The recently concluded 1QCY17 results reporting season continued to show signs of improvement. However, the momentum of the improving trend has shown some signs of weakness.

Among the sectors under our coverage, we noticed that stocks in: (i) Auto, (ii) Gaming, (iii) Media, and (iv) Power Utilities sectors delivered weaker-than-expected results while other sectors were mostly mixed or neutral in nature. In line with the stronger GDP and better results, we have revised up our FY17E/FY18E net earnings growth estimates of FBMKLCI to 2.4%/2.5% from -0.4%/-0.5% previously. Post earnings upgrade and coupled with higher target prices, we have also revised up our end-2017 index target to 1,845 (from 1,775 previously), representing FY17E/FY18E PERs of 17.5/17.0x. While we see higher upside from here, the risk-to-reward ratio may not be attractive at this juncture, as we are fully aware of two potential risk factors; namely, (i) weaker sentiment, and (ii) tougher quarter ahead. Hence, we prefer to “Buy On Weakness” (B.O.W.), if and when the FBMKLCI dips below the 1,735- level. At the same time, (i) laggards and (ii) defensive plays could be our themes for now. For these themes, we like HLBANK (OP, TP: RM15.15), IGBREIT (OP, TP: RM1.82), NOTION (OP, TP: RM1.66), PAVREIT (OP, TP: RM1.92), SENERGY (OP, TP: RM2.24), SLP (OP, TP: RM3.72), SUNSURIA (OP, TP: RM1.61), TGUAN (OP, TP: RM5.40), TM (OP, TP: RM7.10), and TOPGLOV (OP, TP: RM6.11) and ULICORP (OP, TP: RM5.60).

Improving further but momentum slowing. The recently concluded 1QCY17 results reporting season continued to show signs of improvement. The “disappointment ratio” improved further to 22.6% in 1Q17 as opposed to 27.6% in 4Q16 and 34.4% in 3Q16. In order words, out of 137 stocks under our core coverage, only 31 of them delivered weakerthan-expected results. However, having said that, the momentum of this improving trend has shown a sign of weakness with only 19 stocks (or 13.4%) performing better-than-expected in contrast to 25.4% or 34 stocks in 4Q16 (see Figure 1-7 for details). Among the sectors under our coverage, we noticed that stocks in (i) Auto, (ii) Gaming, (iii) Media, and (iv) Power Utilities sectors delivered weaker-than-expected results. These sectors saw cut in FY17E earnings estimates by >40%, 7.5%, ~24% and 8.5%, on average, respectively. Auto sector is still showing lacklustre performances this quarter due mainly to lower-than expected auto sales volume. As for gaming sector, Malaysian casino operator faced lower business volume for premium mass segment. On the other hand, NFO players also reported disappointing results owing to vulnerable luck factor coupled with weaker ticket sales despite being in a CNY quarter. Incumbents of Media sector, on the other hand, continued to post disappointing report cards in 1QCY17, mainly owing to the prolonged weakness in advertising revenue as a result of subdued adex outlook on poor consumer spending sentiment apart from the shift from traditional to digital media. For STAR (UP, TP: RM1.85), in particular, it also saw start-up losses on new initiatives. Generally speaking, Power Utilities sector delivered a letdown quarter as all players reported disappointing results except MALAKOF (MP, TP: RM1.30). Even then, MALAKOF will see weaker earnings in the coming quarter given the unexpected outage at Tanjung Bin Energy immediately after its scheduled outage in April. Elsewhere, TENAGA’s (OP, TP: RM17.17) results missed forecasts on higher costs while YTLPOWR (MP, TP: RM1.50) came below expectations due to higher pre-tax losses in Paka Power Plant as well as weaker Wessex Water as Pound Sterling weakened against Ringgit. PESTECH’s (OP, TP: RM2.00) results were still lower-than-expected given the lower profit margin arising from the early stage of Alex Corp upgrading contract.

