Going forward, we expect better top line growth in 2H18 from ‘zerorisation’ of GST and rebounding consumer sentiment. Narrowing down, potential clamp down on the illicit alcohol and tobacco trade is anticipated to drive sales back to legal players. We maintain our NEUTRAL stance on the sector despite the favourable structural factors as we believe the optimistic outlook has already been priced in.

Potential clamp-down on the illicit market. Pakatan Harapan’s (PH) alternative 2018 budget states the newly elected government intends to collect RM6.1bn and RM2.5bn from tobacco and alcohol excise duty respectively. This is significantly higher than the RM3.5bn and RM1.7bn from tobacco and alcohol excise duty estimated by the previous BN administration. We reckon the government will decide to clamp down on the illicit tobacco trade as opposed to raising the excise duty structure in order to increase tax collection. We believe raising excise duties would only result in lower legal market volumes, and hence less taxable income. Figure 1 & 2 exhibit the decline in legal cigarette volumes and growth in the illicit market when tobacco excise duty was last raised in 4Q15. With regard to the alcohol market, we do not expect a hike in excise duty as Malaysia’s alcohol excise duty is already one of the highest globally.

“Zerorisation” of GST. The absence of sales tax between June and September (i.e. 0% GST but before SST is reintroduced) augurs well for the consumer sector. Upon implementation of SST, consumer’s purchasing power should be higher relative to GST as the SST encompasses a narrower range of products and services. We estimate annual SST collection amounting to RM22.5bn compared to RM44bn for GST (full year 2018 estimate).

Favourable macro factors to benefit discretionary spending. We anticipate private consumption to increase to +8.5% YoY in 2H 2018 (1H 2018: 7% YoY). Rebounding consumer sentiment, sales tax holiday, fuel subsidies wage increase (April 18: 10.2% YoY in the manufacturing sector) should boost disposable incomes in general. Additionally, record EPF dividend in Feb 2018 of 6.9% as well as encouraging retail sales growth (figure 3) in 2017 (9.5% YoY) and Jan-April 2018 (7.2% YoY) (similar to pre-GST level) paint a rosy picture. Note that even before the newly elected government came into power, the MIER Consumer Sentiment Index rose from 82.6 in 4Q17 to 91 in 1Q18 (highest post GST implementation) (Figure 4). We anticipate discretionary counters to benefit from the increased disposable income.

Large caps to remain expensive. We note significant PE expansion from numerous large caps (Figure 5-8). Despite PE multiple’s reaching two standard deviations above their five year averages, we expect these expensive valuations to be sustained at least for the remainder of 2018 given the favourable macro factors mentioned above. However, we would not advocate buying at these levels.

Top Picks. We are overweight on the Brewery sector as we expect Heineken and Carlsberg to benefit from better volumes due to World Cup 2018 and expected clamping down on the illegal market. Additionally, we have a favourable view on Hup Seng Industries due to the expected cheaper input costs (from lower CPO price this year), healthy dividend yield and reasonable valuations.

Forecasts. Forecasts for all the consumer counters under our coverage are unchanged.

Maintain NEUTRAL. Despite favourable macro factors mentioned above, we maintain our neutral stance on the sector as optimistic expectations have already been priced in.

Source: Hong Leong Investment Bank Research - 29 June 2018