KUALA LUMPUR: Investor sentiment on Bursa Malaysia is showing signs of improvement as interest in small- to mid-capitalisation stocks is returning, despite a lack of fresh catalysts ahead of the market, said Kenanga Investment Bank Bhd.

Its head of research Chan Ken Yew said the improvement in market sentiment is reflected in the narrowing of the price-to-earnings ratio (PER) multiple discount between the FBM Small Cap index and FBM KLCI.

“The rule of thumb is that when the market is bullish, the discount between these two will narrow. Small cap stocks will start to play catch-up with the big caps. At times when it’s less bullish, the discount will widen,” he told The Edge Financial Daily in an interview.

In terms of valuation, Chan said small- to mid-caps appear more attractive compared to larger cap stocks, as the Small Cap index is trading about 11 to 11.5 times PER, compared with the FBM KLCI which is trading at around 17 times PER.

He noted that the average discount between the two indices is about four times PER multiple, based on the indices’ past performance.

However, Chan sees a lack of fresh catalysts to drive the market, expecting the FBM KLCI to trade range-bound between 1,695 points and 1,885 points in the second quarter of this year (2Q15), and has advocated for a more trading-oriented investing strategy.

Chan added that Kenanga Research is maintaining its bottom-up approach in stock picking.

Among Kenanga Research’s stock picks are companies in export-oriented industries such as rubber glove players, original equipment manufacturers and electronics manufacturers.

The research house is also positive on construction players, which stand to benefit from potential contract awards or news flow relating to the 11th Malaysia Plan.

“In terms of export play, we have picked stocks like Hartalega Holdings Bhd and Malaysian Pacific Industries Bhd, while for the construction segment, the usual suspects are IJM Corp Bhd, MMC Corp Bhd and Gamuda Bhd,” said Chan.

He also highlighted Mitrajaya Holdings Bhd as a small-cap pick in the construction sector, as its order book reached an all-time high of RM1.9 billion. The company is also currently tendering for RM1.6 billion worth of projects.

Besides that, other picks include Coastal Contracts Bhd based on the company’s long-term contracts, Pharmaniaga Bhd which has posted decent growth in mid-teens, SP Setia Bhd on potential mergers or acquisitions, and Press Metal Bhd for its strong fundamentals and capacity expansion.

On the upcoming reporting season, Kenanga Research expects another uninspiring series of corporate results, due to the implementation of the goods and services tax (GST) on April 1.

“We noticed some companies had started clearing their inventories, resulting in a decline in margins. We expect companies to have tighter cash management and to be less aggressive in credit sales.”

Besides GST, he sees the lower crude oil and crude palm oil (CPO) prices in 1Q15 compared with 1Q14, will also result in lower corporate earnings for the quarter.

The research house is forecasting corporate earnings growth of 5.2% this year, and 4.5% in 2016.

On the outlook for 3Q15, Chan said there has been a “surprising” trend of capacity expansion among small- and mid-cap players.

“We noticed that some manufacturing companies had started to expand their capacity. This is a surprising trend, so we are exploring more on that.

“If the trend proves to be sustainable, it could potentially be a trend in the third quarter,” he said, but did not elaborate.

On commodity prices, the research house has an average Brent crude oil forecast of US$57 (RM206.91) a barrel, and an average CPO price of RM2,200 per tonne for the year.

For FBM KLCI, Kenanga has a year-end target of 1,855 points, implying a PER multiple of 20 times and 19 times against its earnings estimates for 2015 and 2016.

The benchmark index ended 2.08 points lower at 1,845.86 last Friday.

This article first appeared in The Edge Financial Daily, on April 20, 2015.