PH secured 122 (55%) seats in GE14, giving it a simple majority to form the next government. While PH’s reform agenda is long term positive, short term market and ringgit weakness may happen from this unprecedented outcome. PH’s proposal to abolish GST may increase the budget deficit from 2.8% of GDP to 3.1%, still at the low end of the 5-year range. Winners from the GE14 outcome are consumer (no GST) and exporters while losers are construction (mega project reviews) and those with high USD cost (auto, aviation and media). We remove DRB and GKent from our top picks as we turn defensive and replace with Digi and MQREIT. Maintain FBMKLCI target of 1,880 for now.

The Rakyat have spoken. Against all odds, the Pakatan Harapan (PH) coalition led by Tun Dr Mahathir Mohamad won 122 (55%) of the 222 Parliamentary seats in GE14. On the other hand, Barisan Nasional (BN) secured 79 seats (36%) and PAS 18 (8%). This provides PH with a simple majority in Parliament to form the next federal government of Malaysia. We feel that this is a comfortable 11 seat buffer away from a hung Parliament scenario (i.e. 111 seats). For the state elections, PH managed to secure the highest number of seats for Penang, Selangor, Negeri Sembilan, Melaka and Johor with majority and Kedah and Perak with plurality. PH tied with BN with an equal number of seats in Sabah.

Near term market downside. The GE14 results were certainly unprecedented as Malaysia has never seen a change in the BN government since independence. The market may experience a temporary sell down in the short term as investors deal with the perceived uncertainty until further clarity emerges on the policies of the new PH government. Nonetheless, our analysis of stock market performances in other countries post political shocks (i.e. Thaksin, Brexit and Trump) indicate that sell down trends were short lived, with all ending higher 12 months later.

GST to be abolished. PH’s most ambitious manifesto proposal is abolishing GST. Investors would be awaiting more details on how this would be executed. Our estimate suggest this could potentially increase the 2018 budget deficit target from RM40bn to RM44bn or 2.8% of GDP to 3.1% on a proforma basis. Nevertheless, this potential level of 3.1% is still at the lower end of Malaysia’s 5-year (2012-2017) historical deficit to GDP range of 3% to 4.3%.

Malaysia could be a reform play. While investors may have concerns on PH’s governance experience, we highlight that several of its heavyweights have previously been in government. Newly sworn-in PM, Tun Mahathir was Malaysia’s longest serving PM for 22 years (1981-2003). Furthermore, good governance has been the forefront of PH’s campaign – transparency, accountability, reducing leakages and promoting the independence of key institutions. Should PH succeed in improving this, it is not hard to see Malaysia emerging as a reform play.

Winners and losers. The consumer sector would be the key winner if GST is abolished. With the review of mega projects, this would be negative for construction given the risk of cancellation and delays. We also see a short term downside bias for the ringgit which should be good for exporters (tech, wood manufacturing and gloves) but bad for autos (import cost), aviation (operational cost) and media (foreign content).

Tweaking our top picks. We maintain our FBMKLCI target of 1,880 (16.5x P/E on 2018 earnings) for now but will review this post 1Q18 results. Most of our top picks are insulated from the regime change. However, we remove DRB and GKent (both are still rated BUY) as we turn defensive and include Digi (Shariah re-inclusion) and MQREIT (high yielder at 8.5%).

Source: Hong Leong Investment Bank Research - 14 May 2018