POST-1997 financial crisis, the Malaysian stock universe has morphed from a market offering high earnings growth in Asia into a defensive market that provides decent dividend yields and stable earnings potential.
Incidentally, this was also the period the country’s annual economic growth rates moderated to below 6% – down from 9% to 10% in the early-to-mid-90s – and subsequently, below 5%.
The defensive nature of Bursa Malaysia is further supported by the political risk premium it has enjoyed, although one may argue that this has waned substantially since the 2018 general election.
While a defensive stock market has its fair share of fans, including institutional investors like pension funds, the flipside is that it may not appeal to investors looking for robust earnings growth.
After all, strong earnings are what fuel sustained share price uptrend. Strong earnings also justify high stock valuations.
An analysis by StarBizWeek, however, found that the earnings per share (EPS) of FBM KLCI component stocks on an aggregate basis were largely unchanged from where they were a decade ago.
EPS points to how much money a company makes for each share of its stock. A higher EPS indicates greater value because investors will pay more for a company’s shares if they think the company has higher profits relative to its share price.
This, perhaps, explains FBM KLCI’s sluggish performance and its struggle to convincingly cross the psychological level of 1,600 points, which is well-below the record-high of 1,895.18 points seen in April 2018.
Bloomberg data for 10 benchmark indices found that most indices have shown an increase in forward EPS between March 2014 to March 2024 (see charts), although this was not the case for the FBM KLCI.
The Dow Jones Industrial Average’s forward EPS increased by 88.4% and India’s Sensex Index is up 163.5% in the 10-year period.
Meanwhile, the forward EPS of Singapore’s Straits Times Index and Indonesia Stock Exchange Index were up by 35.6% and 48% respectively, in the same period. In contrast, the FBM KLCI’s forward EPS slipped by 0.3%, while Thailand’s SET Index has declined by 8.5%.
Old-economy problem
Experts say that the Malaysian stock universe’s more moderate earnings prospects is the result of the “Old Economy” syndrome.
In simpler terms, this means the biggest players in the market are primarily involved in traditional businesses and their operations have largely matured in terms of growth and market penetration.
Take the FBM KLCI for an example, about two-thirds of its total market capitalisation is controlled by mega-caps from just three sectors, namely, banking (42.12%), utilities (14.75%) and telecommunications (10.8%).
It is worth noting that the technology sector, often referred to as a high-growth sector, has zero representation in the FBM KLCI as no company has met the minimum market capitalisation criteria.
The only technology company on the index, Inari Amertron Bhd
, which is involved in chip assembly and testing, was booted out of the FBM KLCI last June.
It is rather unfortunate that after decades of developing the national semiconductor scene, which has become the world’s sixth largest semiconductor exporter, Malaysia has no technology representative on the list of top 30 listed companies by market value.
Most semiconductor companies on Bursa Malaysia are valued at RM1bil or below.
“Banks’ largest exposure in terms of loans is to the property sector, whose sales momentum is not as good as what we saw more than a decade ago.
“Banks’ overall loans are growing, but at more stable rates. This is another reason why banks are no longer offering high growth like they used to,” according to TradeView Capital chief executive officer Ng Zhu Hann.
Ng also tells StarBizWeek that the earnings of the telecommunications sector have declined in the past decade.
“Apart from being capital expenditure intensive, the sector is also affected by data price war and the slow roll out of the fifth-generation network,” he says.
Fund manager Danny Wong argues that the maturing of more companies may not necessarily be bad, if they deliver decent but stable earnings growth, making them appealing as dividend plays.
“But, if we want to reposition Malaysia as a market with robust earnings growth, we need to change the structure of our economy.
“We must embrace the ‘new economy’, which has started to gain traction such as data centres and artificial intelligence, and build on the complementing businesses including the hardwares and softwares,” says Wong, who is the CEO of Areca Capital.
Most importantly, Wong says Malaysia must leverage on its decades-long strength – semiconductor – by encouraging local players to move up the value chain.
