Portfolio de-risking would cast a downward bias on the market as fundamentals take a backseat in the run-up to the election. Our sense is that domestic portfolio funds would now be selling into strength as opposed to buying on dips, implying that the market may trade sideways with a downward bias in the coming months.
This manoeuvring suggests domestic institutional funds would be cashed up relative to benchmarks moving into the first quarter of 2013. The redeployment of freed capital would depend primarily on the outcome of GE13.
Our base case scenario is that Barisan Nasional will be returned to power. The uncertainty is whether the coalition will secure a stronger mandate compared with GE08. As it is, our yield gap analysis (earnings yield less 10-year MGS yield) shows that the market's yield gap has widened to its five-year average of 3% (peak: 1.6%).
Therefore, the eventual removal of the election overhang should precipitate a market recovery as risk aversion eases to drive domestic equity re-weighting. This would be the primary valuation driver as domestic institutional portfolios account for more than 50% of trades, with foreign funds at about 25%. Foreign ownership has inched up to just 23.6% (January 2012: 22.4%) despite incremental net buying for the most part of this year.
YTD, Malaysia has underperformed its Asean peers. On the flipside, this relative underperformance underscores prospects of outperformance as its premium valuation has narrowed. The greater clarity on the continuation of growth policies embedded in the Economic Transformation Programme (ETP) may spur stronger foreign interest.
Under our base case scenario, we set our end-2013 fair value for the FBM KLCI at 1,770 points - based on a trend-average price-earnings ratio (PER) of 15 times. The key assumption is that macro fundamentals will hold up, with gross domestic product (GDP) growing by 5% in a low inflation environment (2% to 3%) in 2013.
The swing factor on the downside is on the external scene where lingering top-down concerns over the EU, the US and China may reassert themselves on valuations, particularly when the liquidity boost from QE3 runs its course.
Our investment thesis centres on stock selection. Our guiding principle is franchise value where companies emerge relatively unscathed from GE13, regardless of the outcome. We retain our "buy" on IJM Corp Bhd and Gamuda Bhd, given their entrenched market positions. Mah Sing Group Bhd's ascendancy as a liquid proxy to the property sector will not be derailed, given its entrepreneurial spirit and strong residential pre-sales.
Ann Joo Resources Bhd's valuation has bottomed from an assets perspective. At RM1.33 per share, it is trading at just 0.7 times price-to-book value (P/BV), even below its previous trough of 0.9 times in 2008. Lafarge Cement is a "buy" in view of the stock's high dividend prospects, with it turning debt-free.
We expect crude palm oil (CPO) prices to recover in 2013, underpinned by a draw-down in inventory, a large price discount to soybean oil and the revised export tax system. We are buyers of Genting Plantations Bhd, IJM Plantations Bhd and Kuala Lumpur Kepong Bhd.
Transformational growth is taking place in UMW and MBM Resources Bhd. The former is quickly morphing into a dominant oil and gas player with the associated lift to PER.
MBM is emerging as a major auto-parts maker. Its associate, Perodua, is doing well. Assembly joint ventures may be next.
In the banking sector, our top pick is RHB Capital Bhd, given its cheap valuation with the final piece of its Indonesian acquisition falling into place. We are unmoved by CIMB Group Holdings Bhd's lacklustre share price as it has demonstrated its ability to boost regional reach. At 1.8 times P/BV, CIMB looks undervalued relative to its peak of 2.3 times.
Tenaga is a "buy" with a discounted cash-flow-based fair value of RM8.15 per share. The support for a fuel pass-through mechanism undergirds its longer-term margin profile in the event of any price revisions next year. At RM6.90 per share, Tenaga is still trading at a depressed P/BV of one times despite improving operating dynamics.
SapuraKencana Petroleum Bhd is a "buy". Earnings upside will be driven by acquisitive growth from new tender rigs. Benalec Holdings Bhd is a cheaper proxy to the O&G sector. We expect the group to secure off-takers soon, underpinning our conviction in its Johor sites as O&G hubs.
We remain "neutral" on telcos, given the rising earnings risks as market share tussles start to impact service pricing. Telekom Malaysia Bhd is a "hold". DiGi.Com Bhd remains a "sell"; its key segments are most at risk of competition from Maxis and U-Mobile. Our only "buy" is Axiata, for its potential acquisitive growth and voice resuscitation. Axiata stands to surprise on the dividend front, while valuation is very attractive at six times FY2013F EV/Ebitda (sector average of nine times).
Benny Chew is head of research for AmResearch. This story first appeared in The Edge weekly edition of Dec 24-31, 2012.