While the loosening of MCO rules come s as a welcome relief for consumer companies, we continue to expect weak earnings in 2H20 while consumers adjust to the ‘new normal’. With the exception of QL (FY ends in Mar), we expect none of the stocks under our coverage to record earnings growth in 2020. We reiterate our UNDERWEIGHT stance for the sector, our top pick for the sector remains Hup Seng Industries (HOLD, TP: RM1.00). At current price levels, HSI’s dividend yield of 6.4% remains attractive in this time of uncertainty.

Weak consumer sentiment and weak retail sales expected to drag 2H20. Despite the reopening of retail and F&B dine-in outlets, we expect retailers to report weaker YoY earnings in 2H20. Note that in 1Q20, the consumer sentiment index (51.1) was the lowest ever recorded, even lower than during GFC and AFC (Figure #1). With retail spending in 2020 expected to show negative growth in (Figure #2-3), we expect retailers Aeon (SELL, TP: RM0.86), Focus Point (HOLD, RM0.43) and F&B player Bfood (SELL, TP: RM0.90) to report weak 2Q earnings and remain sluggish in 2H20 given (i) consumer’s reticence to return to shopping malls due to Covid-19 risk, (ii) absence of spending from tourists and (iii) higher unemployment (Figure #4) leading to consumers becoming more careful with their spending.

Expect weak brewer volumes and higher marketing costs. While we expect volumes to bottom out in 2Q20 from the MCO (closure of drinking venues and temporary ceasing of production operations of both brewers), tepid volumes will likely persist into 2H20. With the RMCO duration expected to last until 31 Aug 2020, certain nightlife operations (nightclubs and karaoke) are still prohibited from operating, while pubs will be required operate at a reduced capacity for social distancing. We estimate out-of-home consumption of beer for Malaysia accounts for 40-50% (Figure #5). Additionally, we note that both brewers will incur significantly higher marketing costs from their respective marketing campaigns (Heineken: ‘Raise Our Bar’ and Carlsberg: ‘Adopt-A-Keg’) which is aimed at providing financial support to bars which carry their products by giving consumers deals such as ‘buy 1 free 1’ borne by the brewers. Heineken (HOLD, TP: RM22.45), Carlsberg (SELL, TP: RM21.00)

BAT’s decline to continue. Although BAT shared they are able to continue to fulfil orders during the MCO period, this has accelerated the two structural issues which continues to plague the industry, namely (i) higher illicit and vape market volumes which hit record highs in 1Q20 (Figure #6) and (ii) consumer down trading. We reckon BAT faces an uphill battle going forward to reclaim consumers that have shifted their spending patterns to buying vape and illicit cigarettes (priced at just RM5/pack vs. between RM12-18/pack for BAT’s cigarettes), particularly given consumers reduced spending power. BAT (SELL, TP: RM10.60)

Cheaper commodity costs. Since the start of FY20, prices for most key commodities for consumer staples under our coverage, namely Nestle (SELL, TP: RM100.55) and Hup Seng Industries (HOLD, TP: RM1.00) have declined significantly (Figure #7-13) due to weaker demand from the Covid-19 outbreak. However, we do not expect significantly better margins from cheaper raw material costs due to (i) the weaker Ringgit (currently at 4.26/USD vs 4.09/USD at the start of the year); and (ii) increased operating costs associated with safety measures being implemented in response to Covid-19.

UNDERWEIGHT. With the exception of QL (FY ends in Mar), we expect none of the stocks under our coverage to record earnings growth in 2020 for reasons mentioned above. Reiterate our UNDERWEIGHT stance for the sector, our top pick for the sector remains Hup Seng Industries (HSI) (HOLD, TP: RM1.00). At current price levels, HSI’s dividend yield of 6.4% remains attractive in this time of uncertainty.

Source: Hong Leong Investment Bank Research - 16 Jul 2020