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Cover Story: Market charges ahead despite dismal 1Q earnings

TheEdge Thu, Jun 11, 2020 02:00pm - 5 months ago


THE FBM KLCI hit a low of 1,219.72 points on March 19 after a sell-off triggered by the oil price slump and fears over the impact of the Covid-19 pandemic on the global economy. Just over two months later, the local bourse is entering bull market territory after rebounding 20.9%, led by gains in glove, healthcare and oil and gas (O&G) stocks.

On the flip side, after a modest growth of 0.7% in 1Q, the Malaysian economy is set to fall into a recession in 2Q as business activity has almost come to a standstill.

As expected, corporate earnings have been lacklustre. Of the 172 companies that have released their results for 1Q ended March 31 (1Q), 55% showed year-on-year declines while 69% reported quarter-on-quarter slumps. Note that companies have been granted a one-month extension up to end-June to issue their quarterly results, owing to disruptions from the Movement Control Order (MCO), which was enforced on March 18.

Given that 1Q reflected only part of the impact of the MCO, 2Q corporate earnings will definitely be worse.

Glovemakers have been the best-performing sector so far, while telecommunications, construction and property, real estate investment trusts (REITs) and consumer have underperformed. Performance was mixed in the banking, plantation, technology and industrial products and services segments.

 

More pain ahead

“We should see weaker earnings in 2Q. This year is more or less gone unless things stabilise in 3Q, then maybe we can see a revival in 4Q. Again, it depends on how soon Covid-19 could be [put] under control,” Inter-Pacific Securities head of research Victor Wan tells The Edge.

After the sharp decline in 2Q earnings, he expects the outlook to be better in 3Q in view of the economy reopening.

“The economy also looks to be on track to recover further in 2021, [but] it’s very fluid; some industries will take a longer time to go back to normalcy,” he adds.

Wan sees the glove sector poised to be the outperformer again in 2Q, driven by resilient demand, but sectors such as aviation, gaming and consumer will be hit hard.

TA Securities head of research Kaladher Govindan expects a 9% contraction in corporate earnings for 105 stocks under its coverage this year, the bulk of which will come from gaming (-60.5%), insurance (-27.6%) and media (-13.6%).

However, corporate earnings are forecast to rebound 16% next year owing to the low-base effect.

While the glove sector did very well in 1Q, Kaladher says results mostly came within expectations because earnings forecasts had been upgraded in view of the surge in demand.

“Of the four glove stocks that we cover, the results of three companies were within expectations; only Supermax Corp Bhd outperformed mainly because of its own brand manufacturing demand and better margins,” he notes.

 

No signs of market pullback yet

Given weak corporate earnings, ­Inter-Pacific’s Wan admits that strong buying interest in the equity market is not justified.

“Having said that, the whole world is on recovery mode; a lot of helicopter money around, so investors just put [money] in the stock market. There’s too much money flowing into [the stock market]. There are still no signs of a pullback yet,” he explains.

Kaladher also points out that valuations appear to be a bit stretched for the FBM KLCI, compared with its regional peers such as Indonesia, Thailand and the Philippines.

“Eventually, the country will open up its economy, and there’s news that a vaccine could be found later this year. I think the market went ahead because of that, coupled with the rebound in oil prices.

“The valuations [of KLCI] may not be justified and there could be a correction. When economic data starts coming in for 2Q, the jittery feeling will come because we have not seen the full impact of [economic] weakness,” he says.

Given the tight cash flow faced by many companies, Kaladher expects dividend payouts by companies on the local bourse to be affected. “I believe companies would like to conserve their cash for rainy days because we don’t know how long this [the pandemic] will last. So, I presume that companies will start cutting their dividend payouts.”

Although glove companies are expected to continue with their dividend payouts, he warns of their high valuations. “Prices may tumble if a vaccine is found, so you should take profit on some of these stocks and look for other stocks that have been sold down.”

Let’s take a look at how the sectors performed in 1Q.

 

GLOVE MAKERS

Glove stocks are definitely a favourite with investors, with orders for gloves flowing in and selling prices escalating. The virus-led demand is a strong boost for the sector, with analysts saying more significant growth will be seen in the coming quarters. Besides strong volume, favourable forex and low raw material prices are also the catalysts.

Supermax Corp Bhd, the top performer with a share price hike of almost 400% year to date (YTD), recorded a 105.3% surge in net profit to RM71.06 million for 3Q ended March 31, 2020, underpinned by strong demand for its medical gloves.

