Posted Date : 10 Feb 2010
Malaysian Rating Corporation Bhd (MARC) released its outlooks for the economy, the bond market and various industries at the MARC 2010 Investors’ Briefing held at the Hilton Kuala Lumpur on February 9, 2010. About 100 capital-market investors and market players from the financial fraternity were in attendance at the event chaired by MARC’s Chief Executive Officer, Mohd Razlan Mohamed. “The Briefing provides a platform for MARC to communicate its macro views and share its on-going initiatives to increase the robustness of its ratings and analytical capability with our constituents. MARC’s involvement in the Best Practices Committee of the Association of Credit Rating Agencies in Asia (ACRAA) will also provide the rating agency with an opportunity to play a role in promoting best practice among domestic credit rating agencies in Asia” said Razlan.
The Investors’ Briefing is an annual event held by MARC to present the agency’s views on the economy, the bond market, and various industries within its rating universe. The briefing is one of several plans undertaken by MARC to increase awareness and impart transparency in the rating industry.
The upturn in global growth has thus far been attributed primarily to inventory restocking, whilst consumption and lending in the US remains subdued as the impact of household wealth destruction and risk aversion continued to assail consumers and banks respectively. In addition, the weak labour market is preventing a smooth recovery as the jobless rate is still hovering near double-digit territory. Negative sentiments abound in Euro and Japan, with high budget deficits, escalating debts and particularly for Japan, rising deflationary threats, affecting business and consumer confidence.
As for Malaysia, the economic rebound has come on the back of an improvement in the external sector following the strengthening of major export partners. In addition, resilient domestic demand has been aided by consumer spending due to more stable labour-market conditions, as evidenced by a rapid decline in the number of retrenchments. MARC is maintaining its 2010 GDP growth forecast at 3.6% for now with an upside bias. Notwithstanding this, Malaysia’s medium-term growth trajectory largely hinges on the recovery in private investment, which has remained subdued since the Asian Financial Crisis in 1998. Going forward, risk factors which are a potential threat to the sustainability of the recovery include a relatively high household debt to income ratio and a possible correction in the Malaysian equity market that might have a bearing on consumer and business spending.
Against the backdrop of a strengthening of the economy, normalisation in interest rates is expected in 2010 through hikes in both the Overnight Policy Rate (OPR) and the Statutory Reserve Requirement (SRR). Nonetheless, the quantum of increases is not likely to derail economic recovery especially if global economic growth continues its upward momentum.
In the aftermath of the worst global financial crisis since the Great Depression, the bond market has witnessed an unprecedented and intensified level of volatility with economic indicators of most of the major and regional economies slipped deeper into negative territory. In Malaysia, the second order effect arising from recession in the economies of its major trading partners caused the domestic economy to contract with adverse rating implications for corporate bonds as the operating environment became more challenging. However, stimulus injections via the front-loaded monetary easing and expansionary fiscal policies globally have set the stage for a rebound in investors’ confidence. MARC believes that a reversal of 2009’s “flight-to-quality” this year will take place provided the flow of positive economic data persists.
MARC’s views on several key industries within its rating universe can be summarized as follows:-
Following the global financial crisis, there was a marked slowdown in award of new projects, both domestically and internationally. Malaysian construction companies with overseas projects are now sourcing for local jobs to replenish their order books. Aided by stimulus spending, construction sector registered a strong rebound of 7.9% year-on-year in Q3 2009. Growth for 2009 arose mainly from roll out of projects below RM50 million aimed at supporting smaller players with projects with quick turn-around-time. Government led infrastructure projects e.g. the RM2 billion LCCT and the RM7 billion LRT extensions, amongst others, as well as new or deferred projects to be unveiled under the 10th Malaysia Plan are expected to be the growth drivers going forward.
MARC notes that its rated companies with diversified revenue streams have shown greater earnings resilience. Quality of receivables is an important consideration especially for smaller players. MARC expects a recovery of its construction margin on the back of lower volatility of building material prices. Contractors with solid track record will be the key beneficiaries of projects awarded on open tender basis and will be more resilient to a more competitive profit margin environment.
The property market, which is highly correlated to the economy, has been affected by the challenging economic and financial environment. Notwithstanding, property transaction rebounded in 2H 2009 as more definitive signs of economic growth emerged. In comparison to the 1H 2009, the volume and value of transaction recorded higher growth of 17.8% and 12.1% respectively. Key positive factors supporting the rebound include; improving consumer sentiments, accommodative low interest rate environment; proactive government measures to ease rules for foreigners to purchase residential properties and decision by the Employees Provident Fund to allow monthly withdrawal to pay for mortgages.
Although demand for medium to high-end segment is expected to remain stable in selected prime locations, there are indications of over supply situation in some areas. Despite some easing, there is also an overhang of unsold properties in the low to medium segment of the market. Interest in landed properties in Klang Valley remains strong. The commercial sector is expected to come under pressure with substantial incoming supply of office buildings in 2010 to 2012 for KL City and KL fringe with total new supply of 7.2 million sq ft and 6.9 million sq ft respectively.
