DBS GROUP HOLDINGS LTD
D05.SI
Singapore Market Outlook 2018 - Recovery, Revision, Re-rating
- Economic Recovery – gathering momentum, broader based.
- Revision – upside to earnings growth of 8.4%.
- Re-rating - base target 3688, re-rate potential at 3800 for STI.
- Sweet spot – lowest valuation, highest dividend yield and decent earnings growth among ASEAN-5.
Outlook - Stronger Growth, Broader Recovery
Global recovery extends into 2018
- The global recovery this year looks set to continue into 2018 on the back of falling unemployment and improving consumer demand, albeit a slight moderation in manufacturing activity.
- The median forecast for 2018’s world GDP growth has improved from +3.4% y-o-y at the start of this year to +3.61% y-o-y currently. This is also higher than the +3.5% y-o-y figure in 2017 (source: Bloomberg).
- Being a small and open economy, Singapore is in a sweet spot to benefit from the continued recovery. Our economist has lifted Singapore’s 2017 GDP forecast to +3.2% y-o-y (from +2.8% y-o-y) and that for 2018 to +3% y-o-y (from +2.5% yo-y).
- US GDP growth is expected to strengthen further to +2.4% yo-y next year from +2.2% y-o-y in 2017 on the back of improving consumer sentiment and labour market. The European Commission’s index of industry and consumer sentiment rose to a reading of 114 in October, a 17-year high.
- The Eurozone’s path to recovery remains stable, albeit a slight moderation in GDP to +1.9% y-o-y in 2018 from +2.1% y-o-y this year.
Stronger regional economies
- ASEAN countries have benefited from the global recovery this year. Our economist has lifted Malaysia’s 2017 GDP growth to +5.7% y-o-y from +5.2% y-o-y, driven by an improving labour market, healthy pipeline of infrastructure projects, and increased government spending ahead of the election. The 2017 GDP forecast for the Philippines has also been tweaked higher to +6.7% y-o-y from +6.4% y-o-y.
- Regional elections over the next 1-2 years could continue to underpin growth in Malaysia and Indonesia as ruling parties are expected to dish out and execute pro-growth as well as proconsumption policies. In Thailand, the general election to be held in November next year will see a return to democracy after the military seized power in a coup back in 2014.
- Some drag could come from China where GDP growth is expected to moderate to +6.4% y-o-y in 2018 from +6.8% yo-y this year. This ‘engineered’ slowdown by the Chinese government through deleveraging and containing financial risks is meant to increase focus on the quality rather than the pace of economic expansion.
Singapore to enjoy broader-based recovery led by services sector
- Our economist expects the improvement in Singapore’s real economy to broaden steadily from the manufacturing sector to the rest of the economy next year. The manufacturing sector, which has been leading this turnaround since 4Q16, is expected to remain in expansion mode, albeit at a marginally slower pace.
- In contrast, the U-shaped recovery in the services sector, which accounts for two-thirds of GDP and almost 70% of employment, is gaining strength. Hence, when the services sector turns, the economy follows.
- Even the beleaguered construction sector should benefit from large-scale public-sector projects such as the 21.5 km NorthSouth Corridor next year and the stream of progress payments from earlier rail-related contracts awarded in 2016.
Singapore Market – Stars aligned for growth, valuation and yield
- With the 2017 earnings recovery set to continue next year, the Singapore equity market is attractive from an earnings perspective compared to global and regional equity markets.
- The MSCI Singapore Index currently trades at 14x (slightly below +0.5SD). This is attractive both from an absolute and historic perspective compared to 16.1x 12-mth fwd PE (+1.5SD) for the MSCI World Index, 16.7x (+2SD) for the MSCI South East Asia and 13.6x (+1SD) for the MSCI Asia Pac X-Jap.
- Within ASEAN-5, Singapore is the destination of choice that offers the strongest combination of growth, valuation and yield. Based on our score card, assigning 5 to the highest score and 1 being the lowest, Singapore emerged top with a score card of 13, underpinned by the highest dividend, cheapest valuation and moderate earnings growth prospect. With a stable currency leaning on the upside (we expect MAS to push for an appreciating NEER come October 2018), this will be an added ingredient for the Singapore market to outperform.
- As the global and regional recovery continues in 2018, we expect Singapore to be a prominent beneficiary of liquidity inflow seeking fair earnings growth at a reasonably attractive PE valuation.
Improving property market lifts consumer sentiment
- The 3Q17 uptick in the URA property price index was the first since the physical market topped out in 2Q13. For the first time in 4 years, prices in all 3 regions (i.e. core central region, rest of central region and outside central region) turned up.
- The upturn in Singapore’s residential property market looks poised to continue in 2018, powered by strong en-bloc activities, pent-up demand still unfolding, unsold inventories at 16-year low, and possible return of foreigners’ purchases. We see physical property prices rising 6-10% over the next 2 years.
- The residential property market’s upturn should also lift consumer sentiment and spur spending that in turn will underpin the services sector.
Risks that can derail the positive view
1. Acceleration in inflationary pressure pushes interest rates up faster-than-expected
- The steady economic growth coupled with a tame inflation outlook provided equity markets with a big boost in 2017. The assumption is that this Goldilocks scenario should continue next year. The CPI for G3 economies are forecast to stay tame, below +2% y-o-y. Markets have priced in 1 more FED rate hike this year followed by another 3 next year that lifts the FED funds rate to 2.25% by end 2018 as rates normalise.
- The risk to this ‘consensus’ view is that inflation pressures could rise faster-than-expected as the global recovery eventually drives up commodity prices and the improving labour market puts upward pressure on wages. Add in a dose of geopolitical uncertainty in the Middle East that lifts the price of oil, inflationary pressure risks heading up beyond the comfortable 2% level that may in turn pressure the FED to hike rates 4 times next year instead of 3. A faster-than-anticipated hike in US interest rates is negative for companies with high debt levels.
