We maintain UNDERWEIGHT on the Consumer Sin sub-sector. 1QCY14 results for both the brewers under our coverage came in within expectations. However, the recent results season showed a decline in QoQ earnings arising from weaker sales and higher operating costs. Going forward, we expect slower consumer demand in light of rising cost of living from government subsidy rationalisation, weaker sentiment, and competition from contraband beers, which is in line with our consumer sector outlook, causing us to trim our earnings (refer overleaf). We have also altered our valuation method to P/E from DCF, resulting in lower TPs for brewers by 8.2%-9.2%. Our TPs and CALLs are: CARLSBG (MP; TP: RM12.21), GAB (UP; TP: RM12.93). While we are NEUTRAL on overall Consumer, we reiterate UNDERWEIGHT on the Consumer-Brewers.

1QCY14 results in-line. The brewers’ results came in within expectations, making up 26% for CARLSBG’s 1Q14 and 71% for GAB’s 3Q14. YoY topline declined due to the lower sales arising mainly from the timing of Chinese New Year (CNY) which was earlier this year compared to last year implying shorter pre-CNY sales for the period while management did caution of challenging consumer demand outlook going forward. However, despite weaker sales, CARLSBG’s earnings were up by 3.6% from improved Malaysian operations. GAB’s 15.8% decline in sales, coupled with a disproportionate (-10%) decline in operating expense, led to weaker-than-expected earnings, lower by 41.9% to RM35.6m. QoQ, the CARLSBG topline improved by 15.0% underpinned by the peak of CNY festivities, but earnings was dragged down 18.3% to RM52.3m from higher operating expense (+21.4%) and taxation expense (+35%). GAB’s 3Q14 topline on the other hand disappointed, coming off by 25.4% from a higher base in 2Q14 due to festivities during the October-December months. This unsurprisingly dragged down net profits by 46.2% on the back of lower interest income (-46.3%) and higher interest expense (+18.6%).

Brewers facing slower consumer demand from rising cost of living. We are concerned over our country’s growth dynamics. Despite the higher-than-expected GDP growth and slightly improved consumer sentiment in 1Q14, Malaysia’s private consumption expenditure has actually contracted by 0.8% QoQ. Meanwhile for the first five months of 2014, CPI averaged at 3.4%, compared to 1.6% seen in the same period in 2013. We are concerned that the rising cost of living is driven mainly by cost-push inflation rather than real demand. The malt liquor market remained challenging in 1Q14 with consumer spending patterns being affected by the rising cost of living brought about by government subsidy rationalisation, while this has also led to additional competition from contraband beers, which pose a threat to CARLSBG and GAB being cheaper alternatives. Despite the completion of CARLSBG’s stock rationalisation program in Singapore, and the effective roll-out of efficiency programs, we expect some short-term weakness from consumer demand from Singapore going forward due to the 25% rise in liquor excise duty implemented in Feb-14. GAB’s outlook remains dim as it continues to be mired with lower sales and proportionately higher operating costs.

Lowered our earnings estimates for brewers. We have revised our FY14-15E earnings estimates for CARLSBG and GAB, reducing it by 3.8%-7.5% and 10.6%-12.8%, respectively, as we had previously assumed more bullish sales estimates. In light of our weaker outlook for consumer demand going forward, we have adopted more conservative sales estimates by: (i) assuming lower and more flattish MLM growth of 0.2%-0.9% (from 4.1%-4.3%) in FY14-FY15 for both CARLSBG and GAB, (ii) trimming our annual ASP growth assumption of +3% to +2% for both CARLSBG and GAB, and (iii) reduced EBIT margin assumptions for GAB by 0.8ppt to 0.5ppt for FY14-FY15, respectively, as latest results saw YOY and QOQ earnings declines due to margin compression.

Altering valuation method to P/E. We have switched our valuation method for the brewers under our coverage from DCF to P/E due to: (i) the rising cost of operations and weaker consumer demand, which provides less visibility in terms of sales and cost trends, and thus, more unpredictable earnings, (ii) P/E valuations capture the volatility of a liquidity driven market, which has resulted in sharp changes in valuations of large cap counters.

Basis of valuations. Our new valuation is a function of the 3-year Fwd PER cycle to better encapsulate the re-rating process of such large cap defensive consumers over the last few years. Our valuations are as followed; 1. Lowering CARLSBG’s TP to RM12.21 based on 18.5x FY15E PER from previous TP of RM13.30 (DCF). Our applied PER is based on CARLSBG’s 3-year mean. We believe such defensive stocks should trade at historical P/E level, despite the weakening consumer sentiment and rising cost of operations, as demand for beer is relatively less elastic compared to demand for consumer and F&B retail items. Dividend yields are fairly compelling compared to the average consumer sector yield of 3.8%-4.1%. Our TP implies a total return of 7.1%. 2. Lowering GAB’s TP to RM12.93 based on 19.0x FY15E PER from previous TP of RM14.24 (DCF). Our applied PER is based on 0.5SD below its 3-yr mean because of: (i) weak YOY earnings compared to CARLSBG’s positive set of earnings, and its inability to manage declining sales by improving operations, (ii) dividend yields less attractive compared to CARLSBG at current price levels (4.6% vs. 5.2%). Our TP implies a total return of 2.1%.

Decent dividend yields at current price levels. Both share price for CARLSBG and GAB have been on the decline from Jan-14, mainly due to selling by foreign funds. As such, brewer’s net dividend yields are decent at current price levels, at 5.2%-5.5% for CARLSBG, and 4.6%-4.9% for GAB in FY14-FY15E, respectively. This suggests +0.9ppt to +1.5ppt spreads to the 10-yr MGS in FY15, which does not deviate very far from MREITs’ yield spreads of +1.2ppt to +2.5ppt to the 10-yr MGS.

NEUTRAL on overall Consumer sector but maintain UNDERWEIGHT on Consumer Sin sub-sector as we expect slower consumer demand in light of the rising cost of living from government subsidy rationalisation, weaker sentiment, and competition from contraband beers. We maintain our CALLs but downgrade TPs for CARLSBG and GAB by 8.2% and 9.2%, respectively, after trimming our earnings and altering our valuation method from DCF to P/E, based on the 3-year mean average. Our recommendations are: CARLSBG (MP; TP: RM12.21) and GAB (UP; TP: RM12.93).

Source: Kenanga