Future growth built on solid ground

Malaysia’s equities market is likely to offer above-regional-average capital growth for at least the next six months, suggests a straw poll of local investment managers.

The country’s reputation for fiscal prudence, backed by a clear government strategy for moving economic activity away from the lower end of the value chain, makes Malaysia a probable haven for foreign direct investment.

A potentially positive macro influence is the cooling of demand for FDI in the neighbouring Thai market, after poorly implemented capital controls by Thailand’s interim military government. Thariq Ahmad, chief investment officer for KAF Fund Management, says most Malaysian companies are undervalued, though he concedes some of this is strategic, to give managements the option of taking businesses private.

“Telcos have trebled their value in the past five years in terms of earnings per share. I can see significant capital growth across many sectors, though of course any growth in Malaysia will depend on continuing positive sentiment in China.”

UBS recently sponsored the ‘Invest Malaysia’ conference in Kuala Lumpur, attended by the country’s prime minister, Abdullah Ahmad Badawi. UBS is not alone in being bullish but it sees an extended run being built. Its recent Malaysia market strategy report predicts several years of equity capital growth thanks to strong fundamentals in the economy and investor-friendly government policies: “Following better-than-expected earnings for Q4 2006, we now forecast net profit growth of circa 19% for calendar year 2007 and circa 10% for calendar year 2008, representing ROE of 15.3% and 15.6%, respectively.”

The International Monetary Fund estimates Malaysia’s GDP will grow by 5.5% this year and 5.8% in 2008. The IMF gave Malaysia a generally favourable review in its latest report in February, saying: “Executive directors welcomed the continued robust performance of the Malaysian economy with vigorous growth, low inflation, and a strong external position. Malaysia has progressed significantly towards reaching advanced country status and now benefits from deep financial markets and a low poverty rate.” The IMF did stress, however, that rising exposure to the household sector could undermine the banking sector. Household indebtedness is high relative to other countries and to disposable income, but appears “manageable” at present.

 

BS says the foundations of Malaysia’s robust performance are firstly, a government focused on attracting investment. Measures include new incentives for the Iskandar Development Region (IDR), the development of the Islamic finance sector, easing of forex regulations, aggressive fiscal ‘pump-priming’ and an accommodative monetary policy.

Visibility on FDI and fiscal spending are also supporting a re-rating. Major announcements are expected in Q3, including more than RM10bn (€2.2bn) of development projects in the IDR; plans by foreign banks to expand/establish Islamic banking operations in Malaysia and government plans to raise development spending 17% year-on-year. In all likelihood, the Kuala Lumpur Composite Index (KLCI) will break the 1,400-point barrier by the end of 2007, following widespread earnings per share upgrades. UBS says it believes high operating free cash flow yield (an estimated 10% in 2008), solid EPS momentum with forecast two-year EPS compound annual growth rate of 16%, and rising return on equity (ROE) of 14% in 2006 to 15.6% in 2008, support a re-rating to its target forward price/earnings ratio (PE) of 16.5x.

Its tips for top performers in the market offer a useful snapshot of the country’s economy. They include Tenaga Nasional, Malaysia’s main energy company; Bumiputra-Commerce Holdings, the banking group; AMMB Holdings, the investment and finance business with exposure to the growing Islamic finance market; Maxis Communications, the mobile phone service provider with exposure to the high-growth Indian wireless sector, and Lafarge Malayan Cement, the building materials provider likely to benefit from rises in world commodity prices and above average local demand for cement.

Average daily turnover of $808m in Q107 was the highest in a decade and, year to date, made the KLCI (with the exception only of China and Vietnam) the region’s best performing index (up 13.7% in local currency terms and 16.1% in US dollar terms).

UBS expects FDI of at least $7bn in 2007. Total FDI for 2006 was $6.1bn, a year-on-year rise of 48%. The majority of Malaysia’s FDI investment in 2006 was in shares and corporate securities. In 2006, figures from Bank Negara Malaysia (the country’s central bank) show total overseas investment in Malaysian equities stood at RM18.98bn (approximately $5.58bn at current exchange rates). The biggest investors were Japan, with RM9.56bn, the US, with RM2.2bn, the United Arab Emirates with RM889m and Singapore with RM752m. The other main Asian players were Vietnam with RM381m and Hong Kong with RM308m. The biggest European investors in Malaysian equities were the UK with RM398m, Germany with RM381m and the Netherlands with RM217m.