- Closer to home, businesses and individuals are speculating for the GST to go up as soon as next year after Prime Minister Lee said Singapore will be raising its taxes as government spending grows. The government could also be exploring alternative tax revenue, including that on e-commerce spending. A higher GST rate could deter consumers from spending more. Another concern is that if external inflationary pressure picks up over the next 1-2 years, raising domestic taxes will further worsen the situation.
2. High global debt levels
- According to the Institute of International Finance (IIF), global debt hit a new record high of USD226tril in 2Q this year. IIF notes that even with low global rates, many non-financial corporates are running into trouble with debt service. The percentage of “stressed” firms that cannot cover interest expense has reached some 15%-25% of corporate assets in countries such as Brazil, India, Turkey, and China. Many mature markets too have seen a rise in stressed firms, including Canada, Germany, France and the US.
- Rollover risk is high as the FED tightening continues with USD1.7tril of EM bonds and syndicated loans coming due through end-2018. Any major default in the debt market could ignite volatility in global equity markets.
3. High DM PE valuation => little room for earnings disappointment
- The backdrop for global equities has improved in recent years as global economies recover from the shadows of the Global Financial Crisis and the European sovereign debt crisis. But the equity markets of G3 economies have also priced in much of the economic recovery in recent years.
- The MSCI World Index currently trades near a 10-year high at 16x (+1.5SD) 12-mth forward PE. This leaves little room for earnings disappointment especially among the developed markets.
- In the US, the VIX, a measure of institutional sentiment and useful as a contrarian indicator, has fallen to multi-year low level at around 10. Any correction or volatility in the G3 equity markets, especially the US, will also resonate to Asian equities, including Singapore.
4. Geopolitics
- The Eurozone, Middle East and North Korea are 3 potential risk regions.
- In Europe, the immediate concern is the failure of Angela Merkel to form a new German government. The uncertainty dampens near-term confidence but fortunately, the country’s strong underlying economic momentum should limit economic consequences Watch the Italy elections to be held by May next year. The anti-establishment Euro sceptic 5 Star Movement currently has a slight edge over the ruling Democratic Party. Italy has the second highest debt in the Euro area after Greece at more than 130% of GDP. If the 5 Star Movement wins next year’s election, besides raising doubts about Italy’s Euro membership, there will also be heightened uncertainty over the sustainability of the country’s debt.
- The Middle East risk factor moved a notch higher in early November following the surprise arrest of princes, high profile businessmen and government officials on suspicion of corruption. Oil price reacted with Brent headed to about USD65 per barrel. A steady or gradual increase in oil price is positive for the Offshore & Marine (O&M) sector.
- However, inflationary concerns could arise if further political manoeuvres by the Saudi government cause investors to flee the country resulting in a giant spike up in oil price.
Growth & Valuation
From earnings recovery to sustainability
- 2017 was about earnings recovery with the Singapore economy forecast to strengthen +3.2% y-o-y. Corporate earnings are recovering from their 2016 trough, benefitting from a ‘low base’ effect. EPS growth for STI component stocks is expected to rise by 9.9% y-o-y in FY17F, reversing the 7.3% y-o-y decline in FY16. Likewise, EPS growth for stocks under our coverage is expected to rise, +11.4% y-o-y in FY17F, reversing the -5.1% y-o-y decline in FY16.
- We expect the earnings recovery to extend into 2018 as Singapore’s economic recovery turns broader based. We anticipate EPS growth in the high single digit at 7.3% y-o-y for the benchmark Straits Times Index in 2018, and stocks under our coverage as an aggregate is also expected to deliver a very decent 8.4% y-o-y EPS growth next year. The recently concluded 3QFY17 results season also saw the negative earnings revision trend turning positive. We keep our fingers cross that this positive reversal can continue in 2018 as more sectors join the recovery.
- The index heavyweight bank stocks should continue to underpin the STI with mid-teens EPS growth of 14.8% in 2018. We like both UOB and OCBC.
- With the oil market stabilised, earnings growth for the O&G sector is expected to pick up to 21.8% y-o-y from 4.4% in 2017. Our picks are Sembcorp Marine for shipyards and PACC Offshore Services (POSH) for Offshore Support services sector.
- An anticipated recovery in IHH Healthcare’s earnings should reverse EPS growth for the healthcare sector to a positive 38.3% y-o-y in 2018.
- Meanwhile, having enjoyed a strong cyclical recovery this year, EPS growth for the technology sector is poised to moderate significantly to 12% y-o-y next year from 54% y-o-y in 2017.
Straits Times Index upside to 3688
- True to our earlier call, STI attained our 2017 year-end objective of 3400 in November. At 3430, STI currently trades between 13.89x (+0.25SD) to 14.27x (+0.5SD) FY18F PE.
- Our STI year-end objective for 2018 is 3688 pegged to 13.89x (+0.25SD) FY19F PE.
Base case target 3688, potential upside on re-rating – 3800.
- With the earnings revision trend just turning positive, there is a likelihood that the 3688 level could be reached as early as the middle of 2018 should the Singapore market re-rate towards 14.64x (+0.75SD) FY18/19F PE over the next 6 months.
- We do not rule out a re-rating catalyst pushing up STI’s target valuation to 3800, pegged to +0.5SD at 14.3x on FY19 earnings. Stay tuned as 2018 progresses.
Janice CHUA
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YEO Kee Yan CMT
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Lee Keng LING
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http://www.dbsvickers.com/
2017-11-27
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