The 2Q17 corporate earnings seasons was disappointing with the number of misses increasing to 44% of our coverage. With slower GDP growth anticipated in 2H17, there could be further downside risk. Nevetheless, there are sufficient drivers to ensure our lowered 2017-18E corporate earnings growth of 2.7-6.8% is achieved, in our view. Maintain Overweight with a 2017 year-end target of 1,813 (based on 17.9x 2017E earnings).

2Q17 Corporate Earnings Slows to 4.1% Yoy

Sectors that reported positive yoy growth momentum included the Banks, Construction, O&G, Property, Rubber products, Technology, Telco and Small/Mid Caps. Nevertheless, earnings for the remainder 11 sectors (of the total 19) were in negative territory, thus resulting in a weaker 4.1% yoy growth in 2Q17 corporate earnings (1Q17: 20.8%). On the whole, the large cap Plantation sector was a major disappointment due to higher production costs leading to several rating downgrades in this space. Sequential earnings momentum was however negative (-3.9% qoq), although due to the high base in 1Q17.

More Companies Report Disappointing Results – But Large Caps Intact

A growing number of companies reported weaker earnings this quarter. Within our coverage, 44% of companies saw earnings falling below expectations (from 32% in 1Q17) and 45% of companies earnings were downgraded (Fig 3). Fortunately, there were fewer large cap stocks that disappointed – 23% of the FBMKLCI components stocks that we cover fell below expectations. We had rating cuts for 20 out of our 107 companies (Fig 8) due to valuations but more so for their earnings underperformance. Worth highlighting are the 5 companies with rating upgrades – AMMB, PetChem, Uchi, Bonia, MAHB, of which the former 3 raised to BUYs largely on valuations and improved earnings prospects.

3 Sectors Downgraded to Neutral

The Rubber products, Property and Healthcare sectors are downgraded to Neutral due to their price outperformance and largely Hold ratings within the sector. We have also collapsed the Timber companies into the broader Plantation sector as most of the companies in the former are already generating bulk of their revenue and earnings from plantations. Of the 19 sectors under coverage, the Overweights are down to Banks, Construction, Gaming, Insurance, Utilities and Small/Mid Caps (Fig 17).

Corporate Earnings Growth Lowered to 2.7% for 2017E

While 2Q17 earnings was lackluster, the disappointment fell largely within the smaller/mid cap space. As a result, corporate earnings growth for 2017-18E of 2.7-6.8% yoy remains relatively intact (3.2-6.4% yoy just prior). Positively, with the firmer earnings yoy, ytd DPS payout has improved (Fig 4)

Maintain Overweight and End-2017 KLCI Target of 1,813

Although our GDP growth estimate is expected to be slower at 4.8% yoy in 2H17, albeit from a higher base (1H17: 5.7%), we think that banking earnings spurred by construction and infrastructure projects, steady commodity prices and low unemployment rates will help sustain corporate earnings in 2H17. We maintain our Overweight stance on the KLCI with a 2017 year-end target of

1,813 (based on 17.9x 2017E market earnings). Revisions are made to our previous stock selection due to a combination of price outperformance and change in fundamentals. Our most preferred large cap names include Allianz Malaysia, AMMB, Gamuda, Globetronics, Genting Bhd, Tenaga. In the small mid cap space, we like Hai-O, HSS Engineers, Perak Transit and Uchi. Our least-preferred names are AirAsiaX and Star.

Risks

Downside risks: i) decline in commodity prices including CPO and oil prices; ii) further corporate earnings disappointments; iii) Malaysia losing sight of its fiscal consolidation plans; iv) US Fed accelerating its interest rate hike and paring down its balance sheet too fast or ECB easing its monetary policy too quickly; which combined would lead to an acceleration of capital outflows.

Source: Affin Hwang Research - 6 Sept 2017