Kossan Rubber Industries Bhd’s net profit came in at a record high of RM64.8 million in 1QFY2020, an increase of 10.35%. It has received orders close to 10 months ahead of delivery with prices to be finalised one to two months prior to delivery.

Hartalega Holdings Bhd’s net profit rose 27.9% to RM115.58 million in 4Q2020 ended March, thanks to higher sales revenue and lower raw material and energy costs. However, FY2020 net earnings dropped 5% to RM434.78 million versus RM455.18 million in FY2019, owing to higher taxation and operating expenses.

YTD, the share prices of Kossan and Hartalega have jumped 113% and 99% respectively.

Going forward, glove makers’ profitability will be closely monitored to see if their lofty valuations are justified. The pandemic’s impact is expected to be reflected from 2Q.

 

PLANTATION

Plantation players delivered mixed results in 1Q, with a number of them hit by forex losses. These included Kuala Lumpur Kepong Bhd (KLK) and its parent Batu Kawan Bhd, which incurred sizeable forex losses of RM178 million and RM201.3 million respectively.

KLK’s 2QFY2020 net earnings plunged 80.5% to RM27.89 million from RM142.96 million a year ago. Batu Kawan’s quarterly net profit plummeted close to 80% to RM16.02 million from RM79.28 million.

Both companies suffered from the significant depreciation of the rupiah against the US dollar and ringgit during the period.

Forex translation losses also caused IOI Corp Bhd to record only RM100,000 in net profit in 3QFY2020 versus RM245.8 million a year earlier, while TSH Resources Bhd’s 1QFY2020 net profit fell 83% to RM2.25 million from RM13.54 million a year ago.

Meanwhile, FGV Holdings Bhd saw its net loss widen to RM142.35 million in 1QFY2020 from RM3.37 million a year earlier, attributed to lower fresh fruit bunches production and lower margins for palm oil and sugar.

On the bright side, Genting Plantations Bhd’s 1QFY2020 net profit jumped more than twofold to RM91.3 million from RM41.68 million a year earlier.

The profit surge is even more significant for Sime Darby Plantation Bhd, whose net earnings soared to RM394 million from RM90 million, driven by higher earnings from both upstream and Sime Darby Oils.

YTD, CPO prices averaged RM2,500 per tonne against a high of RM3,052 per tonne at end-2019. Last year, CPO futures gained 44%.

Analysts caution that CPO prices could be under pressure in the coming quarters owing to a weak demand outlook.

 

TELCO

1QFY2020 was not a good quarter for telco players. All the big four reported lower earnings during the quarter in review.

The tough operating environment even prompted Axiata Group Bhd to withdraw its headline key performance indicator (KPI) guidelines for FY2020. The decision was made in view of business uncertainties arising from the Covid-19 pandemic.

Axiata had expected 3.5% to 4.5% revenue growth for FY2020, as well as earnings before interest, taxes, depreciation and amortisation (Ebitda) growth of 4% to 5.5%.

Axiata announced a 74% drop in 1QFY2020 earnings to RM188.11 million from RM725.17 million the year before, owing to exposure to forex swings as well as higher operating and finance costs, and taxes.

Lower contribution from the Unifi internet business and wholesale division reduced Telekom Malaysia Bhd’s 1QFY2020 earnings by half to RM152.52 million, from RM308.28 million a year earlier.

Maxis Bhd’s net earnings slipped 12.5% to RM358 million in 1QFY2020 compared with RM409 million a year ago.

Digi.Com Bhd’s net earnings fell 2.78% to RM332 million y-o-y, on the back of higher “other expenses”, a net loss from its foreign currency and fair value movement currency forward contracts.

PublicInvest Research says in a recent note that while the use of telecommunication services (data and voice) is expected to rise in 2QFY2020 with many people working from home, as well as increasing demand for online education, the growth in consumption may not necessarily translate into higher revenue because users’ data plans are underutilised anyway.

 

TECHNOLOGY

Lockdowns worldwide have had some impact on technology players, though they are set to benefit in the new normal post-Covid 19.

For example, travel restrictions have taken a toll on Pentamaster Corp Bhd’s project delivery schedule and site installation of the automated test equipment (ATE) operating segment. As a result, its 1QFY2020 net profit fell 14.28% to RM16.77 million from RM19.56 million a year earlier.

Sales of Inari Amertron Bhd’s optoelectronic products began to slow in January and February. It also recorded lower production volume at its Malaysia, China and Philippines plants during the quarter as a result of lockdowns. Overall, its 3QFY2020 net profit slipped 8.19% to RM35.06 million from RM38.19 million a year ago.

