• The sector earnings for 1Q22 showed an average drop of 3% y-o-y despite a 13% jump in revenue due to higher input costs.

• The sector’s top line growth augurs well on strong sales given the full reopening of the economy that may spur footfall and the HORECA channels. However, the current global economic indicators show that input prices are likely to remain elevated, a risk to earnings.

• Downgrade to NEUTRAL on the sector as margins may likely be under pressure given the risks of elevated input costs despite a better top line growth.

Encouraging Top Line Growth Hurt by Rising Input Costs

The recent 1Q22 results saw the sector’s revenue, on average, jumped by 1% QoQ and 13% YoY driven by higher demand thanks to full economic reopening and an increase in selling prices. Net profit on average fell by 18% QoQ and 3% YoY however, as margins were dampened by elevated input costs. Hence, average sector profit margin dropped by c.9% (-2.2 ppts QoQ, -1.6 ppts YoY). Performance by FBM KL Consumer Index (KLCSU Index) fell by 3% YTD in line with this amid on-going concerns over rising inflationary pressures.

Cautious Outlook: Reduced Margins a Possibility

We are cautious on the near term outlook despite favourable GDP projections given prevailing headwinds such as geopolitics tensions, elevated global commodities prices and food security concerns. This may be added by inflation risks, labour shortage issue, ongoing supply chain disruptions and weakening ringgit which could hurt sentiment and therefore, consumers consumption activity. Consumers may also delay spending given political uncertainty ahead of the 15th GE which must be called by July 2023.

The sector top line growth augurs well on strong sales given the full reopening of the economy that will boost footfall and the HORECA (Hotels, Restaurants and Catering) channels. However, the same could not be inferred for bottom line and margins as global economic indicators shows that input prices are likely to remain elevated on the back of raw material prices that have risen an average by c.20-30% YoY. Key food commodity prices such as wheat, milk, coffee and sugar may remain elevated throughout 2022 and possibly into 1H2023 no thanks to supply and demand imbalance and supply chain disruption. This may push producers to partially pass the rising costs to consumers to mitigate the substantial margins compression.

Changes to Earnings Forecast and Target Prices

We have revised our forecast for some companies under our coverage to factor in the headwinds. We also relook at our valuation method to reflect current developments and roll over our base year to FY23 (refer table 1). Overall, we estimate sector earnings under coverage to grow at c.8% YoY in CY22 (CY21: -6.7% YoY) to be driven by higher revenue and base effect advantage. Nevertheless, sector net profit margins may come in lower or at c.8- 9% versus pre-pandemic margins of c.10-12% due to cost pressures.

Downgrade to NEUTRAL on the Sector

We downgrade our sector call to a NEUTRAL from OVERWEIGHT as we expect margins will likely be under pressure given the risks of elevated input cost despite a better top line growth. In addition, we believe the recent run up in share prices for some consumer counters suggests that valuations may have peak and therefore, fully valued. We have a BUY call on QL Resources (TP: RM5.75), Kawan Food (TP: RM2.36), MRDIY (TP: RM4.40) and Padini (TP: RM3.70), with a HOLD recommendation for Nestle (TP: RM134.00), Dutch Lady (TP: RM33.70), Spritzer (TP: RM1.95), and Amway (TP: RM4.80).

Source: BIMB Securities Research - 1 Jul 2022