MARKET STRATEGY. Portfolio de-risking ahead of GE13

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1 MARKET STRATEGY 28 November 2012 Portfolio de-risking ahead of GE13 Benny Chew, CFA Rationale for report: Market strategy Investment Highlights In the near term, we are taking a guarded approach on the market because the passage of time to the 13 th General Election (GE13) is closing in: GE13 must be held by June The perceived uncertainty over the outcome of GE13 with the associated aversion to risks would trigger a tactical shift in asset allocation leading to a trimming of exposure to equity. Portfolio de-risking would cast a downward bias on the market as fundamentals take a backseat in the run-up to GE13. Our sense is that the domestic portfolio funds would now be selling into strength as opposed to buying on dips, implying that the market may drift lower in the coming months. This de-risking maneuvering means that the domestic institutional funds would be cashed up relative to benchmarks moving into 1Q The redeployment of freed capital would primarily depend of the outcome of GE13. Our base case scenario is that the Barisan Nasional (BN) coalition government would be returned to power. The uncertainty is whether the BN would secure a stronger mandate compared to the previous General Election in A reduced majority in the 2008 General Election was a negative surprise. It led to a steep sell-down: the market collapsed by 9.5% in the immediate aftermath before rebounding. Although a weaker mandate this time around would still be a disappointment, it may not pose that big of a shock particularly with the market already retracing ahead of GE13. As it is, our yield gap analysis (earnings yield less 10-year MGS yield) shows that the market s yield gap has widened to its five-year average of 3% (peak: 1.6%), and may continue to expand on further index weaknesses given the current indiscriminate sentiment-driven selling. Therefore, the eventual removal of election overhang post GE13 should precipitate a market recovery as risk aversion eases to drive equity reweighting of domestic portfolios. This would be the primary valuation driver as domestic institutional portfolios account for more than 50% of trades on the exchange, with foreign institutional funds at circa 25%. Foreign ownership has inched up to just 23.6% (January 2012: 22.4%) despite incremental net buyings for most parts of this year. The foreign ownership stood at 27% in January 2008 before the onset of global recession. YTD, Malaysia has underperformed its ASEAN peers, rising by 5% compared to 27%, 25%, 14% and 13% for the Philippines, Thailand, Indonesia and Singapore; respectively. On the flipside, this relative underperformance also underscores prospects of outperformance post GE13 because its premium valuation has narrowed. The greater clarity on the continuation of growth policies embedded in the ETP may spur stronger foreign interests. Under our base case scenario, we set our end-2013 fair value for the FBM KLCI at 1,770 based on an unchanged trend-average PE of 15x but with earnings rolled over into The potential upside is about 10% from current the index level of 1,600. Corporate earnings are projected to expand by 11.5% in 2013 (2012: 10%). The key assumption under our base case is that macro fundamentals would hold up: GDP growing by 5% in a somewhat low inflation environment (2-3%) in Thus far, domestic demand looks resilient with private consumption and investment spending acting as a cornerstone for growth. The swing factor on the downside is on the external scene where lingering top-down concerns over the EU, the US and China may reassert themselves on valuations particularly when the liquidity boost from QE3 runs its course. Our investment thesis centres on stock selections. We are just starting to see a distinct disconnect between share prices and valuations, particularly in select sectors/stocks construction, building materials, property, oil & gas, CIMB, that are perceived to be impacted in some ways by the outcome of GE13. Despite the apparent value trap from the ongoing tactical sell-down, our guiding principle in stock selections is franchise value where companies would emerge from GE13 relatively unscathed regardless of the political landscape. Construction stocks have been de-rated, with valuations already at trough levels due to concerns about job flows. We retain our BUYs on IJM and Gamuda because of their entrenched market positioning. Capex spending in infrastructure roads, railway and MRT should reaccelerate to kick-start previously delayed projects post GE13. We expect more concrete newsflow on the new MRT 2 and 3 lines where a firm decision could be made by end-1q13 ahead of the project rollout by end Other catalytic projects include Langat 2 WTP, Gemas-JB double tracking, West Coast Expressway, Tun Razak Exchange, and RRIM Sg.Buloh Redevelopment. Mah Sing s ascendancy as a liquid proxy to the property sector would not be derailed by the outcome of GE13 given its entrepreneurial spirit, slick execution track record, brand equity and strong residential presales. PP 12246/05/2013 (032379)

