Going into 2H19, we expect food producers to benefit from slightly cheaper commodity prices, particularly from coffee and CPO. Despite the government’s best efforts, we appreciate it will take time for the illicit market share s of tobacco and alcohol to be significantly reduced due to increasingly sophisticated smuggling methods. We maintain our NEUTRAL call on the sector given the relatively expensive valuations, particularly amongst large cap stocks. Our top pick is Berjaya Food (BUY; TP: RM2.00).

Commodity price trends. FMCG (Nestle, Hup Seng Industries) and F&B players’ (BFood) profitability are tied to commodity prices. 2018 saw significantly cheaper commodity prices in key commodities vs 2017 (YoY: Arabica: -15.1%, Robusta: - 16.2%, CPO: -14.3%, sugar, -22.5%) (Figure #1-7). Despite the cheaper commodity prices in 2018, they have averaged even lower in 1H19, which theoretically should result in better margins for these companies. Going into 2H19, we expect cheaper coffee prices led by dipping Arabica and Robusta prices from expected stabilising weather in Brazil, the number one coffee producing country. Additionally, HLIB expects the CPO price to average significantly lower at RM2,100/mt in FY19 (vs. RM2,318/mt) amid subdued demands, particularly from the EU over environmental concerns. We expect the favourable commodity costs to result in better margins, particularly for Hup Seng Industries (BUY; TP: RM1.12), whose raw materials are predominantly made up of CPO and flour.

Impact of SST on food and non-alcoholic beverage prices. Since the implementation of SST tax regime in September 2018, Malaysian consumer price inflation has slowed (Figure #8-9). Note that during GST regime, CPI and the food and non-alcoholic beverage sector of the CPI averaged +2.0% and +2.7% YoY vs +0.2% and +0.3% YoY, respectively after SST implementation. This indicates that consumer prices are rising at a significantly slower rate since the implementation of SST, indicating that SST has contributed to slower inflation.

Government war on contraband yet to bear fruit. To recap, finance minister Lim Guan Eng declared the government’s desire to clamp down on contraband tobacco and alcohol trades, intending to reclaim approximately RM1bn in lost excise duty from the illicit tobacco trade. Should they achieve this, we estimate this to represent a 13% decrease in illicit tobacco market share, which currently stands at ~62% of the total tobacco market. However, based on the 1Q19 earnings and our channel checks, we reckon the government still has a long way to go in order to achieve this goal as illicit players have become more sophisticated at concealing smuggling activity, which now includes transacting online and tracking law enforcement vehicles with GPS tracking.

Dipping consumer sentiment index bottoming out. MIER consumer sentiment index (CSI) continued to decline in 1Q19 to 85.6 after reaching a high of 132.9 in 2Q18 due to post-election euphoria. Going into 2H19, we expect consumer sentiment to remain at current levels as we do not believe sentiment will deteriorate to levels seen during GST tax regime, which was viewed very negatively by the general public.

Forecast. Unchanged.

Maintain NEUTRAL. Given prevailing expensive valuations, particularly amongst large cap consumer stocks, we keep our NEUTRAL stance on the sector. Of the stocks under our coverage, we prefer Berjaya Food (BUY; TP: RM2.00) due to favourable growth prospects as we expect it to sustain SSSG figures of +2.5-3.0% YoY going forward in addition to the opening of 25-30 Starbucks outlets.

Source: Hong Leong Investment Bank Research - 5 Jul 2019