• Corporate earnings performance for 1Q18 off to weak start

• Plantation and construction companies’ earnings largely disappointing

• Several large caps, i.e. TM, CIMB, Pet Dag were below expectations

• Glove sector earnings continued to surprise on the upside

• KLCI growth moderated, KLCI target 1,865

1Q18 earnings off to weak start

Corporate earnings season which ended yesterday saw poor earnings mainly from 2 sectors, plantation and construction. Earnings growth expectation for KLCI companies have gradually receded since the beginning of the year. The change in earnings reflect the volatility in the commodity market – CPO price realised has been disappointing – and the shifting economic and fiscal landscape for Malaysia, in our view.

Corporate earnings growth for KLCI companies has now tempered to only 2.8% yoy, as opposed to a more robust expansion of 7.5% at the beginning of the year. We noticed that a higher earnings growth is now expected for 2019. In January 2018, consensus had expected earnings for 2019 to grow by only 5.5% yoy, but this expectation has now improved to 8.4%.

Following the recent fall in Malaysian equities, the KLCI’s 15.4x multiple now looks attractive as opposed to its 5-year average of 16.5x. Nonetheless, we continue to be selective in our recommendation and focus on the sound business of companies that will result in continuous earnings growth and superior cash flow generation.

In January 2018, we introduced our key themes for the year as highlighted below, and believe that these themes will continue to play out for the rest of the year.

1. continued expansion in GDP;

2. rising commodities, led by crude oil and industrial metals;

3. digitalisation of the economy;

4. robust growth in private consumption – we still like selective consumer stocks on market weakness however; and

5. elevated multiples in dominant sectors/companies – rubber gloves and technology are still our preferred choice in this space.

Earnings growth for 2018 has moderated sharply

The KLCI’s cumulative earnings performance recovered strongly in 2017, which prompted the market to expect a sustained growth for 2018. However, since the beginning of 2018, this growth expectation has been tempered as several sectors have seen disappointing earnings performance, particularly in 1Q18.

We had initially estimated an annual earnings growth rate of 7.5% for KLCI at the beginning of 2018 (banks’ earnings are derived from consensus). The growth expectation is now at +2.8% yoy for the KLCI, and +3.4% for Hijrah component stocks.

Earnings breakdown by KLCI sub-sectors (refer Table 1 below) shows consensus expects a moderation for 2018 earnings for banks, led primarily by the 2 largest earners – Maybank, and Public. However, utilities and telecommunications – accounting for 27% of KLCI aggregate earnings – are forecast to see negative earnings growth this year, dragging down the overall KLCI earnings for 2018.

The primary drivers behind the earnings expansion expected for the KLCI in 2018 is due to a sustained growth in the banking sector (non-shariah compliant, consensus earnings) and plantation, based on our forecast. Nonetheless, the banking sector’s profit is forecast to see a slower 10.5% growth in 2018 versus 13.1% in 2017. Banks’ capital position is still robust with common equity tier 1 well above the required regulatory level of 8.5% by 2019.

The make-up of our universe differs greatly to the KLCI due to shariah compliant coverage which excludes banks and gaming which make up for close to 51% of the KLCI’s aggregate earnings. As a result, our universe forecasts a net profit growth of only 1% for 2018 (down from +11% in Jan 2018) due to weaker growth mainly from plantation.

Overall, 1Q18 results for plantation companies under our coverage were weak. Out of 11 companies under our coverage, 7 were below our forecast. Generally, earnings were lower than forecas, mainly due to decline in palm product prices realized.

Almost all companies under our plantation coverage recorded a weaker qoq performance. This was mainly due to lower ASP realised of CPO and PK compared to 4Q17, as well as lower margins from downstream segment. We do not expect to see margins for plantation companies improving in the coming quarters as soft CPO prices are likely to prevail.

In the telco sector, TM’s results disappointed as revenue weakened across most customer clusters, especially at TM One and TM Global. This was worsened by the higher opex rose amidst LTE investments for unifi mobile. The effective tax rate also surged owing to earnings drag from webe and absence of any deferred tax assets to cushion the blow. Product innovation remains key for TM but we believe this would also see higher investments which may risk protracted payback period.

KLCI target revised due to weaker earnings expectation and lower PE applied

Following the downgrade in KLCI 2018 earnings, we have lowered our expectation for the index for the year. Our KLCI target is cut to 1,865 from 1,950 which we introduced in April 2018. Apart from the weaker earnings growth, we expect sentiment, and interest, for Malaysia equities to remain weak until we have reached at least the 100 days of new government. We expect to see better clarity from new measures and fiscal policy perspective, beyond this period.

As we have written in our strategy note post-general elections on 14 May 2018, we remain positive on the reforms that are being undertaken. We expect these reforms, if successfully executed, to improve Malaysia’s competitiveness in the long term.

We highlight the sectors’ performance following the 1Q18 results in the following tables. In non-coverage companies, earnings and ratings are derived from consensus.

Source: BIMB Securities Research - 1 Jun 2018