26 October 2015

Budget 2016: The right focus We believe Budget 2016 has the right focus in balancing economic Strategy growth and maintaining fiscal discipline. We expect decent GDP expansion in 2016 that we believe would be conducive to earnings growth. We forecast an overall fully-diluted EPS contraction of 2.4% yoy in 2015 before rebounding to 7.4% yoy growth in 2016. KLCI

The macro environment 1,710 @ 23 October 2015 For 2015, the federal government still believes that GDP growth between 4.5% and 5.5% is achievable. The current account is expected to remain in NEUTRAL (maintain) the surplus range of 1.5-2.5% of GNI, while inflation is anticipated to be 2- 2.5%. For 2016, GDP growth is expected to moderate to 4-5%, current account surplus at 0.5-1.5%, and inflation at a wider range of 2-3%. 2015 KLCI Target: 1,600

Domestic demand to drive GDP growth We forecast 5% GDP growth in 2015 and 5% in 2016. At first glance, the 4- Narrowing government fiscal deficit 5% range in 2016 looks unexciting. However, closer examination reveals that the government is expecting resilient domestic demand but with a bigger drag from the external environment. It sees domestic demand rising 5.9% this year and 5.5% in 2016 versus our 6% and 5.8% forecasts, respectively.

Instilling fiscal discipline The government has made clear its intention on fiscal discipline. In 2015, it expects to hit the 3.2% fiscal deficit target, or RM37bn. Development expenditure is on track at RM47.4bn from its original allocation of RM48.5bn. As for 2016, the projected fiscal deficit is 3.1% of GDP (or Source: Affin Hwang, Bloomberg RM38.8bn), a marginal decline but trending in the right direction. Gross development expenditure is higher at RM50bn, highlighting the balance KLCI vs MSCI World vs MSCI AxJ between spending on economic growth and maintaining fiscal discipline. (YTD)

20%

Sector implications 15% MSCI AxJ -6.7%

We believe the key winner is the Construction sector as the Budget spells 10% out the timeline for project implementation in 2016. Other potential 5% MSCI World -1.2% beneficiaries are Plantations (Vision City), Rubber Products (reinvestment 0% -5% allowances) and Telcos (prepaid GST rebate). However, minimum wages FBMKLCI -2.9% could affect a few sectors more, such as Plantations, Timber and Tech. -10% -15%

Our overall take on Budget 2016 -20%

Jul-15

Oct-15

Apr-15

Jan-15 Jun-15

Feb-15 Mar-15

Aug-15 Sep-15 We are neutral to slightly positive on Budget 2016, as generally the May-15 measures introduced have been widely expected, with no untoward Source: Affin Hwang, Bloomberg negative developments. For the time being, we retain our Neutral stance on the KLCI with an official year-end target of 1,600 points.

Sneak preview: peering into 2016 Undoubtedly, markets have been tough with multiple headwinds in 2015. Nonetheless, Malaysia has weathered all these major challenges relatively unscathed, both on the federal fiscal position and GDP growth. As we look into 2016, there are still risks but we find that Malaysia is navigating from a Kevin Low position of strength with diversified sources of growth, deep financial (603) 2146 7479 markets, a strong banking system, and a low unemployment rate. As long [email protected] as macro parameters such as crude oil prices, low loan defaults, healthy labour market, property prices and consumer sentiment hold steady, we see an emerging case of a conducive environment for earnings growth. Research Team (603) 2146 7599 Risks [email protected] Upside/downside risks are a strengthening/weakening of Ringgit, a rise/fall in Brent oil prices, and wider earnings growth/contraction. Affin Hwang Investment Bank Bhd (14389-U) (Formerly known as HwangDBS Investment Bank Bhd) Page 1 of 22

26 October 2015

The right focus

Hitting the nail on the head The Budget 2016 theme of “Prospering the Rakyat” encapsulates the current pressing issues in Malaysia. It balances boosting economic growth with the need of fiscal discipline while at the same time ensuring help for the bottom 40% of household. The Federal government is still expecting GDP growth in the range of 4.5- 5.5% in 2015 versus our 5% expectation, driven by domestic expenditure. Despite generally weaker external environment, it continues to see a current account surplus in the range of 1.5-2.5% of GNI and inflation to be subdued in the 2% and 2.5% range. In 2016, domestic expenditure should continue to drive GDP growth but it expects a lower range of between 4% and 5%, while our GDP forecast is perched at the high end of 5%. Current account surplus is expected to narrow in 2016 to between 0.5% and 1.5% of GNI. Inflation rate is anticipated to be within a higher range of 2-3% against this year. Key economic indicators

Government Affin Hwang 2015E 2016E 2015E 2016E GDP growth (%) 4.5-5.5 4.0-5.0 5.0 5.0 Current account surplus 1.5-2.5 0.5-1.5 2.8 n/a (% of GNI) Inflation (%) 2.0-2.5 2.0-3.0 2.3 2.5-3.0 Source: MOF, Affin Hwang

