During the 4Q18 results season, 35% came in below expectations, 46% inline and 20% above. Compared to 3Q18, disappointments reduced (45% to 35%) while positive surprises rose (16% to 20%) resulting to an improved ratio from 0.36x to 0.56x. Key sector disappointments were construction (weak margin), plantations (low CPO price) and telco (high cost). We estimate that KLCI core earnings contracted -1.6% YoY in 2018 and project subpar growth of 3% for 2019. Maintain KLCI target at 1,750. Drop Tenaga and FPI from top picks and replace with Top Glove and CCM.

Wrapping up 4Q18 results. From the recently concluded 4Q18 results season, out of the 112 stocks (excluding Gamuda on restricted list) under our coverage universe, 39 (35%) came in below expectations, 51 (46%) were inline and 22 (20%) were above. When the results were stacked against consensus, the outcome was pretty similar with 35% below, 45% inline and 21% above.

Fewer misses. In comparison to the previous quarter (i.e. 3Q18), the proportion of results disappointments reduced from 45% to 35%. On the other hand, there was also a slight increase in the proportion of positive results surprise from 16% to 20%. Consequently, from a ratio perspective, (i.e. % of results above/ below), this improved QoQ from 0.36x to 0.56x (consensus: 0.26x to 0.59x). Dissecting the 39 results disappointments reveal that 44% were due to cost factors, 31% from revenue shortfall (mainly from plantations) and the balance 26% from both.

Key sector disappointments. Sectorial wise, the key disappointments came from construction, plantations and telco. For the contractors, margin compression was evident which likely stemmed from (i) project delays post GE14 resulting to fixed overheads being “uncovered” and (ii) downward revision in budgeted margins which tends to happen during sector slowdown. Apart from that, we noticed that higher finance cost also impacted some contractors (e.g. WCT, Mitra, IJM). On plantations, weaker CPO price and to a lesser extent, lower production were the reasons for the disappointment. In 4Q18, CPO price averaged RM1,972/mt vs RM2,160/mt in 3Q18 and RM2,611/mt in 4Q17. Apart from that, a widened discount between Indonesia’s CPO pricing vs Malaysia was also witnessed. Lastly, results shortfall for the telco sector largely stemmed from higher operating cost which impacted Maxis (one-off expense to enhance fibre and enterprise product quality), Axiata and TM.

Review of top picks. Our 10 top picks saw an equal proportion of positive and negative results surprise at 3 each, with the remaining 4 coming inline. Amongst the results shortfall, Tenaga was hit by a surprise RM640m revenue reversal from the excess revenue generated under the new IBR revenue cap structure. The other 2 disappointments were FPI (high operating cost likely from new plant expansion) and Taliworks (lower associate profit from changing of amortisation method). We remove Tenaga and FPI from our top picks and include Top Glove (recent share price weakness) and CCM (recovering caustic soda price). Despite the results shortfall, we retain Taliworks as it does not alter our investment thesis on its superior yield (c.8%) backed by the impending settlement of receivables from SPLASH.

KLCI target of 1,750. Overall, we estimate that 2018 KLCI core earnings contracted by -1.6% YoY, dragged by Axiata, IOI, KLK, Maxis, MISC, PetDag, Sime Plant and Tenaga. Post 4Q18 results earnings adjustment, we now project 2019 KLCI earnings growth at 3% (from 3.3% previously), below its post GFC CAGR of 7%. While 2018 KLCI earnings are lowered post 4Q18 results season, our KLCI target stays unchanged at 1,750 (15.5x PE or -1SD) as we roll forward our valuation horizon from 2019 to mid-2020.

Source: Hong Leong Investment Bank Research - 5 Mar 2019