The recently concluded 3QCY16 results reporting season continued to be disappointing and has reinforced our earlier view that a broad-based earnings growth story is still missing. Almost 1/3 of the stocks under our coverage delivered weaker-than-expected numbers. Sector-wise, the under-performers mainly came from: (i) Power Utility, (ii) Oil & Gas, (iii) Gloves, (iv) Gaming, and (v) Media.

Post results, we have revised our FBMKLCI earnings growth estimates lower again to -4.0%/6.0% (from 1.6%/7.2% earlier). Consequently, we have lowered our end-2016/17 index target to 1,682/1,732 from 1,715/1,755. Nevertheless, with a strong rebound in crude oil prices, we believe Oil & Gas sector could be a "Dark Horse" in the making. Besides, as FBMKLCI is trading near our earlier mentioned ideal "Buy On Weakness" levels of <1,625, we believe the underlying reward-to-risk consideration is getting attractive.

We are reiterating our 4Q16 Top Picks namely: (i) GKENT (TB; TP: RM2.80), (ii) KIMLUN (OP; TP: RM2.51), (iii) MATRIX (OP; TP: RM2.65), (iv) PWROOT (TB; TP: RM2.56), (v) SCGM (OP; TP: RM3.81), (vi) SCIENTX (OP; TP: RM7.57), (vii) SLP (OP; TP: RM3.11), (viii) MQREIT (OP; TP: RM1.41), (ix) RCECAP (TB; TP: RM1.50), and (x) SUNCON (OP; TP: RM1.81).

Another disappointing quarter. The recently concluded 3QCY16 results reporting season continued to be disappointing. Approximately 1/3 of the stocks in our coverage, or 44 stocks, out of a total of 128, delivered weaker-than-expected results. At the same time, 72 (or 56.3%) and 12 (or 9.4%) of them performed within and above expectations (see Figure 5-7 for details). Among the sectors under our coverage, we noticed that more stocks in (i) Oil & Gas, (ii) Construction, (iii) Consumer, (iv) Gaming, and (v) Media sectors delivered weaker-than-expected results. However, as a whole, we deem Construction and Consumer F&B to be within expectations.

For Oil & Gas sector, we saw further cut in FY16-17 earnings by 12%-27%, on average. This was largely due to slower-than-expected pick-up in the upstream activities. Thus far, services players are still prioritising cash flow management, especially asset-heavy players, to ensure that cash flow from operations are sufficient to cover debt obligation. While Consumer F&B stocks’ results were mostly inline,

Consumer Retail and Sin sub-sectors (i.e. AEON, PADINI, PARKSON, BAT and CARLSBG) somewhat delivered weaker-thanexpected results owing to subdued consumer sentiment and higher operating cost. Gaming sector, on the other hand, was dragged by GENTING (due to weak GENS numbers), BJTOTO and MAGNUM. In general, the results of NFOs were hit by poorer luck factor (for BJTOTO) as well as higher taxation and lower NFO sales growth (for MAGNUM).

Media sector was hit by the prolonged weak advertising revenue (as a result of economic uncertainties and poor consumer sentiment) as well as high OPEX. At the same time, our analysts are also somewhat disappointed with (i) Power Utility and (ii) Glove sectors. MALAKOF’s 3Q16 and YTLPOWR’s 1Q17 results came below estimates. MALAKOF was hit by higher depreciation for gas-fired plant for 9M16 coupled with higher taxation for T4. YTLPOWR was also impacted by the delay in Paka contribution.

All glove makers were also hit by intense price competition in the nitrile segment, resulting in lower margins. On the contrary, out of the 12 stocks that beat expectations, Oil & Gas as well as Plantation sectors contributed 3 stocks (or 25%) each. We view this positively. Recall that we have labelled these 2 sectors as “Dark Horses” as both Crude Oil and Crude palm Oil prices have been showing signs of improvement. More importantly, the low expectations on most of the Oil & Gas stocks make the sector a perfect target for bottom fishing. 3QCY16 was a slightly better quarter for Plantation sector, as FFB yield continued to improve QoQ.

As for our quarterly Top Picks, results of MATRIX (OP↑, TP: RM2.65↔), KIMLUN (OP↔, TP: RM2.51↔), SUNCON (OP↔, TP: RM1.81↔) and SLP (OP↔, TP: RM3.11↔ ) were within expectations. However, due to the price correction, we have upgraded the rating of MATRIX with an unchanged target price.