Meanwhile, the federal government has made clear its commitment on fiscal consolidation, with the key consideration of achieving a balanced budget in 2020. In 2015, it expects to meet its 3.2% fiscal deficit target, which translates into RM37bn. Some small variation in development expenditure but it is more or less tracking the original RM48.5bn allocation (most current 2015 is RM47.4bn). The target for 2016 is a 3.1% fiscal deficit. While just marginally lower, the trajectory is downward as public sector finance is still transitioning to the new environment. In absolute terms, the deficit is RM38.8bn. Gross development expenditure is higher at RM50bn for 2016, highlighting the delicate balance needed to spur economic growth under the constraints of bringing down the fiscal deficit. Fiscal deficit target

Government Affin Hwang 2015E 2016E 2015E 2016E Fiscal deficit target - (%) -3.2 -3.1 -3.2 -3.0 - (RM) 37.0bn 38.8bn 37.0bn 37.7bn Gross development 48.5bn 50.0bn 48.5bn 50.4bn expenditure (RM) Source: MOF, Affin Hwang

26 October 2015

Our take We believe that the government is adopting the right focus on sustainability by balancing growth and the fiscal position. Moreover, the introduction of the Medium-Term Fiscal Framework (MTFF) takes policy makers’ focus away from the noise residing in annual fluctuations and trains their attention over a three-year period. Another reason we like this is because it puts a lot of emphasis on optimising government operating expenditure, which we believe is an area that has been the source of drag to government finances for many years now. On the surface, the government’s GDP growth target for 2016 is unexciting at a lower range of 4-5% for 2016, versus 4.5-5.5% for 2015. However, closer examination reveals that the government is expecting reasonably resilient domestic demand with a bigger drag from net trade. It does seem like the government has factored in a more prudent picture on external trade given the scare on emerging market growth this year. Just to give a sense, we are estimating domestic demand to grow 6% in 2015 while the government is looking at about the same at 5.9%. The difference is that we see net trade contracting 11.3% versus 12.3% by the government. As for 2016, we are looking at 5.8% domestic demand with net trade decline of 1% but government is forecasting 5.5% and 4.4% drop, respectively. That explains the 4-5% GDP growth range for the government. The key point to make here is that although our GDP forecast is at the top end of the government’s range, the underlying resilience of the domestic economy is supportive of earnings growth, in our view. The importance of domestic economy is apparent constituting 92.3% of GDP in 2015, up from 91.5% in 2014. GDP growth

2015E 2016F %yoy 2012 2013 2014 2015F 2016F MOF MOF GDP by Expenditure Components Total Consumption 7.7 7.0 6.4 5.7 5.8 6.1 5.7 Private consumption expenditure 8.3 7.2 7.0 6.2 6.5 6.8 6.4 Public consumption expenditure 5.4 5.9 4.4 3.8 3.0 3.6 3.0 Total Investment 19.0 8.2 4.8 6.7 5.9 5.2 5.1 Private investment expenditure 21.4 12.8 11.0 10.0 8.0 7.3 6.7 Public investment expenditure 15.9 1.9 -4.7 1.0 2.0 1.6 2.3 Domestic Demand 10.7 7.3 5.9 6.0 5.8 5.9 5.5 Net exports -25.1 -9.8 12.8 -11.3 -1.0 -12.3 -4.4 Exports -1.7 0.3 5.1 -2.0 3.0 -0.8 0.9 Imports 2.9 1.7 4.2 -0.7 3.5 0.8 1.5 GDP (2010 real prices) 5.5 4.7 6.0 5.0 5.0 4.5-5.5 4.0-5.0 GDP By Kind of Economic Activity Agriculture, Forestry and Fishing 1.0 1.9 2.1 -2.0 1.0 1.3 1.3 Mining and Quarrying 1.6 1.2 3.3 8.0 4.0 3.5 4.0 Manufacturing 4.4 3.4 6.2 5.0 5.5 4.5 4.3 Construction 18.1 10.8 11.8 9.0 7.5 8.8 8.4 Services 6.5 6.0 6.5 5.5 5.3 5.7 5.4 GDP (2010 real prices) 5.5 4.7 6.0 5.0 5.0 4.5-5.5 4.0-5.0 Source: MOF, Affin Hwang In fact, Malaysia has been able to navigate the headwinds such as the sharp decline in crude oil prices, drop in CPO prices, weakening Ringgit, volatility in global financial markets, slowdown in regional emerging markets, and lower consumer sentiments quite well. Despite these forces, Malaysia’s economy is still able to grow at mid-single digit levels. 26 October 2015

