Things are looking up, but Delta variant could spoil the party

This article first appeared in Capital, The Edge Malaysia Weekly, on September 6, 2021 - September 12, 2021.
Things are looking up, but Delta variant could spoil the party
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THE latest financial results reporting season for the quarter ended June 30 (2Q2021) brought some cheer to the market, as constituent companies on the FBM KLCI recorded the highest-ever aggregate normalised quarterly earnings of RM19.8 billion.

With the political situation improving, following Pakatan Harapan’s assurance not to “complicate” the vote of confidence for Prime Minister Datuk Seri Ismail Sabri Yaakob, and the rising Covid-19 vaccination rate among the population, things are looking up for the Malaysian economy.

However, the spread of the Delta variant is still something that companies and investors will have to watch out for, especially if the government continues with its policy of shutting down the economy when things get worse.

“The core expectation is that things will start picking up. But there are a lot of risk factors. Things [the recovery] will not go up in a straight line,” says Alex Chia, head of research at RHB Research Institute.

“If you look at the UK and the US, although they have seen a higher number of cases due to the Delta variant, their hospitalisation rates have not increased. So, we expect things to improve. However, humankind has generally underestimated this virus.”

The Delta variant has been painted as the reason for the rapid increase in Covid-19 cases in Southeast Asia. As at last Wednesday, Malaysia had 265,274 active cases, with 1,007 patients in intensive care units, while 464 patients required respirator assistance.

To recap the financial performance of the FBM KLCI constituents in 2Q2021, the aggregate normalised earnings of the companies during the quarter after adjusting for non-operational items came in at RM19.8 billion, says MIDF Research in a report released last Thursday.

This was the highest-ever aggregate normalised earnings recorded by FBM KLCI constituents, and follows the preceding quarter’s record earnings of RM19.4 billion. Normalised earnings grew both sequentially and annually in 2Q2021, at 2.1% quarter on quarter (q-o-q) and 171.6% year on year (y-o-y).

The higher aggregate normalised earnings were fuelled by the plantation, industrial and healthcare sectors, according to MIDF Research. Most sectors of the FBM KLCI recorded y-o-y earnings growth in 2Q2021. The exceptions are energy and consumer products and services.

“It is noteworthy that the adjusted sequential performance in 2Q2021 remained on a positive growth trajectory despite the imposition of MCO 3.0 in June. It is also notable that the adjusted on-year performance in 2Q2021 continued to rise in comparison to the 70.6% y-o-y growth recorded during the preceding quarter, principally due to the low base effect from the stricter MCO 1.0 in 2Q2020,” says the research firm.

However, the better performance was not seen across the board. In its report, MIDF Research noted that the percentage of companies under its coverage that registered earnings above expectations declined to 20% in 2Q2021, compared with 22% in the previous quarter.

Conversely, the percentage of negative surprises increased to 39% in 2Q2021 from 29% in the previous quarter. It is notable that the percentage of underperformers in 2Q2021 (coincided with MCO 3.0) was the highest since 2Q2020 (coincided with MCO 1.0), says the research house.

Information compiled by The Edge using Bloomberg data shows that out of the 30 counters that make up the local benchmark index, 16 had negative earnings growth q-o-q in 2Q2021, mainly banks and industrial and plantation companies.

For comparison, only eight had negative earnings growth on a q-o-q basis in 1Q2021. This indicates that on a quarterly basis, the financial performance of many constituent members of the FBM KLCI has deteriorated.

Companies with results that met MIDF Research’s expectations declined to 41% in 2Q2021 from 49% in the preceding quarter. The plantation sector registered the highest percentage of positive surprises at 50% of stocks under coverage, while the energy sector led the percentage of underperformers at 80% of companies under coverage.

Joshua Ng, head of equity research at AmInvestment Bank, says the FBM KLCI constituents have yet to show meaningful improvement sequentially, as the reimposition of various movement restrictions weighed on their financial performance in 2Q2021. In a report released last Wednesday, he says the 2Q2021 results remained subdued, with 27%, 55% and 18% of the companies beating, meeting and missing the bank’s projections respectively, compared with 27%, 50% and 23% in 1Q2021.