“Unfortunately, our semiconductor landscape is still at the low-end, focusing on assembly, packaging and testing,” he adds.
For this to take place, the public and private sector must invest more substantially in research and development (R&D) efforts.
Greater public-private partnerships are needed to reverse Malaysia’s gross expenditure on R&D (GERD) has been declining in the past several years, even before the Covid-19 pandemic.
In fact, the country’s GERD per gross domestic product (GDP) dropped to just 0.95% in 2020, which was the lowest since 2010.
For comparison, countries like South Korea, the United States and Japan spent 4.81%, 3.45% and 3.26% of their GDP in 2020 for R&D, respectively.
Malaysia’s GERD per GDP is also lower than the average for upper middle income nations at 1.58%, based on the data by the United Nations.
TradeView’s Ng calls for government-linked companies (GLCs) to beef up their corporate ventures to encourage more private companies to penetrate into the ‘new economy’ sectors.
“For example, instead of a GLC venturing into a totally new business such as AgriTech or opening a subsidiary with very little experience, the GLC should invest in a small and medium enterprise (SME) which has already built some market presence.
“The GLC can hold a minority stake in the SME so that the entrepreneurial decision making capacity is not disturbed after the emergence of the GLC as a shareholder.
“Once the business grows to a bigger level, it can be listed on Bursa Malaysia, hence enlarging the share of ‘new economy’ companies on the stock market,” he says.
earnings
Go global
There is only so much room to grow if Malaysian companies focus on doing business locally.
Worse, large companies – including those backed by government funds, would end up crowding out smaller-scale companies and hinder them from grabbing a bigger market share.
It is, therefore, necessary for Malaysian companies to expand their operations not just across Asean but also beyond the region.
“Singapore is also a small market, but the difference with Malaysia is that many companies on the Singapore Stock Exchange have increasing global exposure.
“This allows their earnings to grow further,” says Ng.
In the case of Malaysia, Gamuda Bhd is a good example for foreign expansion.
The company, which has presence in eight other countries, including Australia and the United Kingdom, saw its overseas revenue more than double to RM4.7bil in the financial year ended July 31, 2023 (FY23).
In fact, the overseas revenue contributed more than half of Gamuda’s topline in FY23.
YTL Corp Bhd, led by Tan Sri Francis Yeoh, is also another Malaysian success story in terms of foreign expansion.
In the financial year ended June 30, 2023, the conglomerate reported that 79% of its total revenue is derived from its businesses outside of Malaysia.
It is noteworthy that YTL’s net profit in the same financial year surged by almost 58% year-on-year to RM1.1bil, which was an all-time high.
While both Gamuda and YTL have demonstrated the importance of diversifying out of Malaysia, it is easier said than done as a number of Malaysian companies have lost a big deal of money by venturing out.
For example, the Federal Land Authority (Felda) acquired a 37% stake in Indonesia-based PT Eagle High Plantations back in 2015 at 580 rupiah per share.
However, the stock went on free-fall following the acquisition and is currently priced at only 56 rupiah.
Felda bought the stake in Eagle High soon after its listed associate FGV Holdings Bhd called off a plan to acquire the same block of shares.
Meanwhile, Axiata Group Bhd’s foreign venture in Myanmar, Nepal and Pakistan also ended unfavourably, with the telecommunications giant registering massive impairments as it exited the markets.
Risks aside, with more Malaysian companies enlarging their revenue base and venturing into high-growth businesses, the Malaysian stock universe can once again regain its appeal among global investors.
Currently, the FBM KLCI offers one of the lowest total returns in the region.
In the past 10 years, the FBM KLCI‘s total return grew by 17.2%, according to Bloomberg data compiled by StarBizWeek.
In comparison, the benchmark indices of Singapore, Indonesia and Thailand saw total returns increasing by 46.9%, 97.9% and 38.4% respectively.
The total return of India’s Sensex Index, on the other hand, surged by almost 289% in the 10-year period.
