In the November reporting season, out of the 83 companies that we currently track, 23% fell short of expectations, slightly lower than the 24% that had failed to deliver in August. The percentage of companies that outdid expectations fell from 21% to 17% while the proportion of those that lived up to expectations increased from 55% to 60%. The number of sectors that missed the mark increased from four to six — autos, building materials, industrial, infrastructure, properties, and technology. The number of sectors that did better than expectations rose from three to four — F&B, gaming, telco and transportation.

Revision ratio
The revision ratio (number of forecasts revised upwards versus number of forecasts revised downwards) deteriorated from 0.9 times to 0.7 times. This is a troubling trend as it could mean that the earnings momentum remains negative and that the number of underperformers beat the number of outperformers by an even bigger margin than in August. Fortunately, the big caps from the banking, gaming, telco and aviation sectors did better than expected, leading to an upgrade of earnings forecasts for the broader market. What this means is that the two-tier market we have seen so far where blue chips outperformed and small- to mid-caps underperformed is well justified by their earnings performance.

KLCI EPS growth
The year-on-year earnings per share change (EPS) for the KLCI moderated from 30% in 2Q2010 to 23% in 3Q. On a quarter-on-quarter basis, EPS reversed from 8% growth in 2Q to a 4% contraction in 3Q. This is slightly worrying as the q-o-q contraction is the first pullback since the height of the global financial crisis in 1Q2009.

Change in estimates
The three-month period including the November results season was still positive as we raised our core EPS for this year by 1% while upping 2011 by 1.5%. Upward revisions appear to have eased as the revisions are the lowest in four quarters. The upgrades, particularly during the results season, came mainly from the aviation, gaming, telco and banking sectors. Shortfalls came from stocks in the rubber glove, technology and building material sectors. For November, we raised this year’s EPS by 2.5% and for 2011 by 0.7%, after adjusting for changes in the KLCI component stocks.

The number of companies which saw earnings downgrades stayed at 18, namely Tan Chong Motor Holdings Bhd, Bursa Malaysia Bhd, Ann Joo Resources Bhd, Berjaya Sports Toto Bhd, Adventa Bhd, Latexx Partners Bhd, Pelikan International Corp Bhd, MTD ACPI Engineering Bhd, Kurnia Setia Bhd, Media Chinese International Ltd, Wah Seong Corp Bhd, IOI Corp Bhd, Malaysian Pacific Industries Bhd, JCY International, Malaysia Airports Holdings Bhd, MISC Bhd,  Malaysian Bulk Carriers Bhd and Tenaga Nasional Bhd. The number of earnings upgrades, meanwhile, slipped from 19 to 16 — AMMB Holdings Bhd, Malayan Banking Bhd, Tasek Corp Bhd, Carlsberg Brewery Malaysia Bhd, Nestle (Malaysia) Bhd, Genting Bhd, Gamuda Bhd, Masterskill Education Group Bhd, Media Prima Bhd, Dialog Group Bhd, KL Kepong Bhd, DiGi.Com Bhd, Maxis Bhd, Telekom Malaysia Bhd, AirAsia Bhd and Malaysian Airline System Bhd.

CIMB’s core net profit estimates
Since the big jump in profit forecasts in November 2009, earnings estimates for this year have been creeping up and spiked up again in November. Consensus forecasts were similar but the trend has been rising steadily. For 2011, both our and consensus forecasts have shown a gradual upgrade in recent months.

CIMB versus consensus estimates
We expect EPS to rebound 27% this year and continue expanding by a healthy 14% in 2011/12, still higher than consensus growth estimates. Our EPS forecasts are 2% to 4% above consensus estimates, lower than the difference of up to 6% previously. Consensus appears to be gradually catching up with us.

Net profit to GDP growth ratio
The KLCI net profit growth to nominal GDP growth ratio for 2010/11 is in positive territory. We still believe that the figures are achievable as we are coming out of an economic recession and the same pattern was seen in 1999 after two consecutive years of earnings contraction. However, the ratio should be declining for future years as growth goes down a notch.

GDP growth
Growth in the Malaysian economy slowed further to 5.3% y-o-y in 3Q (8.9% in 2Q and 10.1% in 1Q), weighed down by slower export growth and domestic demand. This is lower than our estimate of 5.7% as well as market consensus, also at 5.7%. We are not overly concerned about the deceleration as it is part of the inevitable adjustment from an unsustainable expansion pace.

Domestic demand continued to propel growth, with consumer spending rising, albeit at a slower rate of 7.1% (7.9% in 2Q) and total investment gaining 9.8% (12.9% in 2Q). Much of the domestic demand strength came from the private sector as stimulus spending by the public sector tapers off.

Growth of exports succumbed to easing global demand, falling sharply to 6.6% (13.8% in 2Q). As import growth outpaced exports, net trade again pulled down GDP and subtracted 3.5 percentage points from 3Q’s GDP growth. With the advanced economies facing headwinds, this will continue to weigh on exports.

