US-led trade spat prompts us to cut global and Malaysia 2018 GDP by 0.1ppts to 3.8% and 5.2%. Despite 0% GST and fixed fuel price, the 2.8% budget deficit target is achievable. “New Malaysia” should see a consumption revival but construction slowdown. We expect the new administration to honour contract sanctity, open new tax avenues and push for more open tenders. Foreigners net sold RM10bn since May and the KLCI’s P/E is now -2SD below mean. We project 6% KLCI earnings growth for 2018 and maintain our target at 1,770 (15.5x P/E).

Slight cut to growth. The global economy remains firm as job market improves and confidence remains at high levels despite the 1H18 moderation. Nonetheless, the US led trade spat with major economies is expected to lower global GDP from 3.9% to 3.8% for 2018. On Malaysia, consumption increase should be offset by lower government expenditure. As current tariff measures take effect, leading to slower global GDP growth, we downgrade 2018 Malaysia GDP forecast slightly to 5.2% (from 5.3%). As GDP and inflation is anticipated to be more moderate, we retain our expectation for BNM to maintain OPR at 3.25% in 2018. We forecast USD/MYR exchange rate at 3.90-4.10 for the remainder of the year.

Post GE14 selloff. Despite the post GE14 selloff, on a currency adjusted basis, the KLCI was the least hit amongst ASEAN-5 at -5.9%. While foreigners have been net sellers every day since May (totalling RM10.1bn), we believe it is still premature to call an end to the exodus. Although GE14 was unprecedented, we expect a relatively stable political scene on back of PH’s 48% popular vote, increasing PH friendly seats in Parliament and experienced personalities for key Cabinet posts.

GST out, SST in. On the fiscal front, we believe GST “zerorisation” and fixed fuel prices can be offset by SST reintroduction, higher oil revenue, higher dividends from GLCs and expenditure cuts to meet the government’s unchanged 2018 budget deficit to GDP target of 2.8%. The migration from GST to SST should generally be positive for purchasing power and most sectors as the latter encapsulates a narrower base. This should be positive for consumers, which even prior to GST removal, has seen encouraging signs with (i) private consumption growth recovering from its 2015-2016 lows, (ii) retails sales growth rebounding to pre-2015 GST level and (iii) 1Q18 CSI of 91 at its highest point post GST.

Expectations from “New Malaysia”. Firstly, scrapping (HSR, MRT3) and renegotiation (ECRL) of mega projects will impact contract flows which as it is, are down 23% YoY (Jan-May). Secondly, other tax avenues may be implemented such as (i) clamping down on illicit sins to increase excise duty collections, (ii) price tender for spectrum and (iii) resumption of CPO export tax. Thirdly, we believe contract sanctity will be honoured with (i) toll abolishment to be unlikely and (ii) Tenaga’s ICPT/ IBR mechanisms should be maintained. To note, Gas Malaysia’s higher tariff was recently approved. Fourthly, a possible GLC restructuring could be in the works with the top brass off many removed. Lastly, we see a shift to an increased open tender framework going forward. Good governance has been a key highlight by PH, which if executed well, could eventually see Malaysia emerge as a reform play.

KLCI target at 1,770. It is tough to be positive on Malaysian equites in the near term as the new administration is walking a tight rope between rakyat friendly measures and fiscal prudence while reforms are still in its early days. Abroad, “tariff tantrums” pose an exogenous risk that is tough to predict. However, with the KLCI’s P/E at -2SD and P/B at -1SD below mean, this should give some reason to at least nibble on Malaysia. Our KLCI earnings growth for 2018 is at 6% and we maintain our 1,770 target based on 15.5x P/E (-1SD) tagged to 1 year forward rolling earnings.

Source: Hong Leong Investment Bank Research - 27 Jun 2018