While tracking data shows that corporate earnings for the Jun 2023 quarter broadly met expectations, the reality is more sobering.
RHB Research said today (Sept 4) that Seven out of 18 sectors booked disappointing numbers, and there were downward revisions made on the back of soft toplines and even weaker bottom lines.
The firm’s Market Strategy: Jun 2023 Quarter Earnings Review cited that the misses-to-hits ratio showed a marginal sequential improvement, but the June quarter earnings were lower QoQ and YoY. Earnings revision trends were negative, although the bulk of the cuts were FY23-centric.
The fragility of corporate earnings will limit the fundamental upside for equities, so RHB stands by their end-2023 FBMKLCI target at 1,500pts.
Net earnings downgrades
About 48.5% of companies under coverage reported in-line earnings, while 38.5% missed estimates. The misses-to-beats ratio improved slightly to 2.9, from 3.6 in 1Q23.
Just one sector (2Q23: none) – gaming – exceeded expectations while seven (2Q23: nine) disappointed, ie plantation, oil & gas (O&G), construction, healthcare, utilities, rubber products and basic materials. In absolute terms, the plantation, O&G, bank and rubber products sectors accounted for the most cuts in earnings estimates.
Overall earnings estimates were cut by 3.4% and 2% for FY23 and FY24 (-3.1% and -1.6%. stripping out rubber products). There were no changes in sector weightings following the conclusion of the June quarter results season.
KLCI stocks
Large-cap component stocks did worse QoQ after 37% of companies reported disappointing results (2Q22: 22.2%). Earnings were cut by 3.3% and 2.2% for FY23F and FY24F – mainly from the plantation, O&G, bank and utilities sectors.
The results of the bank sector – a bellwether – were mostly in line, with asset quality data remaining solid. Management guidance was unchanged from the preceding quarter, on the back of China’s macroeconomic challenges and limited forward visibility.
Strategy
Key risks for equities include a weak MYR/USD rate, the slower than-expected pace of economic recovery in China, lacklustre corporate profitability, and the continued stability of the Federal Government.
The recent round of downgrades has resulted in a YoY contraction in FY23 earnings forecasts (-1.6%).
With the brunt of downgrades mainly done for FY23 forecasts, RHB now expects FY24F earnings to grow by 7.7% YoY. At 14.5x FY24 P/E, valuations are not especially demanding, but not in bargain territory either.
The Re-rating catalysts include: i) The pace of implementation of the reform agenda; ii) gradual improvements in the global macroeconomic outlook; and iii) clearer evidence that the tightening of the US Federal Reserve’s monetary policy has run its course.
While a core defensive stance is still preferred, market weakness should be seen as opportunities to gradually deploy cash hoards to add to equity positions.
RHB has an OVERWEIGHT rating on the bank, O&G, utilities, basic materials, nonbank financial institutions (NBFI), healthcare and property sectors. RHB makes no change to their end-2023 FBM KLCI target of 1,500pts.
2QCY23 Report Card – Improved Earnings Delivery
Kenanga Research, meanwhile, said FBMKLCI component stocks reported 2QCY23 results that were more in-line with expectations, after a highly disappointing 1Q.
Power companies felt the pinch from high-cost coal inventories; planters and steel players bore the brunt of low commodity prices; and Corporate Malaysia had to confront slowing domestic demand and exports amidst a global economic slowdown while operating cost stayed elevated.
Following the 2QCY23 results, Kenanga Research now projects FBMKLCI earnings to contract slightly steeper by 1.6% in CY23 (from a 1.1% decline previously), followed by a higher growth of 8.4% in CY24 (from 7.4% previously).
More In-line with Expectations
Earnings delivery (as against our expectations) of FBMKLCI component stocks improved sequentially in 2QCY23, with 10%, 66% and 24% beating, meeting and missing their projections, compared with 7%, 52% and 41%, in 1QCY23, respectively.
However, against market expectations, there was no significant sequential improvement with “above”, “within” and “below” at 10%, 50% and 40% vs. 7%, 57% and 37% in 1QCY23, respectively.
Winners and Losers
Three FBMKLCI component stocks under Kenanga’s coverage beat their projections, namely, SIME (strong performance of BMW Malaysia on the economy reopening), SIMEPLT (strong output but lower cost) and TM (tax credit).
