A dull SEASON
10 Jun 2019
Source: The Edge
The US-China trade war has been drag on global financial markets and if investors were hoping that corporate earnings for the latest financial quarter would provide a surprise boost to the local bourse, they were disappointed.Barely half of the 883 firms on Bursa Malaysia reported higher earnings" "b§3» while profit growth at the big companies was generally tepid.
We ith the global economy on shakyground,a situation exacerbated by escalating trade tensions be-tween the US and China, weak commodity prices and a ruling government that is just a year old, it is not surprising that the earnings of Malaysian companies barely improved in the recently concluded results reporting season.
According to Bloomberg data, of the 883companies listed on the Main and ACE Mar-kets of Bursa Malaysia that reported their lat-est quarterly results, only 440 recorded a year-on-year improvement in their bottom lines.Still, this is slightly better than in the first quarter of 2018, when only 397 of 872 Malay-sian companies recorded better earnings
"1Q2019 earnings were fairly subdued with few surprises. Although more companies re-ported an improvement in their earnings than in 1Q2018, the market had already factored in a weaker corporate performance leading up to the reporting season.Thus, a glass half empty situation," Fortress Capital Asset Man-agement (M) Sdn Bhd investment adviser anddirector Geoffrey Ng tells The Edge
Fourteen or almost half the FBM KLCIcompanies, including Axiata Group Bhd,AMMB Holdings Bhd,MISC Bhd,Sime Dar-by Bhd and Petronas Dagangan Bhd, posted better quarterly earnings. However, this was less than the 19 that had recorded improved earnings last year.
Sector-wise, those that recorded notable improvements in 1Q2019 were automotive,energy and consumer. As for the banks, only three of the eight domestic banking groupsreported higher earnings (see "Subdued 1Q for banks points to tougher times ahead").
Conversely, sectors that under per for medduring the quarter were steel, plantation andtechnology.
Five of the six automotive manufactur-ers listed on Bursa reported an increasein their quarterly earnings with stellar performance by DRB-Hicom Bhd and Tan Chong Motor Holdings Bhd
DRB-Hicom returned to the black with a net profit of RM127.86 millio in its fourth quarter ended March 31,2019, reversing from a net loss of RM59.4 million a year ago, thanksto higher sales volume, particularly of Pro-ton's X70 SUV
Tan Chong, which distributes the Nissan marque, saw its net profit surge to RM15.98million in its first financial quarter ended March 31,2019, from RM4.25 million in the previous corresponding period due to a bet-ter product mix of new models that were launched in Malaysia and abroad.
In contrast, lower sales and weaker mar-gins saw Mercedes-Benz distributor Cycle Carriage Bintang Bhd report a wider net loss of RM4.36 million in 1QFY2019, compared with RM3.19 million in 1QFY2018.
In its market strategy note, Kenanga Re-search says motor vehicle sales volume for 2Q2019 is expected to be stronger than in the first quarter due to the Hari Raya promotions and better financing rates as banks have cut their base lending rates by 20 to 25 basis points.
The research firm maintained its "neutral" rating of the automotive sector and recommended an "outperform" on Tan Chong with a target price of RM2.15 — an upside of 42% from the counter's closing price of RM1.51 last Friday.
Crude oil prices improved 28% in the firstquarter of the year to US$68 per barrel from US$53 at the end of last year. Not surpris-ingly, the majority of the oil and gas service providers liste d on Bursa reporte betterquarterly earnings.
Sapura Energy Bhd reported a net profitof RM500.4 million in its fourth financial quarter ended Jan 31,2019, turning around from a net loss of RM2.29 billion a year ago,thanks to a gain on disposal as well as lower provisions for impairment.
Meanwhile, Dialog Group Bhd's net profit for its third financial quarter ended March 31, 2019, surged 20.9% to RM143.7 million on cost saving s realised from completed projects and an increased share of profits from joint ventures and associates.
Floating production, storage and offload-ing player Bumi Armada Bhd saw a 28.5% im-provement in its net profit for its first quar-ter ended March 31,2019, to RM62.21 million because of lower impairment losses booked during the quarter.
Amlnvestment Bank says it is "neutral" on the sector, given the likely continued volatilityof oil prices in the next six months, lingering balance sheet risks of Malaysian operators,the unresolved US-China trade dispute, de-teriorating global economic growth outlook and easing of US pipeline constraints.
"Our top picks are still companies with stable and recurring earnings, such as Serba Dinamik Holdings Bhd and Dialog Group. We like their recurring income busines model that involves operation and maintenanc eservices. Dialog's earnings visibility is further secured by the Pengerang Deepwater Termi-nal project with its enlarged buffer zone," itsays in a recent report.
