spending that was disrupted by the volatility of oil prices in 2Q17, further delaying some of the contracts awards, which were initially anticipated in 2Q17.

“Based on our channel checks, the estimated RM4 to RM6 billion 5-year maintenance, construction and modification (MCM) tender has been extended to October,” Kenanga Research said. “Besides this, OSV players are also expecting the integrated logistic contract (ILC) award by end of the year.

“Recall that the tender entails 25 packages with variations of firm and call-out contracts with the option of 3+2 year tenure and 5+2 year tenure. The contract is potentially valued up to RM4.0b and expected to commence next year.

“We believe Dayang and Petra Energy Bhd stand good chance to win MCM contracts while the listed OSV players such as Alam Maritim Bhd and Icon Offshore Bhd are in favour to win the ILC. Thus, we expect better contract flow in 2H17, paving for better earnings outlook in 2018.”

From the impact of recent hurricanes such as Harvey and Irma, Kenanga Research believed the potential disruption leading to refineries, platforms and terminals shutdown in US was temporary and thus unable to sustain the push-up for higher oil prices.

“We are still maintaining our 2017E Brent crude forecast of US$51 per barrel in view of limited re-rating catalyst to fundamentally lift oil prices to the US$60 per barrel level.

“Likewise, the support for oil prices is buoyed by higher magnitude of inventory draw-down on healthy oil demand and consumption.

“All in, our preference is still on resilient earnings counters backed by firm contracts. Keep NEUTRAL view on the sector with positive bias.”