Despite the Near Term Headwind, We Expect Softer Decline From FMCO as (i) Businesses Are More Experienced Having Braced Through the Worst in Mar-May 2021; (ii) More Sectors Are Allowed to Open Under Strict SOPs; and (iii) Structured National Recovery Plan Providing a More Sustainable Reopening Path. The Ramping Up of Vaccinations, Loosening of Restrictions and Gradual Reopening of the Economy Upon Herd Immunity Being Achieved Should Lift Overall Confidence and Provide Clearer Visibility on the Recovery Picture. Maintain NEUTRAL as We Expect Varying Degree of Recoveries Across Our Coverage. Our Top Picks Tilted Towards Our Retail Stalwarts Namely, Mr DIY (BUY, TP: RM4.79) and FocusP (BUY, TP: RM1.05).

Expect softer pull back from FMCO. With the resurgence of 3rd wave of Covid-19 and the subsequent FMCO, we expect sector earnings to remain weak in the nearterm. Despite that, we reckon that the impact will be less severe this time around vs MCO1.0 as: (i) businesses are more experienced having braced through the worst in Mar-May 2020; (ii) more sectors are allowed to open under strict SOPs; and (iii) structured plan and objective thresholds in the National Recovery Plan (NRP) should serve as a more sustainable reopening path. Additionally, based on Google Mobility data (Figure #1), the decline in mobility thus far has not been as drastic compared to MCO1.0 (mid-Mar to end-Apr 2020). For example, mobility in Retail & Recreation recorded a -77.3% decline from baseline while FMCO only registered contraction of - 59.6% from baseline.

Consumer spending outlook. To recap, based on DOSM data, retail spending bottomed in April-20 at the peak of MCO1.0 restriction. This mirrored consumer sentiment, which hit rock bottom level of 51.1 in 1Q20 before recovering (Figure #2). Encouragingly, retail spending has rebounded since then and for the first time in 11 months, it has recorded positive double-digit YoY (%) growth reflecting a recovery from the thorough in Mar-April 2020. Furthermore, the recovery trend is in line with the Malaysian Institute of Economic Research (MIER) consumer sentiment index (CSI). CSI rose to a 10-quarter high at 98.9 (+16% QoQ; +94% YoY) but still shy of the optimism threshold of 100 (Figure #3). We opine this is on the back of consumer adaptation to the new normal with more optimism buoyed by inoculation progress and improvements in domestic and global economies.

Double whammy for staples with rising commodity prices. Prices for certain commodities started to climb up since mid-2020 and peaked in early 2021 (Figure #4- 10), in tandem with the gradual resumption of global consumer activities. Notably CPO price, which is the key components for most of food producers has increased by 45% YoY. Thus, we expect patchy recoveries in our consumer universe with staples to be hit with lower margins.

Glimpse of recovery with vaccine ramp up. While we opine that earnings will be less rosy for 2Q21 on the back of FMCO/EMCO restrictions, we remain cautiously optimistic on pent-up demand in 2H21. This will be mainly driven by ramp up of vaccinations program (government target to inoculate 40% of population by 3Q21) and subsequent easing of social restrictions in Phase 3 of NRP. Encouragingly, it is worth noting that we hit over 200k doses of vaccines administered in the last couple of days, with the record high of 268k doses as of 24 June. Additionally, the seasonally strong demand during year-end will also help to boost sector recovery premised on further loosening with scheduled Phase 4 of NRP. We observed that retail sales recover when MCO2.0 ended on 5 March 2021 (see Figure #2) and we expect the same pattern to emerge post FMCO/MCO3.0.

