Lower oil prices a saving grace after weak 3Q results

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AS EXPECTED, corporate earnings results for the just concluded third quarter turned out to be weaker on a year-on-year basis, mired in slower demand and higher costs. Nonetheless, analysts say improvement may just be around the corner as lower crude oil prices could provide a breather to business margins in 2015.

The surprise factor in earnings was sorely absent this round — as it has been for the past year — while the pool of companies that trailed analysts’ expectations grew. Unsurprisingly, this caused research houses to further downgrade the earnings outlook for stocks under their coverage.

Companies in the plantation sector, marred by weak crude palm oil (CPO) prices and suppressed refining margins that affected downstream operators, topped the list of disappointments.

The zero export tax regime implemented on Sept 1, which is meant to curb falling CPO prices and reduce inventory, bode well for upstream plantation companies but resulted in suppressed margins for local refineries as they have to compete more to source CPO.

It is noteworthy that Felda Global Ventures Holdings Bhd (FGV) fell into a net loss of RM9.33 million in the third quarter ended Sept 30 while IOI Corp Bhd’s net profit for the quarter contracted 41.5%. While the main reason for the dismal performance of FGV was unrealised trading losses and IOI, the demerger of its property unit, both are seeing substantially weaker performance in their downstream operations.

Analysts do not think that the margin pressure on the downstream segment will be relieved anytime soon and are placing their bets on plantation firms with mostly upstream operations, which they believe are likely to face less cost pressure compared with those with huge downstream operations.

Retailers such as AEON Co (M) Bhd, Parkson Holdings Bhd and Padini Holdings Bhd saw a dip in earnings as weak consumer sentiment and high operating cost got the better of them. Padini’s net profit declined 30.6% in the quarter ended Sept 30 compared with the previous corresponding period while AEON’s contracted 23.6% and Parkson’s slid 34.2%. This was despite all three companies registering a growth in revenue of between 2.1% and 4.4%.

Meanwhile, food and beverage manufacturers in general also experienced a tougher operating environment, with foodstuff giant Nestle (M) Bhd and coffee chain operator OldTown Bhd delivering rather flat third-quarter earnings. It is worth noting that Dutch Lady Milk Industries Bhd, whose product range is less diverse compared with Nestle’s, saw its revenue and net profit decline 8.8% and 32.5% respectively, largely impacted by the increase in dairy-based commodity prices, which puts pressure on product margins.

The outlook for the consumer segment has been bleak, with the Goods and Services Tax (GST) to be implemented in April next year and the higher cost of living expected to further weigh down consumer spending. However, the sector might see a reprieve as lower crude oil prices could translate into better margins and relieve the cost pressures on these companies, says Phillip Capital Management Sdn Bhd chief investment officer Ang Kok Heng.

Meanwhile, there were no surprises in the oil and gas (O&G) sector. RHB Research says in its report that the earnings for the sector was within its expectations after four disappointing quarters. Out of the 16 companies under its coverage, only Wah Seong Corp Bhd and Favelle Favco Bhd exceeded the research house’s expectations.

“Wah Seong beat our expectations for a second straight quarter due to contributions from the Polarled project for Statoil in Norway, which is almost 70% to 72% completed. As for Favelle Favco, earnings were helped along by an increase in orders for cranes,” it says.

The weakening oil prices globally, coupled with Petroliam Nasional Bhd cutting capital expenditure, could mean turbulent times ahead for the sector, thus putting pressure on players, especially those with highly geared balance sheets and that rely on the renewal of short-term contracts.

In the aviation sector, AirAsia X Bhd and Malaysian Airline System Bhd (MAS) were loss making for the quarter ended Sept 30 as the airlines were impacted by low seat factor and high operational cost. Meanwhile, AirAsia Bhd’s core net profit, which excludes exceptional gains, forex and impairments, dived 41% y-o-y to RM96 million, according to Hong Leong Investment Bank Research.

Nevertheless, the weakness in the oil price and improved yields are expected to improve the performance of the aviation sector in 2015, says RHB Research.

“FY2015 is expected to be a turning point for the sector on the back of more capacity reduction by MAS, which is the culprit for the depressed sector yields given its irrational pricing strategy. The weakness in jet fuel price, which could be persistent in the year ahead, ought to further give a lift to earnings,” it adds.

The glove makers also reported weaker profits. Hartalega Holdings Bhd’s net profit dipped 23.9% due to the higher labour cost incurred in its next generation integrated glove manufacturing complex project. Kossan Rubber Industries Bhd’s net profit declined 2.8% due to the slower-than-expected commercial production in its new plant and the start-up cost incurred. Meanwhile, Supermax Corp Bhd’s net profit declined 22.3%, affected by the lower sales volume.

Despite the weaker results this season, analysts expect demand for gloves to remain resilient, but they note that margins could come under pressure because of price competition and cost inflation on gas and transport.

The results of companies in the construction sector were mixed. Naim Holdings Bhd’s net profit more than doubled to RM39.28 million after it managed to turn around its construction division from the losses it was facing a year ago.

Moving forward, analysts believe the sector has strong prospects given the mass rapid transit project, West Coast Expressway project, Kuantan Port expansion works, among others, that are expected to keep the industry busy for the foreseeable future.

As sentiment wanes in the property market, earnings momentum will be slow for the sector going forward. Nevertheless, most developers still managed to book strong numbers in the third quarter, drawing from the progress billings of outstanding development projects launched just a few years ago.

A star performer was Malaysian Resources Corp Bhd, which saw a turnaround from its net loss position of RM122.4 million a year ago to a net profit of RM27.39 million for the quarter ended Sept 30, due to recognition of revenue from the PJ Sentral development as well as higher progress billings from other projects.

At the broader level, the expectation ahead is that property developers will enjoy a pre-GST demand rally right up to the first quarter of 2015. However, the industry could also see slower days ahead as cooling measures implemented by Bank Negara Malaysia ease demand while the GST could further aggravate the situation.

“We are taking a more moderate stance on the matter as lending liquidity to the property space has slowed down tremendously, which will cap demand upsides. The sector may be going through a period of declining sales, which will hurt future earnings, and cost pressures. We are also concerned that we will be seeing structural changes in the developers’ space once GST is implemented, which will have implications on valuations,” says Kenanga Research in a report.

Meanwhile, the financial sector saw two heavyweights, Malayan Banking Bhd and CIMB Group Holdings Bhd, take a hit to net profits. CIMB’s net profits shrank 16.1% as a result of its weak Indonesian operations while Maybank’s net profits contracted 7.9% as a result of weak non-interest income.

The banking sector as a whole did see stronger earnings momentum in the quarter ended Sept 30, says RHB Research, driven by stronger net interest and non-interest income growth and stable credit cost. But the improvement was still short of expectations.

The recent round of quarterly results painted a bleak picture for Corporate Malaysia, but CIMB Research says in a report that corporate earnings could see improvements in 2015 on the back of the lower base of earnings that has been set this year.

RHB Research is expecting a pickup in corporate earnings in 2015 as lower crude oil prices will help to increase the disposal income of consumers, thereby accelerating the global economic recovery and boosting demand for exports.

This article first appeared in The Edge Malaysia Weekly, on December 8 - 14, 2014.