Investment Highlights

• Mixed 1QCY22 results. The inflationary environment has various degrees of impact on companies under our universe, depending on their ability to manage and/or pass the additional costs, leading to mixed sets of results. Out of 8 companies under our coverage, 3 were above expectations, 2 within and 3 below, during the 1QCY22 results.

• Winners actively managed their cost structure. The outperformers, Padini Holdings (Padini) (fair value: RM3.45), Power Root (FV: RM1.45), and Berjaya Food (BJFood) (FV: RM3.30) managed to sustain their margins despite the rising costs of doing business. Padini and Power Root took precautionary measures by repricing products to offset the inflationary impact. Berjaya Food was partially shielded from rising raw material costs given the long-term sourcing contract from its principal while better product mix also helped to minimise the cost pressure impact. Earnings of Leong Hup International (LHI) (FV: RM0.50) and MR D.I.Y. Group (M) (MRDIY) (FV: RM4.10) fell short of expectations due to deterioration in gross margin, affected by rising input costs. Nestle (Malaysia) (FV RM114) and Guan Chong’s (FV RM3.40) earnings were within our and street’s expectations.

• Decent 1QCY22 sector performance, with 4 out of 8 companies reporting sequentially stronger revenue and earnings (Exhibit 1), despite subsiding pent-up demand from the economic reopening. We believe this is predominantly driven by buoyant consumer confidence as broader economic activities are picking up. Compared to the same period last year, the generally stronger revenue and earnings were mainly due to the low base effect from movement restrictions last year which had suppressed consumer spending. We expect improvement in earnings for 2QCY22, due to seasonally stronger sales given the Hari Raya Aidilfitri festivity.

• Moving forward, inflation remains the sector’s key concern as most raw material prices remain elevated (Exhibit 3-8), exacerbated by rising energy and logistics/shipping costs. The minimum wage hike, which is set to be effective starting 1 May 2022, will cause another round of margin pressure and pose a downside risk to 2QCY22 earnings. Given the inflationary environment, companies with limited pricing power such as LHI may not be able to react as quickly, making them susceptible to the rising costs. Meanwhile, Guan Chong’s cocoa processing/contracting model minimises the company’s exposure to fluctuations in raw material prices, especially under the current situation of recovering demand for cocoa products.

• Continue to ride on the feel-good factor from the economic reopening, consumer demand is expected to remain at a healthy level despite rising prices. Malaysian Institute of Economic Research’s (MIER) Consumer Sentiment Index breached the optimism threshold to 108.9 points (Exhibit 9), following the improvement in consumer expectations of future income and job opportunities. This will provide an advantage to companies with relatively stronger pricing power and brand equity such as BJFood, Padini and Power Root in repricing their products with minimal impact to sales volume.

• We maintain our NEUTRAL call on the sector. We remain selective with our BUY calls against the backdrop of heightened economic uncertainties. We like Guan Chong which stands to benefit from recovering regional demand for cocoa products while its overseas expansion plan allows the company to tap into the European market, providing long-term growth potential. Given that the industry practiced cost pass-through mechanism, the company’s gross margin is partially shielded from the volatility of raw material prices. Separately, we believe that the inflationary environment would benefit MRDIY as consumers become more price-sensitive and gravitate towards cheaper options when shopping for household items.

Source: AmInvest Research - 15 Jun 2022