In view of higher commodity prices and tepid consumer spending in 2020, we cut our sector rating to UNDERWEIGHT from Neutral. Despite headwinds in the consumer sector, we have a favourable view on both brewers as we expect government’s continued clamp down on illicit alcohol to drive volumes back to the legal market in addition to growths in their premium brands. Top pick is Heineken (BUY; TP: RM28.90).

More expensive commodities expected in 2020. Many FMCG (Nestle, Hup Seng Industries, Fraser and Neave, Dutch Lady Malaysia) and F&B players’ (BFood) profitability are tied to commodity prices. Despite the low levels in 2018, many commodity average prices dived even further in 2019. (YoY: Arabica: -11.4%, Robusta: -18.0%, Crude Palm Oil: -2.4%). Looking ahead into 2020, we expect consumer companies to be hit by higher commodity prices. While global coffee consumption is expected to rise by 1.5% in 2020, the International Coffee Organization expects coffee production to decline by 0.9% led by weather issues in key coffee producing markets including Honduras, Brazil and Peru. This is expected to result in significantly higher coffee prices, which have surged by ~12.7% since end November. Furthermore, HLIB also expects CPO price to average RM2,400/mt in 2020 from an average of RM2,244/mt in 2019 due to supply shortages in Malaysia and Indonesia. Note that CPO has surged 59.2% since mid-2019 to RM3,118/mt currently. Higher coffee and CPO prices amongst other commodities are expected to put margin pressure on food producers.

Decelerating retail growth in 2019 expected to continue into 2020. Going into 2020, blanket subsidies on fuel will be replaced by a subsidy scheme that captures a narrower pool of drivers (although the implementation timeline has been delayed). The fuel subsidy, which is capped at RM30/month for car owners with engine capacities of <1,600cc is expected to benefit just 8m motorists. We expect this to have a negative impact on consumer discretionary spending habits. Additionally, weak consumer sentiment of 84 (which is lower than the 100 threshold) exhibits the overall weak consumer spending outlook going into 2020, where we expect retail sales to continue its decelerating growth. Malaysian retailers posted weaker retail sales growth in 2019 vs 2018, averaging just 7.7% in 2019 vs. 11.0% in 2018. Retail Group Malaysia (RGM) attributed this slowdown to limited domestic policies to stimulate consumer spending in addition to weaker consumer sentiment which was due to slower export growth, declining stock market activity and weakening ringgit. Going into 2020, we expect the absence of significant consumer spending stimulus domestically and on-going global trade tensions to continue to result in tepid retail growth.

Brewery growth on the uptrend. We note that both brewers Heineken and Carlsberg have reported robust top line growth in 9M19 of 20.0% and 15.5%, respectively. Both companies attributed better top line to growths in premium brands but also intensified enforcement in illicit alcohol trade. Going into FY20, we expect the government to continue their efforts in reducing illicit trade, evidenced by the government’s stance on cracking down on illicit alcohol trade in lieu of increasing Malaysia’s alcohol excise duty structure. Currently, counterfeit alcohol market share is believed to be as high as 25% in Peninsular Malaysia and 80% in East Malaysia. We expect the increased efforts to result in volumes flowing back to legal players.

Forecast. Unchanged.

UNDERWEIGHT. In view of higher commodity prices and tepid consumer spending in 2020, we cut our sector rating to UNDERWEIGHT from Neutral. Despite the headwinds, we have a favourable view on both brewers, due to reasons mentioned above. Top pick is Heineken (BUY; TP: RM28.90).

Source: Hong Leong Investment Bank Research - 13 Jan 2020