Investment Highlights

• Mixed 4QCY23 results. 4 out of 8 companies (Mr DIY, Leong Hup, Nestle and Spritzer) under coverage reported earnings within expectation while the remaining 4 (Guan Chong, MyNews, Padini and Power Root) net profit was lower-than-expected. The variance to our estimate was due to weaker revenue coupled with higher operational cost as follows:
  
  ➢ Guan Chong (GCB) (FV:RM1.49) was impacted by higher operating cost and interest rates.
  
  ➢ MyNews (MYNEWS) (FV:RM0.49) recorded net losses for 2 consecutive quarters from diseconomies of scale for its food processing center and a longer gestation period for CU stores to breakeven.
  
  ➢ Padini (FV:RM3.62) was impacted by lower gross margin due to unfavourable product mix skewed towards lower margin apparels coupled with promotional deals amid high inventory levels and increased salaries, and
  
  ➢ Power Root (FV:RM1.95) was impacted by higher composition of lower margin products such as franche roast as well as lower sales in higher margin general trades.

• Earnings marginally up by 7% QoQ in 4QCY23. The improvement was contributed by the retail segment (+64%) due to higher store footfalls on festive season and new store openings for Padini (HOLD; FV:RM:3.62) and MR DIY (BUY; FV:RM2.60), partially offset by weaker earnings of the FMCG segment (-27%).

• Consumer sentiments stayed soft. We observed that overall consumer sentiments remained soft despite the festive season and short school holidays. Consumers continued to be cautious in discretionary spending in view of macroeconomic uncertainties. Malaysian Institute of Economic Research (MIER) reported a decline in consumer sentiment index by 15% YoY to 89.4 points compare to 4QCY22. Even though inflation remained low, potential subsidy rationalisation in 2H23 could increase inflationary pressures ahead.

• Consumers will be more discerning in their spending, particularly discretionary items. Malaysian government will introduce a few taxes in 2024, such as (i) 10% sales tax on imported low-value goods from 1 April, (ii) 5%-10% tax rate on certain high value goods tax (HVGT), and (iii) increase of 2%-point to 8% for sales & service tax rate effective 1 March. We expect retail players like Padini and Mr DIY to continue to open new stores and improve the variety of their product offerings. This is to attract higher footfalls in stores to sustain their revenue amid soft consumer sentiments and weaker demand for discretionary goods.

• Modest revenue growth of 4% for FMCG players despite the festive season. We observed FMCG players’ revenue remained soft as evidenced by lower QoQ sales volume of Leong Hup, Power Root, Spritzer and Nestle. This is likely due to the cautious consumer spending contributed by macroeconomic uncertainties. However, Guan Chong increased its cocoa selling prices during the quarter and achieved a 40% QoQ growth in revenue.

• A mixed bag of trend for commodities prices. Cocoa and coffee prices are still trending upwards (+2.9x YoY for cocoa and +10% YoY for coffee) in March 2024. Recently, palm oil prices also increased by 14% YTD to RM4,173/tonne. In contrast, prices of wheat, corn and soybean have declined by 6%-34% YoY in March 2024. Nestle and Power Root’s gross margin improved marginally by 1% QoQ thanks to decline in average raw material cost. We expect cocoa and palm oil prices to continue to be elevated due to tight supplies, while other raw materials prices are expected to be stable. Despite the decline in some raw material cost, we are cautious on the gross profit margin of Nestle, Power Root and Guan Chong due to the weakness in domestic currency, which will raise the cost of imported raw materials.

• Higher operating cost dampening FMCG players’ earnings. FMCG players’ earnings declined by 27% QoQ across the board except Nestle. This is due to diseconomies of scale and higher operating cost such as marketing costs. Average EBITDA margin slid by 16% QoQ. Meanwhile, Nestle’s earnings increased by 11% QoQ due to a lower effective tax rate with the absence of prosperity tax compared to 2022.

• Stable unemployment rate to continue to be supportive of consumption spending on essential goods. Our economics team expect unemployment rate to trend lower to 3.2% in 2024 from 3.3% as at December 2023.

• We maintain NEUTRAL on the sector premised on cautious spending ahead, impacted by macroeconomic uncertainties and downtrading tendencies as consumers seek: (i) competitive pricing or unbranded items, and (ii) smaller-sized packs (value options) for F&B. Our top picks are LHI for its fully integrated operations, which provides a cushion against inflationary shocks, and Spritzer for its solid domestic branding and growing tourist arrivals, which are expected to boost sales while margins improve amid declining plastic resin cost. We also like retail players like Mr DIY to its store network expansion plans and better product mix by introducing new SKUs to cater to the needs of the affordable market segment.

• Key risks: (i) Slower-than-expected economic growth, (ii) higher-than-expected unemployment rate, (iii) higher-than-expected commodity prices, and (iv) slower-than-expected tourist arrivals.

Source: AmInvest Research - 15 Mar 2024