EWM - EWM: Malaysian Equities May Be Close To A Bottom

2023-05-14 09:54:27 ET

Summary

• The iShares MSCI Malaysia ETF’s poor performance in recent years has extended into 2023.
• But with earnings growth intact and the rate hike cycle likely at an end, there is light at the end of the tunnel.
• The multi-year low earnings valuation leaves ample room for the ETF to re-rate higher.

The new Malaysian government's inaugural budget announcement marked another year of expansionary policies, as subsidies and social assistance took precedence over fiscal consolidation for yet another year. While positive for the consumer, elevated deficit levels will need to be funded somehow; if the early signs are anything to go by, a higher tax/higher spending regime may be on the horizon. As the 2023 budget funding is predicated on a high-teens % increase in corporate tax revenue (based on economic growth projections), along with higher dividends from state-owned oil company Petronas (based on higher for longer oil prices), any shortfall could result in a higher tax burden for the large-caps. On the other hand, Malaysia is likely done with tightening following its central bank's latest 25bps hike, which bodes well for equity valuations. While the iShares MSCI Malaysia ETF ( EWM ) doesn't screen particularly cheaply at the current ~13x P/E ratio, underlying EPS growth estimates remain strong in the mid-teens % for 2023. With foreign ownership also at multi-year lows and the government calling for a higher domestic allocation for the country's leading pension fund, the selling pressure may finally be close to a bottom.

Fund Overview - A Concentrated Play on Malaysian Large Caps

The US-listed iShares MSCI Malaysia ETF tracks, before fees and expenses, the performance of the market cap-weighted MSCI Malaysia Index, which comprises the large and mid-cap segments of the Malaysian market (or ~85% of the Malaysian equity universe). The ETF held ~$230m of net assets at the time of writing (down from ~$235m when I last covered EWM), with the expense ratio remaining at 0.5%, below comparable emerging market ETFs. As the only US-listed Malaysian ETF, EWM screens favorably as a cost-effective option for US investors looking for single-country exposure to Malaysian equities. A summary of key facts about the ETF is listed in the graphic below:

As highlighted in the chart below, EWM's sector allocation remains heavily concentrated on the financial sector at 39.4% (slightly down from ~40% prior). Consumer staples is the only other sector over the 10% threshold at 13.0% (unchanged). The most notable shift post-Q1 is the upsized communication sector exposure at 9.1%, with utilities (8.7%) and materials (8.4%) moving down the top-five list. With the top five sectors accounting for a combined 78.5% of the total portfolio, EWM is fairly concentrated from a sector perspective.

In line with the sector concentration in financials, the fund's main holdings are Malaysian banking leaders such as Public Bank ( PBLOF ) at 13.8% (unchanged), Maybank ( MLYBY ) at 10.0% (unchanged), and CIMB Group ( CIMDF ) at 8.1% (down from ~9% prior). Outside of financials, the ETF maintains its fourth-largest position in electric utility Tenaga Nasional ( TNABY ) at 5.6% (unchanged), while integrated chemicals producer PETRONAS Chemicals ( PECGF ) has been replaced by aluminum producer Press Metal ( PSSMF ) in the top five list. With the top five holdings still contributing an outsized >40% of a 34-stock portfolio, investors should be mindful of EWM's single-stock concentration as well.

Fund Performance - Sub Par Capital Growth, but There Are Silver Linings

On a YTD basis, the ETF has declined by 4.0%, moving its rate of compounding to a dismal 1.0% pace (+0.4% post-taxes) since its inception in 1996. As a result, EWM has fallen behind its Southeast Asian peers, with comparable ETFs like the iShares MSCI Philippines ETF ( EPHE ) and the iShares MSCI Indonesia ETF ( EIDO ) outpacing the fund across three and five-year timelines. For context, EWM has returned 2.7% and -5.8% over the last three and five years, respectively; EPHE has delivered +6.6% and -3.9%, while EIDO returned +18.6% and -0.8% over the same time frame.

The fund distribution runs on a semi-annual basis, with the trailing 30-day yield now at a solid 3.6% (3.1% on a trailing twelve-month basis) following the de-rating in recent months. Given the fund's concentration in stable cash generators across financials and utilities, the income stream (and the occasional special dividend) is very sustainable as well. Alongside a portfolio beta of 0.58 vs. the S&P 500 (SPY), EWM should appeal to defensive, income investors. There is something here for growth investors as well, though, with earnings growth expectations for EWM's holdings in the high-teens % for 2023 and high-single-digits % for 2024. Relative to a multi-year low fwd P/E at ~13x, EWM seems very reasonably priced here.

Persistent Deficits are a Concern, but Growth Potential Intact

The post-election budget announced by the new administration saw yet another expansionary package, prioritizing subsidies and social assistance over fiscal consolidation. With the government set to run yet another year of mid-single-digit % deficits (as a % of GDP), the ~3% target is now only set to be achieved by 2025. With Malaysia trailing its regional peers on the fiscal consolidation path and the government showing little political will to cut spending, funding these deficits will be a challenge. Even this year's revised budget could prove to be very tricky, given the lack of conservatism with regard to its growth and commodity price assumptions (note the government intends to tap into state-owned Petronas' dividends). Should Malaysia's growth prospects and global commodity prices falter, recent history (e.g., the 'prosperity tax' last year) suggests corporates could be left footing the bill.

It isn't all bad news for EWM, though. For one, the consumer is in comparatively better shape, helped by the ongoing government subsidies and faltering inflationary pressures. Having already hiked at its latest meeting to pre-empt the initial round of subsidy removal, the central bank's latest policy statement indicates rates are likely to remain unchanged for the rest of this year. Expect the current level of fuel subsidies to remain intact ahead of the upcoming state elections, keeping a lid on headline inflation numbers. Further, supporting the case for neutral rates is a QoQ deceleration in Q1 growth post-Q4 adjustment (~1.2%pt higher to +7.1% YoY) due to a moderation in public spending and private consumption expenditure. A neutral to accommodative monetary backdrop bodes well for EWM's portfolio valuation, which continues to linger well below historical levels despite a strong earnings growth outlook.

Conclusion

The bull case for Malaysian equities took a slight hit following the revised 2023 budget; while it remained expansionary, it also entails another year of elevated deficit levels. The government has dipped into corporate coffers before (recall the 'prosperity tax' last year), so in the event that growth or oil prices fall short of expectations, higher tax burdens could be on the horizon for EWM's key holdings. Fundamentally, though, Malaysia continues to benefit from strong growth and one of the lowest inflation rates in the region. With the central bank likely done with its current tightening cycle post-March hike and foreign ownership also now at multi-year lows, Malaysian equities are not short of valuation tailwinds. Relative to the EWM's low-teens EPS growth outlook for this year, the ~13x P/E doesn't seem too expensive either, leaving ample room for upside from here.

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