The 1Q19 reporting season was a mixed bag, although still with a negative bias as only 9 of the 20 sectors under coverage registered earnings growth. Overall, 1Q19 corporate earnings fell 9% yoy dragged by the Utilities, Transport, O&G and Plantation sectors. There were a larger number of companies that missed expectations in 1Q19 although value is starting to emerge given the sharp number of upgrades. Post the revisions, we lower our 2019E KLCI EPS growth to just 1%, from 3.8% after the 4Q18. Hence, we cut our KLCI 2019E year-end target to 1,679 (from 1,810), still based on 18x 2019E KLCI EPS. As for stock picks, we remove Maybank, KPJ and Sunway Construction, and add Gamuda, Syarikat Takaful and TM to our Top- 10 country-pick list. We maintain our Neutral stance given lackluster corporate earnings growth and the KLCI’s premium valuations.

Corporate Earnings Jump Sequentially, From Lower Base in 4Q18

As expected, corporate earnings improved on a sequential basis, jumping 15% due to the very low base in 4Q18, which was incidentally one of the weakest quarters for corporate earnings in a while. However, improvement was still not good enough to match the performance in the same quarter last year, and earnings fell by 9%, or a drop of RM1.7bn in absolute terms. There were an equal number of sectors posting negative yoy growth in 1Q19 and only 9 of 20 sectors under coverage had positive growth (Fig 6).

Disappointments largely in Plantation, Transportation, O&G, Utilities

There were 4 key sectors that contributed to the earnings decline including Plantations due to lower CPO and PK prices, Transportation, O&G and Utilities. At the company level, major disappointments included Air Asia and Air Asia X, which swung to losses in the quarter, Petronas Chemicals which suffered from lower product ASPs and wider losses at Sapura Energy. Among utilities, Tenaga reported earnings that were higher than allowed under RP2 in the year before, leading to lower earnings yoy.

Larger Number of Companies With Weaker Earnings Delivery

Apart from the weaker earnings yoy, the number of companies that disappointed in terms of earnings delivery also rose to 39.5% in 1Q19 from 30.6% in 4Q18. While companies that reported earnings that fell within expectations in 1Q19 jumped to 47.6% (from 41.3% in 4Q18), the number of companies surpassing expectations fell to 12.9% (from 26.4% in 4Q18).

Looking on the Bright Side, There Were More Rating Upgrades

In terms of rating changes, there were more upgrades (18 in 1Q19, vs. 6 in 4Q18) than downgrades (7 in 1Q19, vs. 13 in 4Q18) this quarter (Fig 9). While it is surprising that we are seeing more upgrades despite the mediocre overall earnings, the upgrades are being led predominantly by valuation and a change in valuation methodology (Nestle and plantations). The downgrades were largely due to earnings disappointments. Worthy to note is the positive earnings surprise at both Dialog and TM, which we subsequently upgraded to BUY (from Hold previously) (Fig 10). IJM Plantation, IOI Properties, Sime Darby Property and Malaysia Airport also reported better-than-expected results and saw a rating upgrade.

Source: Affin Hwang Research - 4 Jun 2019