Brewers. To recap, breweries will not be allowed to operate during the FMCO as they are not listed as essential services. While the current cessation in operation is scheduled to last more than one month, it is likely the absence of brewing operations will last longer. Furthermore, as HORECA (hotel, restaurants and café) dine-in channels are not permitted until 3Q21 while dedicated drinking venues (bars, clubs, karaokes) are not allowed until 4Q21, we expect sales volumes to be tepid going into 2H21. As such, we lower our forecasts for Carlsberg/Heineken (Carlsberg: -4.2%/- 0.7%/-0.7%, Heineken: -5.7%/-0.6%/-0.7% for FY21-23). Post-adjustment, our TPs are revised downwards slightly (Carlsberg: RM21.75 from RM22.00, Heineken: RM23.85 from RM24.00). While earnings in 2H21 are expected to be sluggish, we reckon the negatives are priced in, as Carlsberg and Heineken are currently trading at -44.5% and -26.2% below their pre-pandemic peaks. Maintain HOLD for both.

BAT. Sales volumes are strongly reliant on the government’s clampdown on illicit players, as legal volumes had swelled at the expense of illicit activity in recent years (Figure #11-12). While we are encouraged by governments initiatives which included transhipment and import restrictions resulting an increased number of seizures of illicit volumes (76 m cigarettes seized in 1Q21 vs. 34m in the entirety of FY20), we note that illicit players are starting to shift their smuggling strategies to utilise smaller jetties and unofficial landing spots as opposed to larger ports. As such, we reckon legal volumes seen in 1Q21 (which had grown 19% YoY) may be a one -off. We reckon BAT’s share price has risen to an unjustified level given the earnings uncertainty from (i) chronic high illicit market share; (ii) growth in unregulated vape products; and (iii) consumers down trading to VFM brands. Our TP of RM11.75 based on a DCF valuation methodology (WACC: 9.5%, 2.5%) remains unchanged. Maintain SELL.

Maintain NEUTRAL on the sector as we expect varying degrees of recoveries across our coverage. The ramp up of vaccination, loosening of restrictions and gradual reopening of the economy upon herd immunity being achieved should lift overall confidence and provide clearer visibility on the recovery picture.

Top picks. Our top picks are tilted towards our retail stalwarts namely, Mr DIY and FocusP. We reiterate our BUY call for Mr DIY with TP of RM 4.79. This newly included KLCI index stock has a proven business model and aggressive outlet expansion that will be the catalyst for the group’s growth moving forward. Secondly, we have favourable outlook on FocusP (BUY; TP: RM1.05). We remain confident with FocusP’s scalable business model as we reckon that both optical and F&B segments are able to ramp up fully once operating condition normalizes. In addition, we expect to see more F&B sales with the commencement of its second central kitchen (CK2), cementing its earnings growth. We expect FocusP to be able to secure new corporate clients given the popularity of their product offerings coupled with the availability of additional capacity in their CK2.

Stock rating and forecast changes.

Aeon. We lower our FY21/22 earnings by 20%/6% respectively to account for the softness in property management segment (PMS) following mall closures with FMCO/EMCO restrictions. To note, PMS accounts for 88.6% of the group operating profit for FY20. In turn, our TP falls to RM1.16 (from RM1.32) pegged to an unchanged 19x PE of mid-FY22 earnings. We downgrade our call from Buy to HOLD.

Nestle. We opine Nestle to continue face margin squeeze with the increase in commodities prices coupled with the high Covid-19 related expenses. Additionally, we expect contributions from HORECA segment will continue to remain soft in near-term following the dine-in restrictions. Hence, we lower our FY21/22/23 forecasts by 1.9%/1.3%/1.3%, respectively and our TP falls slightly to RM97.23 (from RM98.55). Reiterate SELL.

Hup Seng Industries. Despite the stable sales, HSI gross profit margin has been deteriorating on the back of the higher CPO price that makes up approximately 40% of the group’s cost. Our house expects CPO price to average at RM3,200/MT in 2021 vs. FY20: RM2,800/MT. As such we lower our HSI FY21 earnings by -4%, our TP falls to RM0.91 (from RM0.93). Maintain HOLD.

Source: Hong Leong Investment Bank Research - 7 Jul 2021