25 M'sian stocks that are expected to outperform the FBM KLCI

Standard & Poor’s recently issued a comprehensive report on Malaysia and the 25 top stocks it was looking to outperform the market in the Year of the Tiger. Below is an excerpt of that report.

AS we enter the Year of The Tiger, we can expect more volatility, especially with the current market valuations providing lesser room for disappointment.

Stock picking is likely to be more important this year, with fewer bargains available particularly as headwind builds.

Although share prices are not as cheap as in early 2009, forward price-to-earnings ratios (PERs) remain undemanding and we believe equities will remain favourable, given the limited alternatives.

We have selected 25 Malaysian stocks that we expect to outperform the FTSE Bursa Malaysia KL Composite Index (FBM KLCI) this year.

We maintain FBM KLCI target at 1,400 points in 2010 for an 11% return, pricing the index at 16 times market consensus earnings for this year.

However, the broader market and recurring income growth are stronger at 31% and 27% respectively.

While we do have a preference for cyclical issues, with 18 of 25 of our picks in cyclical sectors, in terms of market capitalisation, the larger sizes of defensive stock picks means that defensive issues make up 35.7% of our recommended portfolio, mirroring the FBM KLCI.

Based on valuation grounds and growth prospects, we are “overweight” on the banking and healthcare sectors in Malaysia.

We are “underweight” on the telecoms sector.

We see limited change in our overall macro outlook that would change the positive view for the banking and healthcare sectors we have held since mid-2009.

We continue to believe that cyclical sectors should outperform in 2010 in view of the recovering global economy and benefits from ongoing Government stimulus measures.

While we note that the Bursa Malaysia Finance Index was one of the best performing groups in 2009, it has in the past continued to outperform in the second year of a recovery after a global market crash and recession.

The healthcare is a relatively small sector in Malaysia but its components consist of dominant global manufacturers of medical and related gloves.

We see lingering concerns over flu pandemics, including the potential risk of a resurgent H1N1 virus that should sustain demand for rubber gloves.

With comfortable valuations and healthy earnings growth and return on equity (ROE), this sector is our preferred non-cyclical play.

We see potential in the plantation industry but believe that valuations have built in higher palm oil prices.

This leaves the risk of disappointment higher and as such, we maintain our “marketweight” view on the consumer staples sector.

For energy, while we are “overweight” on the sector globally, we are “neutral” on the Malaysian energy sector. This is because the local energy sector comprises solely of services companies which may face margin pressure with excess supply in jack-up rigs and other support services to weigh on day rates.

The 25 stocks picked in the portfolio is meant to be fixed, meaning that it will not undergo any changes for the full year.

The analysts have chosen stocks they believe will be the best poised to benefit from the economic recovery and with relatively comfortable valuations to hold up against the increased volatility in the market.

We have also stuck to managements that we believe have proven track records and/or have selected companies that are the dominant players in their fields.

Disappointment may come from falling margins. Unusually high 2009 margins may not be sustainable if sales do not pick up.

We anticipate around 10% rise of fuel and raw material costs, and we believe that most of this can be passed or absorbed by currency translation gains and more than offset by improved efficiency.

A greater than 10% rise would warrant a more significant reassessment of earnings.

Another key risk is volatile exchange rates and a sharp fall in the US dollar, which may send commodity and energy prices up.

Conversely, a strengthening US dollar may drive repatriation of funds back into the United States and out of emerging Asia.

Geopolitical and pandemic risks remain a possibility.

Unexpected defaults (along the lines of Dubai World) and worse-than-expected commercial property debt troubles may dampen financial sector confidence and lower risk appetite.

S&P's top 25 stock picks for the year

1. Genting Bhd

We like Genting for its wide experience in the casino business, expanding footprint and financial strength.

It offers exposure to the integrated resort in Singapore, which will be a significant contributor to earnings over the medium term, while domestic casino operation will provide relatively stable earnings.

The management continues to seek casino opportunities elsewhere to expand its footprint further.

Valuations are not demanding at current level with the stock trading at a discount of about 20% to its sum-of-parts value.

2. HELP International Bhd

HELP’s track record is evident in its double-digit growth both in revenue and net profit over the past three years, while enjoying the highest net profit margin among its listed peers.

We expect the double-digit trend to continue, underpinned by a steady increase in local and international student intake as well as overseas expansions via franchising and licensing arrangements.

3. QSR Brands Bhd

QSR Brands is well positioned to benefit from improving consumer sentiment.

It provides exposure to two leading franchises in Malaysia and Singapore – market leader KFC as well as Pizza Hut’s higher value concept that normally outperforms in a better economy.

QSR is a cheaper alternative at a 2010 price-to-earnings ratio (PER) of 8.4 times versus KFC’s 10.4 times.

In the longer term, we believe profit growth will emanate from the opening of 30 KFC stores and 16 to 18 new Pizza Hut outlets in Malaysia, while operations in Indochina and India will provide an additional kick to profits.

4. Carlsberg Brewery (M) Bhd

We are positive on Carlsberg in 2010 with its acquisition of Carlsberg Singapore, which is expected to add RM35mil per annum from profit contribution and cost/synergy savings.

