ZLBT Bursa Malaysia Quarterly Market Views

1Q 2011 Market Review >>> We started 2011 with a bang as strong momentum from 4Q 2011 continued in the new year. FBMKLCI surged to an all-time high of 1,576.42 in January amid much optimism of a sustained global economic recovery, and positive domestic news flow from the implementation of Economic Transformation Programme (ETP) as well as the widely expected general election later this year.

Since then, two unexpected external events (referred to as “black swan events” have occurred which sent jitters to the market. The first was the conflict in the MENA (Middle East and North Africa) region in January which was followed by the earthquake and tsunami in Japan in March. The FBMKLCI sunk to its lowest point of 1,484.14 on 15 March, representing a 5.7% retracement from recent peak before closing 1Q11 1.7% higher at 1,545.13.

In terms of market movers, 16 out of the 30 FBMKLCI component stocks ended the quarter in positive territory. The top 3 gainers by index points were Petronas Chemical, Malayan Banking and DiGi, while the top 3 losers were Tenaga Nasional, CIMB and AMMB.

In terms of regional performance, Malaysia’s 1.7% gain outperformed regional market simple average return of -0.5%. China, Korea and Hong Kong led the Asia Pacific equity markets with gains of 4.3%, 2.7% and 2.1% respectively.

Nonetheless, the breakout rally in early January did not last as concerns about rising inflationary pressures in emerging markets like Thailand, India, Indonesia, Philippines & Shanghai, and unrest in the Middle East and North Africa (MENA) region pushed the index to a low of 1,505 in January.

The fall continued in February to a year’s low of 1,474 exacerbated by external factors. The reversal of funds flow into developed markets was attributed to concerns over rising inflationary pressure and interest rates in the emerging markets, improved corporate earnings and economic landscape in the US and Europe. Spreading unrest in the MENA region compounded the downfall when the problem prolonged in Libya and created worries about unwavering strength in crude oil prices.

Sentiment appeared improved in early March when the index clawed back 55 points to 1,529. Announcement of lower jobless rate in the US and higher payroll numbers helped maintain momentum in the following days. Announcement by the PM that Malaysia will allow larger foreign ownership in local banks over and above the 30% cap, on a case-tocase basis, exemplified the Government’s market liberalization efforts and was viewed positively by investors.

Man-made Issues & "God's Wrath"

Unexpected news about China’s biggest trade deficit in seven years that came right the day after shook the market but not as bad as the calamity that struck Japan. The double whammy in the form of earthquake and tsunami that hit

Fukushima rippled through global equity markets. Investors were caught off guard and shaken by potential nuclear plant meltdown and radiation scare. Shutdown of nuclear plants that supply power crippled many industries in Japan and caused disruption in global supply chain.

February Worry : Foreign equity flows started to back paddle
The ASEAN region has been riding on the tailwind of strong foreign equity net inflows in 2010. However, since peaking in Sep 2010, foreign equity flows into the ASEAN region has declined in subsequent months. After 7 consecutive months of net inflow, it turned negative for the first time in Jan 2011. Amid uncertainty in the MENA region, sustained recovery in the developed economies and widening valuation gap between developed and emerging markets, foreign institutional investors pulled funds out of the emerging markets and into the developed markets.

The pace picked up in Feb 2011 with net outflows from the emerging market and ASEAN region amounting to USD15.4bn and USD2.1bn respectively. Malaysia was no exception when foreign fund flows turned negative in Feb 2011 with net outflows of USD0.4bn.

Despite the dark clouds of foreign equity net outflows, we believe Malaysia is relatively sheltered as net inflows into Malaysia prior to the selldown have lagged behind regional peers. This can be seen in the 32bps YTD increase in Malaysia’s country allocation to 2.95% within Asia Ex-Japan. Funds as compared to ASEAN’s 36bps decline to 17.9%.

This was also reflected by Malaysia’s market outperformance against ASEAN’s peers. There is also a silver lining for the emerging markets in the final week of March 2011. According to EPFR, although the trend of net outflow has persisted into March of this year, cautious optimism about Japan's recovery, the strength of the US economy and the possibility of a negotiated exit for Libyan leader Muammar Gaddafi have culminated into emerging market’s first net inflows of USD2.6bn in 9 weeks.

But momentum has been lost …... for now
Although market has rebounded since mid March 2011 and investors’ concern about uncertainty in the MENA region and natural disaster in Japan is dissipating, we believe Malaysian market momentum may not return in the very near term.
Despite signs of an end to foreign net equity outflow, Malaysia’s valuation is not compelling as compared to the developed markets. As of 31 Mar, the FBMKLCI was trading at CY11 P/E of 15.1x as compared to MSCI World (Developed) CY11 P/E of 13.0x. Even when compared to other markets in Asia, Malaysia is more expensive sans India (18.2x) and Japan (16.7x). Earnings growth wise, although Malaysia’s CY11 earnings growth of 11.7% exceeds regional average of 9.9%, it lags behind Indonesia (+32.7%), Australia (+24.8%), China (+23.2%), Korea (+20.0%), Taiwan (+13.8%) and Thailand (+13.4%).