Key sectors benefiting from Budget 2016 include Construction (more projects), Plantation (Vision Valley), Rubber Products (reinvestment allowance), Telcos (GST prepaid rebate). On the other hand, the increase in minimum wage is negative for companies, though the impact varies for sectors and companies. Generally, it could be more pronounced in the Plantations, Timber and Technology space. Stock wise, the key winners are companies in the construction sector such as Gamuda, MMC, and MRCB. Sime Darby also benefits from the Vision City. Our preferred pick for Rubber Products is Karex. All cellular operators benefit from the pre-paid GST rebate but our preference is DiGi. Overall, we err on the side of neutral to positive for Budget 2016, as generally most of the pertinent issues are widely expected without any undue negative developments. For the time being, we are retaining our Neutral stance on the KLCI with an official year-end target of 1,600 points. Sneak preview: peering into 2016 That said, at this juncture it is worth getting some sense of the market outlook, as we look 12-15 months forward. Unmistakably, markets have been challenging with strong capital outflow due to foreign selling, a weak Ringgit, sharp drop in crude oil prices, moderating global growth, and global financial market volatility. However, our preliminary assessment shows that things are finding a firmer footing. Despite these headwinds, Malaysia is entering these challenging times from a position of strength with diversified sources of growth, manageable external indebtedness, our deep financial markets have been able to facilitate rapid fund flows in and out of Malaysia without disruptions, the banking system is still strong, and unemployment rate is low. This has manifested in real GDP that is growing at 5.3% for 1H15 and should be able to expand 5% for the entire year. No doubt risks remain in the short term but as long as some of the macro parameters such as crude oil prices, low loan defaults, steady property prices, unemployment rate, and consumer sentiments hold steady, the environment will be conducive for GDP growth that should translate into earnings growth. The Ringgit should also strengthen thus providing some support to capital flows in and out of the KLCI. For 2015, we are forecasting a fully diluted EPS decline of 2.4% yoy overall in our coverage universe of 99 stocks. However, we are estimating a rebound of 7.4% EPS growth in 2016. The resilience of the domestic economy provides comfort that our 2016 earnings forecast can be achieved. At this juncture, it is also worth highlighting that despite strong GDP growth of 6% in 2014, market EPS grew by just 0.8%. One reason for this was expectation of high inflation (4-5%) at that time resulting in a larger transfer of firms’ profits to employees. Subsequently, lower consumer sentiments prompted some firms to absorb higher input costs from GST without passing through to the end users. Hence companies’ margins have contracted. However, as domestic economic stability returns, there is a good chance that firms may start raising prices and this would boost profitability. The inflation expectation by the government is 2-3% in 2016, which is relatively conducive for price adjustments, in our view. Our stock universe is trading at fully diluted PE of 18.1x for 2015, falling to 16.8x for 2016. This is not demanding, in our view, compared to its long-term average of 17.8x.

26 October 2015

The big picture

GDP in 2015E is on track The Federal government is projecting an unchanged GDP growth range of 4.5% to 5.5% in 2015 versus the 6% achieved in 2014. Anchoring the growth would be domestic demand, which is expected to grow 5.9% or at the same level as 2014. Within domestic demand, private expenditure is projected to post the strongest rate of 6.9% but a slowdown from the 7.9% last year. The government anticipates private consumption to remain robust at 6.8% (2014: 7.9%) despite the introduction of GST this year. On the one hand, GST increases the cost of goods and services but on the other, lower fuel cost has dampened inflationary pressure. A strong labour market with low unemployment rate is also supportive of private consumption. Transfers by the government in the form of Bantuan Rakyat 1Malaysia (BR1M) also helps sustain consumption. Private investment growth is expected to moderate to 7.3% in 2015 (2014: 11%) partly due to adjustments to the new global and domestic economic conditions. However, the government expects strong domestic demand to continue drawing investments into the services sector. High approved investments and capital allocations for economic corridors are also supportive. The government sees public expenditure on target for a 2.8% yoy rise in 2015 (2014: +0.4%). Net exports are expected to drag down growth by 12.3% this year (2014: +12.8%) due to the vagaries of the external environment. Components of GDP by demand

% Share % Change 2015F 2014 2015F 2016F GDP 100.0 6.0 4.5-5.5 4.0-5.0 Domestic 92.3 5.9 5.9 5.5 demand Private 69.7 7.9 6.9 6.4 expenditure Consumption 52.7 7.0 6.8 6.4 Investment 17.0 11.0 7.3 6.7 Public 22.5 0.4 2.8 2.7 expenditure Consumption 13.4 4.4 3.6 3.0 Investment 9.2 -4.7 1.6 2.3 External sector 7.8 12.8 -12.3 -4.4 Exports 71.9 5.1 -0.8 0.9 Imports 64.1 4.2 0.8 1.5 Source: Department of Statistics and MOF

26 October 2015

The government sees all sectors growing for GDP by supply in 2015. Services sector is expected to witness 5.7% growth (2014: 6.5%) with reasonable strength in domestic demand. Manufacturing should slow to 4.5% in 2015E (2014: 6.2%) due to both domestic and export oriented industries. It expects Agriculture sector to grow 1.3% in 2015 (2014: 2.1%) from higher food commodity and crude palm oil production. Mining growth is likely to be 3.5%, accelerating from 3.3% in 2014, due to higher production of crude and natural gas despite the lower prices. Construction should rise 8.8% (2014: 11.8%) with the implementation of large infrastructure projects, though the slowdown is partly due to a high base after multi-year double-digit growth. Components of GDP by supply

% Share % Growth 2015F 2014 2015F 2016F Agriculture 8.9 2.1 1.3 1.3 Mining 8.8 3.3 3.5 4.0 Manufacturing 22.9 6.2 4.5 4.3 Construction 4.4 11.8 8.8 8.4 Services 53.8 6.5 5.7 5.4 GDP 100.0 6.0 4.5-5.5 4.0-5.0 Source: Department of Statistics and MOF

