Budget Market Focus. Boost for small- and mid-cap stocks. Malaysia Equity Research 21 Oct 2016 KLCI : 1,669.98

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1 Malaysia Equity Research 21 Oct 2016 Refer to important disclosures at the end of this report Boost for small- and mid-cap stocks in line with expectations, given the limited fiscal headroom Key takeaways: Positive for small- and mid-cap stocks; negative for property sector FBMKLCI earnings to rebound by 9.2% in 2017 but risk of disappointment remains Stay cautious ahead of external headwinds in 4Q; maintain end-2016 target of 1,700 No surprises amid fiscal constraint. springs no major surprises as the federal government continues to be restrained by its fiscal limitation although the rebound in crude oil prices will boost revenue prospects in There is ongoing emphasis on lifting the well-being of the lower income group and small- and medium-sized enterprises (SME). Impact on equity market. While the focus of is on the lower income group and SME, one positive takeaway for the Malaysian equity market is the allocation of up to RM3bn by government-linked investment companies to external fund managers to invest in small- and mid-cap companies. On the other hand, there is one notable negative for the property sector as high-end developers will be impacted by the 1% increase in stamp duty for the transfer of properties priced more than RM1m. Equity strategy. Looking beyond, we expect an earnings recovery in 2017 following three consecutive years of weak corporate earnings growth. We estimate FBMKLCI 2017 earnings growth of 9.2% from -0.5% in Having said that, with PE valuation at 15.8x which is slightly higher than mean, the market has already priced in such earnings recovery despite concerns that earnings disappointment may continue, particularly for banks (rising credit costs) and telcos (margin erosion). We maintain our end-2016 target of 1,700 based on bottom-up valuation and advise investors to remain cautious given the headwinds in 4Q such as anticipated Fed rate hike and uncertainty over the US presidential election. We continue to favour stocks with strong earnings visibility. Our big cap picks are TNB, PBK, HLBK and GAM which have good earnings visibility and decent upside potential. For alpha generation, we prefer small- and mid-caps such as INRI, SCG and SKP. Top dividend picks are CMMT and SREIT. KLCI : 1, Analyst Bernard CHING bernard@alliancedbs.com Malaysian Research Team general@alliancedbs.com Market Key Data (%) EPS Gth Div Yield 2015A F F (x) PE PB 2015A F F Source: AllianceDBS STOCKS Source: AllianceDBS, Bloomberg Finance L.P. Closing price as of 21 Oct 2016 Price Mkt Cap Target Price Performance (%) RM US$m RM 3 mth 12 mth Rating Tenaga Nasional , BUY Public Bank , BUY Hong Leong Bank , (3.5) BUY Gamuda , BUY Sunway REIT , BUY Inari Amertron Bhd BUY CapitaLand Malaysia (3.1) 9.2 BUY Sunway Construction BUY Group SKP Resources Bhd BUY Refer to important disclosures at the end of this report ed: CK / sa: WMT

