Affin Hwang Capital Research Highlights

Author: kltrader   |   Latest post: Mon, 23 Sep 2019, 5:43 PM


Ajinomoto - Inexpensive play on Halal export growth

Author: kltrader   |  Publish date: Mon, 23 Sep 2019, 5:43 PM

We remain assured of Ajinomoto’s medium-term growth prospects, led by a healthy increase in exports and steadfast domestic business. In particular, we continue to see robust demand from the Middle East for its Halal-certified products amid a developing consumer base. Despite a 3-year forecast core earnings CAGR of only 5%, we like the stock for its undemanding valuations, defensive earnings and Halal export-driven upside potential to growth. Maintain BUY on Ajinomoto, albeit with a lower 12-month TP of RM19.80.

Bright start to FY20; export sales +33% yoy

To recap, Ajinomoto posted a robust set of 1QFY20 results (core net profit +29% yoy). Revenue growth of 6% yoy was lifted by a surge in exports to the Middle East (+55% yoy) and other Asian countries (+24% yoy), aided by a recovery in industrial products sales and a stronger US$ (+5% yoy). We expect a similarly good showing for the rest of FY20 on a healthy domestic private consumption, strong export momentum and stable forex, which should contain raw material procurement costs.

New plant to contribute positively to group’s long-term prospects

Despite the c.4% drag on earnings over the near term due to lower investment income from the group’s high cash pile (14% of FY19 PBT) following its new plant’s construction, we are nevertheless positive on the benefits to be reaped from its plant relocation, which should better position Ajinomoto to tap into the burgeoning Halal food market with improved production capacity and capability to develop new product lines. There would be no production constraint issues during the interim, as the company is able to rely on its regional affiliates’ production facilities.

Maintain BUY, but with a reduced TP of RM19.80 (from RM21.80)

We make no changes to our earnings forecasts. Although earnings growth would be muted by the new plant’s construction and commencement, there could be potential upside to growth given the group’s Halal-driven export momentum. We reaffirm our BUY rating on Ajinomoto albeit with a reduced TP of RM19.80, based on a lower CY20E PER of 20x (from 22x), in line with its 3-year average. At a 17.3x FY20E PER, the stock continues to look attractive due to its undemanding valuations within the F&B staples space. Downside risks: (i) weaker export sales; (ii) higher-than-expected raw material costs; and (iii) a decline in global macro conditions.

FY19 Review

Positive FY19 performance despite external headwinds

In FY19 and especially 1HFY19, Ajinomoto faced a tough external operating environment which had an impact in its export sales performance, due to a weaker US$ (-2.2% yoy) and slower demand for industrial feed products from other Asian markets. The resulting impact which was seen with the industrial segment’s weaker sales (-3% yoy) was nonetheless mitigated by a better gross margin owing to lower procurement costs of a key raw material, alongside improved domestic sales which drove the consumer segment’s decent 5% growth yoy in revenue. All in, the group still managed to register a decent core PBT growth of 7.6% yoy on the back of a 2.6% revenue growth and EBIT margin improvement (+0.7ppt yoy), although core net profit growth was relatively flat due to lower tax incentives.

5-year revenue CAGR of 5%; earnings CAGR 14%

The decent FY19 results despite external headwinds underscore the company’s defensive business and management’s prudent cost control, in our view. On a 5-year CAGR basis from FY14-FY19, revenue grew by 5.3% while core EBIT grew by 11.8% owing to progressive margin expansion (+3.5ppts from FY14-FY19). Core net profit grew at a quicker 5- year CAGR of 14.4% to RM56.4m, boosted by the surge in investment income due to cash proceeds of RM166m from its land disposal in FY17.

Past-5-year export growth lifted by sharp Ringgit depreciation

From FY14-19, export sales grew at a 5-year CAGR of 8.9%, with both revenue from the Middle East (10.5% CAGR) and Asian region (8.6% CAGR) outpacing domestic sales (CAGR of 3.4%) over the same period. A sharp fall in the Ringgit against the Dollar, the primary export currency, was a key factor for the export outperformance, as US$/MYR rose from 3.203 in FY14 to 4.077 in FY19 (+27%). On a US$-adjusted basis, Middle East and Asian region export sales registered average annual growth of 5% and 4% respectively from FY14-19.

Earnings Outlook

1QFY20: encouraging surge in export sales

Despite an 8% yoy dip in domestic sales during 1QFY20, we are encouraged by the 33% jump in export sales yoy, driven by a surge in exports to the Middle East (+55% yoy) and Asian region (+24% yoy) – representing a multi-year high of +27% yoy even on a US$-adjusted basis, and culminating in total sales growth of 5.6% yoy during the quarter. Aside from the stronger US$ (+5% yoy), we believe the strong export performance could be attributed to management’s efforts in strengthening its regional distribution network.

New product to boost domestic sales; operational improvements to support margins

Aside from the improved export sales momentum, we expect the domestic launch of a new stir-fry seasoning product, “Rasa Sifu”, to ride on the rising trend of urban households favouring quick-fix meals and drive FY20’s top-line growth, while local private consumption spending remains healthy. On the other hand, we expect margins to be stable despite forex fluctuations possibly affecting raw material costs, as management remains focused on profitability enhancement through continual improvements along the value chain, in addition to supply chain efficiency gains. All in, we expect the group to register decent earnings growth of 3% in FY20, arising from better sales performances from both the domestic and export front, or +7.1% if investment income stayed constant from FY19.