Growth in 2016 What we are more interested in is growth in 2016. Here, the government expects a lower range of 4-5% GDP expansion, which takes into account growth slowdown in emerging markets and particularly China. It expects private consumption to remain resilient at 6.4% growth. The reasons given are: stable employment prospects, favourable wage growth, easy access to credit, BR1M transfer, accommodative interest rate and benign inflation. Private investment expansion of 6.7% in 2016 is expected to come from the manufacturing and services sectors, as the government promotes domestic investment particularly among the SMEs. We have already seen the government announcing in September an additional RM2bn allocation for the SMEs as part of the working capital guarantee scheme besides an existing RM5bn set aside for the services sector. This is in addition to the Budget 2016 initiative to subsidise financing profit for Shariah compliant SMEs to the tune of RM1bn. Public consumption growth is expected to slow to 3% in 2016 as the government rationalises its spending in favour of some expansion in fiscal spending via higher development expenditure. As a result, public investment growth is expected to rise to 2.3%. Lastly, it expects net exports to decline 4.4% in 2016, taking into account the weaker external environment. 26 October 2015

Ensuring fiscal sustainability Despite pressure on crude oil prices, the government is expecting GST collection in 2015 of RM27bn versus the original budget of RM21.7bn. It then sees GST collection rising to RM39bn in 2016 due to the full-year impact (1Q15 sales and service tax was RM7.6bn). Overall, the government is anticipating an 0.8% rise in revenue in 2015 and a 1.4% rise in 2016. Development expenditure is budgeted at RM50bn in 2016 from RM47.4bn in 2015, which is expansionary and good for economic activities. The bulk of development expenditure is to be spent on the economic sector (59.7% of total in 2015 and 60.6% in 2016). One impressive item in the federal government budget, in our view, is the rapid adjustment in operating expenditure. As a result, the federal government’s operating surplus rises from RM1bn in 2014 to an anticipated RM9.1bn in 2015 and is forecast to increase by another 14% to RM10.4bn in 2016. Overall, the budget allocation increases by 1.7% from RM260.7bn in 2015 to RM265.2bn in 2016. Of this, 82% is to be for operating expenditure in 2015 compared to 81% in 2016. The fiscal deficit could trend down from 3.4% in 2014 to 3.2% in 2015 and 3.1% in 2016, if the government projections materialise. Government revenue and expenditure RM m % Change % of GDP 2014 2015F 2016F 2014 2015F 2016F 2014 2015F 2016F Revenue 220,626 222,455 225,656 3.4 0.8 1.4 19.9 19.2 18.2 Operating expenditure 219,589 213,314 215,224 3.9 -2.9 0.9 19.8 18.4 17.3 Current balance 1,037 9,141 10,432 -50.6 781.5 14.1 0.1 0.8 0.8 Gross development 39,503 47,423 50,000 -6.4 20.0 5.4 3.6 4.1 4.0 expenditure Less: Loan recovery 1,052 1,033 785 -31.1 -1.8 -24.0 0.1 0.1 0.1 Net development 38,451 46,390 49,215 -5.5 20.6 6.1 3.5 4.0 4.0 expenditure Overall balance -37,414 -37,249 -38,783 -3.0 -0.4 4.1 -3.4 -3.2 -3.1

Source: MOF Another interesting government initiative is the introduction of the Medium- Term Fiscal Framework (MTFF) that looks beyond the annual budget horizon and takes a three-year timeframe. It trains the focus at meeting the medium-term targets by identifying potential risks that can derail it. In essence, the MTFF puts a lot of emphasis on containing operating expenditure. In doing so, it sets a total ceiling for each ministry. Other initiatives include gradual subsidy rationalisation, better procurement practices, streamlining the civil service, and possibly cutting back on grants. The MTFF takes the period of 2016-18 and forecasts a fiscal deficit of 2.7% over the cumulative period. Another point worth highlighting is the strong cumulative operating surplus of RM43.8bn. In order to appreciate this figure, 26 October 2015

we compare it to the projected operating surplus of RM10.4bn in 2016, suggesting large surpluses in 2017 and 2018. 26 October 2015

The details

The strategic thrusts There are five priorities in Budget 2016. First: Strengthening Economic Resilience Second: Increasing Productivity, Innovation and Green Technology Third: Empowering Human Capital Fourth: Advancing Bumiputera Agenda Fifth: Easing the Cost of Living of the Rakyat We summarise the key measures announced in each of the priorities that are material with a minimum of RM1bn impact. Strengthening Economic Resilience The first thrust relates to measures to boost domestic investment, invigorate the capital market, provide more assistance to SMEs, improve domestic infrastructure, as well as promote and strengthen economic activity. Key significant measures are:

 RM5bn initial investment in 2016 for Malaysian Vision Valley.  RM11bn over five years for Cyber City Centre in Cyberjaya.  RM7bn for KLIA Aeropolis.  RM6.7bn investment by Khazanah Nasional Bhd in nine high impact domestic projects in healthcare, education, tourism, communication software and infrastructure.

 RM18bn in 2016 for Refinery and Petrochemical Integrated Development Project (RAPID) Complex in Pengerang, Johor.  RM1bn for Shariah-compliant SME Financing Scheme subsidising 2% of financing profit rate.

 New major highways (please see Construction section).  RM28bn MRT II spanning 52km.  RM10bn LRT3.  RM1.5bn Rapid Transit Bus.  RM1.2bn for rural broadband.

