Cover Story: A better year for exports




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This article first appeared in The Edge Malaysia Weekly, on January 9 - 15, 2017.

 

THIS year should have been much better for exporters, coming from a sluggish 2016, which is expected to see exports grow only 0.5% year on year.

The ringgit continues to flirt with new record lows, briefly surpassing the psychological 4.50 level against the US dollar last week. Even though other emerging market currencies have depreciated as well, the ringgit continues to be one of the worst performers against the US dollar, giving Malaysian exporters a competitive advantage.

Meanwhile, the US economic growth forecasts have risen to bullish levels that have not been seen during the global financial crisis in 2008. In fact, growth estimates for global gross domestic product have been revised upwards although China and Europe’s GDP growth are expected to moderate slightly.

In its most recent Global Economic report, HSBC upgraded its global growth forecast from 2.3% to 2.5%. It estimates that global GDP expanded 2.2% last year. The bottom line is that external demand should, at the very least, remain intact this year.

Stronger commodity prices, particularly crude oil and crude palm oil, will also lend support to export numbers this year.

On top of that, domestic-focused stocks are expected to face more volatility as the 14th general election is expected to be held this year.

Put together, these factors should result in a robust year for exporters as well as the corresponding stocks.

“Malaysia’s exports grew at a relatively muted 0.5% y-o-y in 2016. But this year, we are forecasting it to grow 2%, says an economist at RHB Research.

But his forecast is relatively conservative. The consensus estimate for export growth this year is 2.8% and the latest export numbers do give some hope for a rebound.

Data for November released last Friday shows continued signs of recovery for exports. During the month, exports rose 7.79% y-o-y to RM72.83 billion, the quickest pace in 2016. More importantly, the recovery in gross exports was not driven by stronger commodity prices alone. Electrical and electronic (E&E) exports rose 13.2% y-o-y to RM26.2 billion. Note that E&E exports, comprising semiconductors primarily, make up 35.9% of total exports.

That said, higher commodity prices also gave gross exports a boost during the month. Exports of palm oil and palm-based products rose 24.3% y-o-y to RM6.6 billion, due primarily to higher average unit prices.

Interestingly, there was a sharp increase in the volume of crude oil exported during the month; up 3.9% y-o-y and 49.8% month on month. Overall, the exported value of crude oil fell 6.1% y-o-y but rose 43.3% m-o-m to RM2.5 billion in November.

On a year-to-date basis, however, export data still looks rather weak. For the 11 months to Nov 30, gross exports grew only 0.18% y-o-y to RM710.38 billion. December exports are expected to help lift full-year exports growth to 0.5% y-o-y, according to RHB Research, but that is hardly impressive. Instead, it would be among the country’s worst export performances since the global financial crisis.

Some forward-looking data does not look too promising either. The Nikkei Malaysia Manufacturing Purchasing Managers Index (PMI) booked its 21st consecutive monthly contraction of 47.1 in December. (A score below 50 is a contraction). This indicates a continued weakness in manufacturing, which has been blamed on both domestic and foreign demand.

In fact, the new Export Orders Index (a component of the overall PMI) contracted for a seventh consecutive month in December.

“Greater global competition and a slowdown in the world economy were cited as some of the reasons for the decrease in export orders,” notes Nikkei’s latest PMI report.

That said, some economists are bullish for the coming year.

“The PMI tends to be a little subdued. Overall, I expect exports to grow between 4% and 5% this year,” says veteran economist Dr Yeah Kim Leng, an economics professor at Sunway University Business School.

“Other than the stronger commodity prices, I am more bullish because I expect manufacturing, particularly E&E, to perform this year on the back of stronger global demand. The US is estimated to grow around 3% this year, the strongest since the financial crisis. We are also beginning to see some encouraging signs of growing inflation in Europe. Meanwhile, the weaker ringgit should give our exporters a slight advantage,” he explains.

However, he cautions that a possible trade spat led by incoming US President Donald Trump could throw off economists’ estimates.

The US is unlikely to tighten trade with Malaysia. Instead, we need to keep an eye on US-China trade relations once Trump takes office. He has appointed Robert Lighthizer, who has been a strong critic of China, as chief trade negotiator. A trade war could be disastrous for global trade and, in turn, Malaysian exporters.

It is interesting to note that Singapore is Malaysia’s largest export partner (14.6% of total exports). China, the US and Japan follow at 12.1%, 10.4% and 8% respectively.

