Tuesday, February 18

Merger themes coming to play in 2H19


Malaysia’s economic figures indicate sign of recoveries – its leading economic index surged by 2.6 per cent in April as six out of seven components recorded increases.

The FBM KLCI has recovered from its 2019 lows and year-to-date losses have narrowed; strong equity fund outflows in the early part of the year have also subsequently tapered off in recent weeks while the ringgit has recovered by 1.19 per cent from its lows.

How will Malaysia’s economy fare in the second half of the year?

AmInvestment Bank Bhd (AmInvestment Bank) does not rule out the possibility of earnings upgrades for Corporate Malaysia – versus the usual earnings downgrades due to earnings disappointments – in the second half of 2019 (2H19).

This could be driven largely by improved efficiency, particularly in government linked companies (GLCs), and better pricing power amidst consolidation in various sectors.

“For example, already in May 2019 Telekom Malaysia’s 1QFY19 results blew away analysts’ estimates due to huge savings arising from cost optimisation in unifimobile’s domestic roaming, marketing, business procurement and manpower,” it said in a 2H outlook report.

“Despite the FBM KLCI’s underperformance in 1H19, we acknowledge that the Malaysian equity market is still trading at a premium vs. both DM and EM in terms of P/E which also holds true from a historical perspective.

“However, the premium may be justified – at least partially – by virtue of Malaysia being widely regarded as a defensive or “low-beta” market.

“Investors in the Malaysian market may effectively be taking on a lower downside risk (vs. other markets) as certain local institutional market participants may step in to provide liquidity in times of extreme market volatility.”

Mergers coming into play

One major theme observed by analysts is that concerning mergers and acquisitions (M&As). Affin Hwang Investment Bank Bhd (AffinHwang Capital) noted that M&A activity has been rife in Malaysia over the past few months.

Not long after the digestion of news following the announcement of Swiss-based Holcim’s exit of its Malaysian cement business, a grand-scale telco merger was announced by both Norwegian-based Telenor and Axiata, which if materialises, would create the largest telco operator in Asean.

“We would not read too much into the Holcim deal as it appears to be a strategic decision to exit Southeast Asia as it had its own plans to focus on other markets.

“However, the telco merger rings the alarm bell as it involves the possible dilution in interest of Axiata by its parent company, Khazanah, and whether this would kick-start the next wave of asset disposals by the sovereign wealth fund.”

AffinHwang Capital was of the opinion that Khazanah Nasional Bhd (Khazanah) was possibly looking to divest its investment positions in several brass stocks in Malaysia.

“Since the change in government over a year ago, we have seen Khazanah pare down its investment positions in CIMB, IHH (both last year) and more recently its position in Tenaga, which, however, stirred some confusion in the market place as the latter was deemed to be a strategic holding by Khazanah.

“The question then really lies in the motives for such transactions, which in turn addresses the question of whether there could be more of such deals in the coming future.

“Objectively, we think there are several valid reasons behind the disposals, possibly spurred by the change in stewardship of the sovereign wealth fund and its likely objective.

“In our view, the Khazanah disposals serve multiple purposes, including addressing the country’s fiscal deficit and also potentially paring down its debts, which are estimated at a current value of RM1.0 trn.”

More importantly, AffinHwang Capital believed the new government could also possibly be coming to terms with the crowding-out the private sector through its investments, and thus viewed these disposals as a step towards addressing this inefficiency through better allocation of resources and lessening the burden of the government by ensuring these entities, on their own, are self-sustaining.

“This in and of itself could also be the needed catalyst to attract greater FDIs, although significant policy changes in terms of foreign ownership of domestic assets would also be beneficial,” it added.

“In short, there has been sharp stock price re-rating in the cement and telco sectors after their respective M&A announcements, sparking excitement especially given that most sector valuations are relatively low (to their historical averages).

“In our view, further asset disposals by Khazanah for the abovementioned reasons are possible and we think that this could stir excitement, especially for its assets deemed to be in the commercial pool that it would monetise.”