 RM1.4bn to upgrade rural roads nationwide.  RM1.2bn for promoting tourism. Increasing Productivity, Innovation and Green Technology Essentially this is for increasing productivity, accelerating innovation and creativity, as well as promoting the use of green technology to safeguard natural resources. Key significant measures are:

 RM1.2bn fund for Green Technology Financing Scheme until 31 December 2017. 26 October 2015

Empowering Human Capital This priority recognises the need to build human capital for the future of Malaysia. Key significant measures are:

 RM4.8bn for technical and vocational education and training. Empowering Human Capital While the Bumiputera Agenda is a national agenda, the fourth priority specifically spells out the development of the Bumiputera community in Sabah and Sarawak. Key significant measures are:  RM3.7bn allocation for Bumiputera students to continue tertiary education.

 RM16.1bn for toll-free Sarawak Pan-Borneo Highway.  RM12.8bn for Sabah Sindumin to Tawau highway. Easing Cost of Living of the Rakyat The measure focuses on providing assistance to the bottom 40% of households. It has also identified a new household segment with monthly income between RM3,860 and RM8,320 to provide more targeted benefits. Key significant measures are:

 RM1.6bn to build 175,000 houses sold at 20% below market.

 RM4.6bn expenditure for the supply of medicines, consumables, vaccines and reagents to all government healthcare units.

 RM17.3bn allocation to Ministry of Defence for procurement of defence machinery.

 RM1.1bn salary adjustment for 1.6m civil servants.  Continuation of BR1M with an allocation of RM5.9bn.  National minimum wage will increase from RM900 to RM1,000 per month in Peninsular Malaysia and from RM800 to RM920 in Sabah, Sarawak and Labuan effective 1 July 2016.

 RM500 assistance for all civil servants and RM250 for government pensioners totalling RM1bn to be paid in January 2016. Other measures  Income tax increase from 25% to 26% for incomes between RM600,000 and RM1m and from 25% to 28% for those above RM1m.

 Some GST fine-tuning for various items.

26 October 2015

Sector implications

Banks – extension of tax incentives for sukuk Property Comments Main Measures  Extension of tax incentive on issuance of sukuk for 2016 up to 2020.  20% stamp duty exemption on Shariah financing instruments to be extended to 2017.

Key Implications  No significant impact on banks.  Overall, the need for more infrastructure financing should benefit most investment banks.

Recommendations  Maintain our Neutral rating on the banking sector based on a muted earnings outlook, with headwinds in terms of NIM pressure, weak loan growth, lacklustre capital market activities and concerns over asset quality (corporate loans in particular).  For sector exposure, we favour defensive banks such as Public Bank (PBB) and Hong Leong Bank (HLB), given their more stringent credit underwriting standards and established franchises in the domestic retail financing markets: i) PBB (PBK MK, RM18.64, BUY, TP: RM21.80 @ 2.6x P/BV); and ii) HBB (HLBK MK, RM14.20, BUY, TP: RM16.20 @ 1.5x P/BV).

Source: Ministry of Finance, Affin Hwang

Construction – spending continues Construction Comments Main Measures  Government development expenditure budget will increase to RM52bn for 2016 (RM50bn + RM2bn contingency). Budget for 2015 has been reduced to RM47.4bn (-2.3%) from RM48.5bn to meet the federal government budget deficit target of 3.2% of GDP.  New projects announced are RM1.5bn Bus Rapid Transit (BRT Kuala Lumpur- ), RM1bn BRT (Kota Kinabalu), RM0.9bn Jalan Tun Razak Traffic Dispersal Scheme.  Large-scale projects to be implemented in 2016 include RM28.9bn Pan Borneo Highway, RM10bn Light Rail Transit Line 3 (LRT3), RM28bn Mass Rapid Transit Line 2 (MRT2).

Key Implications  Positive that development expenditure budget will increase by 9.7% yoy in 2016.  Improved prospects for good contractors to grow their order books as the government emphasizes on safety and quality for future projects.  Public transportation, road and public utility projects remain the key focus of public spending.  Suncon is a potential beneficiary for the two new BRT lines announced given its good track record in completing the BRT line in Sunway.  MMC Corp and Gamuda are the key beneficiaries of the MRT2 as the project delivery partner (PDP) and potential contractor for the underground work. Other contractors that could win the above-ground work packages are IJM Corp, Sunway Construction (Suncon), WCT (new pre-qualified contractor), Gadang, Mudajaya, Ahmad Zaki, MTD ACPI, TSR.  MRCB and George Kent are the key beneficiaries of the LRT3 as the PDP for the project. Other potential contractors that could win the work packages include IJM Corp, Suncon, Bina Puri, TRC. The increase in the estimated cost of the project by RM1bn will also increase the PDP fee for MRCB-George Kent.

