Disappointing 2017 earnings weigh on foreign interest

This article first appeared in The Edge Financial Daily, on January 10, 2018.
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KUALA LUMPUR: Weak company earnings have continued to dampen foreign interest in Malaysian equities, making them more expensive on a price-earnings (PE) basis compared with their regional peers, according to Nomura Global Markets Research.

“Margins remain a drag on corporate earnings due to the high cost of doing business,” Nomura head of Malaysia equity research Tushar Mohata yesterday told a media briefing on the research house’s outlook for Malaysia’s economy and equity markets in 2018.

He pointed to the disconnect between strong economic growth, which had helped companies improved their top-line, and their margins, hit by various rising costs according to sectors.

According to Nomura, not only were returns on Malaysian stocks the lowest in Asia last year, a large portion of these returns was also the result of changes in the foreign exchange instead of higher forecast earnings. (See Chart 1)

Malaysia’s forward dividend yields were also below the historical average of 3.4, and the average forward PE ratio was above a mean of 15.1 times.

“On a PE-to-growth ratio basis, Malaysia looks like the most expensive market in Asean (see Chart 2),” Mohata said, recommending investors to be selective in stock pickings in 2018.

Nomura selects banking, construction, telecommunications and gaming as its top sector picks for 2018, expected to benefit indirectly from a forecast improvement in consumer confidence.

Meanwhile, Nomura expects the consumer discretionary and utilities sectors to see greater interest ahead of the upcoming 14th general election. “We expect the next general election (to be) in early 2018 and based on historical analyses, we expect a similar outperformance in the consumer discretionary and utilities sectors around the election period,” it added.

“There is already some fragile but positive recovery in the retail and automotive sectors,” Mohata said, noting the real estate sector remains a risk, with oversupply likely to cap any meaningful price appreciation.

Nomura is maintaining its end-2017 FBM KLCI target of 1,860 points based on corporate earnings growth of 4% to 5%. The benchmark index closed 5.2 points or 0.28% lower at 1,826.95 yesterday.

Mohata opines that the current market rally is liquidity-driven as investors want to get ahead of an appreciating ringgit, which slipped 0.29% at 4.0095 against the US dollar yesterday.

While it is difficult to say whether there will be a short-term correction to the current rally, he said the market is likely to remain bullish at least ahead of the 2017 fourth-quarter financial reporting season.

“If the cost of capital for investors remains low, we might see a sustained inflow for the next three to four months,” he said, citing an expected appreciation in the ringgit, a healthy macroeconomic outlook, and pre-election sentiments as drivers.

However, the upcoming election is unlikely to trigger significant market movements as there is less uncertainty over the incumbent Barisan National party winning at the polls, he added.

On the economic front, exports are expected to remain solid this year, leading to ongoing spillover effects into domestic consumption.

“The lift in exports is likely to be driven by continuous demand in the electrical and electronics sector, which may see some moderation considering 2017’s high pace but is still expected to perform,” said Brian Tan, Nomura economist for Southeast Asia.

He said an increase in crude oil price by US$10 per barrel is likely to result in a 0.4% increase in the country's current account surplus, as well as a 0.8% increase in core inflation due to stronger domestic demand.

The rise in crude oil price also has positive ramifications for the federal government’s fiscal deficit target of 2.8%, Tan said, noting the current price of US$68.11 (RM273) per barrel for brent crude oil is already above the US$52 used by the government to table its 2018 budget.

“We expect the government to front-load spending in the first half of the year ahead of the election, and then to reduce spending post-election,” he said.

More cash handouts and targeted subsidies are likely directions for fiscal spending instead of blanket subsidies, Tan added.

While Nomura has yet to update its ringgit forecast, Tan opines that the ringgit is expected to continue appreciating gradually.

As a result, exporters may see a partial reversal of export gains and a slight decline in competitiveness.

“The emphasis is on ‘partial’ because the ringgit is still relatively cheap compared with [the currencies of] its regional peers,” he said, adding that he is “not terribly worried” that an appreciating ringgit will hamper export growth.

Although it is difficult to compete with Vietnam, which has a low base and cheaper costs of production, Tan sees Malaysia “stacking up quite well” as its exports remain diversified.

Greater applications for electronic products are likely to support demand for Malaysian exports as well.