Singapore Market Monitor - 2016 Innings Close: Grinding Towards a Recovery
Another weak quarter but the inflection seems near
- Cumulative revenue, EBITDA and core profit for our coverage universe fell for q/e Dec 2016.
- The only bright spot was the lower ratio of forecast cuts to upgrades in the past couple of quarters, a trend mirrored in slowing overall FSSTI index growth cuts, suggesting we may be near the end of the earnings downgrade cycle.
- One-year forward index PE at 14.4x is not compelling in a historical context (3yr av. 13.7x; 5yr av. 12.8x) with a sluggish earnings recovery outlook and high external vulnerability of the market. Hence our key 2017 stock picks have a defensive bias and a preference for secular over cyclical drivers.
Little to trumpet for q/e
- Dec-16 Revenue for our coverage fell for the fifth consecutive quarter by -2%.
- EBITDA fell by -8%, while core profit, at -7%, continued a four-quarter declining streak. Overall margins were down both YoY and QoQ too with banks and telcos adding to the expected poor industrials sector performance. The easy gains of cost management initiatives of the corporate sector seem to be behind us.
- The Straits Times Index (FSSTI) basket fared better at -4% core profit decline and a modest +3% growth if excluding the Jardine Group companies.
On flipside, expectations appear to be bottoming
- Around 16% of our coverage beat our expectations, 62% were in line and 22% missed – a somewhat better ratio than seen in the prior quarter (4%/69%/27%).
- We raised forecasts for 16% of companies and downgraded 27%, also comparatively better than the prior quarter (9%/33%).
- For FSSTI, the 12M forward earnings outlook has been on a slippery slope since 2015, but we note that the extent of downgrades in the past two quarters has been much lower in quantum and the current 2017 earnings expectation level is close to 3-year lows. We believe the downgrade cycle will plateau in 2017 and the index should witness a modest growth recovery from the current low base (consensus FSSTI core profit forecast at c9%; MKE coverage at 11%).
Key hits, misses, stock outlook change
- On a sector basis the quarter could be broadly characterised by the following:
- Agricommodities performed even better than our (and the market’s) bullish expectations, driven by post La Nina better output and strong CPO price.
- Telecoms generally disappointed despite our (and the market’s) already cautious view on rising competitive intensity to lock in customers ahead of commencement of operations by the fourth operator.
- Financials were generally in line with our expectations (but disappointed the market) on not being able to benefit from loan growth and a rising interest rate environment. While the tail risk of further write-downs and NPA increase did not materialise, we believe the market was negatively surprised by the increase in credit costs in the quarter.
- Industrials posted a mixed bag of results - O&M-related stocks generally disappointed already low expectations but transport and aviation services performed slightly better than expected.
- Property developers were generally in line with our expectations as well as the market with the exception of Capitaland, which positively surprised. For property REITS, barring a minority comprising a couple of stocks, results were generally in line with our and market expectations.
- Consumer results were in line with our and the market’s modest growth expectations. The one surprise in this space was Genting Singapore’s dividend payout of over 100% and management indication that the company was confident of maintaining the absolute dividend level despite the challenging operating environment.
- Healthcare performance was generally in line with the exception of Q&M Dental Group, which disappointed both market and our expectations due to escalating cost associated with operations integration in China.
- We have downgraded ratings for five stocks and upgraded one. We detailed below the key profit forecast beats and misses (where more than 5% variance and with at least 2 quarterly consensus estimates) as well as the specifics of the six rating changes.
Grinding towards a recovery
The macro is looking somewhat better than a quarter ago
- Our 2017 GDP growth forecast is 2.5%, upgraded in Jan-17 from the previous 1.8% outlook from fairly broad-based better-than-expected 4Q16 performance.
- Singapore’s Ministry of Trade and Industry maintains its 2017 GDP growth guidance in the 1-3% range. Our growth outlook however is hostage to the external uncertainties of de-globalisation, which hold higher risks for open trade driven economies like Singapore. In a de-globalisation scenario, we believe while traditional merchandise trade will expectedly be vulnerable, services trade, which is a large segment in the economy, could remain quite resilient.
- Separately, the 2017 budget presented in Feb-17 was somewhat of a non-event for immediate implications to the corporate sector. That said, the government’s emphasis on skills upgrading, technology adoption and improving regional competitiveness of the workforce could likely see some benefits over the medium 2-3 year term in our view.
Preference for secular over cyclical growth
- Our 2017 market outlook and strategy is unchanged from that elaborated in our note ‘Singapore Market Monitor: Slow Grind or Slow Burn, 13 Dec 2016’.
- Against the backdrop of modest economic growth and market earnings growth expectations, external policy uncertainties (and resultant currency volatility) and uncompelling market valuations, we have a bias towards steady businesses demonstrating relatively high cash flow resilience, low or declining capex requirements and benefitting from secular growth trends. While we have elaborated on our relative sector weightings below, we favour bottom-up stock picking for the year to deliver returns given the host of macro and external uncertainties facing the market.
- A modest recovery in commodity prices plus rising rate expectations have seen cyclicals outperform strongly in the past 2-3 months but, in our opinion, this is more a short-term rally driven by a combination of inventory re-stocking (for some commodities) and a prolonged period of stock price underperformance for these sectors. There is little evidence to suggest at this point that final demand for most cyclical sectors have materially changed for the better.
- We have an Overweight on Property REITS, Healthcare and Agricommodities, Underweight on TMT and Industrials, and are Neutral on Property Developers, Financials, Consumer and Gaming. Based on prospective total return relative to the basket and price action y-t-d, the changes in our sector weightings from our Dec-16 note are the following:
- Agricommodities from neutral to overweight.
- Financials from underweight to neutral.
- Consumer & Gaming from underweight to neutral.
- TMT and Industrials from neutral to underweight .
Capital-preservation bias dominates our bottom-up picks
- Our base case end-2017 FSSTI target is based on a range of outcomes using forward consensus earnings growth, 3-year trailing PE mean multiples as well as bottom-up target price valuation at c3,000 levels.
- Approach #1: Consensus earnings growth at 3 year trailing PE mean.
- Approach #2: MKE bottom-up TP of covered, consensus TP for non-covered stocks.
- Approach #3: Consensus bottom-up TP for all stocks.
- Bull and bear case assumes earnings changes by c33% and 0.5sd re-rating or de-rating.
- While this target holds a small 4% downside, we believe selective stock picking could provide 10%+ returns, as was witnessed in 2016 where almost a third of the stocks (15/48) under coverage outperformed a flattish FSSTI and FSTAS delivering c13-48% returns, driven mainly by company-specific dynamics and without any obvious sector factors (barring telecoms).
- On a bottom-up basis, we screen our coverage stocks for low earnings cyclicality, cashflow stability and low balance sheet risk within a preference framework of secular growth drivers over cyclical ones and businesses models with demonstrated track record.
- Our top picks are CapitaLand Commercial Trust, Keppel REIT, Venture Corporation, Raffles Medical Group, United Overseas Land and Bumitama Agri.
- Our key SELL recommendations are OCBC, Keppel Corp, MobileOne, Starhub — stocks where we believe the market is possibly underestimating and mispricing business risk.