RESULTS for the second quarter (2Q) have begun to trickle in and for the most part, they have been in line with expectations. In other words, earnings growth has been lacklustre — a theme that is expected to continue until results season wraps up at the end of the month.
“There is not much upside surprise as 2Q has been quite weak. In fact, the risk is on the downside with potential for more downgrades, although it will not be as bad as 1Q,” says Gan Eng Peng, who heads Equity Strategies and Advisory at Affin Hwang Asset Mangement Bhd.
While Gan points out that the weaker earnings have already been priced in, there are still some areas that have the potential to disappoint further.
“We have already seen from Hartalega the effects of stronger competition. There may be more downside for glovemakers. Meanwhile, some banks, like Maybank, for example, may see higher provisions from loans to the oil and gas sector,” he notes.
Hartalega Holdings Bhd saw its profit fall by 10.4% year on year to RM56.18 Amillion for the quarter ended June 30. With foreign exchange gains playing less of a role, the effects of increased competition have become more apparent. Hartalega points to a fall in margins from 25% to 18.6%, due to price competition and higher costs, for its weaker earnings.
Once seen as a safe haven, exporters are also losing their shine.
“Export performance has been quite weak in 2Q. Gross domestic product growth in the US and Europe point to weaker demand in the second half. Weak exchange rates have helped exporters’ profits in the past. But now, with the same base, profit growth will be weaker,” says Peck Boon Soon, who heads Asean Economics for RHB Research Institute.
Keep in mind, however, that many of these weaknesses are already anticipated.
“Market expectation on corporate earnings has been trimmed following earlier negative surprises. Given more muted expectations now, we expect most companies within our coverage to report earnings within expectation,” says Bernard Ching who heads research at AllianceDBS Research.
However, he also has some concerns going forward.
“We are wary of asset quality issues in a handful of banks while plantation companies may still face earnings risk due to fresh fruit bunch yield loss,” he explains.
Thus far, some of the worst 2H results that have been posted include Malaysia Marine and Heavy Engineering Holdings Bhd, which saw its net profit fall from RM18 million to a net loss of RM2.6 million. Revenue in the same period halved to RM297.4 million.
Another stock that saw earnings miss the mark was British American Tobacco (Malaysia) Bhd which saw a 78% and 11.5% y-o-y fall in net profit and revenue respectively. This was due to tariff-led price hikes, inflationary cost pressures and loss of market share to illicit cigarettes.
Given the bearish outlook, it is no surprise, then, that there has been a strong rotation to defensive sectors like real estate investment trusts (REITs) and consumer staples.
Consumer staples, however, have proven to be more stable than the REITs. Counters like Axis REIT and Capitaland Malaysia Malls Trust have been relatively disappointing thus far says Gan. But then again, funds do not have many options.
“If you need to put money somewhere, where would you put it? There is not much growth anywhere else,” he says, explaining why funds have increased their allocations in such defensive stocks.
“It may look expensive, but it depends on what you compare it against. When you consider that one-fifth of the world’s government bonds have negative yields, then it doesn’t look too bad,” he points out.
One catalyst for REITs would be an additional interest rate cut, says Gan, but he points out that it is a scenario many are already pricing in.
On a separate note, consumer staples look to remain stable despite the slowing economic growth.
“The one bright spot, relatively speaking, is consumer spending, which is expected to remain level. Barring any adjustments on the cost side, consumer stocks should be able to generate stable earnings,” says Peck.
That said, last week saw a slight sell-off in consumer stocks like Nestlé Malaysia Bhd and Fraser & Neave Holdings Bhd (F&N) after both counters hit new record highs. It is worth noting that F&N posted a 12.8% y-o-y increase in net profit to RM93.55 million while revenue increased 1.8% to RM1.096 billion for the quarter ended June 30.
Nestlé’s share price is sitting on a 13.22% y-o-y gain, closing at RM79.68 per share last Friday, while F&N gained 35.65% in the same period to RM24.5 apiece.
Beyond the defensive plays, one sector that might have a more positive outlook is the construction sector, given the huge amount of infrastructure work still in the pipeline.
Ching points out that construction award news flow will pick up in 2H, which bodes well for construction earnings moving forward. Even in the first half, many sizeable contracts have been awarded already.
On the other side of the coin is the property sector, which is still riding on sales made in previous years. While the billings are expected to prop up earnings for the near term, weaker new sales mean that profits will eventually drop off.
For now, it appears that the status quo will hold. Stocks have already been sold down to reflect weaker earnings, and with no obvious catalyst in sight, it is expected to remain this way. That said, some exceptions to the rule are beginning to emerge, like the rally in Felda Global Ventures Holdings Bhd (FGV) to a one-year high of RM1.95 per share last week, despite weak crude palm oil prices. FGV fell into the red in the quarter ended March 31 but it is expected to show an improvement in the subsequent quarter.
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