2 highlights Issue / sector Budget proposals Impact / view Federal government revenue Excluding 2017 budget measures, projected to increase by 3.4% to RM219.7bn in 2017 (GDP forecast 4.0%-5.0%), largely due to higher collection of corporate tax (+9.5% to RM69.2bn). GST collection is anticipated to generate RM40bn, marginally higher than RM38.5bn expected in Oil-related revenue contribution to overall revenue is expected to fall to 13.8% (2016: 14.6% of total revenue). Federal government Excluding 2017 budget measures, projected to increase by 3.7% to RM214.8bn. operating expenses However, operating expenditure (opex) as a % of GDP will narrow to 16.2% in 2017 (2016e: 16.8%). Emoluments and retirement charges (46.1% of opex), debt service charges (13.4%) and supplies and services (14.9%) are the largest spending components. Federal government Excluding 2017 budget measures, development expenses are projected to increase by development expenses RM1.0bn to RM46.0bn from last year. The transport sector (23.0%) is given the largest allocation, up from 18.7% in Fiscal deficit Fiscal deficit is expected to be narrowed to 3.0% of GDP, from 3.1% in 2016 (3.2% in 2015). GDP growth Official GDP growth estimated at 4.0%-5.0% in 2017 (AllianceDBS: 4.4%). Private consumption to grow 6.3%, slightly higher than 6.1% expected in Corporate and individual income taxes will cumulatively make up 45.1% of revenue; sluggish domestic macro outlook could pose downside risks to tax collections Limited room for further operating expenditure cut as subsidies as a % of opex is expected to narrow to 10.4% in 2017, down from 12.6% in 2015 Allocation for infrastructure development projects outlined in 11MP and Economic Transformation Programme However, fiscal deficit value is expected to be higher at RM40.3bn (2016e: RM38.7bn) Private consumption (54.2% to GDP) to be the driver of economic growth Individuals tax reliefs The purchase of reading materials, computers, smartphones, tablets and sports equipment to be combined as the lifestyle tax relief up to RM2,500 per year New tax relief up to RM1,000 for purchase of breastfeeding equipment Tax relief of up to RM1,000 for parents who enrol their children aged six years and below, into registered nurseries and preschools. Not enough to boost consumption but definitely can ease the financial burden for B40 Incentives for SMEs For all SMEs, the tax rate on chargeable income up to the first RM500,000 is reduced from 19% to 18% effective from year of assessment 2017 RM15bn allocation for the various schemes under Syarikat Jaminan Pembiayaan Perniagaan (SJPP) to be extended till % rebate on interest rates for export-oriented SMEs under Syarikat Jaminan Pembiayaan Perniagaan (SJPP) Scheme limited to RM100m for a period of five years (capped at RM1bn) Tiered tax cut for SMEs: 1) One percentage point for increase in chargeable income of 5% to below 10% 2) Two percentage point for increase in chargeable income of 10% to below 15% 3) Three percentage point for increase in chargeable income of 15% to below 20% 4) Four percentage point for increase in chargeable income of 20% These incentives will help to promote the development of SMEs and drive private investments Page 2

3 highlights (cont d) Issue / sector Budget proposals Impact / view Construction Although not entirely a new project, the only major upside for the listed contractors was the East Coast Rail Line project costing RM55bn. The project will likely be implemented in phases and will connect Klang Valley to the East Coast. It will span 600-km rail and will connect townships such as Port Klang, ITT Gombak, Bentong, Mentakab, Kuantan, Kemaman, Kerteh, Kuala Terengganu, Kota Bharu and ends in Tumpat. According to SPAD's website, an RFI was launched on 15 March 2016 and closed on 27 May This project has received more media attention of late where there is speculation that it will be awarded to a Chinese company. But even if this happens, we expect the local contractors to take on meaningful subcontracting roles. An added plus for the listed companies. Gamuda, IJM and Suncon as well as contractors for MRT and LRT projects are key beneficiaries of railway projects The government reiterated its commitment towards the Pan Borneo Highway in Sabah and Sarawak. Most of the packages for the Sarawak portion have been awarded while for the Sabah portion, tenders would likely happen in 1H17. Apart from these mainstream projects, there was mention of other projects such as: 1 ) RM1.2bn to build a total of 616km of village roads and bridges 2) RM4.6bn to maintain state roads in all states Our top picks are Gamuda and Suncon as key proxies to the transportation-led infrastructure theme. Both have peak orderbooks which should ensure steady earnings delivery 3) Upgrading of Jalan Lok Kawi - Pengalat - Papar, Sabah; Jalan Kampung Keruak - Gua Musang - Kuala Berang; construction of Batang Lupar Bridge, Sri Aman; and the reconstruction of Sandakan Power Station Project. This is to stimulate private investment. No specifics were given 4) RM2.1bn for the five economic corridors Iskandar Malaysia, NCER, ECER, SDC, SCORE Consumer 2017 allocation for BR1M is increased by 15.2% y-o-y to RM6.8bn: 1) RM800 financial assistance for households with monthly income of between RM3k and RM4k 2) RM1,200 financial assistance for households with monthly income of <RM3k 3) RM450 financial assistance to single individuals with monthly income of <RM2k 4) Bereavement Scheme will be extended with the RM1,000 compensation given to the next of kin of BRIM recipients for households and the elderly category RM132m is provided to improve access to preschool education in government schools for free Schooling assistance of RM100 each for students from households with monthly income up to RM3k RM1.1bn to include additional assistance payment for school fees, textbook assistance and per capita grant assistance RM250 1Malaysia Book Voucher Programme will be replaced with student debit card worth RM250, which can be used to purchase books, computer accessories and Internet access Financial assistance for poor families, including general assistance of up to RM300/month and children assistance of up to RM450/month Special assistance of RM500 to all public servants, while special payment of RM250 for government retirees As a whole, we believe that this budget will be mildly positive to the consumer sector as the initiatives outlined will help to offset the impact of rising cost of living Page 3