Plant relocation plans will have minor impact on earnings…

In our previous report, we had trimmed our earnings forecasts due to the invariable loss of investment income from cash reserves utilised to partially fund the construction of the new plant in Techpark@Enstek in Negeri Sembilan, slated for completion by FY22. As a result, we project the FY19-22E earnings CAGR to be lower than its 5-year CAGR of 14.4%. After the new plant is constructed, the group would shift its entire operations there from the current base in Kuchai Lama. With a larger land area and expected built-up space to accommodate an initial 20% increase in production capacity, we also expect higher depreciation and interest costs to kick in from FY23 onwards (assuming 33% debt funding for the RM355m plant capex). Meanwhile, management has yet to decide on the purpose of the Kuchai Lama land (end-FY19 net book value of RM27.1m) upon the relocation of operations.

…but nonetheless spur the group’s long-term growth prospects

Nevertheless, the new plant is likely to sustain the group’s business expansion plans for the next 10 years, while driving operational efficiency improvements. An upgraded machinery set-up alongside its strategic location in Techpark@Enstek, also known as a Halal hub, will provide the infrastructure to strengthen its production and development of Halalcompliant products, supporting both its local and Middle East sales prospects, plus an expanded product portfolio.

Near-term exports growth undeterred by production constraints

Over the interim period leading up to the new plant’s FY22 completion, we understand that Ajinomoto Malaysia is able to tap into its neighbouring affiliate companies’ production facilities to meet increasing export demand, such as the Indonesian plant, which is the only other Halal-compliant factory within the Ajinomoto Group. Sales transactions to the Middle East would still be recognised by Ajinomoto Malaysia – the only other listed entity besides the parent company listed in Japan.

ESG agenda could attract sustainability-driven investing

Furthermore, the new plant would see reduced carbon emission by switching energy sources towards natural gas and renewable energy such as solar power, thereby strengthening its ESG profile within the rising sustainable investing space. We note that Ajinomoto is only one of three F&B producers incepted into the FTSE4Good Bursa Malaysia index – alongside Carlsberg and F&N.

Valuation & Recommendation

Core FY20-22E net profit CAGR of 4.6% on lower investment income

We leave our FY20-22 EPS estimates unchanged, although we note there is upside potential to earnings should 1QFY20’s strong export sales momentum be sustained. At this juncture, we project core net profit to grow from FY19-22E at a 3-year CAGR of 4.6%, which lags projected revenue and EBIT 3-year CAGRs of 4.8% and 7.5% respectively due to lower investment income from cash committed to the new plant’s capex. Our revenue projections are underpinned by Middle East export sales CAGR of 5.3%, which is slightly above domestic and Asian export sales CAGRs of 5.0% and 4.0% respectively, while the US$ is expected to stabilise against the Ringgit at 4.10 in 2020E.

Maintain BUY, but with a lower TP of RM19.80

We reaffirm our BUY recommendation on Ajinomoto, albeit with a reduced 12-month TP of RM19.80, pegged to a lower 20x PER to the CY20E EPS (from 22x) in line with the stock’s average 3-year forward PER. This is to reflect the stock’s moderating earnings growth, alongside elevated risks of prolonged global trade tensions which could affect export demand. Nevertheless, we still favour the stock for its defensive business, Halal products’ growth potential and undemanding valuations in relation to other F&B producers in the consumer space, in addition to its listed parent company in Japan trading at a 25% PER premium at 21.7x FY20 consensus EPS. Downside risks to our call include: (i) weaker export sales; (ii) higher-than-expected raw material costs; and (iii) a decline in global macro conditions.

Source: Affin Hwang Research - 23 Sept 2019

Labels: AJI
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KESM Industries (HOLD, Maintain) - Worst Could Finally be Over

Author: kltrader   |  Publish date: Fri, 20 Sep 2019, 11:01 AM

KESM Industries’ FY19 core earnings collapsed 76% yoy largely due to the ongoing inventory correction. However, there was a strong earnings improvement in 4QFY19, albeit off a low base, and this could signal that its weak earnings momentum has bottomed. We have modelled for a further earnings recovery in FY20E, projecting a growth of 127%, although profits are not expected to reach the previous peak in FY17, at least over the next 3 financial years. Maintain HOLD with a slightly higher 12-month TP of RM7.00 based on an unchanged 12x CY20E PER.

Strong 4QFY19, above expectations

KESM reported a strong 4QFY19 set of results that was above expectations. The surprise was largely driven by better-than-expected margins during the quarter. Core net profit for the quarter jumped 738% qoq, albeit from a low base, largely due to margin improvement. The 4QFY19 EBITDA margin jumped 2.1ppts qoq as product mix improved, a likely result from lower EMS work while the proportion of revenue generated from its burn-in and test increased. Management has guided for a progressive recovery barring any escalation of trade tensions and the global macro slowdown, in line with our current FY20 forecast. We make some slight adjustments to our FY20-22E EPS post the results.

