11-09-2008: CLSA Underweight On Bursa Malaysia

CLSA has underweight call on Bursa Malaysia ..............

The ringgit is down 3.5% year-to-date (YTD) and heading towards RM3.50:US$1. Beneficiaries of a weakening ringgit are shipping, plantations and exporting companies. Companies with US$ debt will be adversely affected but we do not foresee corporate defaults yet. Thus although marginal forex movement will somewhat affect earnings, we find that historically it has hardly been a driver for share price performance. Maintain underweight on Malaysia.

Heading towards RM3.50:US$1
• Government’s pro-growth stance, lower current account surplus ahead as commodity cycle turns, and investors’ concerns on potential credit rating downgrade is putting pressure on the ringgit.
• However, international reserves of US$124 billion will provide some support for the ringgit, as it can finance 9.1 months of retained imports and five times short term external debt.

Impact on P&L and balance sheet
• Weakening ringgit is positive for shipping, plantations and exporting companies.
• Companies with US$ debt and US$ operating cost (whilst revenue in ringgit) will be adversely affected.
• Tanjong (U-PF), TMI (BUY) and YTL Power (U-PF) have interest cover ratio <4x>

Little correlation between ringgit and stock performance
• Marginal forex movement of +/- 5% will somewhat affect earnings but hardly a major driver for share price performance.
• In our view, major drivers for share price performance are higher selling prices, government policy and domestic demand for plantations companies, Tenaga, and motor and media stocks respectively.

Underweight Malaysia
• Stick with sectors with relatively inelastic demand, strong management track record, and sustainable dividend yields.
• Underweight sectors which are susceptible to weakening ringgit, softening commodity prices and global growth, and fragile consumer sentiment.
• Valuations are still not cheap as PER of 11.6 times and P/B of 1.7 times is still above the trough level during the last economic slowdown in 2001.

Heading towards RM3.50:US$1
Since hitting a high of RM3.13:US$1 in April, the ringgit has weakened 8.9% to RM3.41:US$1 currently. Thus YTD, the ringgit has depreciated by 3.5% against the US$. The weakening ringgit does not come as a surprise as economist Anthony Nafte has long argued that Bank Negara Malaysia’s (BNM) and Ministry of Finance’s (MOF) pro-growth stance, that is, keeping overnight policy rate (OPR) unchanged at 3.5% since 2006, will put pressure on the ringgit. Furthermore a turn in the commodities cycle will also compress Malaysia’s trade surplus, putting downward pressure on the ringgit. However, the sharp depreciation of the ringgit came earlier than expected as investors fear of a potential credit rating downgrade, given the ballooning government budget deficit (4.8% of GDP in 2008) and rising political risks.

However, the ringgit in not the worst performer in the region – it has outperformed the Korean won (-17.1% YTD), Thai baht (-13.4% YTD), Philippines peso (-11.4% YTD) and Indian rupee (-11% YTD). Key difference here is Malaysia’s current account surplus which stands at 16.5% of nominal GDP in 2008, falling to 11% next year. Furthermore, international reserves of US$124 billion at Aug 15 is sufficient to finance 9.7 months of retained imports and five times short-term external debt.

Impact on P&L and balance sheet
The accompanying tables highlight the winners and losers of a weakening ringgit, both in terms of core and net earnings where the latter reflects forex losses arising from USD borrowings. To ease investors’ concerns on credit risks, we have also screened for companies which have low interest cover ratios, i.e. <4x. src="http://www.theedgedaily.com/cms/storage/images/com.tms.cms.image.Image_4f7bbc03-cb73c03a-98350a00-9ecd9fa0/1/market-5.jpg" align="right" border="0">has the highest interest ratio cover of 3.9% has US$180 million term loan outstanding, whilst TMI and YTL Power do not have US$ debt due till 2010. In conclusion, we believe the recent ringgit weakness is unlikely to result in corporate defaults in the foreseeable future.

Little correlation between ringgit and stock performance
The weakening RM:US$ is positive for shipping, plantations and exporting companies. On the other hand, companies with US$ debt (Astro, TM, and Tenaga) and operating cost denominated in US$ whilst revenue in ringgit, will be adversely affected (airlines, steel, motor and media companies).

However, we have taken a closer look to gauge if marginal forex movement (+/- 5%) has any correlation to share price performance. In the case of plantation companies, it is obvious the forex plays an insignificant role, as plantation stocks experienced sky-rocketing share prices in 1H08 despite the stronger ringgit then.

Similarly for stocks which benefit from a stronger ringgit, that is, Tenaga, Astro, Media Prima, Proton and UMW, share prices failed to rally in 1H08 in spite of the stronger ringgit then.

Therefore we conclude that although marginal forex movement will somewhat affect earnings, it is hardly a major driver for share price performance for individual stocks. In our view, major drivers are higher selling prices, government policy and domestic demand for plantations companies, Tenaga, and motor and media stocks respectively.

Underweight Malaysia
Given our view that the ringgit will not depreciate too sharply and historical evidence that stock price performance is lowly correlated to forex movements, our top buys and sells remain unchanged. We continue to underweight Malaysia, as at current levels, the market is trading at 11.6 times 09CL earnings. This is still above its -1sd PER of 10.9 times. On P/B, 09CL is at 1.7 times, whilst -1sd P/B is 1.4 times.

Notwithstanding the fast deteriorating global economic conditions, we believe applying a -1sd (standard deviation) benchmark is prudent in view of the unprecedented political climate in Malaysia currently. As with the experiences seen in neighbouring countries, Thailand and Indonesia, political uncertainties can be a long drawn affair as it can also have indirect implications on government policies, socio-economic policies and consumer sentiment.