The acquisition also provides Carlsberg a new growth engine outside the anemic Malaysian malt liquor market.

Carlsberg is currently traded at an undemanding 2010 PER of 12 times, below its 5-year historical traded average of 17 times and its key rival Guinness Anchor Bhd, which is traded at 14 times.

5. KL Kepong Bhd

We note much of the good news for the palm oil markets has probably been reflected but we believe that investor interest in the plantation industry should remain strong, underpinned by a favourable outlook and the potential for higher CPO prices over the mid-term.

While the stock is no longer cheap at 19.6 times annualised 2010 earnings, a positive management track record, decent earnings per share (EPS) growth of 32%, and relatively high proportion of young and prime plantation acreages makes KLK the preferred blue-chip plantation pick.

Its recent 60:40 Indonesia joint venture for the replanting of 207,000 hectares of oil palm will provide further growth potential.

6. United Plantations Bhd

Although relatively small in size with planted area of only 46,100 hectares, United Plantantations is still one of the most efficiently managed plantation groups in the country with superior yield and cost-competitive operations.

This is due to its continued efforts in upgrading its facilities and infrastructure.

Its Indonesian operations will be the main growth driver from 2011 when new acreage begins its maiden contributions.

Valuations are not demanding with 2010 PER of 9.4 times versus the sector-weighted PER of 16.5 times.

7. Alam Maritim Resources Bhd

With one of the youngest fleets of service vessels in the industry (average age below six years), all of which are Malaysian-registered, Alam Maritim is a beneficiary of continued upstream oil and gas activities in the country.

We expect a continued expansion in underwater and diving revenue, as Alam Maritim leverages on its venture with Singapore’s Swiber Ltd to own and operate a pipelay vessel.

Upstream support activities are likely to pick up this year, judging from the recent flurry of contract awards by Petronas towards end-2009.

Valuations at nine times 2010 PER versus industry average of 10 times 2010 EPS are not demanding, especially considering above industry average 3-year EPS compounded annual growth rate of (CAGR) 18.2%.

8. Wah Seong Corp Bhd

The execution of the Gorgon LNG pipeline coating project will likely keep Wah Seong busy over the next two years. While contracts newsflow should slow down, we expect increasing earnings visibility and successful execution of its jobs to provide further share price catalysts.

Also, the acquisition of the remaining 32.5% stake in main pipe-coating subsidiary PPSC Industrial Holdings Sdn Bhd from ailing Socotherm indiscates to us the potential for more earnings-accretive purchases, which would also be a positive share price driver.

While Wah Seong is trading at 11.1 times 2010 PER versus industry at 10 times, growth prospects are significantly better, with 3-year EPS CAGR at 19.3 per annum.

9. Allianz Malaysia Bhd

Allianz Malaysia is our preferred insurer as we expect strong earnings growth for the company in 2010 that is underpinned by robust premium growth.

Its underwriting discipline has been excellent, while prudent risk selection processes should help the insurer maintain below-industry-average claims ratio.

Its forward PER of 7.5 times is also undemanding, in our opinion, which is below its industry peers.

10. AMMB Holdings Bhd

AMMB is well positioned to be the strongest second-tier bank and to challenge the established top three banks in the country.

ANZ’s presence as a major shareholder provides more sophisticated risk management initiatives, which we believe should help improve operational efficiency.

The stock is attractive for its undemanding prospective annualised 2010 price-to-book (P/B) multiple of just 1.45 times compared with peer average of 1.93 times. We see the P/B discount gap continue to narrow as AMMB grows its return on equity.

11. CIMB Group

CIMB Group is our pick of the Malaysian banks for relative and absolute outperformance this year.

Our 2010 net profit forecast suggest earnings growth of 24.3%, which comfortably beats the average sector growth of 19.9%.

CIMB remains attractive for its established consumer banking business, strong investment banking franchise and dynamic management. It also has the most developed and best resolved regional banking strategy.

12. SP Setia Bhd

We like SP Setia for its good track record in generating sales even in difficult times, and its ability to enhance the value of its landbank through innovative products.

Its landed residential projects are strategically located in three major states in Malaysia – Penang, Johor and Selangor – as well as in Vietnam.

In addition, it will soon diversify and enlarge its earnings base to include commercial development with the launch of its mega RM6bil Kuala Lumpur EcoCity along Jalan Bangsar in October.

13. Kossan Rubber Industries Bhd

Kossan continues to operate at almost 100% capacity and currently has orders confirmed up to mid-2010. Going forward, it will focus on high-margin glove products and will allocate its new capacity to these products, which will help inflate margins.

We expect Kossan to turn in recurring 2010 EPS growth of about 16% year-on-year, translating into a PER of nine times which is below Kossan’s average PER of 10.5 times and sector’s average of about 12 times.

14. Supermax Corp Bhd

Supermax is expected to benefit from strong global glove demand and currently has an order backlog of five billion pieces of gloves.

The group is expanding its capacity but this is unlikely to meet 2010 demand.

We believe the flu pandemic, rising glove sales and expanding margins would continue to keep investors interest.

The group is presently trading at a reasonable 9.5 times 2010 PER against an expected EPS growth of 16% year-on-year.

