We are maintaining our NEUTRAL rating on the Consumer sector. The tone of the recent corporate earnings season was mixed-to-negative; with nine in line and five below expectations (AEON, ASIABRN, DLADY, HAIO and PARKSON). Looking ahead, the consumer sector prospect remains challenging with no major excitement/ catalyst expected in the coming 2QCY14 reporting season. Signs of progressive weakening were observed in consumer spending and we do not expect the current situation to reverse until 4Q14-1Q15. While we maintained neutral on the overall consumer sector, we are more cautious in terms of valuations amidst the uncertainties in macro environment. Nevertheless, we continue to like companies such as Nestle (OP; TP: RM76.10) and PADINI (OP; TP: RM2.13) for their strong balance sheet, good earnings potential and high dividend yields offered.

1Q14 results for the sector were mixed-to-negative with nine in line and five below expectations (AEON, ASIABRN, DLADY, HAIO, and PARKSON). Retailers were the clear-cut losers for the reporting quarter.

No major excitement/catalyst expected in 2Q14 results. We expect a flattish/lower QoQ earnings growth in the coming 2QCY14 reporting season, due to the absence of festivities. Consumer is still feeling the pinch of the subsidy rationalisation with another round of penny-pinching when the GST is implemented in April 2015.

Expecting a better 4Q14-1Q15. We expect to see a stronger uptick of demand in preparation for the GST that is to be implemented at the start of 2Q15. Based on our study of previous consumption tax hikes in Australia and Japan, bulk-buying or front loading activities tend to happen 6-9 months before the actual implementation of GST with the heaviest demand in the final month. Consumers tend to stock up on non-perishable and big-ticket discretionary goods such as apparel, household appliances, electronics and furniture in advance of GST implementation. Hence retailers such as AEON, ASIABRN and PADINI could benefit strongly as GST approaches, but potentially face slower demand in the months following April 2015.

Maintain NEUTRAL. In the absence of immediate re-rating catalyst in the coming quarter coupled with the moderate growth expectation, we maintain our NEUTRAL rating on the sector. While demand could pick up in 4Q14-1Q15 ahead of GST, it could prove to be short-lived. Hence, we prefer to be more cautious in terms of valuations going forward. As we rolled over our valuation base year to FY15 in the current strategy report, we have also lowered our targeted PER on selective stocks amid more uncertainties in the macro environment (e.g. possible interest rate hikes, further subsidy reduction, and economic growth uncertainties in China, Japan and Europe). Consumer sector average dividend yield of c.4% is currently trading near its 3-years historical average-to-trough levels. At the current yield level, investors might find the consumer sector unappealing vis-à-vis the 10-year MGS of 4.07%.

Selective bright spots. Amid a challenging business environment, we favour companies with strong balance sheets and good cost control. Preferred picks are: (i) Nestle for its ongoing expansion plans and the current 4.4% dividend yield which is at the peak of 3-years historical average levels, (ii) Padini for its strong earnings growth potential backed by its aggressive store expansion plan and 6.3% yield, which is the highest among our consumer space. The consumer sector was one of the best performing sectors in the local market over the year 2010-1H13, as investors found safe harbour in the sector in the face of market uncertainties such as the long-delayed local general election and external economic worries. As a result, the Consumer Index (CI) had been trading at a premium to the FBMKLCI valuations since mid-2012. However, its course started to reverse towards 4Q13 when the consumer sector was fraught with a string of challenges.

Consumers were generally more selective with their spending habits as income levels struggled to keep with the escalating cost of living. This in turn dampened sales growth for the consumer stocks under our coverage, particularly for the more discretionary sub-sectors.

YTD, Bursa Malaysia’s Consumer Product Index (KLCSU) has underperformed the FBMKLCI by 210 basis points. A lot of consumer stocks, especially the Consumer Sin Sector share price has been bashed down by c.5% YTD. At the same time, the 10-year MGS has reversed from its low of 3.05% in May 2013 to the current levels of 4.07% (as of our strategy cut-off date on 20th June 2014). Investors become more selective in terms of stocks picking in the consumer sector.

Source: Kenanga