Yesterday, the prime minister made a surprise announcement to scrap the MRT3 project (against consensus expectation of a project deferral), which precipitated another broad market meltdown. Foreign investors continue to flee the Malaysian bourse following the general election. Nevertheless, while investors are still held in suspense over the government’s decision on tolled expressways, the selldown is overdone judging by our trough valuation analysis. Compelling trades include CIMB and TM. Significantly downtrodden mid-caps include CMS, MYEG and MRCB.

WHAT’S NEW

• Painful reaction to scrapping MRT3. A man in a hurry, prime minister Tun Mahathir announced more measures following the second cabinet meeting of the newly-formed Pakatan Harapan (PH) government (see RHS table). A surprise was the scrapping of MRT3, given that the MRT project is seen as an essential public good, and there has been wide public approval of MRT1. Fears continue to play on the government’s high indebtedness, with the government potentially invoking expropriation clause on tolled road concessionaires, and potential economic ramifications of sharp pullbacks from mega projects. The market plunged 3.2% for the day, after falling 1.3% in the prior trading day.
• Awaiting the government’s high stake decision on tolled expressways. Investors continue to be held in suspense on the government’s impending decision on tolled expressways. Recall that PH’s election manifesto called for the cessation of tolling, and that the cabinet had targeted to make a decision this week (on whether to cease tolling, and if so, how to compensate the concessionaires).
• Maintaining sanctity of contracts should trigger a relief rally. Judging by the steep selloffs of major construction companies with tolled expressways (IJM and Gamuda), to below our assessed trough valuations, the market appears to have over-bearishly priced in a good probability that the government would invoke expropriation clauses in the concession agreements and significantly undercompensate the concessionaires. Nevertheless, we expect the government to undertake a more pragmatic solution which would be acceptable to the capital market, being fully aware that shortchanging the toll concessionaires would broaden investor concerns well beyond the construction sector.

ACTION

• Looking to revise down year-end FBMKLCI target amid a sombre 1Q18 reporting season. There is downside to our 2018 target of 1,830 (based on 15.7x 2019F PE) given that the 1Q18 reporting season has disappointed, particularly in the telco industry. We will officially introduce our new FBMKLCI target after the reporting season ends today.
• Favourite downtrodden stocks to accumulate include large-caps CIMB and TM, and mid-caps CMS, MYEG and MRCB.

Source: UOB Kay Hian Research - 31 May 2018