15. AirAsia Bhd

AirAsia is expected to benefit from the increased attractiveness and acceptability of low-cost travel.

Amid the uncertain economic climate, we see low-cost operating model and growing network of travel destinations as an advantage it has over its competitors.

We expect improved earnings prospects for the airline and we project attractive ROEs for AirAsia of 22% and 19% in 2010 and 2011 respectively.

16. Mudajaya Group Bhd

We like Mudajaya for its fast-expanding order book, which now stands at a record high of RM5.5bil, and its healthy balance sheet.

We expect Mudajaya to continue performing well with the likely securing of more projects locally and overseas, steady operating margins and with its independent power producer (IPP) in India having crossed critical milestones.

The group is expected to benefit from the recurring income of its India IPP project, which is targeted to start operations in 2012.

In our view, at a 2011 PER of 7.7 times, the current share price does not fully reflect Mudajaya’s near-term growth potential (2-year forward EPS CAGR of more than 50%).

17. Sime Darby Bhd

Demand for CPO is expected to remain firm, driven by an increase in consumption and as feedstock for the biofuel industry.

CPO demand will also be boosted by its attractive price discount to soybean oil and rapeseed oil.

At the same time, supply is expected to be tight, affected by the El Nino phenomenon and the seasonally lower production period in the early part of the year.

Sime will also benefit from higher CPO output due to its enlarged mature acreage and better cost control, helped by improved efficiency and lower fertiliser cost.

18. Sunway Holdings Bhd

Sunway’s business has strengthened over the past few years with its expanding construction orderbook of RM3bil, strong property sales and new landbank in Singapore.

We continue to favour Sunway for its high earnings visibility, supported by a sizeable order book with a balanced mix of local and overseas projects, steady quarry earnings and bright prospects for its China expansion where it has built a pool of good manufacturing assets to produce building materials such as pavers and spun piles.

Valuations remain undemanding, with the stock trading at just eight times 2010 earnings.

19. Notion VTec Bhd

The outlook for Notion is positive for the next few quarters, backed by the ongoing strong orders for both its camera components and hard-disk drive (HDD) segments.

Notion will also benefit from its expansion into Thailand, given the rising global demand being seen currently for the interchangeable lense.

The recent entry of Nikon Corp as a strategic shareholder in Notion is also positive and is likely to lead to higher revenue contribution from Nikon over time (now at 40% of Notion’s camera components revenue).

20. Unisem (M) Bhd

We expect Unisem to benefit from the recovery in chip demand, which should drive earnings this year.

We project a more-than-doubling in earnings in 2010 driven by its Chengdu operations, which management expects to grow by 100% year-on-year; a genuine recovery in chip demand; inventory restocking and capacity expansion in the sector; as well as rising outsourcing trend in the region.

We also like Unisem for its hands-on management, conservative balance sheet and clear strategy.

Valuations are attractive, in our opinion, with the stock, at RM2.11, trading at 2010 and 2011 PER of 8.7 times.

21. Malaysia Steel Works (KL) Bhd (Masteel)

After a difficult 2009, we expect the local steel sector to benefit from increasing domestic project implementation this year and a rising average selling price.

Masteel remains one of the cheapest steel stocks, with an estimated 2010 PER below six times against peer average of 8.5 times.

22. Sino Hua-An International Bhd

As one of the largest independent coke producers in China’s Shandong province, Sino Hua-An is well-placed to benefit from the steel industry recovery.

Given the strong operating leverage, we believe Sino Hua-An’s results should improve significantly this year on the back of rising coke prices.

Sino Hua-An’s balance sheet remains healthy (net cash) and at 6.3 times 2010 earnings, valuation is cheap versus peers which trade around 8.5 times

23. Subur Tiasa Holdings Bhd

Subur Tiasa has diversified geographical markets for its timber products and is significantly less dependent on the weak Japanese housing market than other large Malaysian timber companies.

Its logging division is expected to perform well with continued robust demand from India while its maturing palm oil plantation will provide another source of recurring earnings.

In addition, the group’s active share buy-back scheme is expected to provide support to its share price.

24. Axiata Group

We like Axiata for its vast geographical reach in Asia’s fast-growing mobile markets and good earnings growth potential.

Its group-wide ongoing reform, which includes its cost-down initiatives and emphasis on profitability, are nicely panning out and should help support earnings growth, moving forward.

At the current price, the stock is trading at 2010 and 2011 PERs of 13.2 times and 12.2 times respectively. Valuations are attractive, in our opinion, particularly given Axiata’s growth potential and improved balance sheet.

25. Tenaga Nasional Bhd (TNB)

TNB’s earnings visibility has improved, with coal cost expected at US$85 a tonne in the financial year 2010 as 45% of requirements have been locked in at US$65-US$70 a tonne.

Meanwhile, electricity demand is recovering at a faster rate and is expected to exceed 3% year-on-year, driven by the pick-up in the industrial sector.

Foreign shareholding seems to have stabilised at 9.4% in November and December 2009 from the peak of 28.3% in April 2007.

Valuation is undemanding as compared to its peers and its historical trend.

Thestar