Singapore Market Monitor - Maybank Kim Eng 2016-11-18: Still frosty, and spring may be far away

Singapore market monitor - Maybank Kim Eng 2016-11-18: Still frosty, and spring may be far away Singapore Market Strategy

Singapore Market Monitor - Still frosty, and spring may be far away

Capital preservation trumps earnings growth 

  • Cumulative revenue and core profit for our coverage universe fell in the quarter ending Sept 2016; a modest improvement in EBITDA margin was arguably the only bright spot in this set of results. 
  • While there is some indication that downgrades to earnings expectations may be plateauing over the next couple of quarters, for now there is little visibility on when (and to what extent) a growth recovery will occur – at least until there is better clarity on the direction of Asia’s exports engine and other global policy variables. 
  • While the STI 1-year forward PER of c13x appears reasonable in historical context (5yr av. 12.7x), it is so for reasons of a lack of growth drivers and high external market vulnerability. 
  • Our key near-term picks are skewed to a preference for capital preservation over pursuing growth options that may carry lower defensibility.

Yet another lacklustre quarter 

Third consecutive quarter of core profit decline 

  • The demand environment continued to be weak with cumulative revenue for our Singapore coverage universe of c45 stocks dropping -3.3% YoY during the quarter ending Sept. Cumulative core profit fell too for yet another quarter at -6.1% YoY (quarterly core profits last saw growth in Dec 2015). In comparison, we estimate cumulative core profit for the STI component basket (ex Jardine Group cos and Thai Beverage that have not reported) fell a lesser -1.2%.
  • The lion’s share of the decline for our stock universe was driven by, unsurprisingly, the industrials sector where the offshore & marine (O&M) segment is reeling from after effects of severe industry overcapacity against a backdrop of depressed oil prices. Consumer & agri profit was the strongest performing sector (up c26% y-o-y) from steady staples and a rebound for the CPO stocks.

We were somewhat more bullish than the street 

  • The number of results that missed our expectation, as well as street estimates was somewhat similar at 27% and 29%, respectively. But this comparison is wider for those that beat our expectations at just a mere 4% compared to 18% for the street – a number of these stocks where we had higher expectations were somewhat expectedly in the small-cap space where corporate disclosure levels and management guidance can sometimes be scant. Overall, post this results season we raised profit forecasts for c9% of the companies, but cut estimates for around a third.
  • The main surprise element came from the banks where core profit was more resilient than expected (at just a c1% decline y-o-y). This was versus our expectation of tail risks of loan defaults and higher provisioning requirements from the O&M sector materializing to a greater extent.

Cost focus has bolstered margins; but the easy gains have been made we suspect 

  • For three of the past four quarters, aggregate EBITDA growth (or decline) for our coverage has been better than corresponding revenue performance, bearing out what management at many firms have been saying about cost-rationalisation measures. Besides, Singapore being a services-driven economy, has more flexibility than most in the region to manage its cost base.
  • The positive is EBITDA margins have been relatively stable for the past year, in fact rising in the Sept 2016 quarter by +140bps YoY (+90bps exbanks, property) and sequentially by +100bps (+80bps ex banks, property).
  • This was broadly led by consumer & agri, and the property sectors, allaying the declines in industrials and healthcare.
  • On the flipside, cost rationalization cannot go on indefinitely and we suspect the easy gains may have been made. Companies will soon have to seek other levers to grow (technology adoption, M&A, rational diversification etc.) in the face of a sluggish global macro growth and demand environment.

Downgrade cycle may be bottoming 

Level of downgrades for Sept 2016 results lower 

  • The STI consensus index earnings outlook has been on a downward trend for most of 2016 with expectations for 2016 and 2017 sliding by c12% and c14% YTD, respectively. We note that the extent of downgrades during this Sept 2016 results season has been a quantum lower than those witnessed in the first three reporting quarters during this year. Also the 12-month forward earnings outlook for the index appears to have troughed a couple of months ago in Sept.
  • As earnings upgrade and downgrade cycles in the past decade have generally lasted 4-6 quarters (with the GFC period of 2008-2010 being an exception where it lasted longer), we might reasonably expect earnings expectations to be getting close to a bottom over the coming six months.
  • Current market consensus growth outlook for the Straits Times Index for 2017 is c4.5% YoY while the growth expectation for our covered basket of stocks is c7%.

However, the recovery outlook is murky 

  • While earnings expectations could bottom over the next six months, the timeline for a potential growth recovery and the degree thereof is uncertain. This is dependent on a number of external factors, two of which we view to be particularly important – the effect of US trade policy on the economy and the effect of the SGD direction on the market. 
  • While Singapore has a relatively small manufacturing base compared to its neighbours, it is an open trade-driven economy and a hub for the region. Hence, despite the quarterly, and often unpredictable volatility of its pharmaceutical manufacturing sector output, the country’s overall non-oil domestic exports (NODX) have historically had a high correlation to its economic growth. 
  • At this juncture, the outlook for NODX is to a large degree dependent on how new US trade policy will affect trade flows for Asia's exports engine, and while a rise in intra-regional trade could alleviate the effects of a more protectionist US trade policy, this is unlikely to happen overnight.
  • The second factor – i.e. direction of the SGD against its trade weighted currency basket (of which the USD is a material component) has a twofold relationship with the stock market: 
    1. Fundamentally it affects market earnings from the many foreign companies listed in Singapore, as well as a large number of Singaporean companies that have substantial overseas operations. We estimate as much as c45-50% of STI earnings are overseas derived (the broader market being possibly c8-10% lower). Hence a weaker SGD is positive for market earnings growth in local currency terms.
    2. The market correlation with the currency, however, goes against the grain of the earnings growth impact. A weaker SGD has in fact usually been accompanied by a weak equities market and vice-versa. We believe the incongruence is explained by the currency, and not interest rates, being the country’s primary monetary policy tool. Hence a case of currency weakness is a regulator managed one resulting from a lack of inflationary pressure in the economy (imported inflation is high), which is usually reflective of a weak external environment. On this front there are far too many policy unknowns and geopolitical factors at play to have some level of certainty about medium-term direction of the USD and regional currencies. We would expect more clarity on this front after the incoming Trump administration has been at the helm for a few months at least.

Neel Sinha Maybank Kim Eng | 2016-11-18
Maybank Kim Eng SGX Stock Analyst Report