Strong market follow-through in 2010: The FBM KLCI gained 18.3% in the year to Nov 21, keeping pace with the recovery momentum after the index gained 45% in 2009. The index hit all-time highs of 1531.99 points on Nov 10, or 20.4% for the year to date.
Fourth best in Asia: At the point of writing, the FBM KLCI is set to be the fourth best performer among major indices in Asia this year, measured in both, local currency and the US dollar. The FBM KLCI trailed the Jakarta Composite Index, Philippines Composite and Thailand’s SET. It is apparent that the “TIPs” markets are the Asian darlings of investors this year as investors are concerned over the “bubbles” in China.
Several factors defined the market’s performance in 2010
• The price of crude oil retraced by more than 10% on three separate occasions this year. This happened in January/February, May and August. In the process it depressed the equity market.
• The Greece debt crisis almost derailed the global equity market recovery in the second quarter. The Ireland saga is practically a replay of the Greece episode.
• The dollar has been in a secular downtrend. This was probably the single most important factor driving funds into Asian equity.
• There was a surge of foreign fund into Asian equities in 4Q10.
Property led in 2010: The property sector was the best performer in 2010 thus far, with the sub-index having climbed 27.5%. Five sectors rose more than 20% this year; namely Property, Finance, Construction, Consumers and Plantations.
The TMT sector set to be the worst performer in 2010: The Telecom & Technology Index rose by only 4.9%, the worst performer in 2010 (until Nov 21). It was the star performer in 1Q10, but the sector gave back most of the gains in 2Q10 and 3Q10. It remained a laggard in 4Q10. The other two underperforming sectors were Industrial and Services/Trading.
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Underperformers: KNM remained the worst performer among the stocks under our coverage with a loss of 43% year to date. Of our top 10 stock picks for 2010 which came out in our annual outlook in December 2009, only two stocks had underperformed the FBM KLCI, namely Pelikan Bhd and Century Logistics Bhd. Both are small-cap stocks.
ii. Macroeconomics: Performance and outlook
• We are upgrading our GDP growth estimate for 2010 slightly to 7.2% from 7.0% previously led by the strong 1H10 performance. Recovery in global trade and a broad-based increase in domestic demand saw a strong economic rebound with 1HCY10 averaging at 9.5% (-5.1% in 1HCY09). With the growth trajectory normalising in 2H10 as the base effects wears out and slower external demand, we estimate the economy would expand by 5% during this period. This would mean 4Q10 would decelerate to 4.8% from 5.3% in 3Q10.
• For 2011, we have downgraded the GDP growth to 5.3% from our previous projection of 5.8%, which is still within the official estimates of 5%-6%. We have penned out a conservative view driven by the less favourable base effects, unwinding of policy stimulus, and more subdued growth in several major export markets. Despite lowering 2011 growth, we believe the economy will not fall into a “technical recession”. Drivers of economic growth that could put a lid on the downside risk will be private expenditure, i.e. private consumption and fixed investment. We expect private expenditure to expand favourably supported by the strengthening labour market and the output gap that is reducing. Public consumption will remain subdued following the move to fiscal consolidation.
• Recent rate hikes showed Bank Negara Malaysia’s (BNM) ability and flexibility to vary its monetary policy. With a cumulative of 75 basis points (bps) increase from the three 25bps hikes in 2010, the policy rate is now close to our neutral level of 3.5%. We reiterate our view that the Overnight Policy Rate (OPR) will stay at 2.75% in 2010. Looking ahead into 2011, with BNM having the ability and flexibility to raise OPR, we expect the policy rate to increase by 50bps-75bps in 2H11, and less likely in 1H11 in order not to dampen the slower economic growth. Nonetheless, the possibility for BNM to raise rates in 1H11 will take place if BNM decides to weigh on inflation as opposed to growth.
• Exports growth is projected to moderate over the rest of 2010 and into 2011 due to (1) less supportive external environment; (2) completion of inventory buildups in industrial economies; and (3) lower prices of some commodities. Meanwhile, import growth is expected to remain robust due to the buoyant domestic demand. The narrowing trade surplus is expected to be reinforced by a further deterioration in the income balance from the increased outflows of profits and dividend payments. But this narrowing will be partly offset by an improvement in the services account, when the inbound tourism picks up. We forecast the current account surplus would edge down to 13.1% of GDP in 2010 and 12% in 2011. On that note, we reiterate our 2010 and 2011 RM/US$ forecast of 3.10 and 3.00, respectively.
iii. Corporate earnings
• Good earnings in 2010. The latest concluded earnings season was largely within our expectation. In all, 43% of the stocks under our coverage reported earnings that were in line with our expectation versus 27% outperformers. We maintained our forecast earnings for 78% of the stocks under our coverage, upgraded 10% and downgraded 12%. The best earnings performance was registered by the automotive, consumer and property sectors.
• Earnings prospect for 2011 is still healthy despite external uncertainties. The economy is expected to stay healthy and that bodes well for corporate earnings. Superior earnings prospect can be found in the traditional key sectors. These are:
i. Banks: Earnings for the banking sector are estimated to grow by 12% in FY11, on the back of better net interest margins, expansion in fee-based income and improving contributions from overseas ventures. The OPR is expected to rise again in 2H11 that would provide further upside to the banks’ earnings potential. Improving asset quality will keep provisions under control.
ii. Construction: The 10MP and the ETP would provide the earnings impetus going forward with increasing expectation of more jobs to be announced in 2011. Furthermore, we expect construction margins to improve as material costs stabilise. Our construction sector earnings are estimated to grow at an average of 25% next year.
iii. Oil & Gas: One of the key sectors under the ETP and is the direct beneficiary of Petronas’ ongoing quest to expand its oil & gas reserves. As such, FY11 is on track to become a very good year for O&G companies where earnings outlook is very promising, underpinned by (i) more deepwater E&P activities. (ii) enhanced oil recovery (EOR) to rejuvenate matured fields and (iii) development of small fields. As such, we are looking at a potentially strong earnings growth of more than 20% in FY11.
iv. Plantation: We are anticipating a good FY11 for the plantation sector due to (i) stronger demand growth of 8% from China and 10% from India, outpacing the growth in production of 5%, (ii) higher average CPO price of RM3,000/MT, and (iii) improving yield. On average, we estimate the sector could see products growing more than 15% next year.