Munir Abdul Aziz, an investment lawyer and partner specialising in mergers and acquisitions and equity capital markets at Wong and Partners in Kuala Lumpur, says Malaysia is now adopting the Japanese and South Korean strategy of moving out of low-margin, high-volume manufacturing as part of the country’s plan for economic growth.

“The government is intent on leading Malaysia up the value chain. Until recently we relied on export-led manufacturing. Now, in the area of electronic products for example, we are outsourcing the lower value work to places like China. This is necessary because we cannot compete against China on price. We cannot even compete against Vietnam for low-cost manufacturing.

“When it comes to outsourcing and investing in neighbouring countries, Malaysia has certain inherent advantages. It is a highly multi-racial country, made up of ethnic Malays and significant proportions of ethnic Chinese and Indian people. We can exploit these cultural and commercial links by making investments in places such as China, India and Indonesia.

“We are fast catching up with Singapore. Malaysia’s domestic market is relatively small with only 25m people, so companies are seeking new markets and seeking to play on a regional basis.”

 

he country has a proven track record of delivering consistent growth (with a few notable macroeconomic blips such as the speculative assault on the ringgit in 1997) stimulated and regulated by government economic planning. At the time of the currency crisis in 1998, the ringgit became non-convertible externally and was pegged at RM3.80 to the US dollar. Since coming off that peg in July 2005, the currency has reached RM3.40 against the background of a weakening dollar.

UBS agrees with the IMF on aggregate GDP growth over this year and next, but believes the spread will be slightly different - up 10 basis points on the IMF’s 2007 estimates to 5.6%, and down 10bps on IMF estimates for 2008 to 5.7%. Fee Yee Leong, head of equities, Malaysia, for UBS, says: “Growth will be driven by increased spending on the ninth Malaysia plan 2006-10, with a possible acceleration in spending in the next 12-18 months ahead of a general election, due in 2009.

“Corporate pre-exceptional earnings growth is forecast to be 17% in 2007. Increased M&A activity and the current trend to take private undervalued companies are also expected to help re-rate the market. Government-linked companies which are some of the largest companies by market cap on Bursa Malaysia are also expected to deliver more tangible proof of their restructuring efforts over the last two to three years via stronger earnings growth, better capital management and higher ROE,” he says.

There are relatively few investment restrictions in Malaysia. Foreign institutional investors can buy shares listed on Bursa Malaysia directly. Exchange traded funds and structured products are not actively traded yet.

“The main advantages of Malaysia are relatively strong earnings growth, political stability and the government’s strong commitment to improve the delivery of public services via major restructuring of its biggest service companies in the power, telco and banking sectors. These plans are constantly being monitored to ensure delivery and maintain predictability in economic activity,” says UBS’s Leong.

There are restrictions for certain industries and sectors - in particular telcos and financial institutions have single shareholder limits irrespective of whether they are local of foreign. No individual can own more than 5% of a bank without prior permission from the central bank and no group can own more than 20% of a bank. Certain companies such as Malaysia International Shipping Corporation and Public Bank Berhad have self-imposed limits on foreign ownership. In most other cases, there are no restrictions.

 

In mid-May, US investment banking group Goldman Sachs acquired 2.1% of Suria Group, which has interests including ports management. The company recorded revenues of RM65.7m for the first quarter 2007 a year-on-year increase of RM26.3 million or 67%.

In Malaysia, once the maximum permitted level of foreign ownership has been reached, the stock is quoted in two prices, local and foreign. The only limit on foreign shares is that the holder has no entitlement to vote. All other shareholder benefits such as dividends, rights issue entitlement, bonuses or share splits are unaffected.

“Malaysia is a very well established investment destination,” says Aziz from Wong and Partners. “We have encouraged FDI since the early 1980s. We have a very solid legal framework. This includes a common law heritage allowing business to be regulated administratively rather than necessarily by statute - though with safeguards for judicial review. We also have a fairly well educated work force that speaks good English. Taken overall, it’s an excellent basis for further growth.”