4 highlights (cont d) Issue / sector Budget proposals Impact / view Healthcare Build new hospitals and clinics in Perlis, Kuching, Mukah, Jempol, Muar and Johor Bahru. Total allocation of RM15.96bn Upgrade hospital facilities with an allocation of RM536m Allocate RM4.5bn for the operations of 340 1Malaysia Clinics, 11 1Malaysia Mobile Clinics, 959 health clinics and more than 1,800 existing rural clinics Allocate RM4bn for supply of drugs, consumables, vaccines and reagents to all government hospitals and health facilities Cooperate with the private sector or NGOs to operate non-profit charitable hospitals based on government hospital rates. A total of RM20m is allocated in the form of loans for the purchase of hospital equipment One-off grants worth RM200k for purchasing equipment for private haemodialysis centres, with total allocation of RM40m The National Community Health Empowerment Programme will be expanded to prevent and control contagious disease such as dengue and Zika. These programmes involve an allocation of RM80m The budget will ease the mid-lower income group's need for healthcare, however, demand still outweigh supply and the mid-affluent will still seek private providers for immediate treatment. Property Ministry of Urban Wellbeing, Housing and Local Government (KPKT) to build 9,850 houses under People s Housing Programme (PPR) with RM134m allocation Provide government s vacant lands at strategic locations to government-linked corporations and PR1MA to build more than 30,000 houses priced between RM150k and RM300k Build around 10,000 houses in urban areas for rental to eligible youths with permanent job including young graduates entering labour market SPNB to build 5,000 units of People s Friendly Home (PMR) with RM200m allocation. Step-up end-financing scheme for PR1MA programme effective 1 Jan 2017 Stamp duty exemption on instruments of transfer and housing loan instruments for first home priced below RM300k increased to 100% from 50% at present Stamp duty on instruments of transfer of real estate worth >RM1m increased to 4% from 3% effective 1 Jan 2018 Complete 30,000 units of 1Malaysia Civil Servants Housing (PPA1M) priced between RM90k and RM300k No clear benefit for property developers Plantations Allocation of RM286m to increase the exports of palm oil, rubber, cocoa and pepper Allocation of RM50m to conduct scientific research to enhance the quality of palm oil products Grant of RM30m through MPOB (Malaysian Palm Oil Board) for smallholder replanting RM20m for estate road upgrades for palm oil smallholders Minimal impact expected for corporates as proposals are directed towards smallholders and long-term outcomes (replanting, research). While it was not revealed how the allocation will be used to increase exports, there may not be material benefit to larger palm oil players, especially since it is shared among several other agricultural products Page 4

