3Q results – most disappointing quarter post GFC crisis

DBS

Supercuts. 3Q11 results were the most disappointing since the global financial crisis. 3Q net earnings fell 10% y-o-y, with half of the stock under our coverage reporting a drop in earnings. We cut earnings by 3% each for FY11 and FY12, and cut target prices for 48% of stocks covered. About 10% of our recommendations were cut to Sells or Holds.

Earnings could bottom in 1Q12 barring a financial dislocation. Despite 4 quarters of earnings cuts, earnings have yet to bottom. Our economist expects the Singapore economy to bottom out in 1Q12, barring a financial dislocation. During GFC, earnings downgrades either hit bottom a quarter ahead or in tandem with the GDP bottoming, implying market has yet to find its floor.

Valuation inexpensive but upside capped at 3000, higher downside risks to 2500. We believe it is too early to position in cyclicals, which remains vulnerable. Macro risks prevail, and a deleveraging of European banks giving rise to liquidity squeeze, could take the STI down to 2500 (-1.5 SD). Risk aversion will cap the upside at 3000 (-0.5SD). Our previous stress tests would have discounted a recession scenario, but not a crisis scenario with downside to 2000.

Sell cyclicals on strength, stay defensive. As such, we would take the recent rebound to sell cyclicals on strength and stay defensive in stocks with high earnings visibility, low earnings risks and high yields. Stocks on our buy list are Singtel, Comfort Delgro, CMT, Global Logistics, MCT, SembCorp Industries and UOL. Sell City Developments, SGX, Cosco Corp, Goodpack, NOL and SIA.

3Q results – most disappointing quarter post GFC crisis

Despite cuts in earnings since Mar 2011, 3Q results were the most disappointing after the global financial crisis. Among our DBSV portfolio, 35% of the companies reported results below our expectations vs only 18% above our expectations. This compares against disappointments of 22% in 2Q11 and 1Q11 and 13% in 4Q10. Among the underperformers were blue chips stocks such as SIA, ST Engineering, Wilmar, Noble Group, StarHub and the banks – UOB and OCBC.

3Q overall net earnings fell 10% yoy, with half of them reporting a drop in earnings. Industrial sector suffered the biggest drop in earnings, due to losses incurred by NOL, Noble, Broadway and lower earnings from SMM, Cosco Corp, Keppel T&T, Amtek and Hi-P. While the real estate sector was affected by the change in accounting policy, performance for Consumer Services were dragged by poorer earning from SIA and SMRT on higher fuel costs and losses from Tiger and Banyan Tree. Growth in oil and gas was driven by a doubling of profits at STX OSV and Ezion offsetting lower earnings from Ezra and CHO.

We cut target prices for 48% of the stocks compared to 19% with upgrades. On average, we have reduced target prices by about 8%. Stocks with at least 20% cut in target price include Conscience Food, Kencana Agri, Mewah, SIA, Amtek, PEC, Tiong Seng, Ezra, CapitaLand, CapitaMall Asia and CSE Global.

We have also downgraded recommendation for stocks like SIA, Indo Agri, Kencana Agri, ST Engineering, Keppel T&T, Noble Group, SingPost, CH Offshore, Wheelock Properties, Mewah, Goodpack, Amtek and Ezra.

On a more positive note, we raised our target prices for Sakari Resources by 22% on higher coal reserves, Yangzijiang by 13% on better margins assumption and Sound Global on slightly better than expected 3Q earnings and optimistic forecast. Growth going forward is backed by large orderbook and strong contract flows.

Overall, we have cut our earnings for FY11F and FY12F by 3% each. About 40% of the stocks suffered a cut in earnings, either for FY11F or FY12F or both. Among the sectors, Consumer Services and Technology suffered the biggest cut in earnings. Even the more resilient sector like REITS suffered a net change of -0.2% and -0.6% in earnings for FY11F and FY12F respectively post results. We now expect overall FY11F to slip into negative earnings growth of 0.7%. For FY12F, earnings are expected to grow 12.2%. However, sectors with further downside risk to earnings for FY12F include the index heavy banks, property and consumer services sectors.

Consumer sector suffered one of the biggest earnings cut mainly affected by SIA, on lower yields assumption and weaker outlook, especially for US and Europe. We also see more downside ahead for the Technology sector. Earnings risk and higher than market valuations herald further de-rating. For industrials, Noble Group reported its 1st quarterly loss in 14 years amid extreme commodity and forex volatilities. Broadway’s earnings were cut due to further non-HDD losses, higher labour costs and start-up expenses in China. Keen competition in offshore and slow orders for new vessels affects earnings outlook for Cosco Corp while Hyflux is affected by slower contract flows.

When will earnings bottom?

The 3Q11 results season that just ended saw one of the steepest cut in earnings. Consensus cut earnings estimates by 2% and 6% for FY11F and FY12F respectively while DBSV’s cut averaged 3% for both years.

Based on historical trend, GDP growth tends to track earnings revisions. During GFC, earnings downgrades either bottom a quarter ahead or in tandem with GDP bottoming.

Our economist expects the Singapore economy to bottom out in 1Q12. On a q-o-q basis, he expects a weaker 4Q considering the current external uncertainties and a possible pullback from pharmaceutical production in the fourth quarter. Indeed, Singapore's recent October non-oil exports disappointed, posting its sharpest fall in 30 months since the GFC, down 16% yoy. NODX fell across all major segments due to lower demand and a high base last year. Notably, shipments to the European Union, its biggest export destination, fell 30.9% y-o-y, compared with a 5.0% rise in the previous month. Exports to the US fell 50.6% after falling 35.5% in September. Electronics suffered the worst decline, down 31.2% y-o-y, after falling 13.6% in September, while non-electronics shipments also contracted at - 6.7%, compared with a 0.7% rise last month. Assuming the trend continues, earnings could bottom in line with GDP around 1Q next year, barring a financial contagion from the West.


Which sectors pose the highest earnings risks?

On the earnings front, much depends on the development in Europe and the US. Whether the problems in Europe will trigger another global financial meltdown will rest upon the ability of the European countries and Asia, especially China to rectify. Our economist has lowered his US GDP growth forecast for this year to 1.7%, and a slight improvement to 2.3% in 2012.

Worsening macro backdrop and a prolonged economic crisis will adversely impact all sectors in particular those sectors with high global exposure. High-risk sectors that are most vulnerable to further earnings downgrades include transport and logistics, technology, banks, offshore and marine, plantation, supply chain management and property.

For aviation sector, though we expect earnings to rebound from a low base in FY11, a prolonged economic slowdown could affect yields. The current lacklustre outlook could be further aggravated by high fuel cost. Current situation could turn out worse than 2008’s GFC, as cost was lower then due to the decline in jet fuel cost.

Banks are vulnerable to a sudden surge in provisions as default rates increases when recession hits while a prolonged low interest rate environment is not helping the low net interest margin. Take-up rates in the property sector remain healthy. However reduced job security and potential rise in interest rate could dampen housing interests and a 5% to 10% drop in selling prices will affect earnings and RNAVs of property companies. Offshore and marine companies and environmental engineering, which are order-driven, may see significantly lower earnings, if orders dry up resulting in cancellation or deferment of orders amid the supply glut.

Plantation stocks are vulnerable to weather changes and volatile selling prices while Technology stocks are at risk to the weak global demand, volatile USD against S$ and margin squeeze.