2 As in previous market downturn, share buy-backs are gaining traction. Most notably, Ann Joo Resources (AJR) has bought back some 23m shares in recent months. Admittedly, its earnings outlook is somewhat clouded by uncertainty over steel prices. We believe that the market may have under-appreciated the strategic importance of its blast furnace plant the second blast furnace plant in ASEAN. Despite the near-term earnings headwinds, we believe that valuation has bottomed from the assets perspective. At RM1.33/share currently, AJR is trading at just 0.7x PB, even below its previous trough of 0.9x PB in Lafarge Malayan Cement (Lafarge) is a BUY in view of the strong prospects of high dividends, with the company just turning debt-free. We expect CPO prices to recover in 2013F underpinned by draw-down of inventory and a large price discount to soybean oil. We believe that palm oil exports would be supported by the revised export tax rate system in Malaysia and soft soybean production in the US. The revised export tax rate system in Malaysia, which would be implemented from 1 January 2013 onwards, would give upstream players more options to sell their CPO. Upstream players would be able to export their CPO apart from selling them to the local refiners. Although soybean production in South America is expected to expand, this would only come from 2Q2013 onwards. As such, importers would have to buy more palm oil in the meantime due to the shortage of soybean from the US. We like Genting Plantations for the strong volume of FFB production coming from Indonesia. The group would record a double-digit percentage expansion in FFB output in Indonesia in FY13F on the back of an increase in mature areas. For the group, we expect FFB production growth of 20% in FY13F after a 3% deficit in FY12F. The banks leading loan indicators have remained slow in the past few months, both from the household and corporate segments. We foresee loans growth to taper off slightly to 8.0% in 2013, from 10.1% in The latest bank results indicated that earnings were boosted by impaired loan recoveries. Our top pick is RHB Cap, given its cheap valuation, with the final piece of its Indonesian acquisition falling in place soon. CIMB s share price has been lacklustre but we are unmoved. CIMB has demonstrated its ability to boost regional reach with strong growth from its Indonesian bond market income and treasury activities. It also offers the most comprehensive banking infrastructure. At 1.8x PB, CIMB looks undervalued relative to its peak of 2.3x PB. Tenaga is a BUY with a DCF-based fair value of RM8.15/share. While the commencement of the Lekas regassification plant in Malacca has been deferred to June next year, the continuation of the current fuel cost sharing mechanism with Petronas and the government provides earnings visibility over the next 6 months. Also, falling global coal prices translate into a leaner cost structure, which cushions the net impact of any potential shortfall in natural gas deliveries from Petronas. And, the regulators continued support for a fuel-pass through mechanism undergirds the group s longer term margin profile in the event of any revisions in natural gas and electricity prices next year. At RM6.90/share currently, Tenaga is still trading at a depressed P/BV of 1x despite its improving operating dynamics. On the oil & gas front, the recent lull in project rollouts due to project deferrals, re-tendering exercises and design changes should fuel a pent-up resurgence of fresh contract flows post GE13. The RM8bil hook-up and commissioning umbrella contract, and over RM1bil fabrication contracts for the Malikai tension leg platform job are expected re-catalyse the sector. Next year, the rollout of the second phase of the North Malay basin gas cluster project, which will involve a large central processing platform at the Bergading field and multiple satellite well-head platforms are added-kicker to share prices. Our sense is that there would be renewed focus on RAPID, Pengerang and Tanjung Piai in Johor. We are cognisant of the high valuation of the oil & gas stocks. But given an accelerating capex cycle at all points of the value chain, newsflow momentum would continue to be strong. PE would remain elevated. Our top pick is SapuraKencana Petroleum, which will be completing its value-accreting and growth transforming acquisition of new tender rigs early next year. We also like Dialog Group, which is set to refuel its growth trajectory with its recent 50%-equity participation in the US$1.2bil Bayan enhanced oil recovery project. Benalec is a cheaper proxy to the oil & gas sector. It has been awarded the concession to reclaim some 3,485 acres in Tanjung Piai and 1,760 acres in Pengerang. We expect the group to secure off-takers soon which should underpin our conviction in the high development potential as an oil & gas hub on both of these sites. Glove manufacturers are turning more optimistic and expecting volume growth of 8%-10% in To cash in on this recovery in demand, the top four glove manufacturers are accelerating their capex by a further 47% in 2013 (2012: +80%). Coupled with an improving operating environment, we expect EBITDA margins to continue expanding going forward. We like Top Glove as its position as the largest and purest natural rubber glove manufacturer makes it the prime beneficiary of easing latex prices. With high industry operating leverage, the enlarged revenue base will ensure profits continue on an upward trajectory. Top Glove is currently trading at an undemanding PE multiples of 15x to 16x FY13F and FY14F earnings, midway its 4-year historical PE band. Our fair value of RM6.50/share is based on a higher target PE of 19x FY13F EPS (0.5SD above its mean). AmResearch Sdn Bhd 2

