The sector was fraught with a string of challenges in 2013 causing consumers to become selective in their spending habits as income levels struggled to keep up with the escalating living costs. This in turn dampened sales growth for the consumer stocks under our coverage, particularly for the more discretionary sub-sectors. Higher operating costs also pressured margins as the higher national minimum wage policy was implemented and fuel subsidies were cut back. While the F&B sector had been relatively resilient amid the challenging business environment, the more discretionary sub-sectors such as retail and brewery were particularly hard hit, which led to a spate of earnings misses in the most-recent quarter. Looking ahead, we expect the headwinds to persist with the recent hike in electricity tariffs, which came into effect in January and more subsidy rationalisation at the horizon. At the same time, the 10-year MGS has reversed from its low of 3.05% in May 2013 to the current levels of 4.25% (+14bps since our last sector report in January). In contrast, the majority of consumer stocks under our coverage continued to offer uninspiring dividend yields (averaging at 4.2%) as well as tepid earnings growth. With the country's overnight policy rate (OPR) is expected to increase in 2H14, we believe that investors will become more demanding in terms of yield, and therefore, we prefer to look for value in consumer stocks which are either able to offer above-average dividend yields or better earnings growth. Among other reasons, we favour PADINI (OUTPERFORM; TP: RM1.97) for earnings growth of 10.1% (vs. retail peer avg of 8.5%) and a dividend yield of 6.0% (vs. 3.3% retail peer average). PADINI also offers an attractive valuation of 12.1x fwd PER vs. avg fwd PER of 12.9x for the retail stocks under our coverage.

Retail and MLM sub-sectors - NEUTRAL

While Retail Group Malaysia (RGM) expects retail sales growth to improve from 3.9% in 4Q13 to 4.8% in 1Q14, this is still a far cry from the 7.6% growth registered in the same period last year (1Q13). In fact, our in-house economist had recently forecasted a lower private consumption growth of 6.1% for 2014, compared to an earlier forecast of 7.6%. Higher cost of living, increased subsidy rationalisation and anticipation of GST being implemented are among the factors which underpin the more cautious spending habits of consumers (and hence affecting sales growth and operating margins for retailers). More recent negatives that have transpired include the likely increase in overnight policy rate by the second half of the year as well as lower tourist arrivals for Visit Malaysia Year 2014 due to the unfortunate missing flight MH370. Overall, we are less sanguine on the consumer retail and MLM subsectors in the absence of immediate positive catalyst and modest earnings growth expectations. Of the seven consumer retail and MLM stocks under our coverage, we have just a single OUTPERFORM call, namely PADINI (TP: RM1.97). MARKET PERFORM calls include AMWAY (TP: RM12.65), ASIABRN (TP: RM4.10), HAIO (TP: RM2.47), PARKSON (TP: RM2.79), while UNDERPERFORM calls are AEON (TP: RM13.83) and ZHULIAN (TP: RM2.83).

F&B sub-sector - NEUTRAL

As the F&B consumer sector is facing a challenging macro backdrop and lack of positive catalysts, we remain cautious and have maintained the F&B sub-sector’s rating at NEUTRAL. We expect a quiet 2Q14 and 3Q14 and believe that 4Q14 will be strongest quarter given the holiday season and also consumer may start loading up goods to 1Q15 before the implementation of GST in Apr 2015, which we believe will boost share prices in 4Q14 and 1Q15 prior to the new tax system but with a likelihood of potential crrections after that. BR1M will likely neutralize the potential negative impacts of the continued reduction of subsidies that may affect spending power. Product innovations and marketing drive will driven the sales growth opportunities in 2014 for NESTLE, OLDTOWN and DLADY. However, most stocks in this sub-segment are already fully valued or offer limited upsides, as such we have MARKET PERFORM for all of them, which include NESTLE (TP: RM72.80), QL (TP: RM3.32); DLADY (TP: RM50.36) and OLDTOWN (TP: RM2.14).

Sin sub-sector – UNDERWEIGHT

For the tobacco industry, the substantial RM1.50/pkt excise-driven price hike in late-September was able to mitigate the impact of volume decline at the gross profit level. Nevertheless, broader concerns remain with regards to overall shrinkage of the legal market consumption in contrast to the incidences of illicit trade, which currently stand at an all-time high of 38.9%. That said, we are maintaining our TP and rating on BAT in view of the recent takeover offer for competitor JTI which may cause investors to switch to BAT given the lack of alternatives. As for the brewery industry, the malt liquor market remained challenging with consumer spending patterns being affected by government subsidy rationalisation, weaker sentiment, in addition to the unfair competition from contraband beers. While GAB continues to be mired with high operating costs, CARLSBG’s earlier initiatives to buoy margins have begun to bear fruits. CARLSBG’s planned stock rationalisation program has been completed and we expect its Singapore operations to be back on track to support overall Group margins which underpin our recent upwards earnings revision and TP for the stock. Post earnings season, we have a MARKET PERFORM call on BAT (TP: RM63.00) and CARLSBG (TP: RM13.07) and an UNDERPERFORM call on GAB (TP: RM14.24).

Source: Kenanga