FBM KLCI delivered yet another sequential quarter of firmer earnings in terms of meeting or exceeding expectations in 2QCY24. We revise our end-2024 target to 1,760 (from 1,700), on slightly higher market valuation of 16.5x CY24 PER due to improved investment cycle. In our view, we canvas that Corporate Malaysia’s broad guidance post 2CYQ24 has been relatively prudent, leaving scope to over-achieve. Near term, however, US rate cut decision looming closer means that FBM KLCI may be choppy, especially with Kenanga economists seeing MYR may slightly weaken from here; hence, we think picking sector winners is the more enduring strategy. Accordingly, in the 2QCY24 earnings season, we have narrowed somewhat breadth of positive recommendations in telco and banks, after FBM KLCI returned a firm 15% YTD. Even so, we have more conviction in data centre roll-out proxies, such as in TENAGA, and upgraded MAHSING (despite contrarian consensus underweight in property sector). Sector picks include RHBBANK, PBBANK, TENAGA, CDB, IHH, and DAYANG (see exhibit 4 for list).

KLCI names delivered to expectation, but broader segment is still catching up

KLCI, which has outperformed its regional peers, returning a 15.3% gain YTD, has witnessed earnings delivery to back up expectations. Earnings have been sturdier versus the past two quarters, by our count, with a higher 73% of KLCI names that met our earnings expectation (1QCY24: 64%; 4QCY23: 60%), while a narrower 17% only were misses (see exhibit 1). Examining broader into coverage universe reveals however, close to a quarter of stocks reported a miss to earnings in 2QCY24. Technology sector was culpable in this with nearly as many misses as there were in-line results (although we are cognisant investors tend to look further ahead into the cycle). By contrast, utilities was a sector that stood out, representing the lion’s share of expectation-beating results.

As the breadth of sectors with positive momentum narrowed, investors may be more selective as reflected by our recommendations

BURSA daily trades of c.RM4b on average suggests market interest is still solid. However, while FBM KLCI continued to edge up, a narrower breadth of sectors only continued to do well. Case in point, only banks and plantations were among sectors firmer MoM in August. Moreover, buying interest induced by the MYR strength may take a slight pause going by economics team forecast for USD/MYR to recover to 4.42 by year-end; the FBM KLCI has historically been highly correlated to the performance of the MYR, benefitting the banks. Combined with cautiously optimistic company guidances, a stock picking environment may persist, and overall our recommendations have also been more selective – especially within sectors of telco and banks where we emerged with less Outperform stocks post 2QCY24. Some of these are purely a share price risk-reward considerations, where we lowered our recommendation on CIMB, whereas some are more structural such as in telcos, CDB where we see synergies realization that will help it pull ahead of competition.

Corporate Malaysia guidance is not aggressive, leaving potentially some scope to over-achieve

Canvassing the broad outlook guidances across various sectors (see exhibit 2), we opine corporate Malaysia has been mostly prudent. This is good, leaving scope to deliver. For example, banks generally held back on guidance upgrades and we will not be surprised to see upward revisions later (anticipating this would be on loan volumes). On end-demand, it was anticipated that materials-related plays were more guarded in guidance, seen both in PMETAL and OMH, but planters heralded a slightly brighter outlook, evinced by better upstream margins broadly (+300 bps in general). The tone by contractors were comparatively the firmest. Majority of the firms we cover had in 1QCY24 already revised upwards their order book forecasts, but given the potential dovetailing of infrastructure projects ahead in addition to data center play, to some extent this is still playing out. We are also seeing accumulating opportunity in the solar EPCC space (SLVEST).

Areas where we remain more sanguine fundamentally as demand outstrips supply include upstream oil and gas service providers. We have kept our positive sector recommendations (DAYANG) as its results were strong and sector activity remains buoyant. Conversely, resisting the urge to give in to market’s earlier exuberance in the glove sector has seen us vindicated as 3 of the 4 names we cover missed consensus expectation (but in line with ours); guidance in this area is for gradual demand pick-up. In 2QCY24, some export demand could have been indirectly induced by some frontloading amid rate cut uncertainty affecting USD strength (echoing observation by BNM during GDP briefing). This quarter we noted better demand in oleochemicals (likely from Europe). Meanwhile, we also saw product spreads improving in PCHEM (though insufficient for us to turn bullish), and caught glimpse of greenshoots of recovery for SIME in China.

