Malaysia’s market on the defensive

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For the second half of this year, Corporate Malaysia is expected to see several improvements in different sectors, buoyed by improved domestic policies and other factors.

Analysts have warned that the domestic market has been languishing at current levels for quite a while and as such, it is in need of a massive boost to blast out of its doldrums.

With uncertainties still lingering in global markets, foreign investments into Malaysia have shifted to lower gear as investors grow seek safer havens elsewhere.

However, analysts have seen evidence of trade diversion and investment relocation as shuffles in supply chain are benefitting Asean countries, as proven by the surge in approved manufacturing foreign direct investments (FDI) in 2018 for Asean economies – namely Malaysia, Thailand, Philippines and Vietnam – has thus far sustained this year.

Maybank Investment Bank Bhd’s research team (Maybank IB Research) said it is cautious but constructive on Malaysia’s macro outlook.

“We have trimmed Malaysia’s 2019 real GDP growth forecast to 4.4 per cent from 4.7 per cent previously on trade tension overhang plus factoring in the actual 4.5 per cent year-on-year (y-o-y) growth in the first quarter of 2019 (1Q19).

“The downward revision reflects lower growth forecasts for manufacturing, construction, external trade and investment, in view of our cautiousness over the global economic and trade outlook, amid domestic policy overhang and political noises, as well as soft business confidence and consumer sentiment.

“However, we remain constructive on the Malaysian economy given the better-than-expected 1Q19 growth in consumer and Government spending as well as services; rebounds in agriculture and mining sectors; domestic stimulus via BNM’s 25bps interest rate cut – with room for more – as well as the revival of major infrastructure and development spending projects; evidence of trade diversions and investment relocations from MIDA’s approved manufacturing FDI numbers; and fiscal consolidation that is on track,” it opined.

Meanwhile, AmInvestment Bank Bhd’s research arm (AmInvestment) did not rule out the possibility of earnings upgrades for Corporate Malaysia (compared with the usual earnings downgrades due to earnings disappointments) during 2H19, driven largely by improved efficiency, particularly in government linked companies (GLCs), and better pricing power amidst consolidation in various sectors.

“Already, in May 2019, Telekom Malaysia Bhd’s (TM) 1QFY19 results blew away analysts’ estimates due to huge savings arising from cost optimisation in unifimobile’s domestic roaming, marketing, business procurement (via contract renegotiation) manpower,” it added.

However, it pointed out that the upside of sector consolidation could be nullified by government policies.

“A case in point is the recent decision by the government to disallow the proposed hike in cement prices on concerns that this would translate to higher costs for affordable housing.

“Lafarge Malaysia/YTL Cement were in a position to raise cement prices as they have emerged the price leader and setter with a combined cement market share in excess of 60 per cent in Peninsular Malaysia following the recent takeover of Lafarge Malaysia by YTL Cement,” it explained.

In a separate note, Affin Hwang Investment Bank Bhd’s research team said, it sees three catalysts that could be positive surprises for Corporate Malaysia.

The research team explained that some of these catalysts could be a sharper-than-expected cut in Fed rates leading to fund inflows back to the region, heightened M&A activity spurring investor focus, particularly in depressed sectors, and GDP upside surprise as infrastructure spending accelerates.

Nevertheless, it said: “Although from a corporate earnings and valuation angle this may not warrant funds to re-visit Malaysia, we believe that the sharp fall in stock prices over the past two years, low foreign holdings and the potential thematic ideas could spark some selective interest.”

With volatility to continue, Maybank IB Research reiterated its defensive strategy for Malaysia equities.

“However, amid the volatility, there will be windows to pick up on value stocks (during periods of weak global economic data releases especially in 4Q19, reaffirming the effects of the US-China trade tension), and for a trade (closer to the announcement of FTSE Russells’ decision on Malaysia bonds, and other periods of  US dollar-ringgit volatility which will impact sectors/stocks most sensitive to the ringgit movements; also during the period running up to Budget 2020 announcement).”

With that, BizHive Weekly takes a closer look at the sectors that shine and those that won’t for the remaining half of 2019.

 

Construction sector: En route to recovery as contract flow resumes

Following a year of uncertainties after the shift in Malaysia’s administrations, the construction sector is catching a break this year as more mega projects which were previously under-review, received the green-light.

Analysts are generally slightly more optimistic on the sector’s prospects in the remaining half of this year as more project contracts are expected to be awarded to construction players nationwide.

Maybank Investment Bank Bhd’s research team (Maybank IB Research) highlighted that sentiment for the sector has improved, mainly from the revival of two major projects East Coast Rail Link (ECRL) at a lower cost of estimated RM44 billion and Bandar Malaysia (estimated RM150 billion in gross development value).