Major economic sectors continue to expand, albeit at a more moderate pace. Leading the pack is the manufacturing sector (7.5% versus 16% in 2Q), followed by services (5.4% versus 7.3% in 2Q), construction (2.8%) and agriculture (2.7%) sectors. The mining sector contracted 1%.

The bottomline is that the growth outlook for the Malaysian economy is still positive, though the pace will come off. The continued expansion of domestic demand should at least support the economy. There is, however, a risk that growth will slow more dramatically if export growth falls sharply as a result of a more abrupt slowdown in global demand than we forecast. We maintain our real GDP growth estimates of 7% for this year and 5.5% for 2011.

Valuations and recommendations
The third quarter was a repeat of 2Q as the revision ratio was still below one times but market EPS was raised due to strong performance by big caps. This means that positive earnings surprises for the broader market are still elusive and the market could continue to see two tiers where big caps do well and small- to mid-caps lag. Mergers and acquisitions activity and sectors with strong news flows such as properties and construction could still see a re-rating but other smaller-cap stocks may be bypassed. The banking sector has again performed well and lifted market EPS for five to six quarters in a row. In view of the mixed November results season, we are keeping our end-2011 KLCI target of 1,610 points which is based on an unchanged 2011 PER of 13.8 times. We maintain our overweight rating on Malaysia, underpinned by the potential re-rating catalysts of: 1) the various transformation programmes, 2) continued inflow of foreign funds, and 3) the spillover of M&A activity from the property sector.

Sectors to ‘overweight’
Although we remain positive about the rubber glove sector, we have replaced it with the property sector in our preferred sectors as cyclical sectors should come back into favour due to pump-priming activity by the government, the Economic Transformation Programme and the flurry of M&As of late.

Banking — We maintain our overweight rating on the banking sector given the positive earnings outlook. Banks rank among the key beneficiaries of the economic recovery, which will lead to increased business activity and investment banking deals. We envisage a favourable operating environment in 2011, with still healthy projected loan growth of 8% to 9% and stable, if not lower, impaired loan ratios. This, coupled with healthy growth in non-interest income, will help banks to achieve our projected net profit growth of about 16% in 2011. The potential share price triggers are: 1) strong earnings growth, 2) increase in investment banking income, 3) stronger growth potential for overseas operations, especially in Indonesia, 4) potential write-backs and 5) upside potential to our dividend forecasts.

Construction — We maintain our overweight rating on the construction sector as 2011 is likely to be a stronger year for execution, backed by the government’s ETP. The RM36 billion KL MRT, RM7 billion LRT extension/upgrade and other key jobs under the 10th Malaysia Plan are making good progress towards tenders and awards. Positive news flows for the sector are likely to pick up in the next six to nine months and pave the way for further re-rating of the sector. Gamuda and WCT are our top picks.

Properties — Property developers have enjoyed record sales this year, which bodes well for longer-term earnings growth. The postponement of the IFRIC 15 accounting policy and implementation of a 70% loan-to-value ratio cap removes two major uncertainties plaguing the sector. Now that the bad news is out of the way, the undervalued sector should be re-rated. Also, the spate of mega mergers including those by UEM Land-Sunrise and MRCB-IJM Land will ignite interest in the sector and speculation on which developers will be next. We continue to be overweight on the sector and see share price triggers in: 1) robust sales and earnings growth, 2) M&A activity which would unlock the hidden value of developers, and 3) news flows on landbanking exercises.

Regional comparison
Despite the strong year-to-date performance of the KLCI, Malaysia’s PER premium over the region has fallen from 15% to 20% six months ago to around 8% to 11%. This could be due to even stronger performances by Indonesia’s Jakarta Composite Index and Thailand’s SET. Malaysia’s 2011/12 PER remains one the highest in the region but is now behind Singapore and Indonesia. Malaysia’s EPS growth is also roughly in line with the region.

Portfolio investment flows
Net portfolio funds remained in positive territory for the fourth straight quarter in 3Q2010. We expect continued inflows in 4Q on the back of large IPOs, the new all-time highs chalked up by the KLCI in November and the 13-year high charted by the Malaysian currency.

Recommendation changes
In the past three months, we had more upgrades than downgrades, the reverse of the previous results season. We upgraded heavyweights in the telco and plantation sectors. All in all, the number of stocks we upgraded edged up to nine (eight leading up to August) while the number downgraded shrank to six (14 leading up to August). The downgrade-to-upgrade ratio was only 0.67 times against 1.75 times in August. The lower number of downgrades is due to a combination of decent results and the more promising outlook as we roll over to 2011. Note that we have dropped coverage on several stocks (Ekovest Bhd, Suria Capital Holdings Bhd and Hunza Properties Bhd) due to their small size, illiquidity and lack of investor interest.

This article appeared in The Edge Financial Daily, December 3, 2010.