On the contrary, the Gloves sector, which had delivered disappointing results in the previous results reporting season saw good progress. Apart from SUPERMX (MP, TP: RM1.95) which still recorded weaker-than-expected results, most listed gloves manufacturers registered fair decent results. This development has reinforced our earlier anticipation of steady to higher ASPs and profit margin improvement after seeing more gradual ramp-ups in capacity. The underperformance of SUPERMX could be an outlier. It results were hit by higher raw material prices, pre-operating costs incurred on new start-ups overseas as well as advertising & promotional costs incurred in launching its new contact lens products overseas. On the other hand, the results announced by the star performers of the previous quarter - (i) Building Materials and (ii) Technology sectors – were pretty much in line with market expectations and that of ours.

As for our quarterly Top Picks, SENERGY (OP, TP: RM2.24) and TM (OP, TP: RM7.10) delivered better-than-expected results. SENERGY saw stronger-than-expected contributions from the E&C segment as well as its JV earnings while TM enjoyed higher revenue, lower-than-expected OPEX as well as lesser forex fluctuation. On the contrary, as mentioned earlier, TENAGA’s results were hit by higher bad debts provision for steel industry as well as higher interest expense on financing for new projects. Apart from SCGM (MP, TP: RM4.48) and TOPGLOV (OP, TP: RM6.11) which practise odd year-ends, other Top Picks – HLBANK (OP, TP: RM15.15), IOIPG (OP, TP: RM2.30), NOTION (OP, TP: RM1.66), PIE (OP, TP: RM2.87), SLP (OP, TP: RM3.27) and SUNSURIA (OP, TP: RM1.61) – results were largely inline.

Upwards revisions. In line with the stronger than expected real GDP growth of 5.6% in 1Q17, we have revised up our

FY17E/FY18E net earnings growth estimates of FBMKLCI to 2.4%/2.5% from -0.4%/-0.5% previously. Despite such revisions, we believe our estimates are still conservative in contrast to consensus estimates of 4.8%/7.2% (vs. 2.9%/6.4% previously).

Post earnings upgrade and coupled with higher target prices (as analysts start to roll over their valuations benchmark year to 2018), we revise up our end-2017 index target to 1,845 (from 1,775 previously), representing FY17E/FY18E PERs of 17.5/17.0x. Our index target is derived from the average of …

• Top-Down: An unchanged PER target of 16.5x to our FY18E earnings estimate, hence index targets of 1,820 (vs. 1,750 previously), and

• Bottom-Up: 1,870 (vs. ~1,800 previously), representing 17.7/ 17.3 PERs to our FY17E/FY18E earnings estimates.

Our revised index target of 1,845 is not far out as compared to the consensus index target of ~1,850 as of end-May 2017. Figure 9 clearly shows that consensus index target has been in a rising trend after registered a low of ~1,620 in end-Nov 2016. Besides, this upgrade is also in line with our upgrade in 2017 real GDP forecast to 5.2% (from 4.7% in the previous quarter). From FBMKLCI-Market-Cap-to-GDP ratio perspective, based on the Index Target of 1,845, it only implies a market cap of RM1,135b. Together with 2017/18 real GDP growth forecasts of 5.2%/5.0%, the estimated FBMKLCI market cap will only be traded at 0.97x/0.93x to 2017/18 real GDP. These market-cap-to-GDP ratios are not excessive and are within its historical track records. Recall that for the period 2010-2016, the ratio registered at 0.90x-1.09x. Note that this ratio was even higher at 0.99x- 1.09x in 2012-2014, which was one year before and after the previous General Election (GE) year.

Feeling more optimistic… Previously, with a narrower “Discount” (between consensus index target and FBMKLCI), we were concerned over potential corrections in the benchmark index. However, we believe it is now the time to downplay this concern as the Discount (with a current reading of 4.4%) has widened and dipped below its 3-year average (of 4.2%) (see Figure 10), in line with the higher consensus target. While we do not rule out the possibility of the Discount widening to -1SD below the 3-year mean level (of 6.0% or implying an index level of ~1,735), the current level may also be deemed as a decent re-entry point.

Besides, our Accumulated Price-Volume Study (APVS) continues to prove the strong underlying buying momentum (see Figure 11). Recall that the study suggests a Trend-Following strategy until the 30-day SMA is violated convincingly. Moreover, with the stronger performance in Ringgit, we believe the local equity market should be supportive. YTD, ringgit has registered a total return of 6.3%, making it one of the Top 5 best performed currencies in Asia region despite talks of rate hike in the U.S. (see Figure 12). We believe the stronger ringgit could be fuelled by stronger foreign inflows into the equity market (YTD: RM9.8b) while less aggressive sell-down in MGS as evidenced by the decline in 10-year MGS yield since Apr 2017 (>4% back then) to 3.88% apart from stronger GDP numbers.

