The just-concluded 3Q18 reporting season showed some signs of improvement. However, we believe the improvements are insufficient to excite the market as we continue to see negative earnings revisions despite our earnings downgrades since the last two quarters. We further cut our FBMKLCI FY18E/FY19E earnings growth estimates to -0.2%/3.5% (from 4.2%/1.4% as of 2 Oct 2018 and 4.3%/3.5% as of 4 Sep 2018). As such, our end-2019 index target is lowered to 1,805 (from 1,870 previously), representing FY18E/FY19E PER of 15.7x/14.7x. Note that, apart from lower earnings, substantial cuts in some key index constituents’ target prices; such as GENM, GENTING, IHH, TELEKOM and TENAGA, have also attributed to the downgrade in Index Target. For the quarter, (i) Building Materials, (ii) Media and (iii) Utilities sectors were the major culprits while (i) Construction, (ii) Consumer and (iii) Plantation sectors displayed some signs of weakness as well. Post results revision, we still maintain OUTPERFORM rating for most of our 3Q18 Top Picks: - AEON (TP: RM2.60↔), AIRASIA (TP: RM3.25↓), BIMB (TP: RM4.95↑), D&O (TP: RM1.00↔), PESTECH (TP: RM1.95↔), PPB (TP: RM18.35↔), SERBADK (TP: RM4.45↔), TAKAFUL (TP: RM4.85↑) and TENAGA (TP: RM16.45↓).

Improved, but … The recently concluded 3Q18 results season showed some signs of improvement. Out of 146 stocks under our core coverage, 45 of them delivered weakerthan-expected results, implying a “disappointment ratio” of 30.8% (vs. 33.6% in 2Q18 and 32.0% in 3Q17). On the other extreme, 15% of the stocks under coverage (or 22 stocks) outperformed our expectations in this reporting season as opposed to the mere 10.3% (or 15 stocks) seen in the previous quarter. Nonetheless, despite such improvements, we believe the improvements are not enough to excite the market as we continue to see earnings downgrades of 9.1% for this financial year and 6.4% for the next financial year, on average, for the 146 stocks under our coverage. We deem this as continued earnings weakness as we have revised down our earnings estimates since the last two quarters.

Sector-wise, (i) Building Materials, (ii) Media and (iii) Utilities sectors were the major culprits while (i) Construction, (ii) Consumer and (iii) Plantation sectors displayed some signs of weakness as well (see Figure 8 for details).

• Building Materials: The major disappointments were caused by (i) higher-than-expected alumina prices for PMETAL, (ii) higher-than-expected raw material prices and lower steel demand for ANNJOO, (iii) lower-thanexpected cement demand for LAFMSIA, and (iv) lower-than-expected tiles demand for WTHORSE.

• Construction: Disappointments were largely due to (i) slowdown in infrastructure projects after project reviews, (ii) lo and er-than-expected margins due to higher billings of lower margin projects/products.

• Consumer: Overall, the sector was hit by the overly optimistic sales growth assumptions on our end. Besides, the positive impact of zero-rated GST tax holiday was not as strong as we had initially assumed.

• Media: Prolonged weak advertising revenue as a result of subdued adex outlook on slower economy and policies’ uncertainties continued to drag incumbents’ profitability.

• Plantation: All planters under our coverage recorded lower YTD CPO prices received with an average decline of 17.2%, overshadowing the sector’s flat FFB growth (+0.8%). As a result, all the planters posted softer core earnings with the exception of PPB, which was lifted by other non-plantation segments.

• Utilities: TENAGA missed forecast on higher fuel costs as well as rising finance costs on new Sukuk issuance. YTLPOWR fell short of expectations due to PowerSeraya’s maiden losses. MALAKOF was hit by another boiler-related issue, which may lead to operational uncertainties. Meanwhile, PESTECH had a slow start in the seasonally weak quarter due to lower work claim progress.

While the Telco sector did not outright outperform our expectations, the sector has somewhat shown positive developments coming from TM and OCK. TM posted decent operational performance and OCK’s regional contribution continued to climb despite some slowdowns in the local segment.

