Corporate Malaysia has turned the corner

While Budget 2023 is expected to be an election budget with goodies for the people and businesses, with no tax hikes or new taxes, the real pain will be felt down the road if fiscal reforms are not implemented.

THE recently concluded second-quarter 2022 (2Q22) reporting season did not entirely disappoint, as more companies reported earnings that were ahead of expectations and with the consensus now raising market expectations of a stronger 2023 earnings season than this year.

Compared with the resource-based companies that outshined in the 1Q22 period, in the 2Q22 period, it was the banking sector, selected consumers, including the automotive sub-sector, as well as property and real estate investment trust or REIT companies that posted earnings that beat expectations.

Telcos were a mixed bag, except for spectacular 2Q22 earnings from Telekom Malaysia Bhd.

For the second quarter in a row, the biggest drag to corporate Malaysia’s 2Q22 report card was again the glove makers, as earnings plunged on lower average selling prices and higher operating costs.

Despite the impact of a fully opened economy, the aviation and the gaming sectors, as seen in the 1Q22 period, remained under pressure and continue to post losses.

Economy remains strong

The 2Q22 nominal gross domestic product (GDP) expanded by 19% year-on-year (y-o-y) and 4.8% quarter-on-quarter (q-o-q).

Economically, the Malaysian economy for the 2Q22 period was surprisingly strong, as the economy expanded by 1.7% q-o-q and 8.9% y-o-y, flatly beating market expectations of a 7.9% y-o-y growth.

In nominal terms, the economy expanded by a staggering 19% y-o-y and 4.8% q-o-q to hit Rm442.7bil.

On a y-o-y basis, strong nominal growth was seen in accommodation services, up 141.6% y-o-y; motor vehicles expanded by 72%; mining and quarrying jumped 49.2%; the transport sector grew 37.4%; while the food and beverage sector experienced a 29.3% y-o-y growth.

With the 2Q22 GDP growth rate beating the consensus estimate, the 2Q22 net earnings momentum, excluding the volatile earnings of glove makers, rose 14.3% y-o-y, translating to about 0.75 times the nominal GDP growth, which is a big improvement from the 1Q22 ratio of 0.40 times the nominal GDP growth.

With the stronger earnings momentum, the ratio of companies’ earnings that surprised the market against those that were below expectations too improved, as 26% of companies reported earnings that were above expectations against 27% that were below consensus estimates.

This was stronger than 1Q22’s reporting season when 21% of companies reported results that were above expectations and 30% that were below expectations.

Hence, the earnings disappointment ratio improved to 1.05 times, against the preceding quarter’s 1.43 times.

The q-o-q trend is not unexpected as the 2Q22 period typically tends to have much better results due to a higher element of certainty from the 1Q22 reporting period.

FBM KLCI fairly valued at 1,570

As expected, with the 2Q22 earnings season out of the way, there have been minor adjustments to earnings estimates for this year and the next.

For 2022, from the earlier forecast earnings contraction of 2.5% at the end of the 2Q22 reporting period, the revised estimate now shows an earnings contraction of 4.6%, a two percentage points (pps) deterioration while earnings for 2023 are now estimated to grow by 10.2% from the 9.6% that was estimated previously.

Index-wise, one broking firm upgraded its FBM KLCI’S fair value by 50 points, while four others downgraded their estimated FBM KLCI fair value by between 30 and 80 points.

This brought the FBM KLCI fair value to 1,570 points, down 21 or 1.3% from the previous fair value of 1,591 points.

The market is now seen as fairly valued based on 14.9 times earnings compared with 14.7 times three months ago. Based on Thursday’s index close of 1,495 points, the market has an approximately 5% upside.

Challenging months ahead

While inflation and rate hikes continue to dictate investor sentiment and expectations, economic indicators have already taken a turn for the worse.

The global economy has entered into a contraction phase as the latest J.P. Morgan Global Purchasing Managers’ Index (PMI) Composite Output Index for August fell below 50, with a reading of 49.3 from 50.8 in the month of July.

This is the first time since June 2020 that the index has shown a reading below 50, which is the threshold between economic growth and contraction.

The eurozone, which is battling an emerging energy crisis, looks weak as well as the Final S&P Global Eurozone Composite PMI fell to 48.9 – a new 18-month low, against 49.9 in July.

The weakening economic conditions are worrying, especially at a time when global central banks are on a tightening cycle.

The past week alone we saw the Reserve Bank of Australia raising rates by 50 basis points (bps), while the Bank of Canada (BOC) and the European Central Bank (ECB) hiked their respective benchmark rates by a whopping 75 bps each.

The BOC has been among the most aggressive central banks within the developed economies as it has raised the key rate by a full 3%.

Budget 2023 and GE15

While Malaysia’s 3Q22 GDP is still expected to be robust with a high single-digit number, economic challenges will start to kick in after the 4Q22 period starts.

This is not only due to the base effect of the high absolute 4Q21 GDP level, but also domestic events that will likely take precedence and shape the nation’s direction in the next five years.

While Budget 2023 is expected to be an election budget with goodies for the people and businesses, with no tax hikes or new taxes, the real pain will be felt down the road if fiscal reforms are not implemented.

With Parliament likely to be dissolved right after the tabling of Budget 2023, paving the way for the 15th General Election or GE15, investors are expected to take a cautious approach until a clearer picture emerges.

A decisive victory for one of the coalition parties will be a positive for the market, while a hung Parliament will leave investors with more questions and uncertainty.

Pankaj C Kumar is a long-time investment analyst. The views expressed here are the writer’s own.