With the GST implementation and further subsidy rationalization at the horizon, we remain concerned that inflationary cost pressure could compress margins of the consumer stocks under our coverage. At the same time, consumers would become increasingly selective in their spending habits given the trickle-down effect of rising costs, which would be a dampener on spending volume. Nevertheless, we see selective bright spots emerging and as such we maintain our NEUTRAL rating on the consumer sector. We believe that the F&B sector would escape relatively unscathed and, in fact, we are expecting such companies to benefit from cost-push inflation and their ability to pass on the rising costs to consumers. In contrast, retailers and brewers would be the ones most at risk as their products are more discretionary in nature. Having said that, we have turned more positive on selective retail and MLM stocks such as PADINI and ZHULIAN as we like the former for its: (i)earnings growth through new store expansion and focus towards value-for money products, which is more resilient during a slowdown in consumer spending, (ii) undemanding valuation and large cash pile, and (iii) high dividend yield of 6.7%. As for the latter, we are positive on its 11-15% earnings growth vs its peer average of 9%, regional expansion plans and predominantly export market, which would allow the company to benefit from a weaker ringgit.

Retail and MLM sub-sectors - NEUTRAL

Increasingly selective spending habits of consumers, pricing competitiveness and rising operating expenses are challenges that retailers and MLM companies are likely to continue facing this year. Nevertheless, we see efforts being made to adapt to the new paradigm of rising costs and to drive sales growth. Among other things, there is a growing trend of retailers: (i) Opening larger format outlets with a wider range of products to cater to a wider range of customers, (ii) More focus towards neighbourhood malls where rental is less burdensome, and (iii) A shift to more value-oriented product offerings, which are less discretionary to consumers. Similarly, for the MLM companies, earnings growth will be underpinned by expansion into new markets, introduction of new products and increased operational efficiency, which should provide a buffer against cost inflationary pressures. While we are positive on the measures taken to counter the challenging business environment, we maintain our NEUTRAL view on the retail and MLM sector for now given the headwinds ahead. Our OUTPERFORM calls are ASIABRN (TP: RM4.60), HAIO (TP: RM2.95), PADINI (TP: RM1.90) and ZHULIAN (TP: RM5.40). Meanwhile, we have MARKET PERFORM calls on AEON (TP: RM14.76), AMWAY (TP: RM12.65) and UNDERPERFORM calls on ENGKAH (TP: RM2.28) and PARKSON (TP: RM2.97).

F&B sub-sector - NEUTRAL

While the purchases of domestic cardholders seem to be staggered from the current level, we remain cautious and have maintained the F&B sub-sector’s rating at NEUTRAL. F&B companies would still likely register revenue growth in 2014 to be driven mainly by cost-push inflation. As the non-discretionary consumer goods are price-elastic, we expect demand for NESTLE and DLADY products to remain consistent. Besides, BR1M will also likely lend a hand to neutralize the potential negative impacts of the reduction of subsidies that will impact spending power. Hence, profits margin would likely be sustained. For the whole of 2014, we believe 4Q14 will be strongest quarter given the holiday season and consumer may start loading up goods up to 1Q15 before the implementation of GST in Apr 2015. We have MARKET PERFORM for all of our stocks, which include NESTLE (TP: RM72.80), QL (TP: RM4.62); DLADY (TP: RM49.70), OLDTOWN (TP: RM2.67) and KIANJOO (ACCEPT OFFER; TP: RM3.30).

Sin sub-sector - UNDERWEIGHT

Tobacco – Maintain NEUTRAL. Increased contribution from the contract manufacturing segment and an improvement in operational efficiency has thus far helped BAT to register modest bottomline growth. Nevertheless, broader concerns remain for the tobacco sector, namely: (i) more stringent regulations by the government to curb smoking and (ii) high incidences of illicit trade. The recent RM1.50/box price hike which came in response to the 14% hike in excise duty is also expected to add further pressure to the already shrinking legal market. Given the reasons above, we are NEUTRAL-cautious of the tobacco industry, and maintain our MARKET PERFORM rating on BAT (TP: RM63.00).

Brewery - Downgrade to UNDERWEIGHT. Although the (i) absence of an excise hike during the National Budget 2014 and (ii) Visit Malaysia Year 2014 are positives for the brewers for the year ahead, we remain cautious on GAB and CARLSBG outlook as increased subsidy rationalisation and the implementation of the GST could be a double whammy for brewers. The Malt Liquor volume growth is particularly susceptible to a slowdown in consumer spending, while at the same time, increased competition from cheap imports and rising operating costs could pressure margins. Post earnings cut and downgrade on CARLSBG (from MP; TP: RM13.36 earlier), we now have UNDERPERFORM calls on both the brewers - GAB (TP: RM16.52) and CARLSBG (TP: RM11.94).

Source: Kenanga