FY19 core earnings declined 76% yoy, but DPS pleasantly surprises

FY19 core earnings contracted by a sharp 76% yoy to RM9m although revenue only fell 12% yoy. This was largely due to the loss of operational leverage and hence a collapse in EBITDA margins (-6.9ppts yoy). The unfavourable shift in revenue mix towards the lower-margin EMS work had also partially buffered the revenue decline, while negatively impacting margins. Despite the weaker set of results, management announced a FY19 DPS of 9 sen, or a payout of 62%, above its historical range of 10-31%.

Maintain HOLD with a higher target price of RM7

Amidst the inventory correction that KESM is facing, we believe the company remains well managed, as reflected by its healthy quarterly performance and net cash position. We remain positive on the company’s long-term prospects as the company is well positioned as a captive burn-in and test provider for the automotive industry. Maintain HOLD with a higher TP of RM7.00 based on the stock’s long-term (c.20-year) mean PE of 12x applied to our higher CY20E EPS. Key downside/upside risks include a loss/gain of customers and a reduction/gain in outsourcing opportunities.

Source: Affin Hwang Research - 20 Sept 2019

Labels: KESM
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Apex Healthcare (HOLD, Maintain) - Minimal Impact From Medicine Price Control

Author: kltrader   |  Publish date: Fri, 20 Sep 2019, 10:52 AM

We believe the proposed medicine price control measure is not expected to hurt Apex Healthcare (Apex) as it does not produce any single-source drugs, while contribution from the distribution of singlesource drugs for its customers are not significant. While we look forward to maiden earnings contribution from its oral solid factory and remain upbeat on Apex’s long-term prospects, we expect near-term earnings to be weak, given the estimated 1.5-2 year gestation period for the former. We make no changes to our earnings forecasts and maintain our HOLD call on Apex with a 12-month TP of RM2.11.

Expect minimal impact from the proposed medicine price control

The impending medicine price control measure is mainly focussed on curtailing the prices of single-source drugs to ensure the affordability of drugs. However, this will likely to be a non-event to Apex’s manufacturing business as it does not produce any single-source drug. While it is involved in the distribution of single-source drugs for its customers, its entire distribution business is estimated to make up only c.7% of the group’s core net profit in 2018. Based on our sensitivity analysis, every 10% decline in Apex’s distribution revenue would reduce the group’s core net profit by only 1% for 2019-21E. On a positive note, Apex may renegotiate the fee imposed with its customers in order to cushion this impact.

More opportunities ahead, but near-term outlook remains weak

Apex is currently in the midst of transferring high-volume products from its existing plant to SPP NOVO. With the new capacity from SPP NOVO, the group will be able to cater to more high volume production, especially government tenders. That said, we think its near-term earnings are likely to be weak given the estimated 1.5-2 year gestation period for SPP NOVO.

Orthopaedic devices manufacturing business on expansion mode

Given the rising demand for orthopaedic devices, Apex’s 40%-owned associate Strait Apex, an orthopaedic devices contract manufacturer, is also looking at expanding its production capacity by renting a third facility, with a target to bring in equipment to the new facility by end-2019. Notably, the associate has managed to secure new customers due to trade tension as most of its customers are US multinational corporations (MNCs).

Maintain HOLD with TP of RM2.11 on near-term weakness We maintain our earnings forecasts and HOLD call on Apex with an unchanged TP of RM2.11, based on 2020E target PER of 17x. On a side note, we note that the worsening haze, which has led to rising demand for masks, could potentially provide a one-off upside to Apex.

Likely to be shielded from the impending medicine price control

Not in the manufacturing of single-source drugs

On 2nd May this year, the Cabinet announced that price control measures for pharmaceutical drugs would be implemented in 2019. The MoH will use external reference pricing (ERP) to benchmark drug prices in Malaysia, averaging the three lowest drug prices in three countries to determine ceiling prices. Ceiling prices will be imposed at the wholesale and retail levels. While the specific mechanism to be used has yet to be determined as it is still in the discussion stage, we understand that the intention is to curtail the prices of single-source drugs to ensure the affordability of drugs. For Apex’s pharmaceutical manufacturing business, we think the group is shielded as it does not produce any single-source drug.

Distribution business might be affected, but likely to be minimal

While for its distribution segment, Apex is involved in the distribution for its customers’ single-sourced products. As it charges a distribution fee based on a certain margin computed on the products’ sales value, the implementation of price control for medicine is expected to have adverse impact on the group. That said, note that the entire distribution division only made up 23% of the group’s revenue in 2018 with a very thin net profit margin estimated at 3% (vs. the group’s blended core net profit margin of 9% in 2018). Based on our estimates, distribution business made up c.7% of the group’s core net profit in 2018. Our sensitivity analysis shows that every 10% decline in Apex’s distribution revenue would reduce the group’s core net profit by only 1% for 2019-21E. On a positive, Apex may renegotiate the fee imposed with its customers in order to cushion the impact.

More opportunities ahead with SPP NOVO…

In the midst of transferring products to SPP NOVO

Post-receiving regulatory approval to start commercial production of SPP NOVO on 16th May, Apex has been working on transferring high-volume oral solid dosage products from its existing plant to its new oral solid dosage manufacturing plant, SPP NOVO. This involves migration and validation process to test the robustness of the equipment and process as the equipment, process and production volume for SPP NOVO are different as compared to its existing plant. So far the group has validated 3 products in different batches, and plans to transfer 7 products by end-2019.

