We reiterate our NEUTRAL stance on the consumer sector as we expect the stronger sales driven by aggressive promotional and marketing activities to be offset by margin compression. We do not expect to see significant recovery in consumer sentiment as well as actual spending due to the inflationary pressure a/servlets/staticfile/252795.jsps well as negative perception in anticipation of GST implementation. We expect the retail space to be more affected by the soft consumer sentiments and lower consumer spending as consumers are likely to cut down their discretionary spending on the back of high living costs environment. Thus, we prefer the F&B subsector for its more resilient nature (necessity consumer products) vis-à-vis discretionary consumer products (retail and MLM subsectors).

As for the sin sector, we upgrade it to NEUTRAL from UNDERWEIGHT, as we see greater value in the sector; (1) it could provide a relatively safe shelter for investors in weathering the market volatility, (2) dividend play with yields >5%, (3) better coming quarter foreseen in view of the festivities and pre-GST stocking up activities, and (4) the successful illegal trading clamp down efforts by the authorities.

Better for F&B, still tough for retailers. 7 out of 14 stocks under our coverage reported results below expectations. Interestingly, all of the underperformed stocks (AEON, AMWAY, ASIABRN, HAIO, PADINI, PARKSON, and ZHULIAN) were in the retail and MLM space while every single one of the F&B coverages posted results within expectations. The negative deviation was lower-than-expected YoY sales due to persistently weak consumer sentiments and compressed profit margins on the back of higher operating costs in relation to the higher marketing and promotional expenses.

KLCSU slightly outperformed KLCI. As of our cut-off date (19th Dec 2014), the KL Consumer Index (KLCSU) recorded YTD decline of 7.7%, which was slightly better than the performance of the KLCI (-8.1%). One of the top performers in the consumer index includes QL, which raked up impressive 18.4%

YTD gain thanks to its robust earnings growth and favourable raw material prices; while BAT was also one of the big names which registered positive return during the period, at 4.3% probably due to the positive earnings results. On the flipside, GAB was the worst performer in the index with YTD decline of 18.2% as the Group has failed to maintain its stellar record of successive earnings growth in FY14 due to the higher operating costs and heightening threat from contrabands beers; while DLADY which was affected by higher operating costs and unfavourable forex, was down by 7.2% during the period under review.

Stronger sales on seasonality… Moving forward, we expect the stronger sales momentum sequentially to be sustained moving forward, supported by the marketing and promotional activities in conjunction with the yearend festivals as well as school holidays. With the latest reading of consumer sentiment index showing a slight decline to below 100-point level, we conservatively expect the consumer sentiment to stay subdued in view of the latest round of the subsidy rationalization program, which directly undermines the spending power of local consumers as a result of lower disposable income, as well as in view of the negative perception in anticipation of the GST implementation.

…but at thinner margin. In view of the aggressive marketing and promotional activities in coming quarters in conjunction with festivities and school holidays, we are expecting further margin compression, particularly in the retail space. Price discounts and promotions are widely expected to be given to consumers in order to boost sales as well as clearing off-season shipments on the back of the highly competitive retail market. Thus, we do not expect the net earnings growth to be in tandem with the top line growth judging from the anticipated higher advertising and promotional (A&P) and selling and distribution (S&D) expenses.

Not looking good economically. According to latest reading, private consumption rose slightly to 6.7% in 3Q14 from 6.5% in the previous quarter on normalizing prices. Moving forward, our economists are forecasting consumption to improve to 7.1% in 4Q14 on additional spending surrounding the year-end festivities and in early preparation for the GST. Meanwhile, for the Consumer Price Index (CPI), our in-house forecasts are guiding for 2015 CPI average of 4.0%, influenced by cost-push factors mainly due to the GST and the weaker ringgit but partly mitigated by lower oil prices. In a nutshell, the macro picture for 2015 is slightly more on the negative side for the consumer sector with 2015 private consumption foreseen to be lower at an average of 6.1% against 6.9% in 2014, further worsened by the higher inflation rate with CPI projected to be higher at 4.0% vis-à-vis 3.1% in 2014.

Source: Kenanga