Market Outlook 2011 / DB

Let's see which research house is most bullish. Got my hands on Deutsche Bank's prognosis for 2011. My comments in colour.

Off to a strong start (3.9% YTD); transformation underway

In an ASEAN context, Deutsche Bank is positive on the Malaysian market in 2011. Confounding the skeptics, Malaysia is (finally) delivering on its ambitious transformation plans and this is increasingly being recognised by the market. Food and fuel subsidies are gradually being abolished (kerosene +4.2% since November, diesel +8.6%). This is a bold political move given decades of hefty subsidies. (Yes, they are bold moves, and necessary as well. Will that hit their political hopes to get a bigger majority? Probably not as the overall economy is still chugging along, property is still up, stocks are up, when there is +++ in the wallets, not many will complain. Will there be harsher moves on subsidies after the election? Maybe, a GST is likely, which is good really for the longer term. To be fair to the government, they have not shied away from reducing subsidies for fear of losing political support. That in itself is a significant measure to foreign investors as Malaysia certainly can no longer afford that same level of subsidy for the past few years. The sooner we change tack the better. The subsidy mentality also affects the same sense of entitlement, and is actually a poor way of managing resources - naturally the lowest strata will be badly affected, but as long as we make sure they are properly counter balanced, the subsidy removal actually causes all businesses to be more proactive and take steps to have a more competitive business model. Ever wonder why so many local companies cannot go regional, its the subsidy mentality, many can no longer see the required margins once they leave the kampung - hence the removal of subsidy is in effect a much needed change of mindset).

Local contractors are busy again with projects (e.g. RM36bn MRT project just approved by the cabinet) essential for keeping pace with economic growth. Malaysians are confident again, evident in the strong rebound in retail sales (projected at 10-12% YoY in 2011), M&A activity accelerating (Malaysia posted the biggest YoY jump in M&A in Asia in 2010) and property sales lifting.

This is not a defensive market; Malaysia to deliver 26% growth in 2011

Collectively, the structural initiatives over the last five years have started to pay off. These include:

a) the aggressive restructuring of most GLCs,

b) rapid offshore expansion by Malaysia companies,

c) market liberalisation measures,

d) abolishment of the Foreign Investment Committee (FIC) guidelines in selected sectors, and

e) the listings of companies such as Petronas Chemicals, MMHE and Maxis.

These initiatives have raised earnings volatility but, in turn, earnings growth has strengthened materially. Earnings from offshore entities (largely ASEAN based) now account for 32% of total earnings (based on our universe of stocks) versus just 10% in 2005. By 2012E, we forecast this number to climb to 36%. This is a significant change that we believe the market has yet to fully appreciate. And it is why Malaysia’s earnings growth of 26% in 2011E is just slightly behind that of Indonesia at 27%. The Malaysian market offers a strong growth proposition combined with a dividend yield of 3.5%, above the regional average. (Important point which I agree totally, though the Indonesian market has been the blue eyed boy for foreign funds over the last 2 years, the gap between Malaysia and Indonesia should start to narrow. In fact, we are seeing some of the same funds, parlaying similar bets into Malaysia just as they did in Indonesia two years back).

14% upside to our FBM KLCI index target of 1,790

We see further upside risk to earnings in 2011 as commodity prices stay lofty, M&A activity accelerates further, and earnings from offshore entities have an impact. Our index target of 1,790 suggests 14% upside to the market over the next 12 months, pegging the market at 15.5x PER 2012, which is one standard deviation above post-2002 earnings. We do not think this is demanding for a market that is delivering on positive structural changes, offering superior growth in 2011 and greater exposure to the ASEAN growth footprint.

Malaysia is enjoying strong inflows into the equity market (ADTV YTD at US$830m vs. US$480m in 2H2010), foreign shareholding is climbing (22% as of December 2010) and by June, FTSE should upgrade Malaysia from “Secondary Emerging” to “Advanced Emerging”, which should drive passive inflows (c. US$392m) and positive sentiment. For exposure to Malaysia’s growth themes, we like CIMB, Petronas Chemicals, KLK, AMMB, IJM Corp, AirAsia and SP Setia. (My target for this year is not as high as 1,790. I think the exuberance would propel the local index to 1,700-1,730 as the high range. I would start to reduce leverage and maintain at least 50% cash as the markets move beyond 1,700).