5 highlights (cont d) Issue / sector Budget proposals Impact / view Telecom Effective January 2017, fixed-line broadband service providers will offer services at a higher speed for the same price Within the next two years, there would be reduction in broadband prices by up to 50% RM1bn will be provided by MCMC to ensure that the coverage and quality of broadband nationwide reaches up to 20Mbp Minimal impact to TM. Prices reduction could refer to new affordable packages being introduced Source: Budget Speech / Economic Report 2016/2017 Page 5

6 Key economic indicators RM m % growth RM m % growth RM m % growth Domestic Production Gross Domestic Product (constant 2010 prices) 1,062, ,107, ,159, Agriculture 94, , , Mining and quarrying 95, , , Manufacturing 244, , , Construction 46, , , Services 568, , , Per Capita Income (current prices) in RM 36, , , Federal Government Finance Revenue 219, , , Operating expenditure 216, , , Current balance 2,091 5,469 4,926 Development expenditure (net) 39, , , Overall deficit -37,194-38,727-40,344 % to GDP Prices Index % growth Index % growth Index % growth Consumer Price Index (2010 = 100) Producer Price Index (2010 = 100) Labour Thousands % growth Thousands % growth Thousands % growth Labour force 14, , Unemployed / (unemployment rate) (3.1) (3.4) 4 - (3.2) 5 1 Revised estimate, 2 Budget forecast, 3 Jan-Aug 2016, 4 Jan-Jun 2016, 5 EPU forecast Source: Economic Report 2016/2017 Federal government development expenditure by sector ( ) RM m % change % share Economic services: 23,286 27,623 25, Agriculture and rural development 3,105 2,877 2, Trade and industry 5,638 5,996 4, Transport 6,693 8,419 10, Social services: 11,161 10,812 12, Education and training 4,758 3,874 5, Health 1,442 1,481 1, Housing 2,008 2, Security: 4,754 5,041 5, General administration: 1,567 1,524 2, Total (gross) 40,768 45,000 46, % GDP Revised estimate, 2 Budget forecast Source: Economic Report 2016/2017 Page 6

7 Consumer: Mildly positive (Analyst: King Yoong CHEAH) In, the government has adopted initiatives to boost consumer spending such as (1) raising BR1M cash handouts, and (2) providing special assistance of RM500 to all public servants, with a special payment of RM250 to government retirees. As a whole, we believe that this Budget will be mildly positive to the consumer sector as the initiatives outlined will help to offset the impact of rising cost of living. As expected, there is no announcement on excise duty hike for breweries and tobacco companies. Nevertheless, we advise investors to exercise caution as we do not rule out a postbudget excise duty hike in the coming months. We believe that among the consumer stocks under our coverage universe, Sasbadi (BUY, TP: RM1.40) is the biggest beneficiary of since the government has committed to strengthen Malaysia s quality of education. The specific measures announced that we believe will benefit Sasbadi include (1) RM132m provided to improve access to preschool education in government schools for free, (2) free tablets to assist teaching to 430k teachers, (3) schooling assistance of RM100 each for students from households with monthly income of up to RM3k, (4) RM1.1bn to include additional assistance payment for school fees, textbook assistance and per capita grant assistance, and (5) implementation of student debit card worth RM250, which can be used to purchase books, computer accessories and Internet access. While the Budget is people-friendly and mildly positive for the sector, we observe that there are no significant catalysts for us to alter our Neutral stance on the sector. Oldtown (BUY, TP RM2.15) remains our pick for the sector. Property: Focusing on affordable housing (Analyst: QUAH He Wei) To address the pressing issue of home ownership being affected by skyrocketing property prices, continues to focus on the implementation of various affordable public housing projects by several government agencies including Perumahan Rakyat 1 Malaysia (PR1MA) and Syarikat Perumahan Negara Berhad (SPNB). The government will provide its vacant lands at strategic locations to government-linked corporations and PR1MA to build more than 30,000 houses priced between RM150k and RM300k. A special step-up end-financing scheme for the PR1MA programme under the collaboration of the government, Bank Negara, Employees Provident Fund and four local banks (Maybank, CIMB, RHB and AmBank) will be provided to encourage home ownership. Also, stamp duty exemption for first-home buyers will be increased to 100% from 50% at present for properties worth <RM300k from 1 Jan 2017 to 31 Dec However, stamp duty on instruments of transfer of real estate worth >RM1m will be increased to 4% from 3% effective 1 Jan 2018 which may result in weaker demand for high-end properties priced above RM1m. There is no clear incentive for private developers in to tackle the relatively weaker property market in Malaysia which has witnessed weaker take-ups and slower loan approvals. Developers have been facing difficulty in converting their initial high bookings to sales because of stricter bank lending, as banks get more cautious towards the property sector despite keen interest by potential home buyers. We have a Neutral stance on the Malaysian property sector. Unbilled sales remain healthy for most of the developers under our coverage, thanks to robust property sales over the past 2-3 years. We continue to like developers with large exposure to affordable housing and landed residential properties, which are still seeing resilient demand. We reiterate our BUY rating for Matrix Concepts (TP: RM3.20), MKH (TP: RM3.20) and Eco World (TP: RM1.50). Page 7