It has been a good year for manufacturer of food and beverages, thus far. Wheat miller Ma-layan Flour Mills Bhd saw a more than tenfold increase in its net profit for the quarter ended March 31,2019,to RM19.87 million on a higher operating profit in its flour and grain segment.
Egg producers were not too shabby either.Teo Seng Capital Bhd saw its net profit for its first quarter ended March 31,2019, more than triple to RM22.09 million as poultry farming revenue rose primarily on stable egg prices and improved production efficiency. Similarly,LTKM Bhd saw its net profit spike to RM5.49million in its fourth financial quarter endedMarch 31,2019, from RM1.78 million a yearago due to improved egg prices.
Brewers Heineken Malaysia Bhd and Carls-berg Brewery Malaysia Bhd both recorded higher earnings. Heineken attributed its 8.3% improvement in its first quarter netprofit to RM52.8 million to a successful fes-tive season campaign and increased sales in priority channels while Carlsberg said its 8.4% increase in net profit to RM87.6 million was because of higher sales during Chinese New Year in both Malaysia and Singapore.
Cocoa grinder Guan Chong Bhd got off to a good start this year with its net profit for its first quarter ended March 31,2019, skyroclc-eting 35% year on year to RM53.14 million on improved margins.
Beverage maker Power Root Bhd returnedto the black with a net profit of RM4.96 mil-lion, compared with a net loss of RM9.9 mil-lion, in its latest quarterly results, thanks to a favourable sales mix, while Fraser NeaveHoldings Bhd saw a 12.8% increase in its net profit to RM104.4 million in its second quar-ter ended March 31,2019, driven by a strongperformance at its Thailand unit.
Crude palm oil (CPO) prices, crucial for theplantation sector, faltered from RM2,390 pertonne in June last year to RM2,14 per tonne in March this year. This took a toll on the plantation counters with giants IOI CorpBhd, Sime Darby Plantation Bhd and Gen-ting Plantation Bhd reporting a decline inth£«r earnings
IOI's net profit for the third quarter ended March 31,2019, tumbled 88.12% to RM245.8million due to foreign exchange losses and lower plantation earnings as a result of low-er CPO prices.
Sime Darby Plantation saw its net profit for its third quarter ended March 31,2019, fall 70.3% to RM74 million due to a sharp fall in CPO and palm kernel prices, as well as higher finance costs.
This was also the fate of Genting Planta-tions, which saw its net profit for the firstquarter ended March 31,2019, fall to RM41.68million from RM100.98 million a year ago,dragged by lower palm product selling prices.
Kenanga Research says it expects CPO pricesto remain under pressure in the second half of the year, potentially trading in a range of RM1,800 to RM2,100 per tonne, and averaging RM2,000 per tonne this year.The firm has an"underweight" call on the plantation sector.
It was not a good start to the year for steel players with the majority of them reportinga decline in earnings.
Lion Industries Corp Bhd slipped into the red in its third quarter ended March 31,2019, with a net loss of RM72.2 million com-pared with a net profit of RM60.7 million a year ago due to lower revenue as a result of lower steel prices.
Ann Joo Resources Bhd suffered the samefate in its first quarter of the year, incurring a net loss of RM6.6 million compared witha net profit of RM61.44 million a year ago.
This sector, which is highly sensitive to de-velopments in the US-China trade war, saw some big names report a decline in earnings in their latest financial quarter.
Inari Amertron Bhd, for example, saw itsnet profit for its third financial quarter end-ed March 31,2019, fall 31% to RM38.19 mil-lion due to lower volume loading on a majorsensor product.
Meanwhile, KESM Industries Bhd saw its net profit decline 84% to RM870,000 in its third financial quarter ended April 30,2019,on lower revenue and an increase in raw ma-terials and consumables used.
Kenanga Research says lacklustre smart-phone and vehicle sales in China and the EU will continue to depress the near-term pros-pects for th e sector. The firm has a "neutral"call on the sector.
Subdued iQ for banks points to tougher times ahead
The subdued first-quarter earn-ings of Malaysian banks portenda trend of weakening profitability,analysts say.
As difficult as it was for lenders to grow core earnings in 1Q2019, it will be even tougher to do so in the remaining quarters of the year,given uncertainties from deteriorating US-China relations and last month's cut in the overnight policy rate (OPR) by Bank Negara Ma-laysia as well as competitive funding costs, which will further weigh on mar-gins. Weaker capital markets may also lead to softer non-interest incomes for banks.
