FBM KLCI in 2019 – see you at 1,600

The Star Malaysia - StarBiz - - Viewpoint - PANKAJ C. KU­MAR

THIS week’s busi­ness head­lines were fo­cused on bro­ker­age re­ports for the re­cently con­cluded third quar­ter (Q3) re­sults sea­son as the re­port­ing win­dow for quar­terly pe­riod ended Sept 30 just ended the pre­vi­ous Fri­day.

One con­clu­sion we can make for the quar­terly pe­riod was that Cor­po­rate Malaysia’s re­sults were clearly a sur­prise – not to the up­side, but hugely to the down­side.

This was the quar­terly pe­riod where Malaysians en­joyed two months of tax hol­i­day due to the abol­ish­ment of the Goods and Ser­vices Tax (GST) and one month into the in­tro­duc­tion of the Sales and Ser­vice Tax (SST), which came into ef­fect on Sept 1. It was at a time where Malaysia’s Con­sumer Sen­ti­ment In­dex posted a read­ing of 107.5 and although down steeply from the eu­pho­ria gen­er­ated from Pakatan Hara­pan’s vic­tory at the polls, it is still in an ex­pan­sion mode as the read­ing was well above 100.

In ad­di­tion, de­spite the coun­try’s GDP ex­pand­ing by 4.4% year-on-year (y-o-y) dur­ing the quar­ter, which was be­low ex­pec­ta­tions mainly due to the sup­ply shock in the com­mod­ity sec­tor, quar­terly earn­ings came in way off the line.

For­get about the one-off rea­sons why earn­ings were sig­nif­i­cantly higher or lower for com­pa­nies like Telekom Malaysia, Gent­ing or even FGV, but just look­ing at the core earn­ings and as pooled by the re­search houses, Q3 earn­ings, on av­er­age, dropped on all counts. Third quar­ter earn­ings fell by 6.2% q-o-q and 8.3% y-o-y re­spec­tively. Worse, the Q3 per­for­mance was so bad that net earn­ings growth for the first nine months of 2018 has now turned neg­a­tive 1.9% y-o-y.

Are we still sur­prised that the mar­ket is not do­ing as well as we think it should?

Third quar­ter earn­ings sea­son came in at a time where most com­pa­nies would al­ready have the half-year re­port card in the bag and hence the Q3 pe­riod would see much bet­ter ac­cu­racy in terms of whether the com­pany’s earn­ings met ex­pec­ta­tions or oth­er­wise.

But, alas, it was not the case, yet again, as the num­ber of com­pa­nies that dis­ap­pointed the mar­ket was 2.9 times more than those which sur­prised the mar­ket. This is the av­er­age among the eight bro­kers that was tab­u­lated and tak­ing into con­sid­er­a­tion only nor­malised earn­ings.

As a re­sult, down­ward re­vi­sions in earn­ings growth were in­evitable as net earn­ings for the mar­kets were slashed by 3.1 per­cent­age points (pps) for 2018 to just 0.5% while earn­ings for 2019 was re­duced by 2.5 pps to 5.1%. Again, this is the av­er­age among the eight re­search houses but in­ter­est­ingly three re­search houses were al­ready look­ing at neg­a­tive earn­ings for 2018 while for 2019, earn­ings growth for one re­search house is only at 1.5%.

The hard part in any post quar­terly re­sults sea­son is the changes in the mar­ket call, es­pe­cially with re­spect to FBM KLCI tar­gets, tak­ing into con­sid­er­a­tion the earn­ings mo­men­tum as well as rel­a­tive val­ues of the mar­ket vis-à-vis the re­gion.

With just a lit­tle over three weeks to go be­fore year-end, re­search houses have placed a clos­ing FBM KLCI value at be­tween 1,704 and 1,750 points or at an av­er­age of 1,735 points, which is an up­side of 3% from Thurs­day’s close of 1,683. At 1,735 points, the FBM KLCI is val­ued at about 16.9x 2018 PER mul­ti­ple based on re­search houses’ av­er­age es­ti­mate, which is in­deed very rich for a mar­ket that ex­pected to ex­pe­ri­ence earn­ings growth of just 0.5% on av­er­age this year.

For 2019, based on re­search house es­ti­mates, the FBM KLCI’s fair value is be­tween 1,674 and 1,830 or an av­er­age of 1,774 based on for­ward PER rang­ing be­tween 15.4x and 17.4x. Is this fair value a fair assess­ment of the mar­ket when earn­ings growth is now pro­jected at only 5.1% on av­er­age?

This is ob­vi­ously by no means a her­culean task for com­pa­nies to re­port given that earn­ings growth over the past five years com­ing in, at most, at about 0.7x GDP growth. Hence, with the GDP in 2019 ex­pected at about 4.9%, tak­ing this 0.7x mul­ti­ple, the pro­jected earn­ings growth in 2019 is prob­a­bly in the re­gion of just 3.4%, which is a third lower than the mar­ket is presently ex­pect­ing for next year.

It is likely, as it had been hap­pen­ing over the past five years, re­search houses will be­gin to trim their ex­pec­ta­tions af­ter the re­lease of Q1 and Q2 earn­ings in 2019 and along with it, the fair value for the FBM KLCI.

But in­ter­est­ingly, the mar­ket doesn’t wait for re­search houses to cut their es­ti­mates as the mar­ket would prob­a­bly re­act much ear­lier as how it has be­haved over the past few months, es­pe­cially af­ter some ma­jor in­dexlinked stocks re­ported poor quar­terly earn­ings.

Let’s face the fact, our mar­ket is not cheap, judg­ing by the cur­rent PER mul­ti­ple it is trad­ing at. Worse, if we were to com­pare with other Asian ex-Japan bourses, the FBM KLCI is trad­ing at a sig­nif­i­cant premium. At 1,683 points, ac­cord­ing to Bloomberg es­ti­mates, the FBM KLCI is al­ready trad­ing at 16.7x for 2018 earn­ings and at a premium of 20% to the re­gion’s sim­ple av­er­age PER of 13.9x.

With earn­ings mo­men­tum likely to be just 3%-4% in 2019 at best, is the cur­rent year’s 16.7x mul­ti­ple jus­ti­fied?

His­tor­i­cally, the premium that the FBM KLCI has en­joyed over the re­gional peers is 5%-15% and if we were to take a premium of 10%, the ap­pro­pri­ate mul­ti­ple for FBM KLCI’s 12-month for­ward earn­ings is about 15.3x for­ward PER. At this mul­ti­ple, the FBM KLCI should be fairly val­ued at 1,540 points for this year and im­ply­ing earn­ings growth of about 3.4% in 2019, the FBM KLCI’s fair value 12 months for­ward should be about 1,600 points. There is in­deed a 5% down­side risk for the mar­ket in 2019.

With the cur­rent mar­ket volatil­ity and con­cern of po­ten­tial re­ces­sion in the hori­zon, a pull­back on the mar­ket is not to­tally un­ex­pected, more so since the FBM KLCI has been one of the out­per­form­ers this year, fall­ing 6.3%, out­pac­ing the Asia ex-Japan av­er­age by 3.2 pps year-to-date.

star­[email protected]­tar.com.my

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