Tuesday, September 23, 2008

Deutsche Bank on Malaysia: A cocktail of negative trends...

A painful adjustment period for equities, fixed income and the currency
Not the time to own Malaysia; no quick resolution to political uncertainty
The market is going through pain not felt since the Asian crisis. We anticipate further risk to earnings (commodity slowdown, higher input costs and waning consumer spending), a weaker currency, higher funding costs for companies and further deterioration in the political landscape. We now expect the economy to grow at a slower pace of 5.8% and 5% for 2008 and 2009, respectively. But much of this assumes that commodity prices do not tumble further. Also, the lack of policy direction and much needed reforms adds to what is already a fragile market.

Not at bargain valuations yet; inferior EPS growth (with more downside risk)
The market is not yet at bargain valuations. In fact, valuations look expensive with the market at just a 2% PER discount to the region at 12.3x PER and 1.9x P/B. The market should be trading at a wider discount considering inferior growth of 1.7% and 6.5% for 2008 and 2009, respectively (vs. the region at 6.8% and 17.8%). Watch out for further EPS cuts as the street adjusts for falling palm oil prices, higher input costs from steel, fuel, etc., potentially higher cost of funds (spreads have widened by 100-150bps) and waning consumer spending. We think the worst is not yet over. Critical policy decisions should be made to reverse negative trends but there are just too many political distractions in the way for now.

Worrying trends: widening fiscal balance, weaker currency & wider spreads
The recent budget failed to restore confidence in the market. The overly generous handouts to soften inflationary blows and the big lifts in development expenditure (fiscal deficit to rise to 4.8% in 2008 vs. 3.2% in 2007) have sent the bond market worrying about the 'wall' of issuance from the Government. This has put pressure on the currency at a time of significant negative interest rates. Beneficiaries of a weaker currency are: MISC, KNM Group, YTL Power and QL Resources. Potential 'losers' are Tenaga, Lafarge, MAS, AirAsia, Proton and UMW.

Underweight maintained; KLCI target at 975, suggesting 9% downside
Our KLCI target of 975 is based on a 10% PER discount to the region, implying 8.5% downside or valuations at 11.3x and 10.7x for 2008 and 2009, respectively. We are Underweight large cap sectors like banks and plantations. For investors who have little choice but to remain invested in Malaysia, we advocate defensive names like TM, PLUS, Berjaya Sports Toto and KLCC Property. For longer term investors seeking deep value, we like IGB, Gamuda and KNM. The key risks on the upside for the market are: (a) a sharp recovery in commodities lifting the palm oil sector, (b) resolution to the political uncertainty, and (c) Government policies to restore confidence in the currency and the domestic bond market. Underweight.

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