… but, weaker sentiment and quarter ahead. Despite our cautiously optimistic view, we are fully aware of two potential risk factors; namely, (i) weaker sentiment, and (ii) tougher quarter ahead. Based on our Market Sentiment Study (see Figure 13-14), the Forward PER Differentials between FBMSC and FBM70 against FBMKLCI have room for corrections as the former’s discount (Figure 13) has pulled back from its +2SD-band and could be in the midst of a swing towards +1SD and mean levels while the latter’s premium (Figure 14) is traded way above the historical +2SD-band, which is not sustainable statistically speaking. As we see no major earnings upgrades post results for these small-and-mid-cap stocks, price corrections in the nearterm are highly probable. Moreover, based on FBMKLCI’s Seasonality Study, 3Q is normally the weakest quarter. As observed in Figure 15, the months of July to September show higher chances of registering negative price performance.

All told, our NEUTRAL view remains unchanged. While we see higher upside from here, the risk-to-reward may not be attractive at this juncture. We would advise lower risk appetitive investors to “Buy On Weakness” (B.O.W.), if and when FBMKLCI dips below the 1,735-level.

Switching to low gear? As for stock picks, we probably will switch to a more conservative or defensive mode ahead of an anticipated tougher 3Q. Besides, with the listing of Lotte Chemical Titan coupled with various major/potential Merger & Acquisitions such as SPSETIA-I&P and RHBBANK-AMBANK, we should see quite substantial changes in FBMKLCI constituents. As such, (i) laggards and (ii) defensive plays could be our themes in the coming quarter. Thus far, Top Picks and selected stocks that we like (see the following section for details) and are still underperforming the FBMKLCI in terms of YTD or QTD are HLBANK (OP, TP: RM15.15), IGBREIT (OP, TP: RM1.82), NOTION (OP, TP: RM1.66), PAVREIT (OP, TP: RM1.92), SENERGY (OP, TP: RM2.24), SLP (OP, TP: RM3.72), SUNSURIA (OP, TP: RM1.61), TGUAN (OP, TP: RM5.40), TM (OP, TP: RM7.10), and TOPGLOV (OP, TP: RM6.11) and ULICORP (OP, TP: RM5.60).

Other Points - Sector/Stock Review

Post results review, we have downgraded one of 2Q17 Top Picks, SCGM, to "Market Perform" from "Outperform" as we believe most upsides have been priced as its share price has been doing well with a YTD surge of ~20% YTD. However, at the same time, we have upgraded one of its peers - TGUAN (TP: RM5.40) to "Outperform" from "Market Perform", as its fundamentals remain solid while upsides are attractive after its share price corrected by ~8% since our last report (dated 28th Feb-17) owing to weaker market sentiment.

Surprisingly, we also see a longer list of "Outperform" call in our Oil & Gas coverage post results review despite the uninspiring oil prices. This is because we still maintain our in-house Brent oil forecast of USD55/bbl in 2017. Recall that the decision of OPEC and non-OPEC members agreeing to extend production cut for 9 months was slightly disappointing as some were expecting deeper production cuts. With this outcome, we expect oil prices to trade at a lower range of USDS48-52/bbl in the near term vs. USD53-57/bbl during the initial cut in Dec 2016. However, better oil prices could be seen in 2H17 banking on stronger demand and potential further price propping actions led by Saudi ahead of valuations for Saudi Aramco’s IPO.

On a separate note, the listing of Lotte Chemical Titan could see positive spill over effect to petrochemical players, including PCHEM (OP, TP: RM8.09), should the IPO perform well upon and after listing.

