Investment Highlights

• Carbon pricing initiatives. Together with Bursa Malaysia, AmInvestment Bank recently organised an investors’ webinar titled “Carbon Pricing Instruments to Support Net Zero Ambitions” which was presented by ERM, the world’s largest pure play environmental, health and safety, risk and sustainability consultancy. The objectives were to introduce investors in Malaysia to existing global and domestic carbon pricing instruments, provide a high-level overview of recent carbon pricing developments and opportunities globally and in Malaysia to support climate and net-zero ambitions.

• Offering financial incentives to decarbonise. Carbon pricing is an instrument capturing the external cost of greenhouse gas (GHG) emissions and ties them to their sources through a price on the emission of carbon dioxide (CO2). This creates an economic signal to regulate and reduce GHG emissions while providing a strong financial incentive to divest from a high emission fossil fuels-based technology towards cleaner technology.

• Emphasising government, business and investment prerogatives. Governments tend to adopt a “polluter pays” principle which can be a source of revenue for budgets to support climate projects that may be not commercially attractive yet. For businesses, the mechanism evaluates the impact of mandatory carbon prices on operations, identifying potential climate risks and opportunities. Investors analyse the potential impact of climate change policies on their investment portfolios, allowing the reassessment of investment strategies and reallocation of capital toward low-carbon activities.

• Opting between ETS and carbon tax. In 2021, carbon pricing initiatives, including for international aviation, covered 11.6 gigatonnes of CO2 or 21.5% of global GHG emissions. The 2 types of carbon pricing mechanisms are: i) emissions trading systems (ETS), or commonly referred as cap-and-trade, that limit the total GHG emission levels and allow industries with low emissions to sell their extra allowances to larger emitters; and ii) carbon tax which directly sets a price by defining a tax rate on GHG emissions.

• Encouraging voluntary initiatives. Carbon offsets and renewable energy certificates (REC) are being used by companies to meet mandatory targets under the domestic carbon pricing policy or voluntary commitments such as carbon neutrality and net zero claims when an organisation cannot reduce its direct or indirect GHG emissions. Carbon offsetting involves purchasing the equivalent (tCO2e) in carbon reduction credits from external parties to compensate for its own carbon emissions. However, carbon insetting means investing in sustainable initiatives and practices to reduce carbon emissions within its own value chain.

• ICP adoption. Multinationals have increasingly begun adopting internal carbon pricing (ICP) mechanisms voluntarily to value their GHG emissions in driving positive changes as the cost assigned to each tonne of carbon can be factored into business and investment decisions, thereby incentivising efficiency and enabling low-carbon innovations. These include using an internal tax, shadow price or implicit carbon price. In 2020, the number of companies in Asia adopting ICP reached 796, above Europe’s 661 and North America’s 359 (Exhibit 2).

• Reducing Malaysia’s carbon intensity. Malaysia, the fourth largest ASEAN GHG emitter with 240mil CO2 released in 2018, has ratified both the Kyoto Protocols (1997) and Paris Agreements (2015). In the 12th Malaysia Plan, the government pledged to become a carbon-neutral country by 2050, committing to reduce its carbon intensity (against GDP) by 45% in 2030 compared to the 2005 level, of which 35% will be unconditional with 10% conditional to financing and technology transfer by developed countries. For Peninsular Malaysia, the government declared a renewable energy mix of 31% by 2025 and 40% by 2035.

• Endorsed voluntary ETS. While a Malaysian carbon tax framework has yet to be announced, a voluntary domestic emissions trading scheme has been endorsed by the Ministry of Environment and Water (KASA). Hence international voluntary carbon offsetting programmes such as Verra and Gold Standard, and REC have established a presence in Malaysia. ERM expects the government to take 2–3 years to implement the carbon tax/ETS policies, and another 3–5 years to implement its objectives.

• Expanding ESG champions. Given the growing importance of ESG prerogatives, we have added another 7 stocks to our list of champions, which now include Petronas Chemicals Group, Petronas Gas, IHH Healthcare, Westports, Inari Amertron, Sunway Holdings and Astro (Exhibit 10). These companies have ESG scores of 4 stars and demonstrate strong commitments towards sustainable business models and initiatives.

• Bargain valuations emerge as the FBMKLCI has fallen by 9.5% YTD to 1,419 currently, close to our year-end worst-case scenario of 1,415 based on 2 standard deviations below its 5-year median forward PE of 16.3x (Exhibit 8). This was driven by the continuation of foreign net equity sales of RM145mil this month to date following the RM1.3bil net foreign outflow in June amid low liquidity (Exhibit 5). As a comparison, the FBMKLCI’s median was 1,525 at a forward PE of 17.6x in 2020 when the Covid-19 pandemic caused Malaysia’s GDP to drop by 5.6%. Meanwhile, our economist maintains a 2022F GDP growth of 5.6% and year-end USD/MYR target of 4.20.

• Lowered base-case end-2022 FBMKLCI target at 1,630 (from an earlier 1,745), pegged to 0.5 standard deviation below its 5-year median at 16.3x from no discount earlier, on growing concerns that our 2023F earnings growth of 8% (Exhibit 7) could be eroded by higher operational and inflationary costs as the government proposes new mechanisms to reduce subsidies and raise federal revenues (such as GST reintroduction) against the backdrop of a prolonged Ukraine-Russia military conflict, heightened global recessionary possibilities and domestic political noises. Near term, fund flow volatility could continue to drive the index within a wide range of 1,400 to 1,600.

Source: AmInvest Research - 8 Jul 2022