Morgan Stanley analysts say the outlook for Southeast Asian markets is set to improve next year, compared with a gloomy second half of 2012 that has been weighed down by a series of issues, from the fiscal stalemate in the US to recession in Europe and Japan. Of course, some markets will perform better than others, and the brokerage has picked out Thailand, Indonesia and Singapore for different opportunities.

Overall, the Asean market is expected to deliver an average return of 9.9% through next year. The star performer is expected to be the Thai equities market, according to Morgan Stanley, where companies will see strong earnings improvements supported by robust economic growth. Indonesia also offers opportunities, but investors should be aware of risks associated with its rising labour costs, uncertainties in its commodities sector and delay in infrastructure spending, among other issues. In contrast, Singapore’s prospects are significantly weaker, given the economy’s links to external trade and capital, which makes it vulnerable to the vagaries of global growth cycles.

Morgan Stanley analysts Hozefa Topiwalla and Trong Tri Tran prefer domestic companies with high growth visibility, consumption commodities and attractively valued and dividend-yielding stocks.

The analysts explain in an Asean Equity Strategy report dated Nov 26 that, given the uncertainty in the global economic outlook and with even emerging markets struggling with growth, investors will continue to seek out earnings growth visibility and macroenvironment stability, as well as markets with a high proportion of oligopolistic growth companies.

Strong earnings growth in Thailand
As such, Thailand is Morgan Stanley’s “most preferred market”, and the brokerage is “positive” on Thai equities. The analysts are extremely bullish about the kingdom’s prospects and expecting GDP to grow at 4.6% annually from 2012 to 2014, “supported by reasonably loose fiscal and monetary policies”.

The Bank of Thailand has decided to keep its policy rate unchanged at 2.75%, following an unexpected cut of 25 basis points in October on account of weak global demand. The central bank is now more upbeat on Thailand’s economic prospects, noting in its recent statement that exports should recover on the back of an improvement in the global economy.

Still, the government is expected to support growth at home. Morgan Stanley sees investment as a share of GDP rising from 22.8% to 23.4% next year.  Furthermore, key infrastructure projects in the pipeline, including mass transit lines and energy and water-related projects, are likely to drive investments. “Thailand has a relatively supportive and benign macroenvironment, with [the] potentially rising probability of political reconciliation,” said Topiwalla and Trong.

In a base-case scenario, for 2012 to 2014, the analysts project 17% compound annual growth in earnings per share of the MSCI Thailand Index, which is about 5% higher than the consensus estimate and implies a 21.2% upside from current levels through to December 2013.

Is this a good time to invest in Thai stocks, though? The Thai market has done well in recent months, outperforming the rest of Asia, excluding Japan, by 615 basis points (bps) and 2,274 bps since the beginning of this year and 2011 respectively, giving rise to investor concerns that it may be overvalued. “We disagree,” the Morgan Stanley analysts wrote, noting that the market has since corrected by 2.3%. And, the MSCI Thailand Index is trading at 10.7 times 12-month forward earnings, compared with the long-term average of 10.4 times.

Significantly, four of Thailand’s key sectors — energy, financials, materials and utilities — are trading either at or below the 12-month forward earnings benchmark of the corresponding sector in the wider Asia ex-Japan market. These four sectors account for nearly 78.8% of the MSCI Thailand Index.

“We believe the Thai market is still attractively valued, given its high growth visibility and improved return on equity prospects,” said Topiwalla and Trong. Furthermore, in the past two months, the market has underperformed the wider Asia ex-Japan markets by 285 bps. “We believe that this consolidation gives another good entry opportunity in the Thai markets,” they added.

Nevertheless, investors should also be aware of potential risks lurking in Thailand’s history of political upheavals. Inflation, hikes in minimum wages of up to 300 baht (RM30) a day and a tight labour market could also pose a threat.