Eyeing opportunities in government tenders

Revenue contribution from government contracts to the group grew 70% yoy to RM63m in 2018 (10% of group revenue in 2018 vs. 6% of group revenue in 2017). Recall that the group has only started to be more active in government tenders as it did not have sufficient capacity to take on such orders previously. With the commencement of commercial production at SPP NOVO, the group will be able to cater to more high volume production, especially government-sector tenders that come out from time to time throughout the year. The new capacity also comes at the right time, providing the group an edge to grab a larger pie in government contract, especially as the government tries to address the monopoly in drug distribution in the country.

Rising government healthcare expenditure bode well for the group

The Malaysian government’s growing emphasis on quality healthcare and social welfare protection would also see the government continuing to allocate higher budget for healthcare in the upcoming Budget 2020, which should bode well for Apex. The 2019 budget allocation for Ministry of Health (MoH) of RM29bn, which represents a 7.8% increase over the RM27bn for 2018, is a significant change relative to its 3-year (2015-2018) CAGR of 4.5% in budget allocation for MoH. In addition, Apex is also eyeing more opportunities from Singapore’s rising budget for healthcare allocated to meet the growing demands of its ageing population. According to Singapore’s Minister for Finance, the government healthcare spending is expected to grow to SGD11.7bn in FY19, which represents a 10.4% increase from SGD10.6bn in FY18.

… but near-term outlook remains muted

Near-term earnings likely to remain weak on start-up expenses

While the commencement of product sales manufactured by SPP NOVO should lead to higher revenue to the group and help to partly mitigate the start-up expenses in second half of the year, we expect the new plant to be in a gestation period in the near-term given the high start-up expenses and lower margin from government tenders. To recap, the group’s core net profit declined 10% yoy in 6M19 due to higher operating and finance expenses arising from the start-up of SPP NOVO, despite recording higher revenue (+4% yoy).

Associate’s business on expansion mode

Secured new customers as a result of trade tension

The group’s 40%-owned associate, Straits Apex Sdn Bhd’s contribution grew strongly by 121% yoy in 2Q19, which offset the significant decline in 1Q19 (-57% yoy). The volatility has largely to do with the associate having secured a new customer and in the process of setting up facility and testing for the new customer in 1Q19. Notably, the contract manufacturer of surgical grade orthopaedic devices has managed to secure new customers as a result of the US-China trade tension as most of its customers are US multinational corporations (MNCs). Cumulatively, the contributions from its associate grew 31% yoy in 6M19.

Capacity expansion to cater to growing demand

Given the rising demand for orthopaedic devices, Straits Apex is looking to expand its production capacity by renting a third facility with around 50,000-60,000 sq. ft. of additional space in Prai. Currently it operates a main production facility in Prai Industrial Estate and a clean room facility for packaging in Penang Island. The quantum of increase in capacity are not certain at the moment as the associate just signed the tenancy for the third factory and haven’t bright in any equipment to the factory. The group aims to bring in equipment to its third factory by end of 2019. According to Absolute Markets Insights, global orthopaedic device market is expected to grow at a CAGR of 3.6% over the period of 2019-2027 and reach US$58.4bn by 2027E, owing to cutting-edge technological advancements.

Potential one-off puff from haze

Worsening haze

The haze has worsened in several parts of Malaysia recently due to the dense smoke blown in from forest fires in Indonesia. The Air Pollution Index (API) readings soared to >200 in some of the states in Malaysia, with Kuching being the worst, which resulted in Malaysia being ranked among the top 10 countries with the world’s worst API, according to the World Air Quality Index (Fig 1). The World Health Organization (WHO) had on 30 August issued a warning to vulnerable communities due to the air pollution. This is not just an environmental issue but a public health issue. According to the largest international study on the short-term impact of air pollution on death conducted to date by measuring particulate matter and daily death rates in 652 cities in 24 countries, more air pollution means more deaths, even with short exposure to low levels of air pollution.

A potential beneficiary, but could be minimal

Our channel checks found that most of the stores and pharmacies in Malaysia have run out of masks given the rising demand as people are now more aware of the importance of using masks to protect themselves from the haze that has blanketed the nation. This is especially for N95- type face masks, one of the masks that offer the best protection as they are designed to filter at least 95% of the tiny, 0.3-micron particles. We think that Apex could potentially benefit from this, as it is involved in distribution and wholesale for 3M, the company that produces one of the relatively affordable N95-type masks. While this could provide a positive bump to Apex’s 3Q19 earnings, note that it is a one-off event and could be minimal to the group’s full-year earnings (c.2% to Apex’s 2019E earnings).

Valuation and Recommendation

Maintain HOLD with a TP of RM2.11 All in, while we look forward to the contribution from SPP NOVO and remain upbeat on Apex’s long-term prospects, the group’s near-term earnings are expected to remain weak given the estimated 1.5-2 year gestation period for SPP NOVO (our forecast: 14% yoy decline in 2019E core earnings). We maintain our earnings forecasts and HOLD call on Apex with an unchanged TP of RM2.11, based on 2020E target PER of 17x. Upside risk: lower-than-expected start-up expenses for SPP NOVO. Downside risks: higher-than-expected start-up expenses and product recall risk.