The sectors that fall under this category are telcos (Axiata), banks (CIMB), property development (UEM Sunrise) and healthcare (IHH).

However, AffinHwang Capital had already seen deal announcements in the healthcare and telco spaces, potentially leaving the Property and Bank sectors as the next candidates.


M&As exciting the capital market

Despite a potential short-term correction in the benchmark index, Kenanga Investment Bank Bhd (Kenanga Research) remain hopeful on the comeback of a bull cycle that would probably lead the market to chart new highs in the next one to two years.

Of course, the million-dollar question is what can be the catalysts? Despite a potentially better-than-expected Budget 2019 announcement and a more favourable external condition, the firm believe mergers and scquisitions could act as the much-needed and much-awaited market catalysts.

“The domestic market has been languishing at current levels for quite a while and is certainly in need of a massive boost to blast out of its doldrums,” it said.

“While we reckon the recent euphoria over the reviving of certain mega infrastructure projects have had rekindled some buying interests, the magnitude remains less than desired.

“Therefore, we reckon what the market really needs is some sort of transformation within the domestic companies namely some M&As resulting in the emergence of new solid entities.”

Kenanga Research said it has seen numerous examples where domestic companies failed miserably in their attempts to go regional. As a result, many opted to remain within their domicile, hence the lack of regionalisation news-flow of late.

“Until recently, we were all taken aback by the news of a possible Telenor/Axiatamerger which may rouse the M&A theme again in Malaysia,” it said.

“We are excited over the Telenor/Axiata proposal and view it as a potential step-up catalyst to boost the sentiment of the local bourse. Whilst the merger will enjoy Telenor’s presence in the country but most importantly, we foresee this as a platform to transform Axiata into a mega regional telecommunication player.

“Therefore, we believe M&As with regional giants should be the way forward for local companies to embark on their regional quests and we also believe such merger talks may not only be limited to the telco sector.”

In fact, the research house said it could probably see the emergence of M&A talks in the banking sector.

“Moreover, with the advent of digitalisation, one cannot but to embrace such technology advancement going forward especially for prominent sectors namely Banks and Telecommunication.

“Already we are seeing many traditional banks losing their market share from the emergence of digital banking service providers as this is already a major disruptive force within the banking sector.

“If the local banks do not heed such warnings, many will find it too late once the “Digital Tsunami” hits. Hence, we reckon it is high time for banks be on a lookout for regional collaborations and to strengthen their core. And more importantly, should the above-mentioned expectations materialise, they should also serve as market catalysts.”


Attempted M&As and privatisations in 1H19. (SOURCE: Maybank IB Research)

Other sectors with potential

In its indepth analysis, Maybank Investment Bank Bhd (Maybank IB Research) said M&As and privatisation is one of its thematics for the year highlighted in our “2019 Outlook and Lookouts” report.

“We had screened companies listed on Bursa Malaysia, specifically those listed on FTSE Bursa Malaysia Top 100 Index, Bursa Malaysia Property Index and Bursa Malaysia Plantation Index, that could be M&A and privatisation candidates.

“Our screening then had resulted in 82 hits – 30 from FBM100, 46 from KLPRP, 6 from KLPLN.

M&As and privatisations have indeed moved at a fast pace. Since early this year, two major corporate exercises have been announced.

In addition, our records show eight other attempted M&As and privatisations involving listed companies in 1H 2019, bringing the total attempts to 10. Of the 10, two had appeared in our earlier screening – YTL Land & Development (YTLL MK), which was made a privatisation offer by YTL Corporation (YTL); and Axiata, now involved in a mega-merger with Telenor for their Asian ops.

Save for YTL Cement-Lafarge Malaysia and Axiata-Telenor mega-merger, the other eight attempts involved outlays of less than RM1 billion each, namely the smaller market capitalisation companies and thus, they did not appear in our earlier screening.”

