In a move that favours borrowers over the banks, the finance ministry and banks have agreed to keep loan repayments unchanged for hire purchase and Islamic fixed-rate loans after the 6-month moratorium is over, with those loans’ tenures extended by 6 months. The losses that the banks will have to provide as result coupled with the earlier-than-expected 50 bps OPR cut on the 4th May have led us to not just downgrade the sector from OW to Neutral. It has also led us to shave our estimates for the FBMKLCI FY20 EPS from 87.2 sen to 84.5 sen and for FY21E EPS, from 98.2 sen to 96.6 sen. With the FY21E EPS trimmed, our end-2020 FBMKLCI target is reduced from 1,463 to 1,439. Our top picks are D&O (OP; TP: RM0.83), F&N (OP; TP: RM36.20), HARTA (OP; TP: RM9.30), KESM (OP, TP: RM10.20), MEDIAC (MP; TP: RM0.245), MPI (OP, TP: RM13.30), PADINI (OP, TP: RM2.40) and PWROOT (OP; TP: RM2.65).

Modification losses on hire purchase loans add to gloom: The major dailies have reported that the finance ministry and banks have agreed that hire purchase loan repayments will remain unchanged after the end of the 6-month moratorium. Essentially, this means that borrowers get a free ride as the monthly interest payments throughout the 6-month period will be waived. This also means that those who have chosen to opt out earlier would likely want to opt in. And for the banks, stinging in terms of P&L impact is of course the opportunity cost lost on half a year’s uncollected repayments. Of course, the extent of the impact would depend on the individual bank’s exposure to HP and fixed-rate Islamic financing.

Banks account for 33% of the FBMKLCI weight: Banks are a crucial component of the main market barometer – it makes up 33% of the FBMKLCI weight based on the latest closing prices. And by our estimates, the bank components collectively account for 48% of FBMKLCI’s FY20 earnings.

FBMKLCI earnings shaved by 3% on modification losses: Our banking analyst has cut his FY20 earnings estimates for the banks to reflect day 1 modification losses based on the entire HP loans and Islamic financing portfolios opting in (see today’s Banking Sector Update: HP Moratorium Interest Waiver). Although certain banks may lobby for some forms of compensation from the government to lessen the burden, we believe that a draconian treatment on earnings assumption is appropriate if only to be prudent given that downside risks remain amidst the current economic uncertainties. With EPS cut for the bank components, their collective earnings in FY20 are expected to now contract by 16% versus 11% estimated previously, which leads FBMKLCI’s EPS to be trimmed by 3%.

End-2020 FBM target reduced 3% to 1,439 (from 1,463 previously): This new target is based on applying a PE multiple of 14.9x (2 standard deviations below 5-year mean) to the reduced FY21 EPS of 96.6 sen. From a bottom-up approach, our target for end-2020 is 1,420 based on the updated target prices of the components.

The immediate fair value for the FBMKLCI is 1,330: As we look to the end of the 1QCY20 earnings season, which may extend beyond 31st May due to the MCO-related disruptions, it seems likely that there remain downside risks even to our trimmed 2020 EPS. For long-term investors, however, the driver of the end 2020 FBMKLCI target is 2021’s EPS. For shorter term investors, we see the immediate fair value to be at 1,330 (based on 14.9x applied to the rolling 12-month forward EPS of 89.2 sen) with 1,220 points being a fundamentally strong support justified by 1.2x PB value – which was the floor PB multiple observed at the lowest point of the 2009 GFC recession.

Source: Kenanga Research - 8 May 2020