In a weak oil prices environment, airlines could be one of the major beneficiaries. In fact, we remain positive on AIRASIA (OP, TP: RM3.82) on the back of its capacity expansion in FY17 and targeted increase in aircraft utilization rates from 12.5 hours to 14 hours. On the back of this macro environment, resin cost is expected to remain low at USD1,100-1200/MT. Despite an improving trend in Ringgit, the relatively low USD/MYR exchange rate bodes well for sales for these export-heavy Plastic Packaging players in terms of foreign demand and margin boosts.

For other export sectors, we continue to like Gloves and Technology, especially in the OSAT sub-segment. We reckon that the stage is set for Glove markers to deliver solid FY17 numbers with the past two quarters results gathering positive momentum moving into 2H17. We expect Top Glove and Hartalega to lead the way, judging by their past two quarterly results, which are gathering momentum spearheaded by: (i) higher volume sales, (ii) higher ASPs, and (iii) margin expansion pointing towards a solid 2H17. For OSAT space, overall industry continued to show improvement as the global semiconductor sales in February 2017 increased by 16.5%, marking the seventh consecutive YoY growth which is also the largest YoY growth since November 2010. Meanwhile, our channel checks also revealed that the equipment manufacturers are seeing higher demand from their end-customers. Taking these as positive signs, we believe the spill-over effect will also be reflected in the Malaysian back-end Semiconductor players. In fact, both MPI and UNISEM’s managements are guiding for stronger sequential growth.

On the domestic front, we are positive on the steel sector on the back of: (i) reduced China imports due to the Chinese Government’s initiative to cut output coupled with safeguard measures into Malaysian shores, which will provide sustainable steel price of >RM2,000/t for local steel manufacturers, and (ii) higher demand of steel products when major infrastructure projects pick up in 2H17. While we reiterate our OVERWEIGHT sector call on Property sector, we recommend that investors be more selective versus last quarter where tactical positioning of property stocks was more broad-based.

Of late, with the launching of Digital Free Trade Zone (DFTZ), we have also seen e-commerce being the central theme within the logistics space. Parcel delivery players such as GDEX (UP, TP: RM1.93) and POS (UP, TP: RM4.00) are seen as direct earnings beneficiaries. However, due to their lofty valuations, we prefer to stay-sidelined from this logistic sub-sector.

As for TENAGA, while it announced a set of weaker-than-expected numbers, we remain positive as the high fuel cost in 1H17 will adjust in the coming Tariff Review in June, which will be passed through to end-users eventually.

With a potential tough quarter ahead coupled with a decline in 10-year MGS yield, we are considering to upgrade the M-REIT sector. Among players in the sector, we like (i) PAVREIT for asset acquisition potential, (ii) MQREIT backed by stable assets and dividends, commanding the highest yield among MREITs under our coverage (6.5% yield), and (iii) IGBREIT for asset stability and yields on the higher end vs. peers at 5.8%.

Of late, we have also initiated four "Outperform" calls under Bursa's Mid-and-Small-Cap Research Scheme (MidS). These stocks are A&M (OP, TP: RM3.00), KESM (OP, TP: RM15.20), PWROOT (OP, TP: RM2.90) and ULICORP (OP, TP: RM5.60).

• A&M: We like the company for its healthy margins, light balance sheet, strong new sales, earnings growth, and its future catalyst, i.e. Pulau Carey that is set to ride on the potential port development project undertaken by SIME and MMC. We estimate FY17-18E sales growth of 195%-29% while earnings are seen growing by 33%-30%.

• KESM: Despite its share price more than doubling over the past year, we believe that this under-researched gem has further upside potential amid rising car production by global automakers and increased chip content in vehicles. Among the initiatives taken to capitalize on these trends include: (i) massive RM75m-80m/p.a. CAPEX plans over the next two years, (ii) developing technologies to take on more complex/higher margin products iii) Increase operational efficiencies and greater economies of scale. We are estimating FY17/FY18E net profits of RM38.8m/RM44.3m (+26.5%/14.1%).

• PWROOT: We see potential in the stock, driven by its growing export segment and expansion plans on the Middle East and North Africa market. In addition, we expect the stock to fetch decent dividend yields of above 4%.

• ULICORP: We like the stock for its leading market position and strong rooting against unfavorable economic conditions, coupled by its solid growth prospects and margin expansion from the progressive commissioning of production facilities in its new plant.

Source: Kenanga Research - 2 Jun 2017