26 October 2015

Construction Comments Recommendations  Overweight. High development expenditure and commitment to implement large- scale projects provide a strong pipeline for contractors to grow their order books.  Top BUYs are Gamuda (GAM MK, RM4.72, BUY, TP: RM5.84), IJM Corp (IJM MK, RM3.36, BUY, TP: RM3.76), WCT (WCT MK, RM1.40, BUY, TP: RM1.84) and MRCB (MRC MK, RM1.23, BUY, TP: RM1.44).  Key risks are delays in implementation of projects and shortage of foreign workers. Source: Ministry of Finance, Affin Hwang

Other noteworthy issues:  The government is promoting the use of industrialised building systems (IBS) by setting up an IBS Promotion Fund of RM0.5bn through SME Bank to provide soft loans to developers and contractors in category G5 and below. Mostly should benefit unlisted contractors since the majority of the listed contractors are in the highest category, G7.  Further investment of RM18bn in 2016 to develop RAPID Complex in Pengerang, Johor, would likely lead to more civil work contracts for contractors such as WCT, Gadang and Muhibbah Engineering.  The increase in national minimum wage from RM900 to RM1,000 should not affect the construction sector, as most workers are receiving wages in excess of RM1,000.

Fig 1: Development expenditure allocation

Source: Ministry of Finance, Affin Hwang estimates 26 October 2015

Value Potential listed co. Project Comments (RMbn) winners Pan-Borneo Highway 28.9 RM16.1bn for 1,090-km highway Cahya Mata Sarawak, in Sarawak. RM12.8bn for 706- Naim, WCT km highway in Sabah. Cost increased from initial estimate of RM27bn. To start in 2016 and be completed in 2021. Mass Rapid Transit Line 2 28.0 To start in 2Q16, complete in MMC-Gamuda (PDP), 2022. IJM, Suncon Light Rail Transit Line 3 10.0 Cost increased from initial MRCB-George Kent estimate of RM9bn. To start in (PDP), IJM, Suncon 2016, complete in 2020. Sungai Besi-Ulu Klang Expressway 5.3 Privatised project under Prolintas IJM, Suncon, WCT, Sdn Bhd. Ahmad Zaki Damansara- 4.2 Privatised project under Prolintas IJM, Suncon, WCT, Sdn Bhd. Ahmad Zaki Bus Rapid Transit (KL-Klang) 1.5 IJM, Suncon, WCT Upgrade 700 km of rural roads 1.4 nationwide Bus Rapid Transit (Kota Kinabalu) 1.0 IJM, Suncon, WCT Jalan Tun Razak Traffic Dispersal 0.9 Public-private partnership IJM, Suncon, WCT, Scheme project. Ahmad Zaki Rural electrification 0.9 Water treatment plants 0.9 Taliworks, Loh & Loh Flood mitigation 0.7 MRCB, Ekovest Rural water supply 0.6 Improve reliability of Sabah electricity 0.5 MRCB supply Upgrade road in FELDA settlements 0.2 Expressway NA NA Build 5 new hospitals NA In Pasir Gudang, Kemaman, IJM Pendang, Maran, Cyberjaya. Total 84.9 Source: MOF, Affin Hwang

26 October 2015

Consumer – Increase in BR1M Consumer Comments Main Measures  Increase in BR1M (refer to table below).

Key Implications  We believe the increase in BR1M will continue to spur retail spending, especially in the F&B sub-sector.  No excise duty hikes for brewery and tobacco players spell positive news for the sector.

Recommendations  Maintain Neutral.  We expect the F&B subsector to remain robust.  No impact on the retail sub-sector as well as tobacco and brewery players.  Top pick: Carlsberg (CAB, RM12.14, BUY, TP: RM14.05).

Source: MOF, Affin Hwang

BR1M BR1M categories New (RM) Existing (RM) Participants in e-Kasih database with monthly income below RM1,000 1,050 NA Household with monthly income of RM3,000 or below 1,000 950 Household with monthly income of RM4,000 to RM3,001 800 750 Single Individuals aged 21 with monthly income of less than RM2,000 400 350 Bereavement Scheme 1,000 1,000

Healthcare – Affordable Healthcare Healthcare Comments Main Measures  Brands of GST-free medicines to be increased to 8,630 from 4,215.  Tax relief up to RM 5,000 per year for individuals who provide medical treatment for their parents.  Full treatment cost for foreigners in public hospitals and clinics.

Key Implications  We think the increase in the number of GST-free medicines is positive for the sector, as these should slightly reduce costs for private hospitals.  Foreigner patient volume in private hospitals is expected to increase given that public hospital will no longer provide any subsidies for foreigners.

Recommendations  Overall positive.  We believe that demand for private healthcare in Malaysia will continue to be robust.  Top pick: IHH (IHH MK, RM6.50, BUY, TP:RM6.71)

Source: MOF, Affin Hwang

Other noteworthy issues:  Government to build five new hospitals: Pasir Gudang, Kemaman, Pendang, Maran and Cyberjaya.  Commencement of public Kuala Lumpur Women and Children Hospital in October 2016.  Adding 33 new 1Malaysia clinics to existing 328 clinics.  Redevelopment of Kajang Hospital.

26 October 2015

Media – Broadcasting digitalisation project Media Comments Main Measures  RM250m allocation for the national broadcasting digitalization project. This is to enhance the audio visual quality and provide added value to TV content as well as interactive data transactions.

Key Implications  The national broadcasting digitalization project was already mentioned during the 11th Malaysia Plan.  Mildly negative for Media Prima (MPR MK, RM1.33, SELL, TP: RM1.07) as we believe the digital broadcasting fees charged after the simulcast period are likely to be higher compared to the current rates Media Prima pays to the government or even to the other broadcast TV operators. There is risk to Media Prima earnings should the higher digital broadcasting fee be enforced.