“We believe M&A and privatisation will be a recurring theme into 2H19 as the broad market weakness has unlocked values.”

Although Maybank IB Research now screen all companies listed on Bursa Malaysia, it doubted that those with very small market capitalisations warranted investors’ attention.

Excluding companies with market capitalisation of less than RM100 million returned 55 hits or six per cent of all companies listed on Bursa Malaysia,” it continued in its analysis.

“Seven of the 55 hits are covered by us – CSC Steel Holdings, Media Chinese International, Tambun Indah Land, Lotte Chemical Titan Holding, Star Media Group, Harbour-Link Group and Asia File Corp.

“By this point, we notice a pattern beginning to emerge. Companies from a few sectors dominate, namely those in property (11 hits), steel (eight hits), plantation (eight hits) and technology (6 hits) sectors.

“Unsurprisingly, the four aforementioned sectors are in a down cycle. Conversations with our fellow analysts reveal that the property, steel and pPlantation-linked industries are experiencing oversupply, while the technology sector is at caught in the US-China trade tiffs.”

That said, Maybank IB Research posit that value is beginning to emerge from these companies.

“We posit a list of 55 companies as being ripe for corporate exercises. Up until this point, the data points we employed have been historical and not forward looking.

“Therefore, we peruse through the 14 companies which are covered by research houses (not just Maybank Kim Eng) and screen for those forecasted to generate free cash flow yield of less than eight per cent per annum (exceeding two times the current 10-year Malaysian Government Securities yield of 3.6 per cent) for two consecutive years.

“This resulted in Media Chinese International, KESM Industries and Harbour Link Group appearing as interesting M&A and privatisation candidates, in our view. We cover Media Chinese International and Harbour-Link Group.

“While we rate both as HOLDs due to their unexciting earnings prospects, we gather that value is beginning to emerge from these companies. In the case of Media Chinese International, a whopping 72 per cent of its market capitalisation is backed by its net cash position.”


Signs of recovery on the horizon?

As Malaysia currently focuses on free market, quality investment and high productivity, it will have significant impacts on economic growth.

As highlighted by MIDF Research in its 2H Strategy report, despite the temporary chaos during the transition period which deteriorated investors’ confidence, economic direction is clearer now.

“The resumption of infrastructure projects such as the East Coast Railway Line (ECRL) and will restore investor confiddence in trust in Malaysian market, translating into investment flows.

“Malaysia economic growth in 2019 will be influenced by various external and interal factors such as global sslowdown, global financial instability, threats of protectionism, volatility of commodity prices and labour market conditions.”

MIDF Research maintained its GDP growth forecast at 4.9 per cent for 2019, based on current developments and indicators.

On that note, analysts see Malaysia’s gross domestic product (GDP) doing alright, expanding by some 4.5 per cent year on year (y-o-y) in 1Q19 – above market expectations of 4.3 per cent y-o-y.

Annually, the 1Q19 GDP growth was a slowdown from 4.7 per cent seen in 4Q18 and 5.3 per cent from a year ago.

MIDF Research commented it was ‘commendable economic numbers on the local front.’

“The slight moderation in GDP growth is due to among others global trade uncertainties and volatility in commodity prices as real exports grew at tepid pace of 0.1 per cent y-o-y, slowest in ten quarters.

“On the other hand, domestic front stays solid given that domestic demand increased 3.9 per cent y-o-y, supported by private consumption and government spending.

“Looking forward, we expect the GDP growth in 2Q19 to remain above 4.5 per cent y-o-y underpinned by overall business performance which is set to improve at 2.8 per cent in 2Q19 according to the Business Tendency Survey.

“Domestic-oriented sectors such as services and construction and petroleum-based sector is predicted to recover in the quarter.”

FBM KLCI’s performance against regional peers.
(SOURCE: AmInvestment Bank)

Hinge on private investments

As for the country’s investment activity, AffinHwang Capital believe the economy will likely be supported by possible higher total development expenditure allocation for 2H19, despite some cutback in operating expenditure.