MARC rated issuers are generally concentrated in the mid to high-end property segment and have benefited from good location, strong branding and solid reputation.
MARC notes that Malaysian banks have come out relatively unaffected from the global financial crisis. This could be attributed to their limited exposure to the direct effects of the crisis as well as the proactive measures taken by the authorities. As such, MARC believes that the recent reported healthy financial performance of banks must be viewed in the context of the unprecedented scale of fiscal stimulus and monetary policy loosening, structural adjustments to improve repayment ability of borrowers and counter-cyclical regulatory policies. These measures have enabled the banks to successfully cope with the secondary effects of the global financial crises, including the downturn in the real economy. In this light, MARC believes that the fundamental credit strength of Malaysian banking sector has still not materially changed over the past 12-18 months. Admittedly, risk management standards have improved, although they are no longer viewed by MARC as a competitive advantage – they have fast evolved into an absolute necessity. Further, MARC is taking a moderate view on the present high capital adequacy ratios of domestic banks as the Basel Committee’s move to make the banking system more resilient to financial shocks would inevitably result in more demanding regulatory capital requirements. On balance, MARC maintains a stable outlook on the banking sector. Going forward, evidence of sustained improvements in competitive position and financial performance may trigger positive rating actions for some banks over the next 3-4 quarters. However, any such rating action taken by MARC will be premised on an objective assessment and the individual merits of each case.
Oil & Gas Support Services Sector
The Oil & Gas support services sector has had a dull 2009, with a decline noted in the number and value of contracts awarded during the year. While most MARC-rated companies have an order book that can generate revenue into 2010, going forward, earnings visibility into 2011 remains a key concern for the sector in general. Vessel operators, who are expected to take delivery of new vessels and companies that are directly linked to drilling activities appear to be the most affected should the expected award of new contracts does not materialize in 2010. At the same time, the industry also stands to gain should there be an upswing in contracts awarded. With oil prices showing signs of stabilizing in the USD70 - USD80 per barrel band, the oil majors are likely to increase their exploration and production activities as the expected medium-to-long term consumption of oil & gas remains unchanged despite the current economic slowdown. On balance, MARC maintains a stable outlook on the oil & gas sector.
Despite the recession in 2009, traffic volume on highways saw steady growth except for Q1 2009. Vehicles on highways increased by 3.9% and 6.1% in 2Q 2009 and 3Q 2009 respectively despite GDP remaining in negatives during those quarters. The positive growth in traffic volume was mainly attributed to retail fuel price being kept low since December 2008 and extended deferment of toll rates hike of eight highways in 2009. Moving forward, the toll rates for 10 highways will be coming up for review in 2010. The Government has also indicated that a new fuel price subsidy mechanism will be introduced which could lead to higher retail fuel prices. The financial impact on toll road operators from our rating perspective is neutral.
Electricity demand is highly correlated with GDP growth. After contracting for two quarters, electricity demand has shown continued improvement since March 2009 with growth rate turning positive in July 2009. Fluctuation in fuel prices remains a challenge as 36.7% and 62.5% of electricity are generated by coal and gas. As price of gas is subsidised, any government review to reduce gas subsidy without a review for an increase in electricity tariff would impact Tenaga Nasional’s bottom line.
Water Services Industry
The water service industry was characterised by different water enactments and regulatory bodies for different states with lack of central regulations and coordination among the stakeholders. Some of the states were constrained in funding their capital expenditures. The Enactment of the Water Services Industry Act and the National Water Services Commission Act were passed to ensure uniformity of local policies and regulation. In conjunction with these enactments, the National Water Cervices Commission was established to act as the regulator and supervisory body for the water supply and sewerage services. To help states fund their capital expenditure, Pengurusan Aset Air Berhad (PAAB) was formed to be the owner of all water assets. Existing concession holders are given the option to migrate to a new licensing regime or remain as concession holders. PAAB has taken over the water assets in Malacca, Negeri Sembilan and Johor with total acquisition value of RM6.1 billion. PAAB is expected to close the acquisition of water assets in Selangor, Perlis, Kelantan, Perak and Pahang this year.
The current water supply capacity in Selangor may not be sufficient to meet future demand and the state could experience water shortage in 2014. The RM3.9 billion Pahang-Selangor Raw Water Transfer Scheme is expected to address the capacity shortage and is scheduled to be completed by 2014. The water-restructuring scheme in Selangor remains protracted with the Selangor state government, PAAB and the four concessionaires yet to come to an agreement on price.
Summing up MARC’s overall outlook for 2010, Razlan said, "MARC is cautiously optimistic. Although the economy has stabilized and we expect the volume of corporate bond issuances to reach RM45 – RM50 billion in 2010, the economy still faces several challenges. Uncertainty prevails over the sustainability of the recovery in the US, a country which still remains an important trading partner for Malaysia, and the nascent recovery in private investment, which will be crucial for medium-term growth."