Apr 2, 2010

BURSA MALAYSIA`EQUITY IS NOT CHEAP BUT....

FBM KLCI TARGET 1,390 PT

Equity not cheap but better than cash return
We view that the worst is over for the global economy but opine that the impending recovery is not without its risks albeit ones that are manageable at this point. At home, the Malaysian equity market may get a leg up from stronger than expected earnings growth momentum as well as further OPR hikes as BNM undertakes the process of normalising interest rates. This action, we believe, will lend support to the MYR. Our end-2010 FBM-KLCI target remains at 1,390, which is derived using a 15x P/E target on CY11 earnings.

With the current FBMKLCI at 1,320.57, this implies an  upside of only 5.3%. Nevertheless, Malaysian equities remain decently attractive as compared to holding cash which has very low real return. While we continue to like banking, property, oil & gas, power and consumer sectors for recovery play, we also advocate lowering the beta of portfolio with defensive dividend stocks.
• The worst seems to be over for global economy
Global economy continues its path towards recovery though the pace of recovery varies quite widely. Asia ex-Japan economies performed remarkably better than the advanced economies. Despite the encouraging set of numbers in 4Q09, we continue to take a cautious view of the pace of global economic recovery. US and the Eurozone, which account for 46% of global economic output, are still grappling with high unemployment rates and that will limit consumption growth in the near term.

• Recovery is not without risks but manageable for now
 
Although global equity markets have bottomed out in March 2009 and have since bounced back strongly on the back of improving GDP numbers in succeeding quarters, the road has not been a straight forward one. Investors are still wary of any external shocks which may derail recovery and send the fragile global economy into a double dip. Recently, there has also been much concern over (1) sovereign debt crisis in Europe, (2) sooner than expected monetary tightening, and (3) protectionism arising from currency stand-off between China and US. However, we believe these risks are currently being managed.

• Equity valuation not cheap but better than cash return

Valuation wise, Malaysian equities are not cheap vis-à-vis regional peers. At P/E of 14.0x based on CY11 consensus earnings, valuation is just a shade lower than China 15.2x but more expensive than Indonesia 11.9x. However, EPS growth wise, Malaysia lags behind these two economies at 14.0% vs. 22% in Indonesia and 19.2% in China. Although there is no compelling reasons why investors should remain invested in the equity market, there is no alternative out there. Real return from holding cash is very low despite OPR hike as the system is flushed with liquidity.

• Earnings growth momentum may be underestimated

While valuation of Malaysian equities is not compelling, earnings growth momentum could be underestimated. Leading the earnings growth momentum are the banking stocks which have weathered the global financial crisis largely unscathed. If corporate earnings continue to remain strong and surprise on the upside, Malaysian equities will see some renewed interest in the months ahead.

• OPR normalisation and strengthening Ringgit

The Malaysian equity market may also get a leg up from further OPR hikes as BNM undertake the process of normalising interest rate. This action will lend support to the MYR. Being relatively defensive, the Malaysian market, including equities, may be a good proxy play for strengthening Asian currencies against the G3 currencies.

• Stay invested but reduce beta
Our end-2010 FBM-KLCI target remains unchanged at 1,390, which is derived using a 15x P/E target on CY11 earnings. With the current FBMKLCI at 1,320.57, this implies an upside of only 5.3%. Nevertheless, Malaysian equities remain decently attractive as compared to holding cash. While we continue to like banking, property, oil & gas, power and consumer sectors for recovery play, we also advocate lowering the beta of portfolio with defensive dividend stocks.
malaysia-sector-socks

Recovery is not without risks but manageable for now
Although global equity markets have bottomed out in March 2009 and have since bounced back strongly on the back of improving GDP numbers in succeeding quarters, the road has not been a straight forward one. Investors are still wary of any external shocks which may derail recovery and send the fragile global economy into a double dip. The Dubai debt crisis was one which turned out to be nothing but some “noises” on the path towards recovery. 

Recently, there has also been much concern over (1) sovereign debt crisis in Europe, (2) sooner than expected monetary tightening, and (3) protectionism arising from currency stand-off between China and US. Are these noises or should investors be genuinely concerned?

The sovereign debt crisis in Europe is a reflection of excessive government spendings in yesteryears. In the centre of this crisis are the PIIGS economies i.e. Portugal, Italy, Ireland, Greece and Spain which are experiencing (1) high public debt, (2) high budget deficit, and (3) high unemployment rate. Such over-leverage public financial position and chronic economic situation has resulted in fears that governments may default on sovereign debts, triggering the sharp rise in yields as well as widening credit default swaps (CDS) premium on these sovereign debts. Greece is pretty much the focus among these economies right now as its budget deficit of 12.7% to the GDP is almost 4 times higher that allowed by Eurozone rules. 