Source: Affin Hwang Research - 20 Sept 2019

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Economic Update – Malaysia- Budget 2020 Preview

Author: kltrader   |  Publish date: Fri, 20 Sep 2019, 10:38 AM

A Likely Expansionary Budget 2020, Mainly From Higher DE

Budget 2020 likely to include measures to sustain private consumption

The 2020 Malaysian Budget will be presented on 11 October 2019, with the theme “Shared Prosperity: Sustainable and Inclusive Growth Towards High Income Economy.” The upcoming 2020 Budget is crucial as it will be the final budget under the Eleven Malaysia Plan (11MP) for the 2016-2020 period. Similarly, the strategies on the Budget proposals should be seen in the context of ensuring a transition to the development plan of the Twelve Malaysia Plan (12MP) for the 2021-2025 period, as well as setting out the directions and right strategies for Malaysia to become a high-income economy.

Despite widely expected to be an expansionary budget to stimulate domestic demand amid the global economic uncertainty in 2020, we believe the Federal Government will remain focused on fiscal discipline, incurring a slightly lower budget deficit of 3.2% of GDP in 2020, compared with a deficit of 3.4% of GDP in 2019E, slightly higher than the initial official target of 3.0% of GDP (see Fig 1).

The increase in the budgetary allocation for operating expenditure will be gradual, but allocation for development expenditure (DE) will likely be increased in Budget 2020. Based on our estimate, we believe the Government’s operating expenditure will be slightly higher by 2.6% to RM235.9bn in 2020 (RM222.9bn in 2019E). We believe development expenditure plays an important role to sustain the country’s economic growth, where the expansionary impact will help to preserve the Government's revenue source (i.e., direct taxation) generated by economic activities.

Our estimate forecasts development expenditure to be higher at RM55.7bn in 2020 as compared to RM54.7bn in 2019E. This move is intentional as development expenditure on construction-related projects generally has a higher multiplier impact on the economy relative to operating expenditure, see Fig 2.

We expect the Government revenue to still outpace that of operating expenditure to register a substantial operating surplus of RM2.8bn in 2020 (RM2.0bn in 2019E), remaining in surplus for 33 years in a row since 1987. Similarly, based on historical trends, it is evident that allocation of development expenditure will be higher in the last year of the five-year plan. The Government had proposed and revised development expenditure under the mid-term review of the Eleven Malaysia Plan (11MP) to RM220bn. Based on our estimate, development expenditure is expected to be substantial at around RM55.7bn in 2020, as compared to RM54.7bn estimated for 2019. In the first four years (2016-2019) of the 11MP, the Federal Government has disbursed about 89.9% or RM198bn of the total RM220bn.

2020 budget may be based on oil assumption of US$70 per barrel

We believe the crude oil price assumption in preparing and tabling for the Malaysia’s Budget 2020 has been revised higher from an initial figure of US$60- 65 per barrel to US$70 per barrel, following the Saudi Arabia oil attacks.

Saudi Arabia oil attacks a turning point leading to higher global oil prices

The drone attack over the past weekend on Saudi Arabia's Abqaiq refinery and oil processing facility and Khurais oil field has impacted production by around 5.7mmbpd, lowering current production from 9.8mmbpd to 4.1mmbpd, as reported. This represents a significant 58% of its own production and 19% of OPEC’s total production as of August 2019, which made up 5% of world supply. Since the attack on 15 September 2019, the price of Brent crude oil has risen sharply by around 15% from US$60 per barrel to US$68 per barrel currently.

While Saudi Arabia had initially guided for full production resumption early this week, Saudi turned less optimistic about a full recovery and currently only expects to restore one-third of the lost production in the near term. It is uncertain at this juncture how long the global outrage will last.

However, we believe the US strategic petroleum reserve may be used to mitigate the shortfall. President Trump has earlier guided that it will tap into US oil reserves to ensure that there is no sharp increase in global oil prices. Higher oil prices will likely be bad for the US economy, especially prior to his upcoming presidential election. We currently maintain our 2H19 Brent oil price assumption at US$65-70/bbl, but there could be upward bias to our current assumption in the short term depending on the timeline of production resumption. Our view reflects the current uncertainty on global crude oil supplies.

Federal Government’s revenue to benefit from oil price gain

From a macro perspective, based on an earlier estimate, for every US$10 per barrel increase in the price of global crude oil, the Federal Government’s revenue will likely translate into a gain of about RM3.0bn a year. While the expected additional revenue can help cover for the Government’s subsidy bill from rising domestic petrol prices, we believe the upcoming proposed implementation of the targeted fuel subsidy scheme will also lower the subsidy amount allocated by the Government for petrol (RON95) and diesel. There will be some windfall from subsidy savings to provide for possible contingency measures (such as additional allocation for development expenditure or cash assistance through BSH), to cushion the negative impact from the global trade war tensions.

Lower subsidy bill from the upcoming targeted fuel subsidy scheme

As guided, with the proposed targeted fuel subsidy scheme, the price cap on RON95 petrol (currently at RM2.08 per litre) may soon be gradually removed. Based on an earlier calculation from last year’s Budget, the targeted subsidy is expected to cost the Government only RM2bn for 2019, with the oil price assumption of US$70 per barrel. While the Government may still be subsidizing RM0.30 sen for every litre of RON95 petrol as well as every litre of diesel, the authority will likely provide a timeframe for phasing out the current system and introduce a targeted fuel subsidy scheme for 2020, which may include proposals such as cash assistance directly given to lower-income households.