As for Unisem (M) Bhd, it remained in the red with a net loss of RM2.82 million during the quarter because of lower sales volume at its plants in Indonesia and Ipoh as a result of lockdowns.

Meanwhile, Globetronics Technology Bhd’s 1QFY2020 net profit jumped three times to RM10.89 million versus RM3.09 million a year ago, driven by higher volume loadings of products and a significant increase in the economies of scale from certain customers in the group.

Higher sales and forex gain helped lift Mi Technovation Bhd’s net profit by 50% to RM10.3 million while Frontken Corp Bhd’s earnings were up 10.4% to RM17 million on better profit margin.

 

INDUSTRIAL PRODUCTS AND SERVICES

Two petrochemical players — Petronas Chemicals Group Bhd (PetChem) and Lotte Chemical Titan Holdings Bhd — are seeing margin compression as a result of the steep drop in global oil prices, which caused fluctuations in the cost of feedstock.

PetChem’s net profit contracted 37% to RM506 million for 1QFY2020 from RM800 million a year ago.

Lotte Chemical, whose share price has fallen 20% YTD, swung to the red with a net loss of RM170.06 million for 1QFY2020 compared with a net profit of RM55.83 million a year ago. Besides margin squeeze, the group also saw an increase in inventory write-downs.

Dufu Technology Corp Bhd, a micro-precision machining manufacturer, chalked up a much higher net profit of RM14.14 million in 1QFY2019 versus RM4.17 million a year earlier, boosted by higher revenue and unrealised forex gain as a result of the stronger US dollar. The higher revenue was due to an increase in volume loading by customers for hard disk drive components.

Steelmaker CSC Steel Holdings Bhd managed to post improved results, with net profit rising 8.68% to RM5.01 million from RM4.61 million a year earlier, thanks to a better product mix and cost management.

 

BANKING

As at last Wednesday, only the country’s three largest banking groups — Malayan Banking Bhd (Maybank), CIMB Group Holdings Bhd and Public Bank Bhd — had released their latest quarterly financial results.

Of the three, only Maybank had reported a growth in its quarterly net profit, which increased 13.3% y-o-y to RM2.05 billion in 1QFY2020 ended March.

PublicInvest Research in a May 22 note says while strong gains were seen in Maybank’s non-interest income numbers, particularly from its insurance business, there was also a sharp increase in loan loss provisions as the banking group took the cautionary step of making additional provisions on forward-looking assumptions.

The brokerage adds that Maybank has already made additional provisioning of RM400 million — based on weakening macroeconomic variables — and RM200 million on its retail portfolio slippage.

YTD, Maybank shares have declined 14% to close at RM7.40 last Wednesday, giving it a market capitalisation of RM83.2 billion. PublicInvest has a “neutral” call on Maybank, with a target price of RM7.50.

“While the group has seen some levels of success in certain key growth initiatives, near-term earnings potential will likely be hampered by margin compressions and asset quality challenges,” says ­PublicInvest Research.

Meanwhile, CIMB saw a 57% y-o-y decline in its 1QFY2020 net profit to RM507.9 million, on lower non-interest income and higher provisions across selected markets. MIDF Research says in a May 27 note that CIMB saw a more than threefold increase in its provisions to RM1.13 billion, owing to loan provisions from a single impairment in Singapore from the O&G sector amounting to about RM430 million.

MIDF downgraded its call on CIMB from “buy” to “trading buy”, with a lower target price of RM3.95 from RM4.30 previously. YTD, CIMB shares have declined 34%, closing at RM3.42 last Wednesday. The stock is currently trading below its book value at 0.6 times.

“We expect that CIMB’s credit costs might remain elevated this year owing to some corporate failure in the O&G sector in Singapore; however, this may improve next year, and there might be some trading opportunities premised upon this potential improvement,” the firm says.

As for Public Bank, its 1QFY2020 net profit saw a marginal decline of 5.7% y-o-y to RM1.33 billion, owing to lower net interest income as a result of the cut in the overnight policy rate, and higher provisions.

In a May 27 note, AmInvestment Bank Research says it is maintaining its “hold” call on Public Bank with a fair value of RM15.50. YTD, Public Bank’s share price has declined 22% to close at RM15.24 last Wednesday.

“We keep our ‘hold’ call on Public Bank as we continue to see declining return on equity (ROE), which will reduce its premium valuation compared with its peers. Our fair value is revised to RM15.50 per share from RM15.95 per share, pegging the stock to a lower FY2020 price-to-book value of 1.3 times, supported by an ROE of 11.1%,” the firm says.

Moody’s Investors Service in a note last Wednesday says the country’s three largest banks face growing pressure on profitability from the coronavirus-led downturn, with asset quality likely to deteriorate from 2021 as loan repayment moratoriums expire.

