• Except for gloves, insurance, technology and plantations, all other sectors saw a sharp contraction in 2Q20 earnings - down 37% qoq and 52% yoy - due to the lockdown.
• 2020E KLCI EPS growth is cut further to -24% yoy. Earnings likely to have hit a trough in 2Q20, but a recovery will be modest.
• Auto and Utilities raised to Overweight, Banks upgraded to Neutral. Remain Neutral on the KLCI with an unchanged year-end target of 1,650. TM and Sime Darby added to Top Buys.

2Q20 Earnings Collapse on MCO Impact

Unsurprisingly, because of the Movement Control order (MCO), most sectors were impacted, resulting in a sharp collapse in 2Q20 core net profit (Fig 6: -37% qoq and -52% yoy). Only the rubber gloves, insurance, technology and plantations sectors showed positive growth momentum. Because of a demand mismatch and capacity constraints, ASP momentum remained on an uptrend for glove manufacturers and is likely to persist in the coming quarters, as most are already operating at full capacity while the pandemic has yet to fade away. The planters showed better earnings due to better production and higher prices, technology due to fulfilment of backlog orders and a recovery from a low base in the previous quarter while the insurers saw lower net claims and higher investment gains during the quarter.

Fewer Disappointments This Quarter Because of Low Expectations

Despite the sharp earnings contraction in 2Q20, we had expected this quarter’s results season to be a lot worse, which was not the case. A higher number of companies beat expectations this quarter (Fig 10), not merely the large cap companies (Fig 2: 29% vs 14% in 1Q20) but also broadly within our coverage (Fig 1: 34% vs 14% in 1Q20). Similarly, those that fell below expectations were far fewer than in the previous quarter. We think that this was largely due to the low earnings expectations in a number of these sectors, for which we had already aggressively cut earnings forecasts earlier in the year.

But Our KLCI EPS Growth Estimate Is Cut Further

Nevertheless, we have cut our 2020E KLCI EPS growth further to -23.6% from -18.7%. Over the past quarter, while we have seen sharp earnings upgrades for the glove manufacturers, earnings momentum had declined sharply for transportation (mainly Air Asia) and gaming primarily due to the closure of borders and hence the restriction on foreign tourist arrivals, and limitations at casinos because of social distancing. The banks also incurred a one-off modification loss, a result of the loan moratorium and extension of the duration of HP loans, which amounted to RM1.8bn. While the banks reported their weakest quarterly earnings in recent times, they were however no worse off than during the Global Financial Crisis.

More Rating Upgrades Than Downgrades

With already low earnings expectations and the pullback in stock prices given the weak underlying market sentiment, we saw more rating upgrades (11 companies) in 2Q20 (Fig 9) vs rating downgrades (9 companies). The downgrades were largely due to valuations and their limited upside. Worth noting is the positive earnings surprise at TM which beat expectations on better-than-expected revenues combined with cost restraints. TM also announced a higher DPS unlike most other companies which had reduced their payout during this challenging period. We recently upgraded TM to Buy and now include the stock under our Top 10 Buys.

Auto and Utilities Upgraded to Overweight, Banks Raised to Neutral

The other 2 significant recent upgrades (to Buys) were Sime Darby and Tenaga on the back of their attractive valuations – trading at forward PERs of 13x and 11x respectively, well below the market PER. We had raised Sime Darby to a Buy prior to its results on the back of a fairly resilient industrial division and demand recovery for its motors division. FY20 earnings fell 5% despite the pandemic but came in above expectations overall. For Tenaga, the stock price had underperformed the KLCI and largely priced in the earnings disappointment. We see earnings recovery in subsequent quarters while DPS upside and postponement of the implementation of RP3 to 2022 should be catalysts for the stock. Given the size and weighting of these 2 stocks in their respective sectors, we raise the sector weightings to Overweight. Our other change is for Banks, which is raised to Neutral from Underweight. The only Sell rating within the sector is CIMB, while the others are Holds. More importantly, we think that the worst in earnings could be over for the banks, although an earnings recovery would be modest, even through 2021. Fig 17 provides a summary of the sector ratings and changes: Rubber Gloves, Auto and Utilities are our sector Overweights, Construction, Gaming, Media and Transport & Logistics remain as Underweights while the rest remain in Neutral.

Sime Darby and TM Added to Top Buys

UMW’s 2Q20 results disappointed, with a core net loss during the quarter. While we expect earnings to recover, this looks already in the price with the stock trading at 17x 2021E EPS. We recently downgraded UMW to a Hold and for automotive sector exposure, we prefer Sime Darby. ATA IMS’ earnings held up well as anticipated and we had downgraded the stock to Hold on valuation grounds. We replace ATA with TM.

Maintain Neutral and 1,650 Year-end Target for KLCI

While we think that market earnings have likely hit a trough in 2Q20, the sharp recovery in the KLCI since its March lows has largely priced this in. We maintain our view that an economic recovery, even moving into 2021, is likely to be modest at best. The KLCI is also trading near its historical mean PER. On the flip side, the strength of market liquidity and suspension of short-selling activities till the year-end will be supportive of the market. We maintain our 2020 KLCI year-end target of 1,650 based on its 5-year mean PE of 19x. Key risks for the market include an earlier-than-expected vaccine for Covid-19 which could result in a collapse in glove stock prices and the KLCI, a sovereign rating downgrade, further weakness in the US$ that aid fund inflows, a sharp decline in oil prices and geopolitical risk.

Source: Affin Hwang Research - 2 Sept 2020