After a difficult start to the year, the SET Index has rebounded nicely. The improvement has come despite a series of subpar earnings performances in the fourth quarter of 2018 (mainly from the banking sector). The rally has been driven primarily by foreign fund inflows into emerging markets, triggered by a weakening US dollar, falling US Treasury yields and signs of a pause in US interest-rate increases.
The coming adjustment in March of the weightings in the influential MSCI emerging markets index, coupled with the looming election and associated improvement in private consumption, as well as recovering oil prices, should all bode well for the Thai market. We maintain our positive view for 2019 and a more cautious outlook for 2020.
Expect more earnings downgrades: the first wave of earnings announcements has been disappointing. Nearly every listed company under our coverage that has reported 2018 fourth-quarter earnings missed consensus estimates (according to Bloomberg) by anywhere between 2% and 30%. The exceptions were SCC (beating the consensus by 9%) and TCAP (10%).
We now expect fourth-quarter 2018 earnings for the SET as a whole at just 22.70 baht a share -- down 10.4% from the previous year. We have also revised down our full-year 2018 earnings per share (EPS) to 104.10 baht from an earlier estimate of 105 baht, though our 2019 and 2020 EPS estimates remain unchanged.
Downside from labour law changes: The National Legislative Assembly (NLA) in December passed amendments to the Labour Protection Act, increasing severance pay to 400 days from 300 for workers who are laid off after 20 years of service. Maternity leave was also extended to 98 days from 90.
Although severance rates remain unchanged, the 33.3% increase in the number of payout days means employee benefit obligations will need to be raised. We expect provisioning charges for most listed companies to increase. We estimate that the impact on full-year 2018 earnings will range between 0.1% and 11%.
Not all of these charges will be booked in the fourth quarter of 2018. Assuming half of the provisions are booked in 2018, and another half in 2019, we see a downside for the SET EPS of 2% per year in total.
Macro outlook still favourable: The SET has risen 5.8% for the year to date as of Feb 7. Our model portfolio has risen by 6% on average, with INTUCH, DTAC, STEC and CPALL the biggest gainers while BJC and TRUE lag the index. The SET has in fact only been in the middle of the rallying pack, with North Asian markets generally outperforming Southeast and South Asia.
We think the reason for the rally is twofold. First, the global macro environment has turned favourable. A declining 30-year Treasury yield, easing trade tensions and a weakening dollar have led to increasing foreign fund inflows. Domestic news has also been positive, led by confirmation of the March 24 election and the recovering crude oil price.
MSCI adjustment: Both the stocks in our model portfolio, INTUCH and DTAC, which could potentially be added to the MSCI EM index in March, have outperformed the market by a large margin. There is also a possibility that the weighting for Thailand in the index could increase by as much as 50 basis points.
Thailand is a small component of the MSCI-EM, which Morgan Stanley Capital International says is tracked by funds holding $1.835 trillion of assets as of June 2018. The EM index trails only MSCI World at $3.6 trillion, EAFE (Europe, Australasia and Far East) at $2.23 trillion, and ACWI (All Country World Index) at $4.42 trillion. The figures include passive and active funds.
We assume that 100% of the passive funds that track MSCI EM and 10% of active funds will adjust their weighting following the March changes. This gets us anywhere between 18 billion and 90 billion baht in potential fund inflows if the weighting for Thailand is increased by 10 to 50 basis points.
Looking at the relationship between institutional buying and SET index movement from 2014 to the end of 2018, for every 50 billion baht of total institutional buying, the SET index moves by 132 points. Of course, local institutional and retail selling could counter a large portion of foreign buying -- thus mitigating the positive effect on the SET index.
China A-shares and Saudi Arabia: MSCI gives, but it takes away too. We estimate that the inclusion of Saudi Arabia (by June 2019) and the phasing in of China A-shares could result in a loss of up to 500 basis points for other members of MSCI-EM. Therefore, even if Thailand's MSCI weight increases to 3%, it could come back down to 2.85% by year-end.
Conclusion: Although we see a strong risk of a further SET EPS downgrade due to provisioning expenses, we believe the market will shrug this off as the increasingly benign global macro environment lifts sentiment. Nonetheless, we believe it would be difficult for the index to rise significantly above 1,800 given increasing headwinds from MSCI rebalancing in mid-2019, a potential decline in crude oil price in the second half of the year, and growing domestic uncertainties over 2020.
We believe that telecoms, banks, commerce and contractors/construction materials should continue to outperform the market in the near term. Our top picks include INTUCH, DTAC, TRUE, CPALL, BJC, ROBINS, KBANK, BBL, TMB, SCC, CK and STEC.