As for the Top Picks selected early of this quarter, despite PESTECH and TENAGA showed temporary weakness, the majority of them (AEON, AIRASIA, D&O, MAYBANK, PPB and SERBADK) had delivered decent sets of results. BIMB and TAKAFUL have proven to be the outstanding performers. The positive deviation in BIMB was attributed to higher-than-expected financing growth coupled with lower-than-expected impairment allowances. TAKAFUL, on the other hand, was boosted by better underlying operational ratios.

Revisions in Growth Estimates and Index Target:

Further cut in earnings. Post results, we continue to see another round of negative earnings revisions. For all 146 stocks under our coverage, we reduced our FY18E/FY19E net earnings by 9.1%/6.4% on average (vs. 6.8%/6.2% in 2Q18). These earnings revisions are much larger in contrast to FBMKLCI constituents. Based on our FBMKLCI Earnings Universe, FY18E/FY19E earnings growth estimates are further revised down to - 0.2%/3.5% (vs. 4.2%/1.4% as of 2 October 2018 and 4.3%/3.5% as of 4 September 2018). Sectors that see substantial cut in earnings are: (i) Gaming, (ii) Plantation, (iii) Power Utilities, and (iv) Telco.

Note that consensus also cut FY18E/FY19E earnings growth to -3.9%/6.9% from -1.6%/6.3% previously, as per Bloomberg data.

Due to our earnings and target price downgrades, we have further fine-tuned our end-2019 index target lower to 1,805 (from 1,870 previously), representing FY18E/FY19E PERs of 15.7x/14.7x. Our Index Target is derived via the average of the followings:-

• Top-Down: Applying an unchanged target PER of 15.5x, coupled with our revised FY19E earnings estimates, we derive an end-2019 index target of 1,830 (vs. 1,860 previously), and

• Bottom-Up: 1,780 (vs. ~1,880 previously), representing 15.5/14.5x PER to our FY18E/FY19E earnings estimates. The substantial downgrade in index target was due to major target price cuts in GENM, GENTING, IHH, TELEKOM and TENAGA.

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 1,825 as of end-Nov 2018 as opposed to ~1,895 as of end-Oct 2018/Sep 2018.

Short-term market outlook:

• Despite recent corrections, the local equity benchmark index, FBMKLCI, is still trading at a premium against its regional peers. The Forward PER Valuation Premium of FBMKLCI over Selected Regional Peers (see Figure 10) was recorded at 19.8%, which is at the higher end of its historical range. This could limit potential foreign equity inflow. In fact, as of end-Nov 2018, we saw total net foreign equity outflows of RM2.1b and RM10.7b, respectively, since end-Sep 2018 and end-Dec 2017.

• At this juncture, there is no concrete trading signal emerging as per our (Monthly) Algo-Trading Model. Indeed, RSI-driven Model is in a buying-mode while PER-driven Model is in a selling-mode. Other models have yet to show any meaningful signals.

• While there is no clear trading signal, we do not rule out that the FBMKLCI could probably trade up to ~1,735 in the immediate term as the discount of FBMKLCI (against Consensus Index Target) could revert back to its 36-month mean of 4.9%-discount, from the current level of 7%-discount (see Figure 11).

• While it is not so meaningful to peg an end-2018 Index Target, there is some 50% probability for the index to close above 1,710, as per our Simulation Study (see Figure 12).

Post results revision, we still maintain OUTPERFORM rating for some of our 3Q18 Top Picks: - AEON (TP: RM2.60↔), AIRASIA (TP: RM3.25↓), BIMB (TP: RM4.95↑), D&O (TP: RM1.00↔), PESTECH (TP: RM1.95↔), PPB (TP: RM18.35↔), SERBADK (TP: RM4.45↔), TAKAFUL (TP: RM4.85↑) and TENAGA (TP: RM16.45↓).

Source: Kenanga Research - 4 Dec 2018