Singapore Strategy:Brexit reinforces earnings risk theme

Event

The full ramifications of Britain’s surprise vote to leave the EU will unfold overtime, but our initial view is that this reinforces our “Earnings risk lingers”theme, and we stay defensively positioned. In our model portfolio, we nowmake ComfortDelgro a slight underweight and reduce our overweight positionin City Developments. This is offset by increased weights in SingTel and CCT.

Impact

Recent signs of strength in top-down drivers likely to ebb. Our top-downmodel calls for ~7% earnings contraction in 2016, vs -3.5% for consensus.

Among the four key macro inputs in our top-down model (Figs 5-8), NODXhas the best correlation with index earnings growth at 89%. The most recentreading for May showed surprising strength (+11.6% YoY) and took the 12-month moving average to -3%. But we keep our 2016 forecast at -4%, in linewith the midpoint of IE Singapore’s expectation range. While Europe and theUK account for only 11% of Singapore’s goods trade, our strategy and FXteams see a broader, global dampening effect on trade post the referendum.

The S$ has seen some strength since the start of the year (we use two FXseries in the top-down model). But our FX team still has a negative outlook forthe currency (S$1.43 in the next six months). MAS’s move to a neutral policysetting in April leaves the currency exposed to likely easing by central banksrepresented in the NEER basket. The above-mentioned dampening effect onglobal demand will also act as a headwind. While the team does not expectany surprise policy changes before the next MAS meeting in October, it doessee some risk of their widening the NEER trading band if volatility rises.

We keep our defensive positioning. We think the cautionary top-downmessage is worth heeding, given the model’s solid R-squared of 83%. Weremain comfortable with the defensive positioning we outlined in our June 13thupdate. We do make some tweaks to our model portfolio (Fig 4) though:

Move ComfortDelgro (CD) from an overweight to an underweightposition: Brexit was not our base case, and CD’s 20% EBIT exposure tothe UK now comes into the spotlight. The direct currency sensitivity maynot look significant but we also worry about second-order impacts onCD’s bus and taxi businesses there. City Developments has 12% revenueexposure to the UK and we lower our overweight slightly.

Increase overweight in SingTel (ST) and CCT. ST shows some of themost stable earnings trends in our bottom-up screening. Concerns over afourth mobile operator in SG continue to weigh on the stock, but weassign a low probability to that outcome. ST is represented in both ourregional strategy team’s ‘Quality & Stability’ and ‘Sustainable Dividends’portfolios. While we have some concerns over new office supply, CCT isrelatively well positioned and offers a 6% yield.

Outlook

While Singapore trades in its lower historical PER channel and offers thehighest dividend yield in Asia (Fig 1-2), lingering earnings risk and potentialcurrency weakness curb our enthusiasm. We do see solid defensive valueopportunities, mainly in the Telecom and Property index sectors.