As such, we believe the increase in the price of global oil will improve Malaysia’s revenue from the contribution of oil-related revenue including PITA, Petronas dividends, petroleum royalties and other oil-related income (such as export duties on petroleum/crude oil and income from exploration of O&G), which is expected to support Malaysia’s fiscal position.

Government to continue with measures to support private consumption

To address the socio-economic conditions from a higher cost of living, we believe the Budget 2020 to continue with its targeted incentives for households under the B40 category. The Government has been assisting the B40 group through cash assistance, such as Bantuan Sara Hidup (BSH), and this will likely be continued in 2020 to support their well-being. Apart from BSH, the budget allocation for the tourism sector will also be another focus in the budget for the 2020 Visit Malaysia Year campaign. In tandem with the event, Tourism Malaysia is targeting 30 million tourist arrivals in 2020 and tourist receipts of RM100bn (28.1 million tourists in 2019E and RM92.2bn in 2019E, respectively). We believe the Government will likely provide additional allocation for the Visit Malaysia 2020 Year campaign, possibly a higher allocation than 2019, to grants for international marketing and promotional programmes.

Cut in corporate income tax on hold to preserve revenue streams

The Finance Minister already guided that the 2020 Budget is not expected to introduce new tax measures targeting the corporate sector and investment community (which may be referring to capital gains tax on shares and inheritance tax). Nevertheless, while we believe the positive upside surprise to the Budget measures will be from an across-the-board 1%-point cut in taxes on corporate income earned, the Government will likely leave its corporate tax rate unchanged in 2020 to preserve revenue streams from direct taxation.

Corporate income tax accounts for 51.1% of direct tax and 38.2% of total Government revenue. We believe any cut in the corporate tax rate will only be implemented from 2021 onwards, after Government revenue starts to increase more steadily. Recently, Indonesia has proposed a reduction in the corporate income tax (CIT) rate to 20% in 2022, from 25% currently, starting in 2021.

Need measures to support economy from uncertain global economy

Going into 2020, the global economy still faces substantial downside risks emanating from the global trade war. The International Monetary Fund (IMF), in its latest issue of the World Economic Outlook (WEO), downgraded its growth forecast on the world economy by 0.1 percentage point to 3.5% for 2020 (3.2% in 2019).

The global manufacturing PMI remained in contraction for the fourth consecutive month at 49.5 in August from 49.3 July. Global semiconductor sales contracted for the seventh consecutive month in July by 15.5% yoy, albeit at a slower pace compared to 16.8% in June. With recent weak external data, as reflected in the global PMI, this may suggest that manufacturers will remain cautious on new orders and international trade going forward.

According to the IMF’s latest assessment of the impact of the trade war, based on a simulation, the recently announced tariffs by the US and China will lead to a 0.3 percentage point reduction in global GDP growth in 2020, where more than half of the impact will be due to lower business confidence and negative financial market sentiment. Assuming that further tariffs are implemented, this may lower global growth by 0.8 percentage points in 2020, with the IMF’s global GDP growth possibly falling below the 3% level next year.

Growth in Malaysia’s private investment is highly correlated with external conditions, where slower growth is likely from some postponement and delay in the actual implementation of investment in the manufacturing and services sectors, due to the global slowdown. Nevertheless, we believe the country's domestic demand, especially private consumption, will sustain its growth momentum, possibly benefitting from Budget 2020 measures.

The Government is likely to project the country’s real GDP growth to average around 4.5-5.0% for 2020, against our expectation of 4.5% (4.7% estimated for 2019). However, in the event that the external environment deteriorates sharply and if there is a need to introduce additional fiscal stimulus, we believe the Government will allow its fiscal deficit target to be flexible to shore up economic growth, whereby the fiscal deficit may be slightly higher than the deficit target set and revert to the fiscal consolidation path once the global economic environment stabilises

Likely sectoral budget strategies and measures

On a sectoral basis, for the construction sector, we expect the Government to likely revive some of the large-scale infrastructure projects (at reduced cost and longer implementation timeline) such as the MRT3 and Pan Borneo Highway Sabah (PBH) projects. We believe the MRT3 will enhance the public transportation system in Klang Valley, while PBH will improve road connectivity in Sabah and Sarawak.

According to our construction analyst, other projects such as the Penang Transport Master Plan (PTMP) and HSR could be implemented based on a public-private partnership concept. However, the decision on whether the HSR will be revived is unlikely to be announced during the Budget 2020 announcement since the deadline agreed between the Malaysia and Singapore governments is May 2020.

Affordable housing will remain a key area of focus

We expect initiatives on affordable housing to continue in Budget 2020. This will be in line with the recent measures by Bank Negara Malaysia (BNM), where the eligibility criteria for its RM1bn Fund for Affordable Homes which began in January 2019, was raised effective from 1 September 2019. The maximum household income eligible is now RM4,360 from RM2,300, while the maximum property price is now RM300,000 from RM150,000. The Fund will be available for two years from 2 January 2019 or until the RM1bn fund is fully utilised. Benefiting the construction sector, we expect the Government’s development expenditure to emphasise building new hospitals, water and sewerage systems, and rural roads to improve the lives of the people in towns and rural areas under the Government’s concept of shared prosperity.

