Lead Story: Market shock wave may see analyst downgrades

This article first appeared in Capital, The Edge Malaysia Weekly, on June 4, 2018 - June 10, 2018.
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THE FBM KLCI has been on a rough ride over the past week as the government’s onion-peeling approach to announcing its policy changes and reforms spooked investors while market sentiment turned even more fragile.

Last Monday, the government triggered another shock wave when it said it had decided to scrap the Kuala Lumpur-Singapore high-speed rail. Two days later, it announced the cancellation of the Mass Rapid Transit 3 project.

The benchmark FBM KLCI saw its worse single-day fall since 2008 last Wednesday, plunging 3.52% to a month-and-a-half low of 1,719.28, before recovering some of its losses on Friday to close at 1,756.38 points.

The week before, the local bourse had also succumbed to a heavy selldown after the government revealed that the country’s liabilities had breached RM1 trillion.

The exit of foreign investors from emerging market equities during the week ended May 25, amid external factors such as the trade dispute between the US and China as well as the US-North Korea summit being called off, also contributed to the decline.

Disappointing corporate earnings for the first quarter of the year, as well as anticipation of further announcements by the government, exacerbated the generally uncertain environment, causing several research houses to mull revising their views on the local market and year-end FBM KLCI targets.

Nomura Holdings Inc downgraded Malaysian equities to “neutral” from “overweight”, citing near-term uncertainties and negative news flow on the removal of the Goods and Services Tax (GST) and the reintroduction of fuel subsidies, which could pose a drag on Malaysia’s financials, and economic and earnings growth rates.

The research house says a drag in investment growth rates could impact credit growth and, subsequently, earnings for the index, highlighting that 40% of the FBM KLCI’s earnings come from Malaysian banks. It adds that there is a potential risk of deteriorating business sentiment amid the policy uncertainty.

“However, we are reluctant to be underweight as we hope the new government will come out with policies which address the fiscal concerns as well as embark on reforms which potentially could improve investor sentiment in the medium term.”

Based on previous experience, Nomura adds that the push for reforms, or even the “hope” of reforms, can be powerful catalysts for stock market rallies, noting the case of India and Indonesia in 2014 and 2015.

The research house says it would like to see reforms in government procurement, reduction in corruption and crony capitalism and the potential rolling back of government involvement in certain areas to promote a level playing field with the private sector.

UOB Kay Hian, meanwhile, says it is looking to revise downwards its year-end target from its existing forecast of 1,830 amid the “sombre” first-quarter earnings season.

“There is downside to our 2018 target of 1,830 (based on 15.7 times 2019 PER) given that the 1Q2018 reporting season has disappointed, particularly in the telecom industry,” says UOB Kay Hian head of equity research Vincent Khoo.

He adds that the government’s decision on toll payments is keeping investors on edge, amid fears over government debt and the ramifications from the scrapping of mega projects.

However, Khoo says the selldown of major construction companies with tolled expressways such as IJM Corp Bhd and Gamuda Bhd is overdone, as investors priced in the possibility of the government undercompensating the concessionaires.

“We expect the government to undertake a more pragmatic solution that would be acceptable to the capital market, being fully aware that short-changing the toll concessionaires would broaden investor concerns well beyond the construction sector,” he adds.

MIDF Research head of research Mohd Redza Abdul Rahman also indicates that the research house may review its year-end forecast for the FBM KLCI after reviewing corporate earnings for the first quarter.

“We might review it and there might potentially be a downgrade from our year-end target of 1,900 points, pending our assessment of the latest corporate earnings. While the banks look good, our concerns lie in the major constituents like Axiata Group Bhd, Telekom Malaysia Bhd, Tenaga Nasional Bhd, plantation and property counters,” he tells The Edge.

But not all are that pessimistic.

AmBank Research says the disappointing first-quarter performance did not jeopardise the growth trajectory of the FBM KLCI’s earnings and forecasts growth of 6.3% and 7.1% for 2018 and 2019 respectively, on the back of expected gross domestic product growth of 5.5% and 5.3% respectively.

“We have year-end targets of 1,900 points and 2,040 points in 2018 and 2019 respectively for the FBM KLCI, based on 18.5 times 2018 and 2019 earnings respectively,” AmBank Research analyst Joshua Ng writes in a note.

He says the FBM KLCI will be driven by a cyclical upturn in corporate earnings growth and the introduction of high PER stocks in the recent round of changes to the FBM KLCI component stocks, namely Press Metal Holdings Bhd, Nestle (Malaysia) Bhd, Dialog Group Bhd, Hartalega Holdings Bhd and Malaysia Airports Holdings Bhd.

He adds that greater clarity in the new government’s policies, along with potential improvement in sentiment on emerging markets and a more level playing field across sectors, are key catalysts for the benchmark index.

Meanwhile, downside risks include stronger-than-expected US inflation and wage growth, which increases the probability of a steeper rate hike in the US and a stronger greenback, an escalation in geopolitical tensions and earnings disappointments from FBM KLCI heavyweights like banks, telcos and Tenaga Nasional Bhd.

Inter-Pacific Securities head of research Pong Teng Siew also maintains his year-end target of 1,890 points despite the recent developments, although he reiterates that the index is unlikely to touch a new high this year.

“Generally, the FBM KLCI takes a while to climb but when sentiment is down, it drops fast, like how we have seen the pullback in recent weeks. It took less than two months for the index to climb to its all-time high in April, so it will like take two or three times the duration for the FBM KLCI to recover to previous levels,” he tells The Edge.



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