The share of impaired loans increased by 36 basis points to 3.4% at CIMB and by seven basis points to 2.7% at Maybank, largely driven by new loan impairments in Singapore and Indonesia, the note says.

“Asset quality was stable at Public Bank, which is more focused on the Malaysian market with 80% to 90% of its loans under repayment moratoriums. By comparison, so far, just 45% to 50% of loans were under moratoriums at CIMB and Maybank, although the banks expect the percentage could increase.

“The banks’ strong loss-absorbing buffers will help mitigate the rise in asset risk, with loan loss reserves exceeding 100% of impaired loans at most banks as at March 2020,” says Moody’s.

 

O&G

Some O&G companies, such as Velesto Energy Bhd, managed to report a turnaround in earnings in 1QFY2020.

Velesto reported a net profit of RM16.32 million in 1QFY2020 from a net loss of RM22.2 million a year ago, thanks to a higher average jack-up rig utilisation of 86% compared with 66% last year for its drilling services segment.

However, CGS-CIMB Research in a May 20 note says the outlook for Velesto has deteriorated, with news reports emerging in April that its Naga 3 contract was terminated early by Petronas after the latter could not get its platform infrastructure ready in time, and the rig worked only 202 days of the 366-day contract between May and December 2019.

“Three other rigs currently working for Petronas (Naga 2, Naga 5 and Naga 6) will have their charters end in May/August, and there is no indication if Petronas will exercise the 1+1 year option periods for all four rigs. It is possible that Petronas may seek to negotiate new charters as and when it finalises its revised drilling programme in light of the currently low oil prices,” says CGS-CIMB.

The Covid-19 pandemic and the collapse in demand for transportation and travel caused Brent crude oil prices to fall 65% in the first quarter of the year to US$22 per barrel. Prices have improved, hitting US$35 per barrel last Wednesday.

CGS-CIMB downgraded its call on Velesto to “reduce”, with a target price of 10 sen. YTD, Velesto share price has declined 58% to close at 16 sen last Wednesday, giving it a market cap of RM1.3 billion.

Meanwhile, Dialog Group Bhd saw its net profit for 3QFY2020 increase by 5% to RM151.04 million. AmInvestment Bank Research in a May 15 note maintains a stronger FY2021 earnings outlook for Dialog, given the full-year contribution of the fully utilised storage facilities in Pengerang Phase 2, additional capacity from Phase 1 and Tanjung Langsat 3’s tanks.

The brokerage upgraded its call on Dialog from a “sell” to a “buy”, with a fair value of RM3.80. YTD, Dialog’s share price has increased 7% to close at RM3.70 last Wednesday, giving it a market cap of RM20.8 billion.

In a note on the O&G sector last Wednesday, UOB Kay Hian says it retains its US$30 per barrel assumption on sector valuations, but advises against investing based on oil price momentum. “In our view, Petronas’ slow actions in cost cuts only increase sector earnings risk from contract deferrals or renegotiations, despite an oil price recovery. We maintain ‘market weight’ on the sector,” the firm says.

 

CONSUMER PRODUCTS

Lower oil prices caused Malaysia’s leading retailer and marketer of downstream petroleum products Petronas Dagangan Bhd (PetDag) to report a net loss of RM29.4 million in 1QFY2020 — its first quarterly loss since FY2005.

The group attributed the quarterly loss to lower gross profit following a sharp decline in Mean of Platts Singapore (MOPS) price trends, lower sales volume towards the end of the quarter and higher operating expenses attributable to professional services and depreciation costs.

Hong Leong Investment Bank (HLIB) Research in a May 19 note says it expects 2QFY2020 to be worse for PetDag, owing to the full-volume impact of the MCO.

The brokerage also expects volume growth for PetDag in FY2020 to be in negative territory because of the impact of the MCO, while its average selling prices will remain lacklustre on the back of lower MOPS price trend y-o-y. It downgraded its call on PetDag from a “hold” to a “sell”, with a lower target price of RM15.80 from RM20.31 previously.

YTD, PetDag’s share price has declined 7%, closing at RM21.52 last Wednesday, giving it a market cap of RM21.38 billion.

It was also a tough quarter for department store operator Aeon Co (M) Bhd, whose 1QFY2020 net profit plunged 77% to RM7.47 million on lower revenue from its property management services segment, which saw lower sales commissions from tenants during the MCO period, and lower retail business revenue from general merchandise store sales.

MIDF Research in a May 21 note expects a softer 2Q from Aeon as the impact of the MCO may be deeper in April.

