• More companies beat expectations in 3Q20 vs 2Q20. Plantations, gloves, EMS and tech stood out as they registered growth even on a yoy basis
• As 3Q20 earnings were better than expected, we now project a smaller 17% decline in the 2020E KLCI EPS, with upgrades driven largely by banks and gloves
• EMS raised to Overweight, Transport raised to Neutral and Autos downgraded to Neutral. We add Press Metal and VS Industry to our Top Buys. Remain Neutral on the KLCI with an unchanged year-end target of 1,650

Companies that exceeded expectations thumbed those that disappointed

Broadly, 3Q20 was a better quarter as more companies exceeded expectations, both large and small caps. For our coverage, the percentage of companies whose results exceeded expectations came in at a high of 47.9% in 3Q20, compared to only 33.9% back in 2Q20 (Fig 1). For the larger caps (Fig 2), as represented by the KLCI companies, the performance was even better, with 57% of these companies beating expectations (vs 28.6% in 2Q20). Correspondingly, fewer companies within our coverage disappointed although this figure remained static qoq for the large caps. A key notable trend was improved EBITDA margins across most of the companies that were also at 3-year highs (Fig 5), despite revenue being still in a recovery phase post the movement control order. While increased automation was a key factor, we suspect that most companies continued to reduce overheads (marketing expenses) during this economic slowdown, and benefit from the extended work from home arrangement.

Plantations, Gloves, EMS and Tech surprised and grew on yoy basis

Generally the positive earnings surprise was broad-based (Fig 11), with at least one company surprising on the upside in each of the sectors under coverage. However, it was really the Plantations, Gloves, EMS and Tech sectors that stood out, not merely with positive surprises, but also registering earnings growth on a yoy basis (Fig 7). The planters benefitted from higher-than-expected CPO and PK ASPs that were partly attributable to improved demand, tight stock levels, price increases of other edible oils and weather uncertainties. Performance for the glove manufacturers continued to surprise even after several quarters of exceedingly strong results, as realized ASPs were higher than previously forecasted. With a spike in COVID-19 cases, they remained bullish on their ASP guidance for 4Q20. For EMS and Tech, backlog orders could have contributed to the better performance in 3Q20 although we firmly believe that they are benefiting from a structural shift in supply chains due to the trade tensions. In addition, companies with direct exposure to China have seen a firmer recovery following the stronger growth there.

More rating upgrades than downgrades

There were more rating upgrades this quarter (18 vs 11 in 2Q20) than rating downgrades (3 vs 9 in 2Q20). Broadly, this was to take into account our more optimistic views on recovery plays and that most of their stock prices have bottomed out given the good news on vaccines. ATA, Scicom, LPI, Gas Malaysia, Petronas Dagangan and Uchi were raised to BUYs also because of their positive earnings surprise.

Projecting a smaller earnings contraction for 2020

While we were anticipating a better quarter, albeit from a low base, the 3Q20 results still came in ahead of expectations. This contributed to a higher number of companies or 51% of our coverage with a positive earnings revision (39% in 2Q20), leading to our revised KLCI EPS growth estimates of -16.6% for 2020E (from -23.6% previously) and 27.9% for 2021E (from 28.8% previously). While banks, plantation, glove and tech saw positive earnings revisions, the key contributors to the market earnings upgrade were banks and gloves.

EMS raised to Overweight from Neutral

VS Industry and ATA IMS were raised to BUYs from Holds post their results. Both reported a strong sequential recovery in earnings post the weak 2Q20 as manufacturing activity had been impacted by the lockdowns. More importantly, revenue and profits have reverted to pre-Covid-19 levels due to a structural shift as the EMS players benefit from the trade tensions from the re-routing of supply chains leading to not merely new contracts but also new customers.

Transport raised to Neutral, Auto downgraded to Neutral

Transport is raised to Neutral as we turn a little more optimistic on the reopening of economies given the steady progress on vaccine development. This also follows our upgrade on MAHB to a Hold (from Sell). Despite the poor set of results, we believe that investors will look ahead to its earnings recovery in 2022. The Auto sector is, however, moved to Neutral subsequent to our downgrade of large cap Sime Darby to a Hold (from Buy).

Revisions to Top 10 buys – Press Metal and VS Industry added

We remove Sime Darby after the rating downgrade as we see some headwinds for its industrial division stemming from China’s ban on Australian coal while the good news from a recovery in its motor division may already be in the price. While we like HSS Engineers as a beneficiary from the rollout of mega infrastructure projects, it is also taken out given the internal conflict surrounding the misconduct of its former CEO, which may be a near-term overhang. We replace Sime Darby and HSS with Press Metal and VS Industry. We like Press Metal for a play on a global economic recovery and hence aluminium demand. Its timely expansion in capacity (+42%) will also see the largest SEA smelter benefitting from improved prices whilst its integrated operations should help with margin expansion. We like VS for its execution in terms of securing new contracts and gaining new customers which demonstrates its solid manufacturing track record and capabilities.

Maintain Neutral on the KLCI with an unchanged year-end target of 1,650

The market earnings momentum could taper down in 4Q20 because of the reinstatement of the movement control order. However, the market may pay little attention to this especially with vaccines around the corner. The focus remains on recovery plays and especially those that have been beaten down. We believe that compelling buys remain in growth sectors – namely EMS, Building Materials, Gloves and Utilities, our Overweight sectors. However, the positive sentiment could be tempered by rumblings of an early election and the KLCI’s relative outperformance against regional markets, which may cap foreign inflows. Foreigners remain net sellers on the market ytd and the KLCI has seen net outflows for the past 3 years. 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 earlier-than-expected vaccines for Covid-19 which could result in a collapse in glove stock prices, 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 - 4 Dec 2020