3 Despite the recent sell-down on telco stocks, we remain NEUTRAL on the sector given rising regulatory risks and on-going competitive pressure in the market. More importantly, we see rising earnings risks, as the fight for market share in a relatively mature telco market is starting to impact service pricing. Telekom remains a HOLD given that it is most at risk from a regulatory standpoint; in particular, broadband access pricing. Our projections (as well as consensus, we believe) have yet to factor in risks on this front. DiGi remains a SELL as its key segments are most at risk of competition from Maxis and U-Mobile, while valuation remains elevated at 11x FY13F EV/EBITDA. Our only BUY is Axiata for potential acquisitive growth and successful execution of voice resuscitation. Axiata also stands to surprise on the dividend front, while valuation remains very attractive at 6x FY13F EV/EBITDA, relative to the sector average of 9x. We maintain NEUTRAL on REITs given the significant yield compression and rich valuation. The yield spread over the 10-year government bonds for the Malaysian retail REITs has now narrowed to 150bps, versus 380bps in Singapore. At current levels, the yield for both CapitaMall Trust and Pavilion REITs are just a tad above 5%, which is even lower than CapitaMall Trust Singapore s distribution yield of 5.4%. Furthermore, the risk free rate in Singapore is lower than Malaysia. Our top pick is PavREIT (HOLD, FV: RM1.33/unit) underpinned by a strong pipeline of assets likely to kick-in as early as FY14. This is also justified by the recent launch of Fashion Avenue and 67% of NLA up for renewal next year to lift rentals. Dividend yield is estimated at 4.5% and 5.3% for FY12F and FY13. We believe transformational growth is also taking place in UMW and MBM. The former is fast morphing into a dominant oil & gas player with the associated lift to PE. MBM is emerging as a major autoparts maker, having completed its acquisition of air-bag player Hirotako and establishing an alloy wheel plant. Its associate, Perodua, is doing well. Assembly JVs may be next. We like the casino sector for its resilient profitability. Between Genting Bhd and Genting Malaysia (GenM), we prefer the latter for its earnings visibility and growing overseas positioning. In Malaysia, GenM s earnings are expected to be driven by growth in VIP patronage from China. In the longer-term, the expansion of First World Hotel, which would be completed at end-fy14f, would underpin profits in Malaysia. Newsflow for GenM would come in the form of casino liberalisation in Miami and New York. Lawmakers are envisaged to start debating on the legislation of casinos in Miami and decide on the number of full-fledged casinos allowed in New York in early GenM already has a head-start in both jurisdictions due to its purchase of properties in Miami and operations of Resorts World New York in Queens. GenM also has a healthy balance sheet as reflected in its net cash of RM967mil as at end-dec AmResearch Sdn Bhd 3