On the other hand, seven FBMKLCI component stocks under their coverage universe missed projections, namely, AMBANK (higher credit cost), AXIATA (accelerated depreciation and higher funding cost), DIALOG (lower contribution from E&P JV), GENM (low visitor spending), GENTING (weak performance of GENM), IHH (weak showing from operations in Singapore and Turkiye), and TENAGA (high-cost coal inventory).
Common downside factors on 2QCY23 Earnings
On a cautious note, among the key reasons for companies under Kenanga’s coverage (including non-FBMKLCI component stocks) missing their forecasts were high-cost coal inventory (TENAGA, MALAKOF); weak commodity prices (ANNJOO, BPLANT, ENGTEX, HSPLANT, TAANN, TSH); slowdown in domestic consumption (AEON, PWROOT, SLP); slowdown in exports (D&O, JHM,KPS, PIE,PWROOT, SLP, TGUAN, UNISEM); and cost escalation (ASTRO, BPLANT, D&O, HSPLANT, IOIPG,JHM, KIMLUN, KPS, MGRC, MYNEWS, PHARMA, PIE, STAR, SWIFT, VELESTO, WASCO).
End-2023 FBM KLCI Target Maintained
Following the 2QCY23 results, Kenanga now projects that FBMKLCI earnings to contract slightly steeper by1.6% in CY23 (from a 1.1% decline previously), followed by a higher growth of 8.4% in CY24 (from 7.4% previously) owing to a slightly lower base in CY23F.
Kenanga maintains their end-2023 FBMKLCI target of 1,540 based on an unchanged 16.5x CY23F PER, which is at a 0.5x multiple premium to its historical PER range of 14-16x post the economy reopening in 2021-2022 on a reduced market risk premium with the nation sailing into more tranquil political waters after the recent state elections (and the next general election, i.e. the 16th General Election, will only be due in 2027).
Global macro issues back in focus
With the state elections and 2QCY23 corporate earnings reports now out of the way, Kenanga believes investors will shift their attention back to key global macro issues, particularly a potential pause in rate hikes and a more dovish tone by the Fed at the Federal Open Market Committee (FOMC) meeting on 19-20 Sep 2023.
This follows July 2023’s Personal Consumption Expenditures (PCE) price index, the Fed’s preferred inflation gauge, that came in right on the dot of what the market had expected. i.e. 3.3% YoY.
Meantime, while Aug 2023 non-farm payrolls beat expectations at 187k (vs. 170k forecast) alluding to the strength of the labour market, this was mitigated by average hourly earnings that came in weaker at +0.2% MoM (vs. +0.3% forecast) indicating wage disinflation.
The latest Fed Funds futures (at the close on 1 Sep 2023) tracked by CME Group point to the Fed keeping the target range of its funds rate at 5.25%-5.50% at the Sep 2023 FOMC meeting.
The policy response of the Chinese government to the faltering shadow banking and real estate sectors in China. It has been widely reported that the Chinese government has instructed financial giants such as Citic Group and China Construction Bank to review the books of Zhongrong International Trust Co. for a potential rescue (after the trust company, one of the biggest in China and a key backer of troubled property developers in China, missed payments on a number of its investment products).
Meanwhile, to jump-start the real estate market (or to prevent it from spiraling further down), the Chinese government has instructed banks to cut mortgage rates and ease lending curbs, which may have come too little too late as China real estate behemoth Country Garden moves one step closer to defaulting on a private bond this week (two years after the collapse of its smaller rival Evergrande).
Top Sector Picks
Kenanga continues to like banks and telcos as value play and for their earnings resilience.
Telcos are also poised for further re-rating as and when the roll-out of the market-driven Dual Network 5G model is firmed up. Kenanga expects an acceleration in the roll-out of public infrastructure projects post the state elections, benefitting contractors.
They are positive on auto makers/distributors as Kenanga believes a new car is still an affordable luxury for most Malaysian households despite high inflation and a slowing global economy. While they have a NEUTRAL stance on the plantation sector, Kenanga sees an opportunistic risk-and-reward situation by virtue of its downside risk that is well protected by asset value but tremendous upside reward if the current El Niño weather phenomenon turns out to be a strong one.