We perform sensitivity if MYR were to strengthen further, though not our base case

Generally, manufacturers are cognizant of a strengthening MYR, but point out to overall that this can be counter-balanced by focus on higher margin segments that have already been set in motion, such in the case of plastics packaging manufacturer TGUAN. A strengthening of the MYR is not our base case from here, although if it persists, our sectoral sensitivity analysis provides some downside risks worth keeping a close watch. Every 5% strengthening in MYR to the USD would crimp the results of the usual suspects sectors of gloves, tech and planters by up to 6%, and potentially more severe in TCHONG (-10%). Nevertheless, corporates have their mitigation strategies (See exhibit 3]. On the bright side, we would welcome the effects of an improved Ringgit to consumer sector (MRDIY).

Cost past-through has not been convincing in consumer segment, which we think awaits clarity on subsidies

Cost-related pressures have not fully dissipated as recent results in the likes of NESTLE could attest in its quest to pass on price hikes amid signs of downtrading. This was also especially evident in 2QCY24 even in B40 proxies for retail, such as PADINI where margin pressures still prevailed. Thus, clarity on petrol subsidy rationalization timing would be watched to gauge impact on sentiment. Nevertheless, in pockets where it is more directly related to tourism, the encouraging recovery of travel is undeniable (MAHB recorded 95% recovery in passenger volumes vs 2019 levels); we have upgraded CAPITALA and maintained accept offer for AIRPORT; on medical tourism play, we are partial to IHH among the hospital operators. Separately, some of these cost-related issues have been also due to logistics challenges, as gleaned in results of WPRTS confirming disruption from Red Sea tensions. We watch for resolution in these which may reverse challenges on intermittent congestion and Asia-Europe trade for the port operator, and may also have effect on petroleum tanker rates (MISC).

Key moves by Kenanga over 2QCY24 season

• Switch in our bank pecking order. While the banks earnings surprise we saw in 1QCY24 did not repeat, amid a strong 2QCY24 GDP print and exuberant loan applications against approvals, what we think will resonate most with investors is not only loan volumes growth, but those with a disciplined approach to underwriting. Thus our top picks now aside RHBBANK see the inclusion of PBBANK and HLBANK, from previously CIMB and AMBANK. Smaller banks still grappled more with credit costs, but guidance by bellwether banks such as PBBANK on overlay writebacks that have finally taken place in 2QCY24 is a good readthrough on confidence for the economy at large.

• Conviction for data centre plays reinforced. Record sales of energy for consecutive quarters were sufficient for us to upgrade TENAGA to Outperform. We also have a positive recommendation on YTLPOWR (and higher upside of 30%), but this reflects improved risk-reward on share price action and we keep a close eye out for updates on its Artificial Intelligence data centre take-up as a catalyst. Despite contrarian-consensus Underweight on property sector, we have also upgraded MAHSING, which is eyeing expanded geographical footprint in data centres; stock has looked more attractive after slight share price retracement. Not forgetting the tech beneficiaries as we usher in the fit-out phase for data centres in 4QCY24 to 1HCY25 which will accrue benefits to tech names, PIE and NATGATE.

Slightly upgraded 2025 earnings tempo; raised 2024 year-end FBM KLCI target

Our FBM KLCI earnings growth projection of 16% in CY24F is relatively unchanged post 2QCY24 results. We estimate that our earnings growth is ahead of consensus estimates by several percentage points, thanks to higher conviction in utilities names such as TENAGA. However, our CY25F forecast has conversely been slightly uplifted to a 9% growth (from 6.2%), which is foreseen to be continually supported by the plantation, utilities followed by banks.

We raise our end-CY24F FBM KLCI target slightly to 1,760 pts, from 1,700 pts. We had previously pegged our PER at 16x (higher end of FBM KLCI’s historical PER range of 14-16x post the economy reopening in 2021-2023), which is raised to 16.5x. This considers the levels previously attained during a period of investments upcycle as gleaned via high gross fixed capital formation growth rates (back in 2011 to early 2015), which maps to +1 SD over long-term PER (from 2009, per Bloomberg). Better investment sentiment was also shared by BNM (see analyst Clement Chua’s report on 2 September entitled Strong Pillars to Further Embolden Sentiment). Structural tailwinds from trade diversion play, stronger domestic investment, potentially dovetails government project roll-out will usher in such environment.

Assuming applying the same multiple to FY25 earnings would lift the end-CY25 target to 1,920 range. Risk to our outlook would be “hard landing scenario” in the US, which could be precipitated by rate cuts greater than expected by market. For now, as we are not in defensive mode, our key recommendations do not feature high dividend yield names, save for RHBBANK that promises leading yields among banking names. Of note, there has been generally improved dividends such as in CIMB (special dividends) and also HLBANK which has hinted on being more optimistic of improving payout.

Our revised top conventional picks, top Shariah picks and top small-cap picks are reflected in Exhibits 4-6. For now, tech sector names in this list are based on most recent tech thematic report dated 15 August, as tech coverage is in the midst of being transferred.

Source: Kenanga Research - 3 Sept 2024