4 TABLE 1 : AMRESEARCH S PICK OF THE BUNCH Stock Rating Share price (RM) Fair value Mkt Cap. EPS (sen) PE (x) P/B (x) Div yield (%) as at 27 Nov 2012 (RM) (RM bil) FY12 /13F FY13/14F FY12 /13F FY13/14F FY12 /13F FY12 /13F FY13/14F IJM Corporation* BUY Ann Joo Resources BUY Lafarge Malayan Cement BUY 9.60 UR ** Tenaga Nasional* BUY Axiata Group BUY RHB Capital BUY Genting Malaysia BUY UMW Holdings BUY Benalec Holdings* BUY Mah Sing Group BUY SapuraKencana Petroleum* BUY Top Glove Corporation* BUY * Estimates are for FY12/FY13F and FY13/14F ** UR - under review Source: Company data, Bloomberg, AmResearch TABLE 2 : VALUATION AND GROWTH METRICS - MARKET AND SECTORS UNDER COVERAGE SECTORAL WEIGHTING (%) EPS GROWTH (%) PER (X) 2011 A 2012 F 2013 F 2011 A 2012 F 2013 F ALL SECTORS FBM 1, as at 27 Nov AUTOMOBILES 1.6% (7.7) FINANCIAL SERVICES 24.2% BUILDING MATERIALS 0.9% (13.9) CONGLOMERATES 9.1% CONSTRUCTION 1.8% CONSUMER 4.5% GAMING 6.1% (13.9) (8.4) HEALTHCARE 2.7% n/a n/a INFRASTRUCTURE 0.5% MANUFACTURING 0.5% (22.5) MEDIA 0.7% OIL & GAS 13.7% PLANTATION 6.8% 27.1 (9.9) POWER 4.5% (9.6) PROPERTY 3.7% SERVICES 0.2% TELECOMMUNICATION 15.0% TIMBER 0.4% 72.9 (4.6) TRANSPORTATION & LOGISTICS 3.0% (71.1) > UTILITIES 0.1% < < (16.2) Source: Company data, AmResearch AmResearch Sdn Bhd 4

5 CHART 1 : FBM KLCI GENERAL ELECTION 2008 Source: Bloomberg, AmResearch CHART 2 : MARKET S YIELD GAP EARNINGS YIELD LESS 10-YEAR YIELD ON MALAYSIAN GOVERNMENT BOND 12.0 Oct-08, 10.3 Jan-09, /Forward PE, 6.5 Yield (%) % 5.9% Oct2012: 3% Oct-08, 4.3 Jan-09, yr MGS yield, Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Source: Bloomberg, AmResearch AmResearch Sdn Bhd 5

6 30.0 CHART 3 : FOREIGN OWNERSHIP RATIO ON BURSA MALAYSIA (%) Source: Bursa Malaysia CHART 4 : FOREIGN INSTITUTIONAL TRADES ON BURSA MALAYSIA Buy value Sell value (RM bil) Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Source: Bursa Malaysia AmResearch Sdn Bhd 6

7 CHART 5 : LOCAL INSTITUTIONAL TRADES ON BURSA MALAYSIA 25.0 Buy value Sell value (RM bil) Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Source: Bursa Malaysia TABLE 3 : INDEX PERFORMANCE OF REGIONAL MARKETS Country Market For the 3 months to YTD Nov 2012 (%) 23 Nov 2012 (%) Malaysia FBMKLCI Index Indonesia JCI Index Singapore FSSTI Index Thailand SET Index Philippines PCOMP Index Korea KOSPI Index Taiwan TWSE Index Hong Kong HSI Index China - Shanghai SHCOMP Index Source: Bloomberg, AmResearch AmResearch Sdn Bhd 7

8 Published by AmResearch Sdn Bhd ( P) (A member of the AmInvestment Bank Group) 15t h F l oor B a ng un an A m B a nk Gr ou p 55 Jalan Raja Chulan Kuala Lumpur Tel: ( 03) ( re sear c h) F a x: ( 03) Printed by AmResearch Sdn Bhd ( P) (A member of the AmInvestment Bank Group) 15t h F l oor B a ng un an A m B a nk Gr ou p 55 Jalan Raja Chulan Kuala Lumpur Tel: ( 03) ( re sear c h) F a x: ( 03) The information and opinions in this report were prepared by AmResearch Sdn Bhd. The investments discussed or recommended in this report may not be suitable for all investors. This report has been prepared for information purposes only and is not an offer to sell or a solicitation to buy any securities. The directors and employees of AmResearch Sdn Bhd may from time to time have a position in or with the securities mentioned herein. Members of the AmInvestment Group and their affiliates may provide services to any company and affiliates of such companies whose securities are mentioned herein. The information herein was obtained or derived from sources that we believe are reliable, but while all reasonable care has been taken to ensure that stated facts are accurate and opinions fair and reasonable, we do not represent that it is accurate or complete and it should not be relied upon as such. No liability can be accepted for any loss that may arise from the use of this report. All opinions and estimates included in this report constitute our judgement as of this date and are subject to change without notice. For AmResearch Sdn Bhd Benny Chew Managing Director AmResearch Sdn Bhd 8