“We believe the increase in development expenditure will provide a buffer from a possible economic slowdown, if the impact from the global trade war between the US and China drag on the country’s exports,” it stated.

“Based on the development expenditure figures reported in the mid-term review of 11MP last year, the government cut its original development expenditure target of RM260bn by RM40bn to RM220bn, which will translate to an actual average spending of RM44bn per annum.

“In Budget 2019, the allocation of RM54.7bn for development expenditure was higher, as it includes some allocation from operating expenditure (OE), due to the reclassification of items treated as transfers previously.

“The government had spent RM11.5bn in 1Q19 and we expect higher allocations to development expenditure in the three remaining quarters of 2019.”

Nevertheless, it forewarned of some downside risks when it comes to private investment, partly attributed to possible cuts in capex by corporates (such as oil companies), due to uncertainty in the global economic environment.

“Private investment is highly correlated with external conditions, but we believe growth in domestic direct investment (DDI) will remain supportive due to favourable domestic economic conditions.

“We also expect other infrastructure projects, when carried out, such as Light Rail Transit 3 (LRT3), Mass Rapid Transit 2 (MRT2) and East Coast Railway Train (ECRL), to support construction activity.”

AffinHwang Capital noted that construction activity will also benefit from cost savings, where the cost of projects such as LRT3, MRT2 and ECRL, have been reduced by RM16.6 billion, RM30.5 billion, and RM44 billion respectively.

Similarly, the government noted that after the renegotiation of 121 infrastructure projects valued at RM13.93 billion, these infrastructure projects will be carried out and implemented in the quarters ahead.

Malaysia’s net foreign direct investment (FDI) posted a sharp increase at RM21.7 billion in 1Q19.

The FDI was highly supported by the services and manufacturing sectors, which amounted to RM11.1 billion and RM5.9 billion respectively in the period.

In 1Q19, the approved FDI expanded by 73.4 per cent to RM29.3 billion from RM16.9 billion in the corresponding period last year.

According to MIDA, the approved FDI is expected to create more than 41,200 jobs for Malaysians specifically in the manufacturing (22,970) and services sectors (18,000).

Optimistic eyes from World Bank

Malaysia’s economy is expected to expand at a relatively moderate rate, with the gross domestic product (GDP) projected to record 4.6 per cent in 2019, says World Bank.

Lead economist in macroeconomics, trade and investment Richard Record said the GDP was 0.1 percentage points lower than in the previous forecast, reflecting weaker than expected investment and export activity observed in the first quarter (Q1) 2019.

The World Bank had in April maintained its forecast on the GDP at 4.7 per cent.

“Potential risks to growth include those related to escalating trade tensions, a sharper than expected slowdown in major economies, as well as volatility in the financial and commodity markets.

“Relatively high levels of private and public debt also pose risks to growth,” he told a press conference on the Twelfth Malaysia Plan 2021-2025 Kick-off Conference.

He said, while private consumption is expected to continue to support domestic demand, its growth is projected to decelerate to 6.6 per cent this year.

This follows a robust expansion in 2018, especially during the zero-rated GST period.

“In the public sector, the continued rationalisation of government expenditure will continue to weigh on its contribution, with the growth rate projected to stand at 1.8 per cent for the year,” Record said.

According to the 20th edition of World Bank’s Malaysia Economic Monitor (MEM), launched earlier this month, policies should focus on boosting resilience and protecting the vulnerable in the short term.

The report said it was particularly important to rebuild fiscal policy buffers, facilitate private investment and ensure adequate social protection for low income and vulnerable households.

“A widening of the government’s revenue base should also be accompanied by efforts to expand and improve the social protection system to achieve greater overall progressivity.

“The government’s planned move to a more targeted fuel subsidy framework could lead to potential savings for reinvestment in core social welfare programmes.”


Malaysia inexpensive for a defensive market

In its 2H19 Market Outlook report dated July 1, AmInvestment Bank said Malaysia’s bourse was “inexpensive from a historical standpoint.”

