While the Ukraine-Russia conflict complicates global recovery, we believe the impact is rather contained for Malaysia – we maintain our 2022 GDP forecast at +5.5% and 25bps OPR hike in 4Q22. With reopening heading to an endemic stage, Malaysia’s relative appeal amid the geopolitical conflict, and a possible “election rally” on the horizon, we turn more upbeat on the local bourse. Upgrade KLCI target from 1,600 to 1,680 based on 16.2x CY22 PE (-0.75SD). Our stock picks centres on reopening beneficiaries, commodity exposure, laggards and apolitical election plays – Tenaga, PMetal, SDPlant, RHB, Sunway, Bursa, Astro, DNeX, Armada, Kobay, Evergreen and FocusP.

Conflict complicates global recovery but... Following the Ukraine-Russia armed conflict, commodity prices have surged, complicating the pandemic recovery as this pushes inflation higher, lowers real income and weighs on demand. We believe this will lead to a downgrade of 2022 global growth projection by IMF in mid-Apr (current: +4.4%). Although peace talks between the two former Soviet nations appear to be gaining preliminary headway – with Ukraine’s neutrality and territories being points of contention – the situation remains very much fluid.

…contained impact for Malaysia. We believe Malaysia is relatively shielded from direct repercussions of the conflict as (i) Ukraine and Russia collectively accounted for only 0.4-0.5% its trade and (ii) its position as a commodity exporter. We estimate that Malaysia’s current account would increase by 0.62% and 0.16% of GDP for every USD10/brl increase in Brent oil price and RM100/MT increase in CPO price, respectively. Nonetheless, rise in commodity prices would lead to higher inflation, although partially negated by the fuel price ceiling – consequently, we raise our 2022 CPI forecast from 2.0% to 2.7%. While demand may be dented from higher cost of living, we see cushioning from (i) another round of special EPF withdrawal providing a boost to private consumption – up to +4.2ppts by our estimates and (ii) transition to the endemic stage next month, with boarders reopening. As such, we keep our 2022 GDP forecast unchanged at +5.5% and BNM to increase OPR by +25bps in 4Q22.

Expected gyration. KLCI’s YTD (as at 28 Mar) currency adjusted return of +0.7% (absolute: +1.9%) performed inline with ASEAN-5’s +1.3%. The bellwether index’s gyration between 1,509 (low; 25 Jan) and 1,619 (high; 3 Mar) was broadly within our trading range expectation of 1,500-1,600 (see our 2022 Outlook report dated 15 Dec).

Neutrality appeal. While we expect the market to continue trading in choppy fashion, we reckon the Ukraine-Russia conflict has given Malaysia relative appeal in the eyes of foreign investors – a neutral geopolitical stand, relatively insulated economy compared to the West and exposure to commodity plays. Case in point: net foreign inflows to the local bourse have totalled +RM4.23bn since the conflict began in late Feb, more than offsetting last year’s entire -RM2.99bn net outflow. We remain positive on winners of higher commodity prices – plantations, O&G (DNeX is our upstream exposure pick) and PMetal – and would also nibble tech and utilities (Tenaga) on weakness.

Past the Omicron peak. We believe the worst of the Omicron wave in Malaysia is over with daily cases down -34.3% from its peak (based on 7DMA), while R-naught has subsided below 1.0 since mid-Mar. More importantly, despite higher cases vs the deadly Delta wave, “severity indicators” (i.e. symptomatic cases, ICU and mortality) are a far cry from last year – see Figures #4-6. In addition, as headline cases are likely underreported (due to home test kits) these indicators could actually be even milder from a ratio perspective.

Transition to endemicity. With severity indicators under control, alongside high vaccination rates (adults boosted: 66.6%, adolescence fully vaccinated: 91.6%), we believe Malaysia is ready to transition to an endemic stage on 1 Apr. This should benefit aviation (boarder reopening), Genting, consumer retail, healthcare, mall and hotel based REITs (all from foreign tourist arrival) and brewers (pubs reopening and boozing hours past midnight). While mobility has softened amid the Omicron wave, these levels are still higher than during Delta – MySj check-ins: +28% and Google Mobility: +23-40% – indicating that people are adapting to living in endemicity.

Return of foreigners. Foreigners have remained net buyers on Bursa since Aug 2021 (with the exception of Dec), totalling +RM8.79bn (YTD: +RM6.24bn). Despite that, foreign shareholding remains suppressed, with Feb level at a record low 20.1%. We reaffirm our view that this has scrapped the bottom of the barrel, seeing that (i) it is below the GFC-low of 20.7% and (ii) foreign exodus from Malaysia in seven of the past eight years (-RM68.2bn). The return of foreigners would be positive for the market given a decent 68% correlation between KLCI and foreign shareholding.

Calls for GE15 getting louder. The recent 2/3rd majority win by BN in the Johor state elections (and previously, Melaka) has intensified grapevine talk that GE15 could happen sooner rather than later. Taking into account the MoU between opposition-PH and the federal government to not dissolve Parliament before end-July and the east coast monsoon season in Nov-Dec (flooding risk), leaves a window of Aug-Oct if national polls are held this year; GE15’s deadline is by July 2023. Analysis of the KLCI’s performance during the past three election years (2008, 2013 and 2018) indicated an upward trajectory 5-6 months prior to the polls (albeit some profit taking in the last month). With an unprecedented three premiership changes in less than four years, we think investors would react positively should the victor secure a convincing mandate – a plausible outcome considering the recent results in Johor, Melaka and Sarawak. We continue to like Bursa as an apolitical election play as prior GEs have shown to have a positive effect on ADV (see our latest Bursa report dated 16 Mar).

Market can stomach higher rates. As earlier mentioned, we expect a +25bps OPR hike in 4Q22. Bond markets have likely priced this in, seeing that the MGS10 yield has risen +156bps from its low of 2.39% in Aug 2020. Despite the yield increase, the spread between KLCI’s earnings yield and MGS10 is still generous at 2.58% which is +0.7SD above 5Y mean (Figure #14), suggesting the market can stomach higher rates.

Upgrade KLCI target to 1,680. We forecast KLCI earnings growth of -0.6%/+7.3% for CY22/23. With reopening heading to endemicity, Malaysia’s relative appeal amid the geopolitical conflict and a possible “election rally” on the horizon, we turn more upbeat on the market. While cost push inflationary pressures are a key risk, we think the government will try to keep a lid on this as the national polls loom. We raise our KLCI target from 1,600 to 1,680 – valuing the bellwether index at 16.2x PE (-0.75SD to 5Y mean) on CY22 EPS. Our top picks are Tenaga, PMetal, SDPlant, RHB, Sunway, Bursa, Astro, DNeX, Armada, Kobay, Evergreen and FocusP

Source: Hong Leong Investment Bank Research - 30 Mar 2022