The just-concluded 2Q18 reporting season still showed some signs of weakness. We further cut our FBMKLCI FY18E/FY19E earnings growth to 4.3%/3.5% from 5.1%/5.4% previously. As such, our end-2018 index target is lowered to 1,870 from 1,900 previously. For the quarter, (i) Building Materials, (ii) Construction, (iii) Media, (iv) Plantations, and (v) Plastic Packaging were the underperforming sectors, in terms of earnings delivery, while Automotive sector was the only outperformer. The “Mean Reverting” strategy based on our Timing Model has been performing well. However, there is no concrete trading signal seen emerging currently. Thus, we prefer to stay sidelined and will only turn more aggressive if and when the index dips below ~1,755. As for our 2Q18 Top Picks, we still maintain OUTPERFORM call on AMBANK (TP: RM4.50), BIMB (TP: RM4.90), D&O (TP: RM0.830), DIGI (TP: RM4.90), MBMR (TP: RM3.60), PARKSON (TP: RM0.810), TCHONG (TP: RM2.30) and TENAGA (TP: RM17.90) post results.

Nothing to shout about. The recent 2Q18 results season still showed some signs of weakness albeit improving slightly. Out of 146 stocks under our core coverage, 49 of them delivered weakerthan-expected results, implying a “disappointment ratio” of 33.6% (vis-à-vis 37.8% in 1Q18). On a YoY basis, the ratio also deteriorated from 28.8% in 2Q17. On the other end, merely 10.3% of the stocks under coverage (or 15 stocks) outperformed our expectations in this reporting season (as opposed to 10.8% and 10.1% seen in 1Q18 and 2Q17, respectively).

Sector wise, (i) Building Materials, (ii) Construction, (iii) Media, (iv) Plantations, and (v) Plastic Packaging have been disappointed while (i) Gaming, (ii) Property, (iii) Telco, (iv) Utilities as well as (v) Transportation & Logistics also showed some signs of weakness.

• Building Materials: For ULICORP, it was due to higher-than-expected operating costs, while LAFMSIA and WTHORSE were hit by lower-than-expected demand.

• Construction: In general, the disappointments were largely due to: (i) slower billings affected by festive season, (ii) slowdown in infrastructure projects post-GE14, and (iii) lower-than-expected margins due to higher billings of lower margin projects/products.

• Media: Despite a few rounds of earnings cut, the sector continued to remain uninspiring owing to the prolonged weak advertising revenue, as a result of subdued adex outlook on poor consumer spending.

• Plantations: The sector saw the weakest quarter since 2Q14. All planters under our coverage recorded lower YTD CPO prices received with an average decline of 13.3%. As a result, all the planters posted softer core earnings with the exception of PPB, which was lifted by other non-plantation segments and earnings.

• Plastic Packaging: The weaker-than-expected results were due to various reasons, including lower sales, higher raw material cost, lower-than-expected utilization rates, and less-than-favorable product mix, while SCIENTX’s results missed due to lower recognitions in the property segment.

On another extreme, Automotive sector was an outright outperformer. This is expected due to the commencement of zerorated tax holiday since 1 June 2018 and further supported by pre-Hari Raya festive season sales. Other sectors are largely mixed or neutral in nature (see Figure 8).

As for Top Picks selected early of this quarter, the majority of them (AMBANK, BIMB, D&O, DIGI, SLP, TCHONG and TENAGA) have done better in earnings. MBMR and UEMS were proven to be outstanding performers. MBMR delivered betterthan-expected results due to the higher associates’ contribution, especially from the 22.58%-owned Perodua. As such, we have upgraded our earnings estimates and target price to RM3.60 (from, RM3.30 previously). UEMS’ numbers also came above street’s estimate, but broadly within our expectation. Consensus could have under-estimated the margins from its land sale. However, we have downgraded its rating to MARKET PERFORM with an unchanged target price of RM0.970 after the recent share price rally of 30%. Besides, we also expect 2H18 to be weaker given lower land sales recognition.

