On the surface, the 2Q19 reporting season seemed better with more companies beating expectations. However, there was also a corresponding increase in disappointments which resulted in a further cut to our 2019E KLCI EPS growth, which is now down to +0.2% yoy (from +1% previously). Broadly, earnings held up the best in the Healthcare, Insurance and MREITS sectors and we continue to expect these sectors to hold up despite external macro headwinds. Key sector disappointments were largely in the Consumer, Plantation and Airline spaces. We cut our KLCI 2019E year-end target to 1,650 (from 1,679), still based on 18x 2019E KLCI EPS. As for stock picks, we remove Alliance Bank, and add Pintaras to our Top-10 country picks. We maintain our Neutral stance given lackluster corporate earnings growth and the KLCI’s premium valuation.

Larger Number of Hits, and Also Misses

While there was a higher number of companies with results that exceeded expectations in 2Q19 (16.1% in 2Q19 vs 12.9% in 1Q19), there was also a larger proportion of companies that failed to meet our expectations (42.4% vs. 39.5% in 1Q19). Broadly, the key sectors that disappointed included the Consumer, Plantations and Airlines while the Healthcare, Insurance and MREITS had the most companies that largely met expectations. Incidentally, the latter three are also sectors that we have Overweight sector ratings.

Fewer Rating Upgrades in 2Q19

At the company level, among the larger market capitalisation companies that positively surprised included Tenaga, Genting, Petronas Chemical and AMMB, where the latter was also subsequently upgraded to a BUY (Fig 9). Bonia, Heineken and Sime Darby Property also saw rating upgrades, but only due to a pullback in their valuations. BAT and Alliance Bank were among the larger-cap companies that disappointed, leading to rating downgrades. We have also removed Alliance Bank from our top-10 Buy list. Notably, there were fewer rating upgrades this quarter (4 in 2Q19 vs 18 in 1Q19)

Negative Earnings Growth Momentum for the Fourth Quarter

2Q19 was the fourth consecutive quarter where corporate earnings growth remained in negative territory on a yoy basis. Except for the Bank, Insurance, MREIT, Telco, Plastic Packaging and Property sectors which exhibited growth on a yoy basis, all the remaining 14 sectors recorded negative earnings momentum. Worth noting was also the sequential decline in earnings for the Consumer sector (-32% qoq) because of elevated costs and the Rubber product sector (due to weaker sales and margins). On a positive note, 2Q19 corporate earnings growth contracted by a lesser 4.6% yoy, narrowing from -8.4% yoy in 1Q19, potentially signaling that earnings are bottoming out. However, given the deceleration in global GDP growth and negative impact from the trade war, the risk of another leg down in terms of earnings growth could be high, in our view.

Large Caps Continue to Outperform the Small Caps

The large caps (represented by the KLCI30 companies) continued to fare better than the smaller caps with a larger proportion of companies delivering results that met expectations and fewer that failed to deliver (Fig 2). There were also more large-cap companies (Fig 10) that positively surprised (28.6% in 2Q19 vs 14.3% in 1Q19). Broadly, we would prefer the large-cap names because of their better quality. However, given expected market volatility, we think that a diligent stock selection is preferred over stock market capitalization bias strategy. We prefer companies with defensive earnings (within the Healthcare space) and those that offer high yields (found in MREITS).

KLCI EPS Growth Revised Lower Once Again

Post the 2Q19 earnings revisions, market earnings growth revision is still negative and has declined to +2.6% and +6.4% for 2019E and 2020E respectively (from +4.6% and +6.9% previously). For the KLCI companies, growth has dwindled to +0.2% and +4.4% for 2019-20E (from +1% and +4.4%). While the plantation, building materials and logistics sectors were key behind the negative earnings revisions, a 9% EPS upgrade in FY19E for Tenaga helped dilute some of the negative performance.

Pintaras Added to Our BUY List

We replace Alliance Bank (downgraded to Hold) after the earnings disappointment and replace this name with Pintaras which has seen strong orderbook replenishment and likewise earnings delivery, which has been driven by its acquisition of Singapore-based Pintary International. We also believe that Pintaras should be a key beneficiary from the recovery of the domestic property sector.

Overweight on Construction, MREITS, Healthcare and Insurance

We make no change to our sector positioning for now, and stay overweight on the Construction, MREIT, Healthcare and Insurance sectors. We are staying clear of cyclicals and as part of our defensive portfolio strategy, we like exposure to the Healthcare and Insurance sectors, which also ride on the longer structural theme of an improving middle-income segment. Domestic demand (via selective consumer plays) remains one of the key underlying country themes and we expect this to be well supported by the country’s fully employed workforce while cash handouts by the government will ensure that demand is supportive. Construction and infrastructure sectors should also see better prospects ahead as mega infrastructure projects that were initially put on hold due to cost re-negotiations are gradually being revived. MREITs are preferred for their stable earnings and attractive dividend yields and also stand to benefit from a widening interest rate differential as we think the interest-rate upcycle is likely to have already peaked. Ringgit weakness together with CNY depreciation should also benefit the exporters (prefer gloves over technology).

Maintain Neutral on KLCI, Year-end 2019 Target Lowered to 1,650

Our 2019E year-end KLCI target is lowered to 1,650 still based on an 18x or historical 5-year mean. As downside risk to corporate earnings remains given deceleration of global growth and escalation of trade tensions, we expect increased trading volatility on the KLCI. The widening PE premium against regional markets also makes the KLCI a less compelling

Source: Affin Hwang Research - 4 Sept 2019