As for the property sector, we believe the Government will continue or expand on incentives to assist first-time house buyers, as affordability remains an issue for the B40 and low M40 groups, such as stamp-duty exemptions and mortgage guarantees by Cagamas inclusive of down-payment support. There are some reports noting that the minimum property price for foreigners to purchase local residential properties (currently at least RM1m but some states impose a minimum price of RM2m for landed properties) may possibly be reduced to help clear the unsold units.

For the financial sector, potentially additional tax incentives may be given to banks which adopt sustainable financing practices (i.e., green tech, renewable energy) and fund new technology adoption initiated by start-ups (self-driving cars, Prop Tech, Con Tech, Fintech).

As for the gaming sector (i.e., casinos), we believe that there will likely be no increase in gaming taxes or licensing fees after the steep hike in Budget 2019, as company profitability may still be negatively impacted by the hike. Post the hike, Malaysia has one of the highest gaming taxation rates in Asia, which significantly limits casinos’ ability to compete against regional peers for the VIP and Premium-Mass clients. Both gaming volume and margin have are already recorded a significant decline in 2019.

As for the consumer sector, on sin taxes, we believe that the risk of excise-duty hikes on the brewers is less pronounced, with Malaysia’s existing taxation on malt liquor already amongst the highest in the world. The last excise-duty revision in March 2016 constituted a change in the excise-duty structure – from RM7.40/litre plus 15% ad valorem tax, to a flat RM175 per 100% volume per litre of alcohol – rather than a direct hike, and was then preceded by 10 years’ absence of duty hikes.

Moreover, a sales tax of 10% and on-trade service tax of 6% had been already imposed in 2018 following the abolishment of GST. In the event of a duty hike, we expect the brewers’ volumes to be negatively impacted over the short term, should they decide to pass on the cost to consumers – representing a fourth round of price hikes since last year.

For the tobacco players, we do not foresee any excise-duty hikes to materialise in Budget 2020. This is due to the unresolved illicit cigarettes trade situation constituting 60% of the market since the Government’s aggressive spate of duty hikes from 22sen/stick in 2013 to 40sen/stick in 2015, which has been further exacerbated by the rise of cigarettes sold with fake tax stamps, alongside unregulated vape products retailed at relatively more affordable prices than legal cigarettes. We believe any possible revisions to the excise-duty structure would be more likely to occur following the enactment of the MOH’s new Tobacco Act, which is guided to be tabled in Parliament by March 2020 and encompass a broader spectrum of regulations on the usage of tobacco, vape, e-cigarettes and shisha.

For the auto sector, we see several potential initiatives for the sector in the Budget 2020, such as 1) the possible higher allocation or study grants to further strengthen the local workforce (via technical and vocational education training). For instance, the new ‘national car’ definition in the upcoming National Automotive Policy (NAP) 2019 requires the carmakers to use up to 98% local workers in its workforce; 2) higher market development grant/allocation to spur the rate of exports for component manufacturers; 3) possible allocation for the establishment of charging stations, batteries production and management systems for the upcoming ‘next-generation vehicle’, to prepare Malaysia on becoming an energy-efficient carmaker; 4) incentives may be provided in the form of tax breaks/exemptions for carmakers that are keen to expand research and development and higher localisation efforts in Malaysia; and 6) special incentives for first-time national car buyers that may help with affordability among young adults.

As for the healthcare sector, we believe the Government will likely continue with a higher allocation for healthcare, given the Government’s growing emphasis on providing quality healthcare and social welfare protection as well as increasing accessibility to health services. In addition, we believe that the Government might potentially reintroduce the reinvestment allowance for pharmaceutical manufacturers in Budget 2020, which was not renewed in Budget 2019.

As for the insurance sector, we expect continuous tax relief for annual EPF and insurance/Takaful contributions, as well as possible tax incentives for insurance firms, which subsidize insurance coverage for the B40 group / single mothers. As for the plantation sector, we believe that there could be potential allocation by the Government in the Budget for FELDA developments, as well as potential allocation by the Government for development and replanting of palm-oil/ marketing programmes to assist smallholders.

For the telco sector, we expect the Government to highlight the recently launched National Fiberisation and Connectivity Plan (NFCP). Spearheaded by the Communications and Multimedia Ministry, the NFCP is a five-year plan (2019-2023) with an investment cost of about RM21.6bn, to be funded by the Universal Service Provider (USP) fund (RM10bn-11bn) and the private sector. The NFCP is expected to create 20,000 job opportunities. Overall, we expect the potential high investment expenditure to benefit the telco contractors and equipment suppliers.

