We cut our end-2021 target for the FBM KLCI from 1,750 to 1,600 to reflect the negative earnings impact from the one-off hike in corporate tax from 24% to 33% in 2022. This would slash the earnings growth from 9.5% to 3.5% next year.
This aside, external headwinds from Fed tapering and lingering worry over China macro risk may dent risk sentiment, diluting somewhat the kick from the transition to endemic state as the economy reopens in 4Q21. Taken together, the upside potential in a market recovery cycle may now be somewhat capped in the near term. Despite our tempered optimism, we are sticking with our reopening and cyclical themes with the banks as the cornerstone picks.
Expectations of rising interest rates and long bond yield will sustain share price performance, and valuations. Property recovery is already in motion along with consumer discretionary. Elevated inflation expectations would continue to underpin commodity prices. Our top picks are Maybank, Hong Leong, SP Setia, Mah Sing, Berjaya Food, Padini, 7-Eleven, Yinson, MISC, Petronas Chemicals, Ipmuda, KLK and Sime Darby Plantations. Prosperity tax on corporate profits will flatten earnings trajectory From the market’s perspective, the most significant pronouncement in the Budget is the imposition of the Prosperity Tax. For the year of assessment 2022, the first RM100m in corporate earnings will be taxed at the normal rate of 24%. A significantly higher tax of 33% will be imposed on corporate earnings above RM100m. This is a significant move: a steep increase in tax rate combined with a low earnings tax threshold. Based on our back of the envelope calculation, the steep jump in the corporate tax rate would slash the estimated earnings growth for the market from 9.5% to just 3.5% in 2022. This is depressing considering that the economy is projected to accelerate from 3-4% in 2021 to 5.5-6.5% in 2022. The earnings growth trajectory in 2022 has now been flattened by the one-off hike in corporate tax. Despite the negative from the hike in corporate tax, the market impact would likely be worse if there were other more punitive taxes such as hikes in personal income tax, capital gains tax on shares trading or even inheritance tax.
We are not unduly concerned about the proposed tax on vapes liquid containing nicotine as well as the expansion of excise duties on premix sugar-sweetened beverages due to heath consideration. Similarly, we are unmoved by the higher windfall tax on the planters. The Windfall tax threshold will be raised to RM3,000/tonne (previously RM2,500) for Peninsula Malaysia and to RM3,500 (previously RM3,000) for Sabah and Sarawak. The impact is not significant accounting for less than 1% of earnings. We remain Overweight on the plantation sector. Our CPO price assumption is maintained at RM4,000 for 2021 and 2022. Index target for 2021 trimmed to 1,600, from 1,750 previously
The steep hike in corporate tax to 33% means that the post lockdown’s earnings normalisation theme is now less compelling given a flattened trajectory at just 3.5% in 2022. This aside, the external headwinds from Fed tapering in November 2021 and lingering worry over China macro risk may dent risk sentiment, diluting somewhat the kick from the transition to endemic state as the economy reopens in 4Q21.
As it is, malls and restaurants have already bounced back to life given pent up spending. Domestic travel restrictions have been removed. It is a matter of time before select international travel will be allowed. Our sense is that the market will gyrate down in the aftermath of the Budget. Hence, we have slashed our end-2021 index target from 1,750 to 1,600. Thankfully, at the current level of 1,562, the market is already trading below its long-term averages (see charts below). Therefore, there should be some valuation support.
However, the upside potential in a market recovery cycle is now capped in the near term. Despite our tempered optimism, we are sticking with the reopening and cyclical recovery themes with a greater focus now on the beneficiaries of rising inflation and rates expectation. We are Overweight the banks, property, plantation, oil & gas and consumer discretionary sectors.
-Analyst and Economist from KAF