“Six FBM KLCI component stocks under our coverage beat our projections, namely, CIMB Group Holdings Bhd, Sime Darby Bhd, Sime Darby Plantation Bhd, IHH Healthcare Bhd, Petronas Chemicals Group Bhd and Tenaga Nasional Bhd. On the other hand, four FBM KLCI component stocks under our coverage missed our projections, namely, Mr DIY Group (M) Bhd, PPB Group Bhd, Dialog Group Bhd and Petronas Gas Bhd,” he adds.

Beware of Delta variant pitfalls

While the economic reopening and recovery appears to be on the horizon due to the rising number of inoculated people, as well as the government’s strategy of treating Covid-19 as endemic, there is still the possibility of further spikes in daily new Covid-19 cases and more aggressive variants.

Nevertheless, that is a possibility that Malaysia and the rest of the world may have to learn to live with. Many countries, especially in Europe, have reopened their economies despite the number of positive cases being in the tens of thousands a day.

MIDF Research seems to have an optimistic outlook for the constituents of the FBM KLCI. It has revised upwards the aggregate earnings forecast for FY2021 by 0.5% to RM66.1 billion and by 0.1% for FY2022 to RM60.5 billion.

The higher forward aggregate estimates were mainly contributed by upward earnings revisions in plantation and financial stocks while moderated mainly by downward earnings revisions in healthcare (glove) counters, the research firm says in the report.

Meanwhile, AmInvestment’s Ng maintains his end-2021 FBM KLCI target of 1,695 points, based on 16 times its 2021 earnings projection. This is at a discount to the index’s five-year historical average of 18 times.

The discount is to mitigate the distortion arising from earnings spikes from glove counters such as Top Glove Corp Bhd and Hartalega Holdings Bhd in 2021 due to the abnormally high average selling prices that are not recurring, and factor in a higher perceived market risk premium arising from a dynamic political landscape.

“We are optimistic that the world at large will enter into the late stage of the pandemic in the coming months, with more countries attaining herd immunity against Covid-19. A synchronised global recovery is almost a foregone conclusion, underpinned by the reopening of economies and international borders,” says Ng.

“While the highly contagious Delta variant has brought about new waves of infections around the globe, the hospitalisation rate has been kept under control as vaccinated Covid-19 patients typically develop mild symptoms. This alleviates the risk of a collapse of the healthcare system.”

In recent weeks, foreign funds have become net buyers on Bursa Malaysia after 18 consecutive months of net selling, snapping up net RM1 billion worth of stocks in August, according to CGS-CIMB in a monthly market strategy report issued last Thursday. For comparison, foreign investors sold a net RM1.34 billion in July.

The inflow of foreign funds into the Malaysian stock market sent the FBM KLCI 7.1% higher m-o-m in August, ending at 1,601 points. It was the strongest monthly gain since October 2011.

AmInvestment opines that the gains were driven by optimism among foreign investors that political concerns would subside following the appointment of a new prime minister in late August.

The rebound made the FBM KLCI the second-best-performing equity market among the MIST (Malaysia, Indonesia, Singapore and Thailand) markets in August, after the Stock Exchange of Thailand. The FBM KLCI also narrowed its losses to 1.6% y-o-y for the first eight months of 2021.

Will the influx of foreign funds in the local capital market continue towards the end of the year? For RHB Research Institute’s Chia, several factors will drive foreign investors to continue underweighting Malaysian stocks, including a stronger US dollar, the impact of environmental, social and governance (ESG) issues on Malaysian companies, as well as the attractiveness of other markets in the region such as Singapore and Indonesia.

“With the US dollar strengthening, if you are a dollar investor, would you want to invest in the ringgit, with the prospect that the dollar will continue to strengthen? ESG is also a big issue affecting many companies. For sectors that depend on foreign labour, there are big ESG issues that cannot be solved overnight,” he says.

Hot money flowing in

Chia points out that the higher foreign participation on Bursa Malaysia in recent weeks was due to the outflow of funds from China, which has been cracking down on its technology sector. The funds fleeing the Chinese tech market are searching for assets to buy, and some will trickle into Southeast Asian stock markets. The crackdown has cost investors more than US$1 trillion, according to The Economist.

However, Chia warns that the funds are hot money and can flow out as fast as it comes in. “In the current environment, even if foreign funds are coming back to Southeast Asia, I would argue that Malaysia would not be the main market. If I were managing a dollar fund, I would look at Indonesia because of its growing middle class, long-term need for improved infrastructure, stable politics and reforms with the passing of the omnibus law,” he says.