• A mild adjustment of our 2011 earnings forecast. There were slight adjustments made to some of our forecasts that resulted in a mildly higher FY10 forecast of 14.7% from 14.1% previously. While our earnings outlook for 2011 is slightly improved to 15.9% from 15.2%.
iv. Market valuation and stock selection
• We are setting a 12-month base-case FBM KLCI target of 1,650 points for 2011. The index can easily overshoot the target in a liquidity-driven market. The 1,650 is based on 18.0x FY11 core earnings, at 15.8% earnings growth. This is slightly higher than the five-year average at the upper end of the PER band of 17x. At the Nov 21 index of 1,506 points, the FBM KLCI traded at 15.8x based on Bloomberg’s consensus and 16.1x based on MIDF’s forecast. In comparison, the MIDF Research’s stock universe traded at 16.7x on the same day.
• The 1,650 FBM KLCI target is not significiantly at odds with the bottom-up valuation of 1,680 that we have derived based on a set of target prices for each of the KLCI component stocks. Based on the FBM KLCI’s close of 1,506.1 on Nov 21, the target of 1,650 represents a 9.6% upside, while the bottom-up target of 1,680 reflects a gain of 11.5%. This is in line with the 10-year average (2001-2010) return of the KLCI of 10.9%, assuming the index ended 2010 at 1,500 points. (If the FBM KLCI closed 2010 at 1,500 points, it will register a gain of 17.9% for the year).
• The prospects for the KLCI are good moving into 2011. Foreign liquidity should continue to be attracted to Malaysia. In October, FTSE reclassified Malaysia as an “Advanced Emerging Market” to take effect in June 2011. This is expected to attract foreign funds tracking FTSE indices (estimated to be more than US$3 trillion or RM9.5 trillion). Malaysia will be one of only nine countries to be in the category. Only four Asian countries are in the developed bracket (HK, Japan, Singapore, Korea) out of 25.
• It is true that foreign shareholding in companies listed on Bursa Malaysia has been on an uptrend. From 20.4% at the beginning of the year, the percentage shareholding rose to 21.7% at the end of September. However, from a longer-term perspective, this percentage is still relatively low. At the end of 2007, foreign shareholding was 26.2%. As long as Malaysia continues to make the right moves such as climbing up the FTSE classification ladder, foreign funds show be flowing in. For comparison, the proportion of companies listed in the UK, a developed market, owned by foreign shareholders reached a record 41.5% in 2008, according to the Office for National Statistics. The percentage had risen nearly fourfold in 20 years.
• What we can surmise from the flow data is that a sizeable amount of foreign funds have moved into Asian equity in 2010 and most are staying put despite the occasional scare such as the skirmish in Korea. We track the “flow of foreign funds into the equities of six Asian markets (whose stock market authorities make the data available on a daily basis). The six (Korea, Taiwan, India, Thailand, Indonesia and the Philippines) make a good proxy for the rest of East Asian markets. An estimated US$70.3 billion fled the markets in the crisis year of 2008. An estimated US$60.6 billion was drawn back to the “Asian 6” equity in 2009. For the year to Nov 22, data from the respective exchanges show that a total of US$57.1 billion of foreign funds were drawn to the “Asian 6” equity.
• Most importantly, Asian emerging markets (as represented by the TIPs countries + India) are seen as more attractive compared to the developed markets (as represented by Taiwan and Korea). That being the trend, Malaysia should enjoy some spillover effects even if it might not be on the radar screens of many global investors.
Three factors that may draw foreign funds into Malaysia in 2011 are:
• State and general elections. Stocks tend to perform well in an election year and global investors are cognisant of this.
• Commodity rally. Should crude oil price make a gradual rise to the US$100pb-US$110pb range, commodities will rally again, as evident recently. Malaysia offers good plantation stocks that global investors cannot afford to ignore. Likewise, Malaysian oil and gas stocks should make an impression on the investors.
• Continued strength of the ringgit. The ringgit was one of the best-performing currencies in Asia this year, and we expect the currency to have another good year in 2011. In the first nine months of 2010, a total of RM27.4 billion worth of MGS and Treasury bills were bought by foreigners. There was a bit of a seasonal selldown towards the end of the year as some investors dollarise their positions, but we expect the buying to resume in January.
• Otherwise, Malaysia is not really out of sync with regional peers from valuation perspective. Bloomberg data suggests that the Indian and Indonesian markets are trading at richer earnings multiples compared with Malaysia.
• The climb towards our 1,650 objective would be met with surmountable obstacles. Once met, we would strongly advise investors to reduce their equity exposure. It’s the summit and we know what’s on the other side. Once the US starts raising its interest rates, the game will be over.
MIDF stock selection: Our choice of top stock picks for 2011 generally reflects our positive view of the sectors. Most of the selections are key companies in the plantation, oil and gas, banking, construction and telecommunication sectors. There are stocks from the neutral-view sectors, but these were selected mainly for the stock-specific considerations.
This article appeared in The Edge Financial Daily, December 2, 2010.
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