• 3Q18 Earnings Season Was a Disappointment

• Applying 5-year mean PER of 18x on our 2019E EPS, we introduce our end-2019E KLCI target of 1,810. Our new end- 2018E target is reduced to 1,753, based on 2018E PER of 18x, from 1,845)

• Downside risks could arise from contractionary measures taken by the government, geopolitical tension in North Korea or the Middle East, and sell down in the bond market, where foreigners still hold 13.5% of Malaysia’s total bonds outstanding, could adversely affect the Ringgit and sentiment on Bursa Malaysia.

The Fund and Its Objective

The Net Asset Value (NAV) per unit was RM1.7754 as at 6 December 2018, a year-to-date (YTD) decline of 4.1% and 4.6% lower since our initiation date on 6 June 2018. Similarly, KLCI has also fallen 6.3% YTD and 5.3% since our initiation. The Fund’s NAV was RM2.968m as at 6 November 2018.

For the quarter ending 30 September 2018, the fund recorded NAV per unit of RM1.880, translating to total NAV of RM3.157m, an increase of 6.86% from the previous quarter (NAV per unit of RM1.7668 and total NAV of RM2.954m). During the financial period under review, the fund’s performance underperformed the benchmark’s return of 7.28% by 0.42ppt. The size of the Fund remained at 1,672,000 units. No gross income distribution per unit was announced this quarter while the management’s expense ratio was 1.07%, similar to the previous quarter. There were no significant changes to sector weights during the quarter with trading/services and finance comprising the largest portions of the funds at 37.2% and 35.7%, respectively.

Performance in 3Q18

The 3Q18 earnings report season disappointed with earnings showing their sharpest rate of contraction since 1Q18, weighed down by Utilities, Plantation, Construction and Media sectors. The market’s core earnings in 3Q18 contracted 9.2% qoq and 5.1% yoy, impacted by a range of factors including higher operating costs, lower CPO ASPs, slower progress billings for the Construction (ongoing public-sector project reviews conducted by the government) and Property sectors (weak sales), and higher fuel costs for the Transportation sector.

More Cautious Outlook Going Into 2019

In view of this and our lower in-house 2019E GDP growth assumption of 4.7% (compared to our earlier projection of 5%), we lower our FBM KLCI aggregate 2019E earnings growth to 3.2% yoy from 4.8% yoy previously. Our new end-2019E target is 1,810 (applying past-5-year mean PER of 18x to 2019E EPS).

Upside to the Outlook

We remain firm believers that the Ringgit is undervalued based on REER and hence deters capital outflows from Malaysia. With foreign equity holdings on the KLCI appearing to hit a trough, downside to the market seems limited.

Other potential catalysts for the market include the RM37bn tax refund and the effective execution of the new government’s key reforms in order to strengthen the consumer’s purchasing power as well as bring about sound economic fundamentals. Thus far, we believe that the country is heading on the right track in terms of its reforms. Strong FDI inflows reaffirm our belief that the institutional and regulatory reforms taking place are putting Malaysia back on the right footing. This is reflected in the lower infrastructure project costs and the decline in broadband prices, which should translate to an improved fiscal position as well disposable income for the household, while improving productivity (via enhanced broadband bandwidth).

Rejuvenation of the private sector also provides a catalyst to the economy as Small Medium Enterprises (SMEs) account for 37% of GDP and are expected to increase to 41% of GDP by 2020 according to the government. A number of measures were introduced in Budget 2019 to spur the growth of the SMEs, including setting aside a RM2bn allocation for loan guarantees of up to 70% for automation and modernisation. While this is not a new focus of the government, we think that the impact could be more meaningful this time around especially if it coincides with the government addressing its own private investments and eliminating the crowding out effect.

Meanwhile, on the external front, if both President Trump and President Xi Jinping agree to halt any further tariff hikes after the 90-day window or if there are any easing of trade tensions, this should be positive for markets in general.

Downside Risks

Key downside risks include (i) the current government undertaking contractionary fiscal measures that negatively impact GDP growth or Malaysia losing sight of its fiscal consolidation plans, leading to a sovereign rating downgrade; (ii) Geopolitical tensions arising from North Korea or the Middle East disrupting financial markets; (iii) A selldown in the bond market such as in May 2018 where Malaysia saw the highest selldown, which contributed mainly from a drop in MGS foreign shareholdings from 44.3% to 41.9% that adversely affect the Ringgit; and (iv) a pick-up in inflation rate in the US could lead the US Fed to raise rates more than anticipated causing higher-than-expected outflow of funds from emerging markets and the region.

Source: Affin Hwang Research - 10 Dec 2018