Morgan Stanley prefers Thailand’s financial and consumer staples sectors to the utilities and telecoms sectors. Indeed, the analysts acknowledge that, while the Thai consumer discretionary sector seems overvalued, trading at a staggering 123% premium to the MSCI Asia ex-Japan consumer discretionary sector index, “it is important to note that [it] is driven by the media sector, which is significantly less volatile and has a return-on-equity of 65% compared with [the index’s] average of 17%”.

Structural growth in Indonesia, but risks remain
Morgan Stanley said Indonesia still has the best structural growth story in the region because of investment-led growth and oligopolistic growth companies. “Its structural story will continue to be driven by strong demographic-led domestic demand, combined with infrastructure and capacity expansion-led investment cycle,” the analysts wrote.

Infrastructure projects could be delayed by land acquisition issues, though, and rising labour costs, as unions get stronger, could hurt competitiveness, particularly in the manufacturing sector, which would in turn mean Indonesia would find it difficult to shift from a dependency on commodity exports.

Indeed, Morgan Stanley believes that the excesses of the commodities sector, particularly in mining, following the boom in the last three years, needs to be corrected. “We believe that if commodity prices remain lower for longer, the pain that commodities sector may need to go through is probably being underestimated.”

Significantly, things could change for Indonesia if the government decides to raise fuel prices. “A fuel price hike would solve multiple problems,” the analysts argued. “It would alleviate the current account and fiscal deficits, improve investor confidence in Indonesia and improve the potential for government-led infrastructure spends.” Still, fuel prices are a sensitive issue and the analysts believe political considerations would take precedence.

At the start of the year, the brokerage had cut its 2013 earnings forecast for Indonesia by 10.9% and expects further downside risks. Morgan Stanley remains “neutral” on the Indonesian market. “We believe the market has not fully priced in the impact of potentially cyclical speed bumps,” the analysts said. “We remain concerned about any potential widening of Indonesia’s current account deficit and sudden portfolio-outflow-driven balance of payment stress, which could affect equity markets negatively.”

Morgan Stanley is “neutral” on Indonesian equities, with an “overweight” call on Indonesian financial and utilities sectors, but “underweight” on the energy and industrials sectors.

Seek dividend yields in Singapore
Where does that leave investors of Singapore’s equities? Given the economy’s strong links to global trade, Morgan Stanley expects earnings growth to remain limited for longer. Topiwalla and Trong say, “Contrary to popular perception, Singapore’s earnings growth has had high correlation with GDP growth.

We expect Singapore to deliver 4% earnings growth from 2012 to 2014, which compares poorly with consensus expectations of Asia ex-Japan earnings growth of 11.4% in the same period.”

The analysts also note that Singapore equities are trading at 5.9% below their long-term average earnings ratio, at 13 times 12-month forward earnings, and valuations are expected to remain depressed for longer. “However, if global growth recovery is sharper than expected, the Singapore market could do better, driven by a combination of earnings upgrades and modest improvements in valuations.”

As such, they recommend that investors continue with a defensive dividend-yield strategy, as long as bond yields and global growth remain low. Dividend stocks have historically been resilient, the analysts note, pointing out that in the last 22 years, declines in payouts were less than the fall in earnings during tough periods. Indeed, the dividend play is likely to continue to  be a long-term theme in Singapore.

According to Morgan Stanley, dividends have contributed a significant 41% of MSCI Singapore’s total nominal returns since 2002. And, “since 2000, the top five dividend-yielding stocks have [outperformed MSCI Singapore’s total returns] by 801 bps.” The brokerage recommends Ascendas REIT, Keppel Corp and Singapore Telecommunications “as our defensive dividend-yielding stocks”.

Whatever the case, growth in these Asean markets will be driven by government-led investment growth as well as the large proportion of oligopolistic companies, meaning high entry barriers to competition, which in turn “makes Asean’s investment opportunity unique”, Morgan Stanley said. — The Edge Singapore

This article first appeared in The Edge Financial Daily, on Dec 5, 2012.