It also pointed out that the record Sarawak State Budget 2019 has led to the materialisation projects under the Sarawak Coastal Road with the award of five packages (four bridges) worth an estimated RM1.8 billion in 1H19. The remainder of bridges are expected to be awarded in phases in 2H19.

The Federal Gvernment has also made a cash offer of RM6.2 billion to acquire Gamuda’s four highways, namely KESAS, LDP, SPRINT and SMART on June 21.

“Their implied equity value is RM2.36b for Gamuda’s effective stake, which we deem as fair when compare against our equity DCF value of RM2.56 billion.

“We believe this development is positive, alleviating the overhang of an expropriation.

“This could set the precedence of future highway takeovers if the deal goes through,” it opined.

With prequalification for the ECRL underway, the research team expected tenders for the subcontracting packages to start in 2H19, with potential awards by end-2019/ early-2020.

“We gather that packages under the Second Link Road in Sarawak are also currently in the final stages of their detailed design with tenders expected to be out by 4Q19,” it added.

On the other hand, AmInvestment Bank Bhd’s research arm (AmInvestment) said, while the revival of several mega projects are positive for the local construction market, there are still several huge risks in the sector.

It pointed out that the latest mega projects are driven by world-class Chinese contractors (and Chinese funding) which probably leaves the local contractors with only low-value/low-margin supporting roles in the projects; and

It also stressed that there is still the problem of Malaysia’s elevated debts.

Therefore, the government has no choice but to remain steadfastly committed to fiscal prudence which means the revival of the ECRL project could be a “zero-sum game” as it impedes the government’s ability to implement other public infrastructure projects.

“We may upgrade our ‘underweight’ call on the sector to ‘neutral’ or ‘overweight’ if the government decides to pump-prime the economy with public projects in the event of external shocks such as an unexpected slump in the global economy,” it added.

 

O&G sector: Activity levels rising

The oil and gas (O&G) sector, while still plagued by uncertainties brought on by the unpredictable global oil market, its current lull spells slight positivity for the sector as activity levels are expected to rise from the current calm.

Maybank IB Research noted that the O&G sector has had a decent start to the year as crude oil price averaged US$66 per barrel bbl (dated Brent) in 1H19, largely due to the solid OPEC+ partnership and discipline among members in compliance to the agreed output cut (1.2 million barrels per day)

“The resilient support has created a positive environment and fueled much optimism in the market, which drove global capex.

“We observed that activities have picked up and tenders are on the rise. What is positive too is that while asset utilisation continues to improve, we are seeing a revival in day rates.

“Conversely, companies with poor financials continue to struggle; their highly leveraged balance sheets set back their ability to grow. The need to restructure, refinance and impair their assets will take precedence over growth,” it observed.

All in, Maybank IB Research said the market remains on course for an upward trajectory.

It also pointed out that Petroliam Nasional Bhd’s (Petronas) Activity Outlook report for 2019 to 2021, which evokes much optimism for the services industry, would continue to drive domestic undertakings.

“We are already seeing an increase in activities (drilling, fabrication, OSVs, and others) across the segments, especially from 2Q19 onwards.

“We do not rule out potential M&As, as distressed companies are forced to dispose off their assets to de-leverage and re-model their business. Companies with strong balance sheets will be able to capitalise on this opportunity,” it opined.

Meanwhile, AmInvestment pegged a more sanguine view on the sector despite the possible increase in activities in the industry.

It pointed out that the sector continues to be plagued by the likely continued volatility in the oil price direction over the next six months, lingering balance sheet risks of Malaysian operators, unresolved US trade dispute, deteriorating global economic growth outlook and easing of US pipeline constraints.

Affin Hwang Investment Bank Bhd’s research team (AffinHwang Capital) also noted thatsentiment on the sector still hinges on global oil price movements.

“Year-to-date Brent oil prices have averaged US$66 per bbl, as prices in 1Q were still recovering and averaged US$64 per bbl and US$70 per bbl in 2Q.

“We expect oil to trade in the range of US$65 to US$70 per bbl in 2H19. We focus on selective

positioning in the sector, with petrochemical companies and maintenance players being our two favourite themes in the sector,” it said.

 

Telco sector: Banking on M&As

In the telecommunication sector’s (telco) limelight, for now, is Axiata Group Bhd’s (Axiata) proposed merger with Telenor (Asia) which has lifted both sentiments and share prices across the sector.

However, analysts warned that the deal completion is still far from certain as there are no concrete agreements made between both parties.

“We do not rule out the parties potentially having to make various concessions to circumvent prickly issues such anti-competition and job losses,” Maybank IB Research said.

Meanwhile, it noted that the revenue outlook in the mobile space remains challenging, with 2019 likely to be another year of decline for the Big 3.