8 Telecom: Government committed to improve broadband quality (Analyst: TOH Woo Kim) Effective January 2017, fixed-line broadband service providers (i.e. TM and TIME) will offer services at a higher speed for the same price. Citing an example, a current subscriber of 5Mbps package at RM149 (TM s old entry-level package) will enjoy an increase in speed to 10Mbps starting next year. It is also mentioned that there will be a reduction in prices by up to 50% within the next two years. Raising broadband speed for subscribers will only lead to minimal incremental costs, and we believe this would not materially affect TM (BUY; TP:RM7.50). In fact, we are aware that TM has actually been doing this for quite some time, giving free speed upgrade to selected Unifi subscribers who meet certain criteria (i.e. >30 months tenure, good payment record, etc.). While it may appear negative, there is still a lot of ambiguity regarding the price reduction by up to 50% within the next two years. We think TM could possibly introduce new affordable broadband packages, but these usually come with limitations. For example, back in 2015, TM introduced an affordable RM38 Streamyx plan, which is 57% cheaper than the standard RM88 plan but comes with a data quota of only 1GB. Apart from that, it was also announced that RM1bn will be provided by the Malaysian Communications and Multimedia Commission (MCMC) to ensure that the coverage and quality of broadband nationwide reaches up to 20Mbps. We think this could be either part of the RM1.2bn allocation for rural broadband projects (announced in Budget 2016) and/or part of the HSBB2 and SUBB projects that were already been awarded to TM. Page 8

9 DISCLOSURE Stock rating definitions STRONG BUY - > 20% total return over the next 3 months, with identifiable share price catalysts within this time frame BUY - > 15% total return over the next 12 months for small caps, >10% for large caps HOLD - -10% to +15% total return over the next 12 months for small caps, -10% to +10% for large caps FULLY VALUED - negative total return > -10% over the next 12 months SELL - negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame Commonly used abbreviations Adex = advertising expenditure EPS = earnings per share PBT = profit before tax bn = billion EV = enterprise value P/B = price / book ratio BV = book value FCF = free cash flow P/E = price / earnings ratio CF = cash flow FV = fair value PEG = P/E ratio to growth ratio CAGR = compounded annual growth rate FY = financial year q-o-q = quarter-on-quarter Capex = capital expenditure m = million RM = Ringgit CY = calendar year M-o-m = month-on-month ROA = return on assets Div yld = dividend yield NAV = net assets value ROE = return on equity DCF = discounted cash flow NM = not meaningful TP = target price DDM = dividend discount model NTA = net tangible assets trn = trillion DPS = dividend per share NR = not rated WACC = weighted average cost of capital EBIT = earnings before interest & tax p.a. = per annum y-o-y = year-on-year EBITDA = EBIT before depreciation and amortisation PAT = profit after tax YTD = year-to-date Page 9

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