The 11MP MTR saw several headline macro targets lowered: lower GDP of 4.5%- 5.5% (from 5%-6%) and fiscal deficit of 3% in 2020 (from balanced budget previously). As predicted, DE allocation for 11MP was cut from RM260bn to RM220bn. We view this as a signal for a tighter Budget 2019 with less “goodies” and new taxes introduced. Key themes that could emerge from the 11MP MTR include higher income levels especially for the B40 (consumer), greater focus on Sabah and Sarawak (construction and O&G) and governance reform (Malaysia as a reform play in the medium term). While our 2018-2019 KLCI earnings growth is uninspiring at 2% and 5%, valuations look undemanding with P/E at -1.5SD and earnings-MGS yield spread at +1SD. Maintain KLCI target at 1,830 (16x P/E tagged to mid-2019 earnings).

Macro targets lowered to reflect current realities. Lower GDP target of 4.5%-5.5% (previous: 5%-6%) in line with slower global growth, domestic supply side disruptions and ongoing fiscal reforms. Growth will be driven by the private sector with focus on higher value added activities. Consumption will be supported by government’s aim to increase compensation of employees to 38% from 35.2%, enhancement of social protection system to selective recipients and enforcement of price control regulation. On investment, government aims to introduce measures to encourage investment in machinery and equipment, especially in automation. In addition, government is expected to revise the list of industries that qualify for incentives under Promotion Investment Act 1986

Higher fiscal deficit target in 2020. While fiscal deficits are larger than originally anticipated to account for GST and personal income tax refund, the Government’s efforts to increase transparency, optimise expenditure and diversify tax revenue may be seen as positive developments. We revise our fiscal forecast to 3.6% of GDP in 2018, -3.5% of GDP in 2019 and -3.0% of GDP in 2020.

DE cut hinting for a tighter Budget 2019? As predicted in our 4Q18 Strategy report, development expenditure (DE) allocation for the 11MP was cut from RM260bn to RM220bn (-15% vs our expectation of -18%). This is negative for construction given the strong correlation (71%) between nominal construction GDP and DE. We believe the cut in DE signals to less “goodies” for Budget 2019 coupled with the possibility of new taxes (digital tax, soda tax, carbon tax and inheritance tax). Unlike previous Budgets that managed to stir some market excitement, we expect it to be relatively muted this time around.

Key market themes. The 11MP mid-term review (MTR) highlighted 6 development pillars where we envisage 3 market themes that may come to play. Firstly, the push for higher income levels, especially for the B40 should be positive for consumer staples and discretionary as well as autos (particularly the local makes). Secondly, we sense that a greater emphasis will be placed on Sabah and Sarawak. This will include more infrastructure (benefitting local state contractors) and review of MA63 (potentially giving rise to more control of its O&G reserves which could lead to the championing of local state service providers). Thirdly, the governance reform agenda, if executed well, could eventually see Malaysia emerge as a reform play.

Maintain KLCI target of 1,830. While our 2018-2019 KLCI earnings growth projection of 2% and 5% is uninspiring, we do note that valuations are now looking increasingly attractive with (i) P/E at -1.5SD below mean and (ii) earnings yield vs 10-year MGS yield spread at +1SD above mean. We maintain our KLCI target of 1,830 based on 16x P/E (-0.5SD) tagged to mid-2019 EPS.

Source: Hong Leong Investment Bank Research - 19 Oct 2018