Source: Affin Hwang Research - 20 Sept 2019

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Economic Update – ASEAN Weekly Wrap - Bank Indonesia (BI) lowered its policy rate by 25bps to 5.25%

Author: kltrader   |  Publish date: Fri, 20 Sep 2019, 10:27 AM

The policy cut was a preemptive move to support Indonesia’s economy

At its latest monetary policy meeting in September, Bank Indonesia (BI) cut its benchmark policy rate (7-day repurchase rate) by 25bps for the third consecutive meeting to 5.25%, a move that was in line with market expectations. The benchmark policy rate was last seen at this level in July 2018. BI’s move possibly comes after the US Fed cut its Fed Funds Rate by 25bps to 1.75-2.0%. So far this year, BI had cut rates by a total of 75bps. In its statement, BI guided that the move was a “pre-emptive step to support the momentum of domestic economic growth amid slowing global economic conditions.” We believe there is still room for BI to ease policy rates as inflation remains within the bank’s target range of 2.5-4.5% in 2019. In August, inflation rose by 3.5% yoy (3.3% in July), its highest level since December 2017. However, Bank Indonesia expects inflation to remain manageable in the months ahead.

Nevertheless, we believe the country’s current account deficit will remain a concern for BI in deciding on future rate cuts, as its current account deficit widened to 3% of GDP in 2Q19 after narrowing to -2.6% of GDP in 1Q19, which is now on the higher end of its deficit target of 2.5-3% of GDP. Furthermore, although trade balance in August rebounded to a surplus of US$85.1mn from a deficit of US$64.3mn in July, this was mainly due to a sharper drop in imports compared to exports. Exports contracted for the tenth consecutive month by 10% yoy in August from -5.1% in July, its sharpest drop since February 2019. Meanwhile, imports declined further for the second straight month by 15.6% yoy from -15.2% in July.

Separately, Singapore’s non-oil domestic exports (NODX) contracted at a slower pace for the second consecutive month by 8.9% yoy in August compared to -11.4% in July, making this its slowest decline so far this year after five straight months of double-digit declines. Trade balance in August widened to S$4.2bn compared to S$3.4bn in July. Lower decline in NODX was supported by the smaller drop in exports of non-electronic products of 2.2% yoy (-6.7% in July). Going forward, we believe the prolonged trade tensions between US and China will remain as one the headwinds for the country’s trade performance. As China is also Singapore’s largest export partner accounting for 21.4% of total NODX, a continued slowdown in China’s economy will also pose as a downside risk towards Singapore’s NODX growth. Recall in 2Q19, real GDP growth slowed to a ten-year low of 0.1% yoy (1.1% in 1Q19). Therefore, we believe this could possibly prompt Monetary Authority of Singapore (MAS) to ease its monetary policy, by adjusting its trade-weighted exchange rate index.

Source: Affin Hwang Research - 20 Sept 2019

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Economic Update – US Economy - Monetary Policy

Author: kltrader   |  Publish date: Thu, 19 Sep 2019, 11:36 AM

US Fed Cuts Its Federal Funds Rate by 25bps to 1.75-2.0%

The FOMC dot plot suggests no further rate cuts in 2019

The US Federal Reserve (US Fed) lowered its Federal funds rate (FFR) by 25bps to a range of between 1.75-2.0%, in line with market expectations, its second rate cut in 2019. In the latest assessment, the US Fed guided that its decision to lower the FFR was due to “implications of global developments for the economic outlook as well as muted inflation pressures”, the same rationale given in its previous statement for a rate cut in July this year. The US Fed also guided that this was to support sustained expansion of economic activity and strong labour market conditions although uncertainties to this outlook remain. The Fed also highlighted that household spending has been “rising at a strong pace” while business fixed investment and exports have weakened. On the inflation front, the US Fed continues to expect “inflation near the Committee’s symmetric 2% objective” is the most likely outcome despite core-PCE remaining below the 2% inflation target since the start of 2019.

In the latest FOMC Summary of Economic Projection, the Fed revised its GDP growth forecast higher from the June FOMC meeting, from 2.0-2.2% to 2.1-2.3% in 2019. The projection for unemployment rate was unchanged at 3.6-3.7%. Meanwhile, on the inflation outlook, the median expectation of PCE inflation remained unchanged at 1.5%, while core PCE inflation projection was maintained at 1.8%.

Going forward, according to the US Fed statement, the latest FOMC dot plot suggests no further FFR cuts this year, any possibly in 2020. This differs slightly to the previous FOMC dot plot in June, when it projected no policy changes in 2019 but one rate cut in 2020. Nevertheless, we believe the decision on the future direction of the target federal funds rate will be data dependent, especially on the state of the US economic performance. We believe the Fed’s latest decision to cut rates was an “insurance cut” as recent economic indicators have been mixed, such as US retail sales, which rose more than expected by 0.4% mom in August (0.8% mom in July). However, in the US job market, nonfarm payrolls slowed to 130k in August, down from 159k in July, its slowest increase since May 2019.

Although a significant slowdown is not apparent yet in the US economy, we believe that if incoming economic releases continue to signal an across the board economic slowdown, this may prompt the US Fed to cut its FFR further. We also expect the US Fed to monitor the developments of the trade talks between US and China as well as other external events such as Brexit and geopolitical risks. Currently, there are no guidance given on the possible resumption plan of an expansion in US Fed’s balance sheet (i.e QE), despite intervention in repo market. The remaining FOMC meetings in 2019 will be on 29-30 October and 10-11 December 2019. Going into 2020, we expect the US Fed’s decision on the future monetary stance to be tilted towards more easing, possibly another 50bps FFR cut in 1H2020.

Source: Affin Hwang Research - 19 Sept 2019

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