Investment Highlights

• Maintain NEUTRAL on the sector. Prospects for the sector remain unexciting with private consumption expected to ease coupled with lukewarm consumer sentiment being weighed by diminishing but still lofty household debt and elevated unemployment rates. Positively, higher operating cost could be alleviated by softening agricultural prices. Unremarkable earnings growth appears to be fairly reflected by current valuations, trading below their historical mean.

• Consumer sentiment as measured by the Malaysian Institute of Economic Research (MIER) is on the rise, having dipped to an all-time low of 63.8 in 4Q15. However, at the current level of 77.1, it remains well within 100, the confidence threshold. Sentiment is further capped by actual spending ability, as reflected by easing private consumption growth. Our house view is that 2018 will see spending moderate to 6.7% (vs. 2017E: 6.9%, 10-year average: 6.9%) (Exhibit 4). Furthermore, the unemployment rate appears to be elevated, especially when compared against periods of economic strain (2008: 3.3%, 1997: 2.4%). Similarly, the escalated household debt as a percentage of GDP as of end-2016 at 88.3% (2008: 60.4%) would likely limit a potential recovery upsurge in consumer spending and sentiment.

• We may upgrade the consumer sector to OVERWEIGHT from NEUTRAL should these factors crystallise:

o Strengthening of the MYR against the USD (2018 house assumption average: RM4.12). Berjaya Food and Padini are beneficiaries of a stronger MYR. Half of Berjaya Food’s raw material is purchased in USD while most of Padini’s raw material is sourced from China. For every 1% appreciation in the MYR against the USD and RMB, FY18 earnings are estimated to be impacted by up to 2.5% and 5% respectively.

o Agricultural prices soften further. Since reaching their highs in 2017, prices have started to trend downwards in tandem with the expansion in supply. Risks to agricultural prices itself are softer-than-expected production growth resulting from unfavourable weather conditions and crop disease outbreaks. OldTown and Cocoaland are the largest beneficiaries of cheaper commodities prices. Coffee and sugar inputs combined constitute close to 30-50% of raw material cost for these two FMCG companies.

o Structural improvement to economic fundamentals, leading to a re-rating of the sector. Recovery in economic fundamentals such as household debt and employment rate are structural in nature and positive in the longer term. However, improved forward expectations would likely draw interest back into the sector, which has been in a lull since early 2015.

• Few risk factors in the sector. Possible risk factors in the sector that may lead to a downgrade to UNDERWEIGHT from NEUTRAL are likely to arise in the form of: i) operating cost tied to higher oil prices; and ii) significantly steeper minimum wage which is expected to be revised heading into FY18. However, we see limited downside to the sector, especially with average valuations trading below their 5-year historical mean. Seven out of 11 companies are currently trading below their 5-year historical mean amid a gradual turn in broad economic fundamentals.

• NEUTRAL on the MLM sub-sector. In the past quarter, we have maintained a NEUTRAL on the malt liquor market (MLM) sector after downgrading it from OVERWEIGHT in 2Q17 as valuations no longer proved attractive. We expect MLM volume to drum out a 3% growth for 2018. Resulting earnings outlook looks to average a decent 8% growth for both Carlsberg and Heineken off the back of better product mix and marginally higher ASPs for 2018. However, when we factor in valuations that are trading close to their historical mean, we struggle to justify a compelling OVERWEIGHT on the subsector.

• UNDERWEIGHT on the tobacco sub-sector. We believe that the tobacco industry (namely BAT) is undergoing a deteriorating structural shift. Sales volume typically recovers in the subsequent quarter following an excise duty hike in the past. However, after the most recent excise duty hike in 4QFY15, legal volume sales have struggled to recover against the rampant proliferation of illicit cigarettes. Aside from that, BAT has been excluded from the FBM KLCI Index as a component stock. It is likely an overhang to the tobacco company in the interim. Meanwhile, the eventual perpetual excise duty hike will continue to exacerbate headwinds faced by the tobacco industry. As such, we are UNDERWEIGHT on the sub-sector.

• Berjaya Food and Bonia as top picks. Our top picks for the sector are Berjaya Food and Bonia. We like Berjaya Food (BUY, FV: RM1.91) for: i) its attractive growth off a low base, offering a 3-year earnings CAGR of 22%; ii) innovative yet resilient Starbucks brand; and iii) rationalisation of non-performing stores which has positioned KRR Malaysia to see 2 consecutive quarters of positive SSSG. Valuations are pegged to a P/E of 25x, reflecting a 20% premium to its historical valuations. Meanwhile, Bonia (BUY, FV: RM0.67) is attractive for: i) its Braun Buffel brand commanding a regional appeal – with Indonesia supplementing growth; ii) closure of its underperforming consignment stores to elevate FY18F earnings growth; and iii) attractive valuation, which currently trades at a forward P/E of 11.6x, below its 5-year historical average P/E of 16.7x.

Source: AmInvest Research - 15 Dec 2017