LAYHONG and PARKSON, on other extreme, delivered weaker sets of results. LAYHONG’s recent 1Q19 net profit of RM2.0m (-48% YoY) was aggravated by losses in the egg segment. While management guided on high cost concerns, the real issue probably was the heavily depressed 1Q19 average selling prices of egg due to oversupply issue during the Muslim fasting month. Other key segments (i.e. processed foods) appear to be performing as expected. While we await for further management’s updates on the near-term outlook of the group, our indicative revision could lead to a lower target price, say RM0.570 (from RM1.20 previously), and hence we may downgrade our call to a “Hold” (vs. Trading Buy previously), as we earmark to lower FY19E/FY20E earnings by 25%/7% coupled with a more conservative PER valuation of 11.0x (contrary to 17.0x previously) due to its highly volatile sales and earnings profiles. Profitability of PARKSON, on the other hand, was dragged by lower-than-expected sales from China.

Further cut in earnings. Post results, we saw another round of negative earnings revisions. For all 146 stocks under our coverage, we reduced our FY18E/FY19E net earnings by 6.8%/6.2% on average. These earnings revisions are much larger in contrast to FBMKLCI constituents. Based on our FBMKLCI Earnings Universe, FY18E/FY19E earnings growth estimates are now lowered to 4.3%/3.5%, in contrast to 5.1%/5.4% previously. The substantial cut in earnings, from a larger pool of sampling, failed to serve as a solid re-rating catalyst that we are looking for. Post revisions, consensus also cut FY18E/FY19E earnings growth to 4.1%/2.7% (vs. 5.4%/6.8% previously).

Due to our earnings and target price downgrades, we have further fine-tuned our end-2018 index target lower to 1,870 (from 1,900 previously), representing FY18E/FY19E PER of 15.5x/14.5x. Our Index Target is derived via the average of the followings:-

• Top-Down: Applying a lower target PER of 15.5x (vs. 16.0x previously due to lower growth ahead), coupled with our revised FY18E earnings estimate, we derive an index target of 1,860 (almost unchanged due to rounding errors); and

• Bottom-Up: 1,880 (vs. ~1,940 previously), representing 15.6x/14.5x PER to our FY18E/FY19E earnings estimates.

Our index target downgrade is also in line with the recent cut in consensus index target. Note that consensus has recently lowered index target to ~1,890 as of end-Aug 2018 as opposed to 1,940 as of end-May 2018.

Short-term market outlook. The local equity benchmark index, FBMKLCI, had proven resilient. It staged a strong rebound from the recent 52-week low of 1,57.78. At this juncture, there is no strong trading signal seen emerging as per our Timing Model. The FBMKLCI only traded at a 3.8%-discount against Consensus Index Target of 1,890 as of end-Aug 2018. The “discount” represents a marginal uptick above the 36-Month mean of 4.7%-discount. While the “discount” could potentially be testing the +1SD-level, which is the 2.3%-discount, or implying an index level of ~1,850, the lack of re-rating catalyst could limit its upside momentum.

Besides, despite a total net foreign equity outflow of RM1.8b in the last 2 months (Jul 2018 & Aug 2018), the domestic equity market is still traded at a high valuation premium, as per PER multiple, against regional peers. Hence, this could limit the potential foreign inflow into the domestic equity market. Figure 11 clearly shown that FBMKLCI is traded at >17x Fwd. PER in contrast to the regional average of <15x, or representing >20% premium, which is a new high since 2015.

As such, as the potential upside seems unexciting from here at <4%, we prefer to stay sidelined at the moment. Following our trading rules, we will only turn more aggressive if and when the index dips below ~1,755, or implying a ~7%-discount to the Consensus Index Target. 

In terms of our 2Q18 Top Picks, we still maintain OUTPERFORM rating for AMBANK (TP: RM4.50), BIMB (TP: RM4.90), D&O (TP: RM0.830), DIGI (TP: RM4.90), MBMR (TP: RM3.60), PARKSON (TP: RM0.810), TCHONG (TP: RM2.30) and TENAGA (TP: RM17.90).

Source: Kenanga Research - 4 Sept 2018