Recommendations  We are still cautious on the outlook for the media sector as weak business and consumer sentiment affects adex revenue. Also, there is still a lack of feel-good factor for ad spending given the headwinds in the domestic and global markets, as well as the lack of mega events scheduled in 2015.  Top pick for the media sector is Astro (Astro MK, RM2.88, BUY, TP: RM3.35) on our forecasts of: 1) a strong FY16-18 EPS CAGR of 18.6% in the absence of set-top-box upgrades and major sporting events; and 2) a 4.5% FY16 dividend yield.

Source: MOF, Affin Hwang

Oil & Gas – Nothing significant for O&C companies Oil & Gas Comments Main Measures  Minimum monthly wage increase from RM900 to RM1,000 for Peninsular Malaysia and from RM800 to RM920 for Sabah, Sarawak and Labuan.

Key Implications  Impact of higher minimum monthly wages for lower category employees is not expected to be significant and is expected to be cushioned by productivity improvements.

Recommendations  Maintain sector NEUTRAL rating. Oil prices remain weak and the government projects lower oil prices and oil-related revenue in 2016 (RM31.7bn versus RM44bn in 2015 and RM62bn in 2013).  Top picks on valuation are Alam Maritim (AMRB MK, RM0.485, BUY, TP: RM0.54) and Petra Energy (PENB MK, RM1.25, BUY, TP RM1.50).

Source: MOF, Affin Hwang

26 October 2015

Plantation – Good for SIME Plantation Comments Main Measures  Development of the Malaysian Vision Valley covering an area of 208,000 ha from Nilai to Port Dickson, as announced in the 11MP, with an initial investment forecast of RM5bn in 2016.  GLCs to build affordable houses in the vicinity of the MRT station in Bandar Kwasa Damansara. Kwasa Land owned by EPF is to build 800 units and Sime Darby Property 4,600 units.  Minimum monthly wage increase from RM900 to RM1,000 for Peninsular Malaysia and from RM800 to RM920 for Sabah, Sarawak and Labuan.

Key Implications  Sime Darby (SIME MK, RM8.59, SELL, TP RM7.59) owns around 50,000 ha of property development and plantation land within the Malaysian Vision Valley and Sime Darby Property is a wholly owned subsidiary.  Impact of higher minimum monthly wages for lower category employees is not expected to be significant and is expected to be cushioned by productivity improvements.

Recommendations  Maintain sector NEUTRAL rating. There are no measures, which should directly and significantly benefit the plantation companies, other than Sime Darby.  Ratings for plantation stocks are mostly at HOLD or SELL on valuations.

Source: MOF, Affin Hwang

Property – more on affordable homes Property Comments Main Measures  Establish a First House Financing Scheme under KPKT to assist first-time buyers to pay deposits on affordable homes. RM200m allocation.  Allocation of RM40m to KPKT for reviving abandoned low- and medium-cost private housing projects.  Exemption on stamp duty to be given on financing instruments to contractors who revive abandoned projects as well as the original purchaser of the projects. Promote the use of Industrialised Building System (IBS). An IBS Promotion Fund of RM500m is to be established for developers in the category G5 and below.

Key Implications  While no cooling measures were imposed, there were also no proposals that could lift the current soft property market.  The focus remains on assisting middle- to lower-income earners as well as first- time home buyers.

Recommendations  Neutral. The budget proposal should have minimal earnings impact on the developers under our coverage who mainly focus on the medium- to upper- middle-income segment.  With no measures propose to stimulate the property sector, we expect the outlook to remain soft in the next few quarters.  However, we believe the risk is limited in view of developers’ strong balance sheet positions as well as the positive long-term fundamentals of the Malaysia property market.  Top pick: UOA Development (UOAD MK, RM2.17, BUY, TP: RM2.25) for its strong management, good product branding and cash position. The stock should also be supported by a decent yield of 6.0%.

Source: MOF, Affin Hwang

26 October 2015

Other noteworthy issues:  PR1MA (1Malaysia People’s Housing Programme) to build 175k houses, which are to be sold at 20% below market price, with an allocation of RM1.6bn. (2015: RM1.3bn allocation, 80k homes).  SPNB to build 10k units of Rumah Mesra Rakyat with a subsidy of RM20k for each house, through an allocation of RM200m.  To build 100k houses priced between RM90k to RM300k under Perumahan Penjawat Awam 1 Malaysia (PPA1M) by 2018. A facilitation Fund of up to 25% of development cost is provided.  To build 22.3k units of apartments and 9.8k units of terrace houses under the People’s Housing Programme (PPR) with an allocation of RM863m.  GLCs to build affordable houses in the vicinity of the MRT station in Bandar Kwasa Damansara. Sime Darby Property to build 4,600 units and Kwasa Land to build 800 units.  To build houses for the second generation of settlers – 20k units by FELDA, 2k units by FELCRA, and 2k units by RISDA.  RM155m for maintenance of low-cost public housing and 1Malaysia Maintenance Fund by KPKT.