Equity valuation not cheap but better than cash return
After taking stock of the global economy and risk factors, what then is in store for the equity market going forward? Certainly, after a strong market rebound in 2009, when the benchmark FBMKLCI rose 45.2%, all the easy money has been made. YTD, the Malaysian market continued to lag regional peers as it posted gains of 3.8% as compared to Indonesia’s 9.6%. Valuation wise, Malaysian equities are not cheap vis-à-vis regional peers. At P/E of 14.0x based on CY11 consensus earnings, valuation is just a shade lower than China 15.2x but more expensive than Indonesia 11.9x. However, EPS growth wise, Malaysia lags behind these two economies at 14.0% vs 22% in Indonesia and 19.2% in China. On dividend yield, Malaysia is just about average, ranking the 7 highest at 3.2% among 13 selected Asian economies.

It is then not surprising to see declining foreign participation in Malaysian equity market. Foreigners only made up 27% of transactions on Bursa Malaysia in 2009, the lowest in 6 years. Foreign ownership of Malaysian equities have also fallen over last 18 months or so and stood at 20.4% as of Dec 2009. On the flip side, we could argue that Malaysian equities should be more defensive now as there is less selling pressure by foreigners now.

Monetary tightening in G3 economies is unlikely in the near term         Stand-off between China and US will have serious repercussions by believe common sense will prevail            Malaysian equities are not cheap and do not have the strongest earnings growth         Foreign participation has declined which may be a blessing in disguis
With no compelling reasons why one should be in the equity market, should we then follow the widely propagated axiom of “sell in May and go away”? Perhaps. But what are the alternatives? Real return on cash is very low now at 0.7% based on average 3-month FD rate. Although interest rates are rising on expectation of further 25-50 bps OPR hikes in the coming months, we want to highlight that BNM is merely normalising interest rate to prevent financial imbalances. We do not expect BNM to adopt a growth restrictive monetary policy and as such, scope for further interest rate increase may be limited. Furthermore, the system is currently flushed with liquidity as can be seen by the double digits y-o-y expansion in the narrow money supply M1.
Earnings growth momentum may be underestimated
While the P/E valuation of Malaysian equities is not compelling, earnings growth momentum could be underestimated. Over the past few quarters, we have noticed considerable improvement in corporate earnings as fewer companies failed to meet analysts’ earnings expectation while earnings revision ratio continues to be on an uptrend after bottoming out in 4Q08. Leading the earnings growth momentum are the banking stocks which have weathered the global financial crisis largely unscathed. Credit cost remains manageable and on the downtrend while strong loans growth from the household sector underpin earnings growth. Going forward, further OPR hikes is expected to be earnings accretive while a return of capital market transactions willl boost fee-based income.

If corporate earnings continue to remain strong and surprise on the upside, Malaysian equities will see some renewed interest in the months ahead.
We are positive on Malaysian companies which derive income mainly from domestic or regional sources but have USD, EUR and/or JPY denominated liabilities or costs. Some of these companies include Tenaga, AirAsia, MAS and UMW.

However, we are negative on Malaysian companies which derive income denominated in USD, EUR and/or JPY but have MYR denominated liabilities or cost. Some of these companies include Topglove, Kossan, Hartalega, Supermax etc. 

Certain companies which have overseas operations in US, Europe and/or Japan may benefit from natural hedge if borrowings are sourced domestically in the country of operation. Nevertheless, consolidated accounting earnings will still be impacted by weaker foreign currencies. Companies which fall into this category include YTL Power, Pelikan KNM etc.

Our recommendations
To sum it up, we do not see significant upside in the equity market from current levels, in particular the big-caps which make up the FBM-KLCI benchmark index. Our end-2010 FBM-KLCI target remains unchanged at 1,390, which is derived using a 15x P/E target on CY11 earnings. With the current FBMKLCI at 1,320.57, this implies an upside of only 5.3%.

While our base case scenario does not think that risks from external shocks will be significant, we cannot rule out the possibility of a market sell down driven by (1) failure of Eurozone governments in preventing member nations’ from debt default, (2) tightening of monetary policy, and (3) escalation of stand-off between China and US on differing views on the CNY valuation.

Barring any external shocks, the alternative of holding cash is not appealing due to very low real returns. As such, we recommend investors to stay invested to capitalise on potentially greater than expected earnings growth momentum, especially from the banking sector. Furthermore, the normalisation of interest rate by BNM will lend support to MYR, and as such, Malaysian equities may be a good proxy to ride the strength of Asian currencies.

There are no changes to our sector calls other than the downgrading of the gaming sector from OVERWEIGHT to NEUTRAL as valuations of the larger capitalised Genting and Genting Malaysia are fair and has limited upside going forward. We continue to like banking, property, oil & gas, power and consumer sectors for recovery play.
On stock picks, we prefer Maybank, CIMB, Public Bank and Tenaga to ride the earnings growth momentum. Mid- and small-cap growth stocks include Wah Seong and Sunrise. To lower the beta of our suggested portfolio, we have included DiGi, YTL Power and Berjaya Sports Toto for defensive dividend play.

source: ECMLibra Investment Research