Optimism driving market valuation

High PES despite washout second-quarter numbers

“By and large for corporate Malaysia, I won’t expect Q2 results to be a significant derating catalyst. Not yet.”

Vincent Khoo

PETALING JAYA: It will be no surprise that the second-quarter (Q2) corporate earnings will be a colossal washout as listed companies start to release their financial results this month.

The months of April to June took on the full impact of the movement control order (MCO) and the global economic downturn due to the coronavirus (Covid-19), which will culminate in the worst quarterly results the market has ever seen.

In such an unprecedented situation, corporates might also undertake kitchen-sinking strategies since nothing is going to look good for most of them.

Given the forward-looking nature of the stock market, all these negativities would have been priced in, especially during the crash of March 19, but the FBM KLCI, the benchmark index of Bursa Malaysia, has rebounded way off its lows and its valuation was at the upside, ahead of most major markets in the region.

Going by Bloomberg’s data, the index carried with it a price-to-earnings (PE) ratio of 20.49 times, a level usually seen during bull run days as compared to normal levels between 16 and 18 times.

This placed the FBM KLCI ahead of Singapore’s Straits Times Index (STI) with a PE of 14.38 times, the Jakarta Stock Exchange Composite Index (JKSE) at 17.92 times and the Stock Exchange of Thailand (SET) Index at 19 times.

Even Hong Kong’s Hang Seng Index has a PE of only 11 times. The FBM KLCI is only behind Japan’s Nikkei 225 and South Korea’s Kospi with PES of 29.50 times and 28.41 times, respectively.

MIDF head of research Imran Yassin Md Yusof said what will be important is the guidance given by the corporates, as this will provide clues on the earnings trajectory going forward.

“While the market has rebounded strongly, we believe that it is pricing in a blue sky scenario such as the cessation of Covid-19 and the total recovery of corporate earnings.

“We opine that this is too optimistic, as the pandemic continues unabated and this will surely have an economic impact, and thus, affect corporate earnings going forward,” he said.

Imran added that the Q2 corporate earnings are expected to be the weakest they have seen in many years, with contractions on both sequential year and quarter basis.

“Another aspect of the Q2 corporate earnings is that it might affect short-term investor sentiment. With all these combined, we believe that there will be another market correction,” said Imran.

UOB Kay Hian head of research Vincent Khoo shared the same view, saying that Q2 being a washout quarter was already well anticipated and share prices would generally react negatively only if the outlook of the companies continued to deteriorate or highly challenged.

“So that’s the case for industries such as aviation, we all know these companies are not out of the woods whereas for most companies including banks at this stage, I wouldn’t expect much downside in the near term because their expectations are not worsening yet.

“By and large for corporate Malaysia, I won’t expect Q2 results to be a significant derating catalyst. Not yet,” he said.

Asked if the earnings growth would match FBM KLCI’S high PE, Khoo said 2020 earnings would not be a good reference point due to two reasons, one being that a lot of corporate earnings were artificially shell shocked during the MCO period.

Secondly, the 2020 earnings have not fully captured the sensational growth from the glove stocks.

“If you look forward to 2021, valuations may not look expensive, but bear in mind that the earnings of glove counters are at the same time, not so sustainable.

“Therefore, in theory, if you roll forward to 2021, valuations should be below their means,” he said, adding that personal protective equipment (Ppe)-related companies will continue to do well for a good part of 2021 due to their forward sales that were locked in.

However, in the case of the main street such as banks, the status is quite uncertain with no clear signs of how the post-moratorium non-performing loan (NPL) figures were going to look like, and this could post some downside to the earnings forecast.

While the global Covid-19 infection rate, especially in the United States, is not leveling off just yet, Khoo noted that it was on a downtrend and if that accelerates, it will take off a bit of hot air from rubber glove counters, which would impact the index.