On spectrum, it said, following multiple rounds of delays, the award of the 700MHz spectrum could potentially materialise in the next 12 months. The 2600MHz spectrum is also due for renewal in end-2019.

“We continue to expect the regulator to maintain its past practice of keeping spectrum prices reasonable. At Telekom Malaysia, it remains to be seen if the company can maintain its momentum on cost optimisation. The recent appointment of a new (and permanent) CEO could potentially lead to a review of overall priorities and strategies,” it added.

Affin Hwang also pegged a broadly cautious view on cellco’s 2019 earnings outlook but remain optimistic on TM’s profitability.

“The operating environment for the cellular operators is tough – against a stagnant subscriber base and strong competition from the smaller players, the top three operators may continue to see minor declines in the number of subs. This, coupled with lower wholesale revenue and the adoption of MFRS 16 should weaken the cellco’s 2019 profitability.

“While TM is also facing declining revenue, the group’s determined cost-optimisation initiatives are bearing fruit, leading to a record profit quarter in 1Q19. We expect these ongoing cost initiatives to lift TM’s full-year profit margin and drive a strong earnings recovery, It explained.

Overall, Affin Hwang said, “In view of the tough market conditions and weak profitability, we would stay clear of the cellular pure-plays for now. For exposure, we like Axiata for the possible merger with Telenor Asia.

“In the fixed broadband segment, we expect the total numbers of subscribers to grow y-o-y.

“However, TM is losing its Streamyx subs to Unifi, competitors, and the mobile broadband operators. Nonetheless, we expect its ongoing cost optimisation initiatives to more than offset the revenue loss, leading to strong earnings recovery.”

 

Property sector: Challenges remain as demand still lax

The property sector’s prospects remain dim as demand continues to remain low.

“We have turned more cautious on the 2H19 property market outlook as macro activities have yet to pick up, and the sector’s fundamentals remain weak with high overhang stocks of 51,265 residential units (as at end-2018; up 37 per cent y-o-y) amid rising auctioned properties,” said Maybank IB Research.

“While the HOC has helped to reduce some unsold stocks, we do not expect the impact on overall sales to be significant.

“Most developers under our coverage expect declining/flattish sales growth in 2019. Margin compression is expected to continue as developers offer more rebates/discounts to clear their unsold stocks,” it highlighted.

Affin Hwang also pointed out that the core earnings per share (EPS) growth for the property sector is expected to remain flattish with growth at 0.6 per cent y-o-y in 2019 before accelerating to 12.5 per cent y-o-y in 2020E, rebounding from a sharp decline of 14.6 per cent y-o-y in 2018.

“Earnings recovery is muted, compared to our initial 2019E sector core EPS growth of 8.6 per cent y-o-y early this year. This follows earnings cuts due to weak sales and pressure on profit margins. We believe high unbilled sales for most property developers under our coverage, selective new launches and inventory sales will sustain earnings in 2019E,” it added.

It preferred companies with strategic land banks with low holding costs, giving them the flexibility to adjust their property product pricing to cater to demand.

“Property developers with geographically diversified operations in Asia (mainly Singapore and China), such as Sunway and IOI Properties, are also more resilient to weather domestic market weakness. Those with strong balance sheets, such as UOA Development (net cash), should be able to take on opportunistic land acquisitions to drive long-term growth,” it added.

AmInvestment commented: “The Malaysian property sector has been experiencing a challenging past three years particularly for the residential property segment, mainly due to high property prices, stricter lending policies, volatile macroeconomic conditions and weak consumer sentiment.

“The past 12 to 18 months have seen some changes whereby the residential property market has been adjusting to mass-market affordable housing, while at the same time, developers have slowed down their launches and working hard to clear unsold units to reduce the overhang situation.

“Overall residential market still slow. Year to date, there are still no sign of recovery in the local residential property market as most developers under our coverage reported lower new sales y-o-y during their recent quarterly earnings announcements.”

 

Plantations sector: Unexciting 2H outlook

Prospects for the plantations sector still remains unexciting as global challenges continue to threaten the sector’s possible recovery.

Maybank IB Research said, despite the recovery in crude palm oil (CPO) spot price from its low of RM1,717 per tonne in Nov ember 2018, 1H19 spot average selling price (ASP) of RM1,993 per tonne (down 18 per cent y-o-y) was still below its 2019 ASP forecast of RM2,350 per tonne.

“This was mainly due to the record high brought forward stockpile at the start of 2019 and still strong output in 1Q19 that kept stockpile stubbornly high throughout January to April 2019,” it explained.

Furthermore, the re-escalation of the US-China trade war and emergence of the African Swine Fever in China aggravated the overall bearish soft commodity market sentiment in 1H19.

