The collapse of the OPEC-Russia alliance after both parties failed to agree to an output cut has led to a price war. Brent lost USD18 (-35%) in two trading days to settle at USD32.50 yesterday. A fall of this scale has consequences on Malaysia’s fiscal account given how significant oil-related income is to the Federal Government revenue. This event could not have come at a worse time as escalating Covid-19 fears and the abrupt change in government are hammering an already fragile economy. Fiscal position will weaken, as will prices of other commodities and following that, a weaker MYR. These have forced us to relook our sectors and market outlook again. We immediately cut EPS forecasts and target prices for Oil & Gas and Plantations stocks. Banks too are prone to downside risks as interest rates are aggressively reduced and delinquency risks rise. We reduce FY20/21 EPS for the FBMKLCI to 94.2/99.5 sen from 96.5/101.5 sen and growth revised to -1.0%/5.7% from 1.4%/5.2%. Year-end target is reduced from 1,563 to 1,532.

2020 Budget Deficit could widen to 4.3% from 3.4% if Brent averages USD40 this year: Petroleum contributes to the Federal Government revenue in the form of Petronas dividends (where the normal dividend is RM24b), petroleum income tax and to lesser degree petroleum export duties and petroleum royalties. In 2018, they made up about 20% of total revenue by our estimates. Every USD10 fall in price cuts the government revenue by some RM7bn. As we factor in a drop of USD20 from our base case assumption of USD60 a barrel (the government’s base case is USD62), we estimate an impact of RM14bn for the government in 2020. This will widen the budget deficit (post stimulus budget) from RM55.3b to RM69.1b raising the deficit as percentage of GDP from 3.4% to 4.3% - a level not seen since 2012 which at that point in time, the direct federal government debt stood at 51% of GDP versus 53% currently. If government guarantees and lease payments for PPPs were included, the total debt to GDP ratio is closer to 72%. To maintain a deficit closer to 3.5% or 4%, Petronas may be made to pay a special dividend again. As Petronas is in a net cash position of RM82b, a repeat of a special dividend would not surprise us.

2020 GDP cut to 3.0%: Our economics team trimmed their 2020 GDP growth forecast from 4.0% (posted after the stimulus budget recently) to 3.0% to account for heightened risk of lower O&G investments and activities and potentially lower output from the plantation sector on weaker prices.

Oil & Gas earnings downgraded, but sector call remains NEUTRAL: The four O&G components of the KLCI – DIALOG, PETDAG, PCHEM and MISC together make up 11% by weight and 8% by earnings. Of these four, we cut PCHEM’s (the largest component at 4.2% by weight) target price by 29% to RM4.50 as we lower FY20/21 EPS by 43.5%/32.6% to 23.6/32.1 sen on account of lower ASP assumptions.

Plantation sector too have earnings cut based on lowered ASP assumptions: We also cut our average CPO price projection for 2020 from RM2,700 to RM2,550 on lowered biodiesel output given less attractive price spread. Doing so has reduced the FY20/21 sector EPS by an average of 11%/9% and the target prices for IOI (-19% to RM4.15), KLK (-21% to RM22.70), PPB (-6% to RM18.50) and SDPL (-6% to RM5.10). We downgrade Plantation from OW to Neutral.

Reduce year end KLCI target: With the latest sector revisions, our EPS for the FBMKLCI for FY20/21 were reduced to 94.2/99.5 sen from 96.5/101.5 sen. This cuts the previous FY20 EPS growth expectation from 1.4% to -1.0% but raised FY21’s from 5.2% to 5.7% from a lowered base. Applying 15.4x multiple (one SD below 5-year mean) on rolling forward 12-month EPS of 95.1 sen, the current ‘fair value’ FBMKLCI level is 1,465 (reduced from 1,499) while the year-end target is 1,532 (from 1,563 previously).

Source: Kenanga Research - 10 Mar 2020