He adds that there are other issues that Malaysia must contend with, such as whether the country is at risk of a sovereign credit downgrade and what will the new government do to revive the ailing economy. “At this juncture, foreigners are still taking advantage of the bombed-out stocks and sectors that have underperformed. Enjoy it while it lasts. There is a lot of bottom fishing.”

CGS-CIMB says the FBM KLCI tends to perform negatively in September, with an average m-o-m loss of 1% over the past 10 years and loss of 0.8% m-o-m over the past 43 years. This month, investors will be tracking the outcome of the Monetary Policy Committee (MPC) meeting on Sept 9 and the tabling of the 12th Malaysia Plan on Sept 27, says the research house. They will also be looking at potential changes to government policy.

Also in focus will be the US Federal Open Market Committee’s meeting on Sept 21 and 22, the research outfit adds.

On the corporate side, investors will focus on fund flows to detect whether the recent net buying by foreign investors is sustainable. The ongoing 2Q results reporting season as well as plans to relax the restrictions of the current MCO and simplify the standard operating procedures will also be in focus.

The Covid-19 vaccination rate in Malaysia will be monitored by investors, as well as to what degree the Delta variant is affecting the number of daily new cases globally, and the rollout of vaccines.

Investors will also closely watch the political developments in Malaysia when parliament reconvenes on Sept 13, says CGS-CIMB. Issues that are likely to be in focus will be whether the vote of confidence for the new prime minister will be tabled and whether he will initiate a confidence and supply agreement with opposition parties to ensure political stability.

“The market rally could have been due to optimism over less political noise in the near term after the PM reached out to opposition leaders and given the continuity in policy from the previous administration. For the rally to sustain, we think investors would want to see evidence of a recovery in economic activities, higher vaccination rates in states facing higher daily new Covid-19 cases and more states moving to Phase 3 to 5 of the National Recovery Plan,” says the research firm.

CGS-CIMB maintains its FBM KLCI target of 1,604 points for 2021 and views that investors could position into recovery stocks.

Meanwhile, MIDF Research is more optimistic about the prospects of the FBM KLCI this year, with a year-end target of 1,700 points. It says that based on 10-year historical data, the benchmark index generally trades at a forward price-earnings ratio (PER) of between 14.5 times and 15.5 times.

As the research firm forecasts the FBM KLCI’s 2022 earnings at 109.7 points, the benchmark index is expected to range between 1,590 and 1,700 points this year. The FBM KLCI is currently trading at the lower end of the valuation range.

“While the number of Covid-19 infections and related death cases in Malaysia are still high, the tide may turn rather swiftly due to the progressively higher vaccination rate. On this score, the prospect of an MCO-free Malaysia in the final quarter of this year is not unlikely,” MIDF Research says in its Sept 2 report.

“Under this scenario, based on earlier experience [post-MCO 1.0], we can expect to see pent-up macro demand upon the economic reopening. A buoyant economic recovery in the final quarter of this year would help lend a further lift to equity market sentiment as well as valuations.”

CGS-CIMB’s top picks are Public Bank, with an “add” call and target price of RM4.80, Telekom Malaysia Bhd (TM) (“add”; TP: RM7.50) and Unisem (M) Bhd (“add”; TP: RM10.50).

Public Bank is the research firm’s top pick for Malaysian banks as it believes the bank is the most defensive against credit risks arising from the Covid-19 outbreak.

TM is CGS-CIMB’s top pick among Malaysian telcos for its robust core earnings per share (EPS) growth of 18%, 18% and 19% y-o-y for FY2021F, FY2022F and FY2023F respectively, driven by higher internet and data services revenue, as well as its cost containment measures.

Unisem is in a multi-year growth phase, driven by strategic portfolio expansion in radio frequency, power management and sensor products, says CGS-CIMB. “We project an FY2020 to FY2023F core net profit compound annual growth rate of 22%. The stock trades at an average 9% discount to the Malaysian semiconductor assembly and test sector’s CY2021 and CY2022F PER.”

AmInvestment Bank’s top picks are those that are likely to benefit from the  domestic and global economic recovery such as Malayan Banking Bhd, TNB, CIMB, TM, RHB Bank Bhd, Westports Holdings Bhd, Astro Malaysia Holdings Bhd,  ATA IMS Bhd, Hibiscus Petroleum Bhd and Perak Transit Bhd.


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