“The market had even initially ignored the bad weather in the US with its excessive rainfall having delayed the plantings of corn and soybean. But by mid-June 2019, the market has responded to this threat as soybean and corn prices recovered sharply from their recent lows in May 2019. Weather risk in the US remains a threat at the time of publication,” it said.

Nevertheless, it pointed out that fundamentals are improving as the recent low CPO price has stimulated demand.

“In Malaysia, we saw a drawdown of stockpile of 0.8mt (down 24 per cent) in 5M19, as exports (up 12 per cent) outpaced production (up 10 per cent) growth,” it added.

However, it still warned that a global production deficit is developing in palm oil this marketing year and next.

“Oil World is forecasting further tightening in palm oil stock-to-usage ratio (SUR) for 2019/20F marketing year on slowdown in the growth of the mature area due to lack of new plantings since 2015, stagnating palm oil yields on labour shortage and reduced fertilizer applications (mainly by smallholders in periods of low prices since 2H18). In addition, after two years of good harvest post the last strong El Nino of 2015-16, we simply believe the oil palm trees will enter into biological tree rest mode.

“The slowdown in palm oil output growth should trigger improving CPO prices in the next 12 to 18 months,” it said.

On the other hand, Affin Hwang pointed out that despite the improvement in fundamentals – a decline in palm-oil inventory levels, both in Malaysia and Indonesia – CPO prices remained sluggish in 1H19, partly attributable to the ample supply of other edible oils in the market, weak market sentiment as well as the on-going trade tensions between the US and China.

“We expect global palm-oil inventory to gradually decline with higher exports and higher consumption of palm-oil products. Stronger exports and consumption will likely be supported by the energy market and food industries, in our view,” it added.

AmInvestment highlighted
that there is still a silver lining in the sector as biodiesel consumption mogjt increase in Indonesia.

“If vehicle tests are successful, Indonesia would be implementing the B30 biodiesel policy in year 2020F.

“This would lift the country’s biodiesel consumption to a range of seven million to nine million KL (6.1 million to 7.8 million tonnes) in 2020F from an estimated 6.2 million KL (5.4 million tonnes) in 2019E.

“The biodiesel consumption of 7.8 million tonnes in 2020F would be about 18.2 per cent of Indonesia’s CPO production of 43 million tonnes in 2019E,” it explained.

Nevertheless, it pointed out that if crude oil and gasoil prices continue to fall, biodiesel may not be feasible.

“As such, the implementation of biodiesel in Indonesia would require subsidies.

“Hence, Indonesia would need to reimpose the export levy on CPO exports.

“Previously, monies received from the export levy were used to subsidise biodiesel.

“The export levy was reduced to zero in November 2018 as CPO became cheaper than gas oil.

“Also, we believe that the Indonesian government wanted to encourage companies to export CPO to reduce the level of palm inventories in the country. Currently, biodiesel is just barely feasible as the difference between gasoil and CPO is small at US$75 per tonne,” it said.

 

Tech sector: Global trade rift dents prospects, a silver lining for local players

As major economies squabble over trade matters, open economies such as Malaysia are feeling the impact of this global tensions.

For Malaysia, as a major exporter of electrical and electronics (E&E) components, the trade war between US and China has dented prospects for its technology sector.

Maybank IB Research noted that the delay in mass deployment of 5G network coupled with recent US-China tech war (banning of US component/software sales to Huawei) would negatively impact smartphone sales in 2Q19, beyond 1Q19’s decline (down seven per cent y-o-y).

“That said, we expect some q-o-q recovery in the 3Q19 shipment, especially for Huawei, given the lift in ban of component sales announced in the G20 Summit on June 27.

“On an overall basis, we believe that the unresolved US-China trade issue would still suppress consumer sentiment for electronics, especially the premium ones. In addition, we believe that consumers would likely adopt a wait-and-see approach pending mass 5G network deployment, effectively prolonging replacement cycle for smartphone.

“For this, risks remains on the downside for OSAT players with sizeable smartphone exposures,” it warned.

On the brighter side, the trade war between US and China also brings opportunities to local tech industries as both countries look elsewhere for E&E exporters.

Maybank IB Research noted that the rise in foreign tech companies’ direct investments (such as Micron, Jabil) into Malaysia, coupled with a substantial number of enquiries for production relocation for local EMS players (inclusive of EMS MNCs based in Malaysia) could translate to contract wins.

“JVs with Taiwanese EMS players (i.e. MCE Holdings with Fortechgrp and Weltronics, EG Industries with Quanta Storage) and some contract flows to local EMS players (VSI from Bissell, Scope Industries from Inventec Appliances) are the recent positives.

“The first wave of beneficiaries would likely be the local equipment players with excess capacity (Mi Technovation, Elsoft, MMSV, Aemulus),” it highlighted.