"We believe banks operating in theMalaysian market will see visible mar-gin compression, accompanied by slower loan growth and higher non interest in-come volatility for the rest of 2019. Asset quality will likely hold, despite down ward pressure," S P G Global ratings says in a May 31 report
The January-to-March period saw all eight domestic banking groups, except Alliance Bank Malaysia Bhd, register a year-on-year decline in net interest in (NIM), an indicator of profitability.
Alliance Bank saw a seven-basis point(bp) increase in NIM to 2.57%, the high-est margin among the eight banking groups, thanks to its strong focus on higher risk-adjusted return loans such as personal and enterprise loans.
Affin Bank Bhd experienced the big-gest dip in margin (-37 bps to 1.61%),followed by AMMB Holdings Sdn Bhd (-26 bps to 1.78%)
NIMs fell mainly because of highe rfunding costs, fuelled by stronger accu-mulation of fixed deposits and weaker current account and savings account deposits. It should also be noted tha tthere was a 25 bps hike in the OPR inthe same quarter a year ago.
On a quarter-on-quarter basis, five of the eight banks saw a decline in NIM.The only three that saw improvement were CIMB Group Holdings Bhd (three bps to 2.48%), Public Bank Bhd (one bp to 2.19%)and Alliance Bank (one bp to 2.57%).
"However, these improvements are either unsustainable or masked by their overseas operations' NIM recovery (in the case of Indonesia for CIMB)," opinesS P Global. S P Global tracks the five big banks, namely Malayan BankingBhd (Maybank), CIMB, Public Bank, RHB Bank Bhd and AMMB.
Given Bank Negara's 25 bps cut in the OPR last month, there will continue to be downside pressure on NIM.
"[The cut] means there will be further downs id ahead until end-2019, of whichwe typically assume a six-to-nine-month lag for the repricing of these banks' as-sets and liabilities. Continuous tight li-quidity in the market — amid persistent deposit competition — clearly does not help and is increasing the cost of fund-ing. Heightened capital market volatility amid escalating trade tensions between the US and Chin — while not a risk fac-tor unique to Malaysia — is dampening the outlook for local banks' non-interest revenues," says S P Global credit analyst Nancy Duan.
"All these factors contribute to our negative view on Malaysian banks' prof-itability trend this year — especially when we believe there is limited roomfor further cost-cutting. All in all, weare likely to see a disappointing 2019 interms of bottom-line earnings."
Loans are not growing as robustly either. Bank Negara's latest monthly banking data shows that the industry'sloan growth eased in April for the fourth consecutive month, to 4.5% y-oy from 4.9% in March.
However, given that there was posi-tive growth that month in loan applica-tions and approvals, there is optimismthat things could pick up in 2Q and 3Q.Hence, analysts are sticking to their full-year loan growth projections of about5% for the year.
Meanwhile, all eyes will continue to beon banks' asset quality, which has stayed resilient so far despite the pressures.The industry's gross impaired loan (GIL) ra-tio stood at 1.51% as at end-April, having inched up five bps from end-March.
Affin Bank's asset quality, in particu-lar, will be watched. Its GIL ratio inched up six bps q-oq to 3.31%, far higher tha n the industry average, partly due to two problematic accounts.The bank has told analysts that it expects to resolve the two accounts — one in the oil and gas sector and the other in property — by year end.
Most of the banks reported subdued first-quarter core earnings, albeit with in analysts' consensus forecasts.
BIMB Holdings Bhd, which owns Bank Islam Malaysia Bhd, was the only financial institution tha t surpassed expectations. Its 1QFY2019 net profit stood at RM202.5 million, up 17.6% y-oy and 25.5% q-o-q,boosted by strong takaful income,net financing income and benign loan loss provisions (LLPs).
Maybank Investment Bank Research deems the banking sector to have per-formed below expectations in the first quarter. The total core net profit of the banks under its coverage fell 0.9% y-o-yand 7.3% q-o-q.
"We put the banks through quite afair bit of earnings downgrades," it saysin a June 4 report. It now expects banks'core earnings to grow a smaller 3.8% this year compared with earlier expectations of 6.1%. Last year, earnings grew 7.1%.
Maybank's 1QFY2019 net profit, at RM1.81 billion — down 3.3% y-oy and 22.2% q-oq — came in below expecta-tions, making up just 22% ofconsensus estimates for the full year.
This was mainly because of highe rLLPs due to a top-up in provisioning for its exposure to financially distressed Singapore water treatment firm Hyflux.The bank also reported lower net interestand non-interest incomes.
"The bank did not disclose the quan-t um of the additional provision for Hy-flux, but we think that this could form the bulk of the total provision of RM596.4 million for its group corporate banking and global markets in 1Q2019," says CIMB-CGS Research.