New dawn on the horizon
Bursa Malaysia’s price to earnings (PE) valuations have fallen to about 16 times to 17 times in the past decade to 13 times to 14 times in the past couple of years due to volatility in earnings and the political uncertainty factor, some analysts say, with no major party seen to have the public support for an outright two thirds majority anytime soon.
MIDF Research’s head of research Imran Yusof believes the latter reasoning may be flawed.
“We believe what matters most to investors is policy stability rather than political stability per se. We have seen how other countries do experience political instability and the changing of government often.
“The result of a couple of previous elections may have led to perception of policy uncertainty as it was a new experience for Malaysia. However, we have seen some policy stability over the years, and this may allay concerns by investors in terms of policy uncertainty,” he told StarBizWeek.
Past performance of the local market indicates he could be partly right. Despite the Barisan Nasional (BN)-led government losing its two-thirds majority in 2008, the FBM KLCI rose to a historic high in 2014 helped by the US Federal Reserve’s (Fed) expansive monetary policy and China’s rapid growth before the 1Malaysia Development Bhd, or 1MDB, scandal took it on a lower trajectory.
The political risk factor appears to be more pronounced after 2018 when BN fell and Pakatan Harapan took over Putrajaya.
Then the ensuing Covid-10 period and the resultant lockdowns in 2020 and 2021 caused EPS to decline leading to the FBM KLCI trading around its minus one standard deviation below the historical mean. This happened despite many of the corporates listed standing strong with solid foundations. “Thus, we think the lower PE valuation now is mainly driven by dampened investors’ sentiment lately rather than an EPS downgrade.
“Investors may take the precious opportunity to accumulate their wealth in this undemanding market for years, and be patient for the market to rise in the near future,” said Kevin Khaw, research analyst at unit trust funds aggregator iFAST Capital.
As it stands, analysts are expecting the FBM KLCI’s EPS to grow at a much stronger rate in 2014 backed by the sustained growth of the economy, which Bank Negara forecast to range between 4% and 5%.
CGS International Research is the most bullish of brokers, expecting Malaysia’s corporate earnings to grow by 17% in 2024 while MIDF Research is targeting a 10% expansion.
Imran said the lower PE ratio for the FBM KLCI is also partly due to the hiking of rates in the United States, which affected global markets.
“With the Fed will likely be cutting rates this year, we believe that the FBM KLCI will gradually revert to its historical PE of 16 times to 17 times,” he predicted.
The rate cut would alleviate the pressure on the ringgit and lower funding costs of a lot of businesses. Putrajaya’s initiatives announced since the start of the year would also start showing results in the second half of the year assuming smooth implementation of policy. All this factors should help lead to positive earnings revisions.
High-net-worth investor Ian Yoong thinks market risk has tapered off with greater certainty of the unity government holding the reins of power for the medium term.
“The installation of a strong and just Agong is a big plus for Malaysia for the next few years. The unity government has done much to clean up past malfeasance and improve business conditions.
“Granted that a few moves by the unity government are not popular such as reduction in unwarranted subsidies and bumping up certain taxes. While the medicine is bitter in the short-term, the future looks bright for the Malaysian economy and Malaysian stocks,” he said.
This he believes is reflected in Malaysia recording its highest-ever approved investments of RM329.5bil in 2023 while foreign funds have turned net long on Malaysian equities in 2024, helping the FBM KLCI to outperform regional benchmarks and hit a 20-month high of 1,559 points in late February.
“The surge in the FBM KLCI was in the face of net selling by local institutional investors who sold RM964mil of equities in February. Retail investors continued selling for the eighth successive month. Retail investors could have been spooked by the weakening ringgit.
The positive news is that net selling by local retail investors tapered off sharply by about 40% in February. The stage is set for a rebound,” he predicted.
With the macro environment full of uncertainties, Khaw of iFAST said it is unlikely for the FBM KLCI to retest its 2014 highs anytime soon but the strongest near-term catalyst to drive it higher will come from launch of infrastructure projects with the current political stability acting as a tailwind.
“The next three years (at least before GE-17) offer stability for investors and this might help drive the market higher,” he said.