However, it is important to remember that Singapore is not the final destination for most of Malaysia’s exports. Instead, the products go on to the US, China and Europe. Thus, the slow growth in the Singapore economy is not expected to weigh on Malaysia’s exports.

“There has been a significant upturn in manufacturing output in the electronics sector [in Singapore] during 2H2016, which should be supportive of Malaysia’s electronic product exports into the Singapore electronics supply chain,” says Rajiv Biswas, Asia-Pacific chief economist for IHS Global Insight.

He points out that Malaysia’s exports to the US “grew strongly in 2016, up 9.7% y-o-y in the first 10 months of 2016. In contrast, Malaysia’s merchandise exports to China fell 7.2% y-o-y during the period due to the continued slowdown in the Chinese economy.”

Rajiv says Malaysia’s exports are expected to remain subdued as China’s economic growth rate is expected to moderate from 6.7% last year to 6.4% this year.

Another hurdle that global growth faces in 2017 is the uncertainty created by the upcoming French and German elections, which could disrupt current growth trends.

 

Which is the best exporting sector?

The glove manufacturing sector typically comes to mind, but rising cost and intense competition have whittled away any short-term foreign exchange gains it has made (see “Glove makers no longer clear beneficiaries of stronger US dollar” on next page).

This year, however, the spotlight will be on other exporting sectors such as oil and gas (O&G). Given the rebound in crude oil prices, O&G stocks are obvious favourites going into 2017, especially considering that their valuations are still recovering from the oil price crash in 2015.

“It is still much too early for the O&G service providers to benefit from the higher crude oil prices, due to the lag effect. However, the oil producers will definitely do better in the near term,” says Bernard Ching, head of research at AllianceDBS Research.

Stocks such as SapuraKencana Petroleum Bhd are a good proxy to the oil price recovery, he notes. In fact, SapuraKencana’s share price has already recovered by 32.6% from the low of RM1.32 seen earlier this year.

At the same time, Ching notes that downstream O&G companies such as Petronas Chemicals Group Bhd, which has benefited from low crude oil prices in the past, might see their margins being squeezed if the increased cost of petroleum inputs outpaces the price increases for its products. Note that exports of petroleum products contracted 3.11% y-o-y for the 10 months ended Oct 31 last year.

At the same time, Ching is less sanguine about food exporters. “Any gains from the weaker ringgit is going to be dampened by higher raw material costs,” he says.

Rising commodity prices will likely impact the margins of such food producers as well. Take Kawan Food Bhd, for example; approximately 70% of its manufactured volume are exported. However, at last Friday’s close of RM3.80, it is valued at 26 times earnings.

That said, exports of processed food was one of the most robust sectors last year. It grew 9.63% y-o-y to RM16.13 billion for the 10 months ended Oct 31.

In contrast, exports of wood products did relatively poorly this year, increasing only 0.66% to RM12.8 billion during the same period. In fact, the sector fell 13.25% y-o-y in October. Note that this is against a backdrop of a depreciating ringgit, which means export volumes would have declined even more. This is puzzling considering that the improved housing data in the US should have increased demand for furniture.

This casts some doubts on the furniture stocks, which have been in the limelight since the ringgit started depreciating, but perhaps the export numbers will pick up this year. That said, most furniture companies still continue to show relatively consistent earnings.

One export-oriented furniture stock is Poh Huat Resources Holdings Bhd. At last Friday’s close of RM1.89 per share, the group is only valued at 8.34 times earnings.

Against this backdrop, E&E continues to stand out as the sector with the most growth potential. In November, the Semiconductor Industry Association’s (SIA) global sales report said sales hit a record high of US$31.03 billion, up 7.44% y-o-y (see chart: Global semiconductor sales).

This underscores the continued global demand for semiconductors and is reflected in Malaysia’s exports as well.

“So far, our outlook for 2017 is bullish. The weaker ringgit certainly helps us, but we also anticipate more orders this year,” says Chuah Choon Bin, executive chairman of Pentamaster Corp Bhd. The Penang-based company builds automation and testing equipment for smart devices.

Similarly, Ching favours E&E stocks that have exposure to smartphones and smart devices, including Inari Amerton Bhd, SKP Resources Bhd, Globetronics Technology Bhd and VS Industry Bhd.

Ching notes that smartphone growth may be tapering, but that does not reduce the opportunities for growth. Take Inari, which produces radio frequency (RF) testing equipment, for example, he says. Growing RF content in smartphones will drive volume growth for the company, he explains.