Rubber Products – Growing recognition for the sector Rubber Products Comments Main Measures  Increase in minimal wage policy for all sectors by an estimated 11% to RM1,000 from RM900 in West Malaysia beginning 1 July 2016.  Reinvestment allowance up to 60% of qualifying capital expenditure (15 consecutive years) for companies that reinvest in expansion, modernization and automation.  Development of Rubber City, Kedah with an allocation of RM320m which includes building a medical and industrial examination gloves manufacturing company under the East Coast Economic Region (ECER).

Key Implications  Mildly positive impact on the sector.  Any additional cost from the minimal wage policy is to be passed through per industry practice.  Time frame of around 8 months before the hike in minimal wage policy should be ample for glove makers to adjust selling prices with customers.  The development of Rubber City is a testament of growing recognition of the sector by the government, in our view. Hence, we expect the government to roll out more positive initiatives for the sector moving forward.  Similar to the 2015 budget, we believe that the reinvestment allowance will be positive for glove companies, which have been spending capex on automating their production lines.

Recommendations  Maintain OVERWEIGHT on the sector.  We believe that initiatives in the budget are conducive and positive for the sector.  Top pick: Karex (KAREX MK, RM3.46, BUY, TP: RM3.85).

Source: MOF, Affin Hwang

26 October 2015

Other noteworthy issues:  The government will be increasing the rubber production incentive (IPG) for SMR20 FOB to RM5.50/kg from RM4.60/kg.  We believe that this will promote more rubber production, which would lead to the global latex supply glut continuing.

Technology – Higher cost of labour Property Comments Main Measures  Increase in monthly minimum wage from RM900 to RM1,000 for Peninsular Malaysia and from RM800 to RM920 for Sabah, Sarawak and Labuan.

Key Implications  Mildly negative for the sector.

Recommendations  Over the years, Malaysian manufacturers have already turned less competitive compared to regional peers. An increase in labour costs would further reduce the cost competitiveness that most Malaysian manufacturers offer now, in our view.  At the company level, profitability could be negatively affected. Direct labour accounts for approximately 9-10% of a manufacturer’s cost and a 11-15% increase in the minimum wage would take a toll on profit margins (albeit marginally, an increase of up to 1.5%), in the event there is no increase in productivity levels.  Maintain Neutral on the sector. Top pick is Inari (INRI MK, RM3.70, BUY, TP: RM3.89), as valuations look attractive vis-à-vis its strong earnings growth.

Source: MOF, Affin Hwang

Other noteworthy issues:  To facilitate tourism in Malaysia, the government is to implement e- visas by mid-2016. Comment: Could increase the job scope of current e-government service providers. Potential e-government service provider beneficiaries include MYEG (MYEG MK, RM2.86, Not rated) and Scicom (SCIC MK, RM1.97, BUY, TP: RM2.39).

26 October 2015

Telco – Spreading high speed broadband access Property Comments Main Measures  RM1.2bn allocated for several projects, including rural broadband projects, which should see a four-fold increase in Internet speed from 5Mbps to 20Mbps, National Fibre Broadband Infrastructure, high-speed broadband, and undersea cable system.

Key Implications  We are neutral on this development as the above measures were already outlined under the 11th Malaysia Plan.  Nonetheless, Telekom Malaysia is seen as the key beneficiary from further co- investment from the government as well as a potential long-term uptrend in the company’s ARPU due to an increasing base of high-speed broadband users.

Recommendations  Neutral. The budget proposal should have minimal earnings impact on the sector.  DiGi (DIGI MK, RM5.63, BUY, TP: RM6.70) remains our top pick, exhibiting service revenue growth despite more intense competition. We think DiGi also stands to benefit the most from a boost in prepaid usage consumption if the government bears the cost of rebates for GST on mobile prepaid accounts.

Source: MOF, Affin Hwang

Other noteworthy issues:  From 1 January 2016 to 31 December 2016, mobile prepaid users are to receive rebates equivalent to the amount of GST paid, which would be credited directly to their prepaid accounts.  If the government is responsible for bearing the cost of the rebates, prepaid usage levels should see a boost, which would be positive for the mobile players, although competition remains intense.  At this juncture, it is unclear whether the telcos or the government would bear the cost of the GST rebates for prepaid users.  However, according to media reports, Datuk Seri Najib Razak said that the government was willing to “let go” of some earnings from the broad-based consumption tax to lighten the burden on the public.

Timber – Increment in national minimum wage Property Comments Main Measures  Minimum monthly wage increase from RM900 to RM1,000 for Peninsular Malaysia and from RM800 to RM920 for Sabah, Sarawak and Labuan, effective 1 July 2016.

Key Implications  The higher minimum monthly wage is not expected to have such significant impact on the timber companies.

Recommendations  We expect global demand for tropical logs to stay strong on continued tight supply, and this should help to keep prices firm. Also, the appreciation of the US$ against the RM should help to partially offset the flattish outlook for the plywood division. We expect the plantation division to be key to future earnings growth given the expanding matured estates and firmer CPO prices.  Overall, we remain NEUTRAL on the timber sector.  For sector exposure, we prefer Ta Ann (TAH MK, RM3.84, BUY, TP: RM4.46) on its improving earnings in 2015-17E as well as its 5.2% dividend yield.

Source: MOF, Affin Hwang

26 October 2015

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