Following a major underperformance against its regional peers in 1H 2019, the FBM KLCI has become inexpensive from a historical standpoint.

“With Bursa likely to reach 1,680 points next week, the FBM KLCI trades at 18 times and 16.6 times our projected 2019F and 2020F earnings respectively, at a discount to its five-year historical average of about 18 times.

“Past experience tells us that this will be short-lived, and we strongly advise investors to take advantage of the situation while it lasts.”

MIDF Research said after declining 2.8 per cent in the first quarter of 2019, the benchmark FBM KLCI index has so far registered a marginal increase of less than one per cent in the second quarter of 2019.

“It is noteworthy that the local bourse has peaked at 1,655 points on June 10, 2019 during the quarter so far before settling at 1,638.63 points on June 14, 2019.”

Meanwhile, the team at AffinHwang Capital favoured a shift into defensive names with sustainable yields – given that the interest-rate upcycle has passed – while it steered away from cyclical stocks.

This comes as negative sentiment that plagued the currency included news that the US had put nine nations, including Malaysia, on a watch list because of the latter’s trade surplus.

“This aims to monitor the nation over currency manipulation deemed to gain trade advantages over the US, also a precursor to trade sanctions should any findings be deemed legitimate,” AffinHwang Capital added.

In April, China and Malaysia was also put under FTSE Russell’s watch list of fixed-income markets considered for potential reclassification, whereby a downgrade under the FTSE’s global classification framework would render Malaysia ineligible for inclusion in the World Government Bond Index.

“On the flip side, there has, however, been some positive newsflow which aided recovery in some bombed-out sectors,” it said in a more positive tone.

“News of the revival of the ECRL at a massive 33 per cent reduction in its original cost as well as the Bandar Malaysia project did stir excitement amongst the construction and infrastructure names.”

Good news also came in the spate of M&A news.

“While the KLCI has recovered from its lows recorded in 1H19, potentially alongside global markets on easing monetary policies by major central banks, we think upside will likely be capped by dismal corporate earnings and valuations.

“Conversely, foreign shareholdings, which are near their one-year lows, could limit downside to the market and has thus far limited significant outflows in recent months.”

In its own report, MIDF Research guided its FBM KLCI targets to reflect the tepidness of the most recent corporate earnings performance.

It reiterated its 2019 baseline target at 1,720 points of consensus-derived PER19 of 17.4 times, which is at par to the five-year 2014-2018 average multiple.

“Trading activities will likely be strong in 2H19.

“Despite seeing the FBM KLCI at a year-to-date contraction odf minus 3.1 per cent, and a slower trading activities beginning of 2019 leading up to the Chinese New Year break, average daily volume traded (ADV) on a year-to-date basis have been holding up relatively strong at two billion shares daily with average daily traded value (ADTV) currently at RM2.1 billion.

“Investor interests have also been leaning towards the small and midcap arena, where the FBM Small Cap (FBMSC) having recorded gains of 13.7 per cent on a year-to-date basis, while the broadfer FBMEMAS Index is seeing 0.3 per cent gains over the same period.”

MIDF Research observed that political uncertainties and geopolitical risks will continue to rein on investors’ radar, and this will impact their investment-making decision.

“Escalating trade war tensions, for example, will result in uncertainties on the global economic growth as well as impacting business optimism.

“This will in turn impact corporate earnings.

“We foresee that active geopolitical newsflow, as well as developments in the domestic front, will likely result in trading activities to be volatile.”

Thus, MIDF Research upgraded its ADV expectations higher to 2.5 billion shares daily for the rest of the year, but maintained its ADTV expectations at RM2.2 billion.

The firm highlighted many reasons to still be optimistic, among them being the OPR rate cut earlier this year, the depreciating ringgit, major infrastructure projects being rolled out, many companies implimenting cost control methots into place, and the entrance of digitisation and Industry 4.0 resolutionising many sectors in Malaysia.