MIDF is maintaining its “neutral” call on Aeon with a target price of RM1.08. YTD, Aeon’s share price has fallen 26% to close at RM1.05, giving it a market cap of RM1.47 billion.

Meanwhile, brewer Heineken Malaysia Bhd recorded an 8% growth in net profit in 1QFY2020 to RM56.96 million, thanks to its Chinese New Year festivities campaigns. However, the group saw a decline in revenue of 1.8% to RM515.89 million owing to the temporary suspension of operations of its Sungei Way brewery to comply with the MCO.

At its closing share price of RM23.08 last Wednesday, Heineken offered a decent dividend yield of 4.7%. In a May 20 note, HLIB Research reckons that Heineken’s dividend yield should prove attractive in the current volatile market conditions.

“This is to reflect the partial subsiding of ‘production risk’ now that it has been allowed to recommence operations during the Conditional MCO. In addition, FY2020-21 yields of 4.2% to 4.9% should offer some attractiveness,” the brokerage says. HLIB has a “hold” call on Heineken, with a target price of RM22.45.

 

REITs

It was a tough quarter for retail REIT CapitaLand Malaysia Mall Trust (CMMT), whose net property income (NPI) fell by a quarter to RM39.36 million from RM52.75 million a year earlier, owing to lower rental income from its shopping malls, whose operations were disrupted by the MCO.

In a May 22 note, MIDF Research kept its “neutral” call on CMMT with a target price of 69 sen. “We maintain our ‘neutral’ call on CMMT due to its challenging business outlook while we believe that the unit price should be supported by its net asset value, which stood at RM1.24 per unit. Dividend yield is expected at 5.2%,” the firm says.

YTD, CMMT’s unit price has fallen by 20%, closing at 80 sen last Wednesday, indicating a yield of 7.5%.

Meanwhile, Axis REIT, which has a mixed portfolio of commercial and industrial assets, reported a 1.3% y-o-y dip in its NPI to RM48.25 million. The higher property income was offset by higher property expenses because of higher building maintenance expenses during the quarter.

CGS-CIMB Research in a May 21 note says it sees limited revenue disruption for Axis REIT in 1HFY2020 from the Covid-19 pandemic and the MCO.

“Based on our earlier assessment, the degree of potential revenue disruption in 1HFY2020 arising from the extended MCO period would be limited to the potential deferment of rental payments and not outright rental waivers, as was the experience for other non-industrial/warehousing REITs under our coverage,” it adds.

CGS-CIMB has an “add” call on Axis REIT with a target price of RM2.09. YTD, Axis REIT has seen a 13% growth in its unit price, which closed at RM2 last Wednesday, indicating a yield of 4.2%.

 

PROPERTY AND CONSTRUCTION

The MCO has undoubtedly cast a shadow on the property and construction sector. Earnings of property players were affected in the first quarter, with Sime Darby Property Bhd reporting a 95% y-o-y decline to RM14.2 million in 1QFY2020, owing to a significant drop in revenue contributions from its property development and investment segments.

S P Setia Bhd also saw a 62% y-o-y fall in net profit for 1QFY2020 to RM28.46 million on lower earnings from its property development and construction segments, partly owing to the MCO, which led to the closure of sales offices and construction sites and cancellation of social activities, resulting in disruptions to operations.

In a May 5 note on the property sector, HLIB Research says it expects property transaction volumes in 2020 to be affected as buyers may opt to delay property purchases with the pandemic taking a toll on the broader economy. The brokerage maintained its “neutral” stance on the sector, owing to the absence of near-term catalysts to warrant a broad-based rerating in this challenging environment.

The outlook for the construction sector, however, is a little brighter. Sunway Construction Group Bhd (SunCon) reported a 47% y-o-y decline in its 1QFY2020 net profit to RM16.4 million, which was largely due to the imposition of the MCO, but analysts are still sanguine on the stock, with Kenanga Research upgrading its call on SunCon to “outperform”, with a target price of RM2.45.

“SunCon’s 1QFY2020 results disappointed due to slower-than-expected work progress on the back of running fixed costs during the MCO period. While we cut our FY2020 estimated core net profit by 43% by deferring revenue recognition, we remain undeterred by the weak results and upgrade SunCon to ‘outperform’ as we anticipate an impending sector rerating once the government pivots its focus to construction to lead an economic recovery,” the firm says.

MIDF Research also maintained its “buy” call on SunCon with a target price of RM2.26.

YTD, SunCon’s share price has appreciated by 2% to RM1.95, giving it a market cap of RM2.5 billion.

 






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