EWM - EWM: Clearer Skies Ahead For Malaysian Stocks

2023-08-01 11:24:16 ET

Summary

• With inflation pressures swiftly cooling off, the Malaysian monetary policy stance is turning increasingly accommodative.
• Earnings growth estimates also remain solid despite the external headwinds.
• Alongside several technical tailwinds, the reasonably priced iShares MSCI Malaysia ETF could see more upside from here.

Malaysia’s headline inflation numbers have been trending in the right direction – the latest monthly print saw even more deceleration, with core inflation (inflation minus volatile items like fresh food and energy) also quickly converging to the target YoY rate. Alongside slower growth (albeit still within the 4-5% range), a neutral monetary policy stance at the ‘slightly accommodative’ 3% level is the most likely near-term outcome. But with a new governor at the helm, I wouldn’t underestimate a more dovish tilt either, especially if the latest post-meeting statement is any indication. With the market also pricing in a status quo scenario, a more dovish central bank presents upside to current equity valuations.

In the meantime, earnings growth estimates remain solid at +9% for 2023/2024; balanced against a ~14x P/E valuation, the iShares MSCI Malaysia ETF ( EWM ) seems very reasonably priced at current levels. And given the technical tailwinds from foreign participation (currently bottoming out of multi-year lows ), as well as a shift in domestic institutional mandates (the country’s leading pension fund has heeded the government’s call for a higher domestic allocation), I remain positive on the EWM outlook.

Fund Overview – Still a Financials-Heavy Malaysian Large Cap Portfolio

The US-listed iShares MSCI Malaysia ETF tracks (pre-expenses) the performance of the market cap-weighted MSCI Malaysia Index, a 33-stock basket of Malaysian large-caps. The ETF held ~$258m of net assets at the time of writing (up from ~$230m prior), with a 0.5% expense ratio - at the lower end of comparable iShares emerging market offerings despite its scarcity premium as the only single-country Malaysian ETF listed in the US.

In line with prior quarters, EWM’s sector allocation remains skewed to Financials at 39.9%, followed by Consumer Staples (13.0%). The most notable shift post-Q2 is the upsized Utilities exposure, replacing Communication (down to 8.7%). Materials (8.6%) and Industrials (6.6%) are the only other sectors over the 5% threshold.

In line with the financials-heavy sector allocation, the fund’s single-stock holdings also skew toward major domestic banks like Public Bank ( OTCPK:PBLOF ) at 13.5% (unchanged), Maybank ( OTCPK:MLYBY ) at 11.1% (up from ~10% previously), and CIMB Group ( OTCPK:CIMDF ) at 8.0% (unchanged). The ETF’s ex-financials portfolio is led by electric utility company Tenaga Nasional ( OTCPK:TNABY ) at 5.7% (unchanged), followed by integrated chemicals producer PETRONAS Chemicals ( OTCPK:PECGF ) at 4.4%. Of note, EWM has also added a sizeable 5.1% cash allocation, a shift from the portfolio composition in prior quarters. With the top five stock holdings still at >40% of the 33-stock portfolio, investors should be mindful of EWM’s single-stock concentration risk.

Fund Performance – Track Record Remains Below Par; Improved Yield Helps

Despite the rally over the last month, EWM has declined by 4.7% this year, moving its rate of compounding to a dismal +0.6% pace (NAV and market price terms) since its inception in 1996. Due to the YTD underperformance, EWM has fallen further behind comparable Southeast Asian ETFs like the iShares MSCI Philippines ETF ( EPHE ) and the iShares MSCI Indonesia ETF ( EIDO ), both of which have delivered positive returns this year. On three and five-year timelines, EPHE and EIDO have similarly outpaced EWM’s -4.4% and -5.3%, respectively.

The fund distribution has, however, outshined the rest of Southeast Asia, with the trailing 30-day yield moving up to a solid 3.8% (2.9% on a trailing twelve-month basis), helped by the fund’s cash-generative holdings in financials and utilities. By comparison, the equivalent yields for EPHE and EIDO stand at 1.3% and 2.7%, respectively. With the portfolio beta also down to 0.54 vs. the S&P 500 ( SPY ), EWM will appeal to more defensive, income-oriented investors. While earnings growth expectations have declined slightly for its portfolio holdings (~9% for 2023 and 2024), EWM remains reasonably priced at the current low-teens P/E.

Rapidly Decelerating Inflation Supports Dovish Monetary Policy Tilt

Malaysia’s headline CPI index slowed by 40bps to 2.4% YoY in June (vs. 2.8% YoY in May), as a steep decline in food (down 120bps to 4.7% YoY) and transportation inflation (down 100bps to flat YoY) more than offset pressures from healthcare. Core inflation (ex-fresh food, energy, and administered prices) is running higher at 3.1% YoY (vs. the central bank’s 2.8-3.8% target range) but has also notably decelerated from the prior month. More broadly, the consistently decelerating trend across both metrics signals we have likely passed the peak in inflation; with an external slowdown set to hit Malaysia’s export-dependent economy in the coming months as well, continued declines are likely on the cards. Also helping is the limited political appetite to reduce subsidies in the near term amid cost-of-living pressures for the populace. The outcome of this month’s state elections is key – a strong result for the ruling coalition would likely see subsidy rationalization plans brought forward, while opposition strength would entail delays.

On the growth side, an external slowdown will weigh on the outlook, particularly with China, Malaysia’s largest trading partner, seeing manufacturing activity fizzle out post-reopening. Coming off last year’s high base as well (recall the high-single-digit growth), a continued export-led deterioration means GDP growth for this year is more likely than not to come in at the lower end of the central bank’s 4-5% forecast range. While this will hit the major banks’ P&L, which tend to track broader economic activity via loan growth, it could also push the central bank into a sooner-than-expected easing cycle. With a new governor at the helm and forward guidance shifting toward a growth focus (‘the MPC will ensure that the monetary policy stance remains conducive to sustainable economic growth’), the slightly dovish tone bodes well for future equity valuations.

Clearer Skies Ahead for Malaysian Stocks

Since my last bullish piece on EWM, the fund has bounced strongly off its yearly lows, with the YTD losses narrowing to the low-single-digits. From a valuation perspective, the near-to-mid-term setup looks compelling. Decelerating consumer inflation (headline and core) and a modest growth slowdown should keep the central bank on hold for now. But with inflation converging quickly towards target, I wouldn’t rule out a sooner-than-expected pivot either, particularly given the slightly more dovish tone in the new governor’s first policy statement. Relative to underlying earnings growth, the EWM portfolio isn’t that pricey at ~14x earnings as well, suggesting scope for the fund to grow into its valuation over time. Key catalysts include this month’s state elections and increased domestic institutional flows (Employees Provident Fund to inject ~$13bn by year-end).

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