However, KOSSAN (MP↓, TP: RM6.90↓) and SKPRES (OP↔, TP: RM1.48↔) registered weaker-than expected results. The negative variance of KOSSAN’s results was due to: (i) lower-than-expected volume due to an unexpected plant revamp work on one of its plants, and (ii) lower-than-expected ASPs. To be prudent, we have cut both FY16E and FY17E net profits by 8%. Hence, our lower target price and rating. As for SKPRES, while its 1H17 net earnings came in below expectations due to weaker-than-expected margins from new revolutionary products, we believe its medium-term prospect remains decent, driven by continual ramp-up production for new and existing products alongside with easing labour costs.

Earnings downgrades. Post results review, Kenanga Research has revised FY16E/FY17E earnings for its core coverage stocks by -8.5%/-3.8%, on average. The downgrades were across the board and more aggressive than -6.4%/-1.6% back in 2Q16. In line with such revisions, our FBMKLCI earnings growth estimates have also been revised lower, again. Our FY16E/FY17E net profit growth estimates are now re-estimated as -4.0%/6.0% (from 1.6%/7.2% earlier).

Lower targets. Consequently, we have lowered our end-2016/17 index target to 1,682/1,732 from 1,715/1,755. Our index target is derived from the average of …

• Top-Down: An unchanged PER target of 16.0x to our revised FY16E/FY17E earnings estimate, hence index targets of 1,635/1,735 for end-2016/17, and;
• Bottom-Up: 1,729, representing 16.9x/16.0x to our FY16E/FY17E earnings estimates.

All told, our NEUTRAL view remains unchanged. The recently concluded results reporting season has reinforced our earlier view that a broad-based earnings growth story is still missing. As such we see no immediate re-rating catalyst emerging at this juncture despite market valuation seems undemanding.

From market-cap-to-GDP ratio perspective, based on the Index Target of 1,732, it implies an end-2017 market cap of RM1.05 trillion. Together with 2016/17 real GDP growth of 4.3%/4.7%, the estimated FBMKLCI market cap will only be traded at 0.95x/0.91x to real GDP. This market-cap-to-GDP ratio is NOT excessive, judging from the historical track records. For the period 2010-2015, the ratio was registered at 0.92x-1.09x. Note that this ratio was even higher at 0.99x-1.09x in 2012-2014, which were one year before and after the previous General Election (GE) year.

Besides, the relatively undemanding valuation can be seen from the near historical low PER valuation premium to regional markets. Vis-à-vis regional markets, the Fwd. PER valuation of FBMKLCI (@ 16.3x as per Bloomberg) only traded <5% premium above regional average (of 15.5x) as opposed to the historical range of 4%-18%.

However, this advantage has been eroded by the weak domestic currency against US dollar. The unfavourable forex movement (especially after Trump's victory over US Presidential Election and the expectation of US Fed to raise interest rate) has been causing aggressive foreign outflow. To-date, we have seen a total of RM1.9b net foreign outflow from local equity market. In fact, in the month of November 2016, the domestic equity market had experienced RM3.9b net outflow. Should ringgit continue to weaken, theoretically speaking, we could see more divestment activities by foreign investors as per Modern Portfolio Theory.

Nevertheless, with a strong rebound in crude oil prices, we believe Oil & Gas sector could be a "Dark Horse" in the making. Besides, as FBMKLCI is traded near our earlier mentioned ideal "Buy On Weakness" levels of <1,625, which is the 3-year average discount (of FBMKLCI over consensus target) of 4.6%, we believe the underlying reward-to-risk ratio is getting attractive.

Post results review, we have taken out KOSSAN, MYEG (TB; TP: RM2.80) and SKPRES from our list of 4Q16 Top Picks. This is because we have downgraded KOSSAN due to weaker results and we are also less positive on MYEG and SKPRES due to their volatile quarterly earnings profile.

Nonetheless, we reiterate other 4Q16 Top Picks such as (i) GKENT (TB; TP: RM2.80), (ii) KIMLUN (OP; TP: RM2.51), (iii) MATRIX (OP; TP: RM2.65), (iv) PWROOT (TB; TP: RM2.56), (v) SCGM (OP; TP: RM3.81), (vi) SCIENTX (OP; TP: RM7.57), (vii) SLP (OP; TP: RM3.11), (viii) MQREIT (OP; TP: RM1.41), (ix) RCECAP (TB; TP: RM1.50), and (x) SUNCON (OP; TP: RM1.81).

Source: Kenanga Research - 2 Dec 2016