• We maintain our NEUTRAL outlook on the consumer sector for the next 12 months. Prospects for the sector are expected to be supported by improving private consumption and consumer sentiment. However, we expect higher operating cost and elevated agricultural prices to offset top-line gains. As such, uninspiring earnings growth is envisaged to limit any upside potential to existing lofty valuations.

• Improving private consumption growth of 6.2% in 2017 (vs. 2016: 5.9%) (Exhibit 1) and consumer sentiment are expected to elevate consumer spending in the near term. Also according to the Malaysian Institute of Economic Research (MIER), consumers' shopping plans are on the rise. In spite of these positive indicators, we believe that things have not normalised yet as private consumption growth is still below the historical average of 7% (Exhibit 1) while consumer sentiment index of 76.6 for 1QFY17 is way beneath the 100.0 sentiment neutral benchmark (Exhibit 2).

• We may upgrade the consumer sector to OVERWEIGHT from NEUTRAL if consumer spending takes an upswing and is sustained. Possible catalysts in the short term include Southeast Asian Games in August and a potential general election in 2017. But after that, we foresee recovery taking a gradual turn as cost pressures and rising household debt weigh on consumers. Other possible factors for a re-rating include the sustained strengthening of the MYR against the USD (2017 house assumption average: RM4.44–4.48). Berjaya Food, Padini and Bonia's raw materials are denominated in foreign currencies and as such, they stand to benefit from a stronger MYR.

• On the flipside, we may downgrade the sector to UNDERWEIGHT from NEUTRAL if: i) earnings, going forward, disappoint, leading to a de-rating of the sector; and ii) unfavourable commodities’ prices.

• On average, valuations of the companies under our coverage are currently trading at +1SD above their 3-year mean on a 1-year forward PE basis (Exhibit 4). The only exception to this is Bison Consolidated, which is trading below its historical mean. We think that current expectations are already reflective of a robust earnings recovery in FY18F. Hence, should earnings growth turn out to be softer than expected in the quarters ahead, this could lead to a potential valuation de-rating.

• YTD commodities’ prices have been higher than 2016. Specifically, YTD coffee, palm oil and milk prices are trading between 8% and 21% higher against their average prices in 2016 (Exhibit 5). On a positive note, since reaching their highs in 2017, prices have started to trend downwards in tandem with the expansion in supply. Risks to commodity prices are softer-than-expected production growth resulting from unfavourable weather conditions and crop disease outbreaks. These may cause input costs to rise for companies under our coverage.

• In the past quarter, we downgraded the Malt Liquor Market sector to NEUTRAL from OVERWEIGHT as valuations are no longer attractive. Despite favourable industry demand dynamics and the introduction of new product mix with superior margins amidst the turning of consumer sentiment, earnings outlook is unexciting as reflected in our projected growth of less than 10% for FY18F. Hence, we do not think current PE valuations are justified. Both Heineken Malaysia and Carlsberg are trading close to 20x PE or well above +1SD of their 3-year historical mean.

• We believe that the tobacco industry (namely BAT) is undergoing a deteriorating structural shift. Sales volume typically recovers in the subsequent quarter post an excise duty hike in the past. However, after the most recent excise duty hike in 4QFY15, sales slid for 5 consecutive quarters. At the same time, illicit cigarettes commanded a record high market share of 57.1% in 2016 vs. 36.9% in 2015. Therefore, we expect authorities to gradually stem the rampant illicit market, which may result in an excise duty hike after FY18F. The eventual perpetual excise duty hike will continue to exacerbate headwinds faced by the tobacco industry. As such, we are UNDERWEIGHT on the tobacco sub-sector.

• Our top picks for the sector are Bison Consolidated (dominant position as the largest home-grown retail convenient store, potential margin enhancement, underpinned by better product mix and growth off a small base) and OldTown (China-driven growth, outstanding track record and market share leader in the white coffee segment). We have fair values of RM2.70/share for Bison and RM3.20/share for OldTown.

Source: AmInvest Research - 21 Jun 2017