The confluence of demand-pull inflation driven by strong economic growth in the emerging economies and loose monetary policies in the developed economies, and cost-push inflation driven by rising energy prices due to the conflict in the MENA region adds to the uncertainty besieging the emerging markets. All eyes will be on China in particular whether it can engineer a soft landing again. As the emerging markets are more susceptible to inflation pass through as compared to the developed markets, we believe the cautious stance on the emerging markets will likely persist until the second half of 2011.

Black swan events have became a common place of late and the question to ask is whether more of such events could occur in the near term. We are particularly concern about the Eurozone sovereign debt crisis and the potential early withdrawal of the second round of quantitative easing (QE2) in US, which will zap massive liquidity from the markets.

Maintain year end 2011 FBMKLCI target of 1,655

Taking into account our view that fundamentals of Malaysian equities is intact but external uncertainties has derailed momentum in the near term, we maintain our end-2011 FBMKLCI target of 1,655 which is premised on expected CY11 and CY12 earnings growth of 11.7% and 9.6% respectively and mid-cycle P/E valuation of 15x. Departing from our previous view of a possible extension of a liquidity driven rally, we are now ruling out such a possibility due to potentially muted foreign investors’ net inflow going forward.The benchmark index is likely to be range bound in the near term, as it digests positive news flow on the domestic front (financial sector liberalization, ETP implementation, general election etc) and potentially negative news flow on the external front (Eurozone sovereign debt crisis, escalation of the MENA crisis, early withdrawal of QE2 etc).

Of late, investors’ interest has switched from big-cap stocks to small/mid-cap stocks. This can be seen by a 77.2% y-o-y increase in trading volume of small/mid-cap stocks in the first 62 trading days of 2011 as compared to a 38.4% y-o-y increase seen in the top 100 big-cap stocks. When we compared the trading volume with the last 62 trading days in 2010, the results is even more telling. Trading volume in small/mid-cap stock has increased by 39.8% as compared to just 7.9% in big-cap stocks.

This is not entirely surprising as P/E valuation gap between big-cap and small/mid-cap stocks is now 7x as compared to the average of 3.2x since 2002. As such, we believe near term focus will very much be in the small/mid cap stocks.



STRATEGY
Given external headwinds, our strategy for 2Q 2011 is to be vigilant and defensive, sell big-cap stocks into strengths, and accumulate undervalued small/mid-cap stocks with positive medium term outlook.

Domestic events to watch out for in the next 2 quarters include (1) Sarawak elections, (2) general elections, (3) policy announcements during Invest Malaysia, and (4) further monetary policy tightening by Bank Negara Malaysia.

Oil & gas is still the clear cut sector winner
On sector weighting, we have recently downgraded aviation and construction sectors from overweight to neutral. The aviation sector is facing rising fuel costs which pose downside risk to earnings should airlines fail to fully pass on higher cost to passengers without affecting load factor. While construction sector is expected to see more news flow particularly the MRT and LRT extension projects, we believe most news flow has already been priced in. There is little positive surprise going forward. On the other hand, rising energy prices could add cost pressure to construction players.

We maintain our existing overweight calls on consumer, media, and oil & gas sectors. The latter is still the clear cut winner as more laggards start to see positive news flow in the months ahead. Examples are vessel players such as Alam Maritim which will see a revival in demand, and Perisai which benefits from M&A play.


5 Top Pick Stocks

Axiata is our top pick in the telco sector given strong growth prospects and potential upside surprises in dividend payments. Valuations are not demanding, given that earnings are still expected to grow strongly.


AirAsia is a longer term play given expected near term share price weakness due to rising fuel costs. Investors should accumulate on weakness as the low cost carrier is set to benefit from stronger passenger traffic growth and rising revenue per passenger. Earnings CAGR of 10% expected over the next 3 years. CY11 P/E of 7.4x is still undemanding when compared to Tiger Airways which currently trades at 11.6x CY11 P/E.


SapuraCrest has one of the strongest orderbooks within the oil & gas sector due to the award of the 11 PSC umbrella jobs which spans 5 years and will contribute some RM1.5bn in revenue per annum. Given recovering job flow in the industry and several new deepwater fields slated for development, we do not see SapuraCrest running short on jobs. The group is now in a net cash position which would allow them to gear up for M&A opportunities.


Sunway Holdings is our preferred entry into the enlarged Sunway group upon the merger of Sunway Holdings with Sunway City. The combined entity will become the 3rd largest property developer by market capitalisation. Based on our combined earnings estimates for both entities, valuations of the enlarged Sunway group will be less than 10x P/E as compared to P/E in excess of 20x for the top 2 developers i.e. UEM Land and SP Setia.


Alam Maritim is a laggard among oil & gas stocks. The worst is already behind the group following the write-down of debt due from Vastalux. Demand for vessels is at an inflexion point as development activities pick up pace. Rates are also expected to rise. Alam is our preferred vessel demand recovery play as valuation is compelling vis-à-vis other vessel players.

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