T he research house notes that Maybank is, nevertheless, sticking to its guidance of a credit charge-off rate of 40 bps for FY2019, despite the 48 bpsin 1QFY2019, suggesting that the bank is expecting lower average LLP per quarterin the next three quarters.
Maybank's exposure to Hyflux stand sat about S$602.4 million (RM1.83 billion),which it is working to recover.
"We understand that Maybank is work-ing with all the parties involved for the recovery of the amount owed by Hyflux.However, the bank has not given any indication of the expected completion timeline for the process nor the possi-ble outcome," says CIMB-CGS Research.
Maybank has guided for a potential negative impact of one bp on its NIM this year from the OPR cut. RHB Bank ismaintaining its return on equity target of 10.5% for the year, but has guided an-alysts that it expects a further five bps compression in NIM, from an earlier guidance of three to five bps
Most analysts continue to have a "neu-tral" call on the banking sector.
"We continue to rate Malaysian banksat 'neutral', given the concerns over mar-gin erosion and an expected uptick incredit costs.On a positive note,the sector's dividend yield is attractive at a projected 4% for 2019," says CIMB-CGS Research.
The stocks with the most "buy" callsby analysts currently include RHB, CIMB,Alliance Bank and Maybank. The Finan-cial Services Index on Bursa Malaysia hasshed 2.7% year to date, similar to the fall in the key benchmark index FBM KLCI as at last Thursday.
The trade war and corporate earnings conundrum
Just last week, Morgan Stanley said that a recession could begin as soon as nine months' time if US Presi-dent Donald Trump pushes to im-pose a 25% tariff on an additional US$300 billion of Chinese exports, and if China retaliates with its own coun-termeasures.
This does not bode well for Malaysian corporations, some of which have already experience a deterioration in earnings as a result of the Sino-US conflict.
Despite a recent report by Japanese bank Nomura that Malaysia has been identified as the fourth biggest benefi-ciary of trade diversion after Vietnam,Taiwan and Chile, Finance Minister Lim Guan Eng said Malaysia wants the trade war to end.
"Malaysia hopes that the trade war will end because, eventually, there will be no winners, only losers. All partiesshould instead enhance cooperation at the regional and global levels to allow the global economy to grow sustainably," he said in a statement on Friday.
"The ongoing trade war and its effect of slowing global trade has certainly im-pacted the export sectors — mainly intechnology, the electrical and electronicsexports, oil and gas, plantations and alsologistics," Fortress Capital Asset Manage-ment (M) Sdn Bhd investment adviserand director Geoffrey Ng tells The Edge.
Thus, he does not see the earnings of corporations that have been impact-ed by the trade conflict improving an-ytime soon.
"With limited visibility of a resolutionto what looks like a worsening trade ne-gotiation, we expect the next couple of enquarters to reflect even more subdued corporate earnings from sectors that are dependent on such trade flows for primary and intermediate products and services from China.
"That said, we are also on the look-out for companies and sectors that may benefit from the medium-to-longer term adjustment of supply-chain activity fromChina," Ng adds.
Optimistic about a better 2H?
With the performance of stocks depend-ing on corporate earnings, among others,foreign selling on the local bourse thusfar is indicative of the expectations of companies' performance.
In its 1Q2019 results review note,Kenanga Research says that year to date(up to March 2019), total foreign out flow of RM1.36 billion is a tell tale sign of the softer confidence in the local market.
"Still, we are optimistic about a better second half of 2019, with our strategists'view that the weakness in sentiment could be nearing its end.
"This is premised on the potential bottoming of local benchmark indices,potentially backed by healthy and sus-tainable oil prices. On another note, the introduction of the T+2 settlement cycle for the securities market could lead to arise in transaction volumes, and hence,trading participation," the firm says.
It is worth noting that HSBC Global Research recently upgraded its rating on Malaysia to "neutral" from "underweight".
"MSCI Malaysia was among the worst-performing markets in Aseanyearto date, down 5.9%. However, we think the economy looks resilient , with domes-tic demand strong and manufacturing growth holding up.
"Low earnings growth is a concern but we see limited further downside. Valua-tions, while not as attractive as in other markets in the region, are not particu-larly expensive. The market has strongdefensive qualities, which should reduce downside risks if trade tensions escalate,"the firm adds.
The FBM KLCI closed at 1,649.33 points last Friday, down 2.4% year to date. The market is currently trading at 16.7 times PER, relatively higher com-pared to its regional peers such as the Singapore Straits Times Index at 12.49 times, the Stock Exchange of Thailand SET Index at15.37 times, the JakartaComposite Index at 15.06 times and theHo Chi Minh Stock Index at 16.15 times.