We reiterate our NEUTRAL stance on the consumer sector as we expect the GST implementation to impact the psychological side of the consumer rather than changing the overall spending patterns, while expecting the transitional period to be c.6 months, which is in line with the guidance we gathered from the management of our covered companies as well as our economists. 1Q15 earnings might see a spike-up due to pre-GST stocking up, but we also foresee subsequent taper-off as consumers take time to adapt to the new costing environment. We also maintain our NEUTRAL rating call on the SIN sector. We favour the sector as a safe shelter for investors in weathering the market volatility on the back of steady earnings growth amid weak consumer sentiment and decent dividend yields of 4.5%-5.4%. However, the lack of organic volume growth in the sector discouraged us from upgrading the sector further, while price increases are unlikely considering the enforcement of Price Control and Anti-Profiteering Act 2011 in conjunction with GST implementation.

Better for F&B, still tough for retailers. Eight stocks from our coverage managed to match or exceed our expectations with their 4CY14 results. As expected, four out of the five underperforming counters were from the retail & MLM subsector due to the more discretionary nature of their product portfolios which we think took the biggest hit from the slump of consumer sentiment in end-2014, and more specifically due to the lower gross margin and the higher operating expenses. Moving forward, we expect the sin sector to sustain its earnings momentum in view of the continuous enforcement efforts as well as pre- GST stocking up activities. Retail and MLM will still be facing headwinds and margin erosion while we also foresee flattish growth for F&B players.

Consumer index on early rally. Having slightly underperforming the KLCI in 2014, the KL Consumer Index rebounded since early 2015, raking up YTD returns of 7% in contrast to the 2.4% of KLCI. The leading mover of the KL Consumer Index included our previous top pick, QL with YTD returns of 24.5% thanks to the robust earnings growth which was outstanding amid the challenging consumer space. Meanwhile, breweries GAB and CARLSBG also recorded decent YTD returns of 17.2% and 12.3%, respectively, after returning to investors’ radar on the back of higher earnings led by better enforcement efforts and earnings margin. On the flipside, the lagging performance of the consumer index was led by Tan Chong Motor (-7.9%) due to the lacklustre vehicle sales and higher costs, while ZHULIAN and PADINI recorded declines of 6.8% and 4.5%, respectively, as both were in the more discretionary market of MLM and retail, which will be bracing for more challenging times in view of the implementation of GST.

F&B spot on. To recap, we indicated our preference in F&B sub-sector in our last strategy report dated 30th Dec 2014 by cherry-picking of the F&B stocks (QL and NESTLE) as our top picks in the consumer space due to their resilience nature. It turned out to be the right call with QL raking up return of 23.8% while NESTLE also gained 9.1% during the period. The remaining two stocks OLDTOWN and DLADY recorded gains of 17% and 14%, respectively. While we still favour F&B, we reckon that the valuations may have peaked (15.2x-28.7x PER 1Y Fwd) with positives already priced into the share prices.

Lower consumption anticipated. Private consumption grew 7.8% YoY in 4Q14, bringing CY14 private consumption growth to 7.1% following the normalization of the effects of fiscal consolidation alongside lower energy prices, while also further aided by the seasonal effects of the year-end festivities. Moving forward, our economists are expecting slower spending on the back of GST normalization period but expect mitigation from lower energy prices. However, the private consumption is still forecasted to grow at a slower pace of 6.2% in CY15, while inflation is projected to stay in the range of 2.5% to 3% in CY15. Thus, we do not see too much positives from the macro economic angle.

Life goes on with GST. With GST on scheduled to be implemented from 1st April onwards, we do think that the transition or normalization period is inevitable as consumers take time to adapt to the new costing environment. We reckon that GST will exert more psychological impact to the consumers rather than changing the overall spending pattern of consumers. The labelling of GST on the price tag on consumer goods might create psychological barrier for consumers to spend normally for a certain time period as the phenomenal of price increases are common to consumers. Thus, we expect a slowdown in spending of c.6 months post GST implementation, but we think that more promotions and sales campaigns may be launched in order to mitigate the GST impact by comforting the consumers. From consumers’ point of view, we expect companies with discretionary products to be more impacted due to the higher price elasticity as compared to the sin products or necessity products, for instance, food and beverages.

Barred from price increases. In conjunction with the GST implementation, the provisions of the Price Control and Anti- Profiteering Act 2011 will be fully enforced to monitor, control and take action on any price increase from excessive profiteering. Thus, we expect companies to expand their margin through better efficiency rather than price increase with the Act going to be enforced for 18 months in between the GST implementation (1st Jan 2015 to 30th June 2016). In this sense, we expect the SIN sector to be most impacted as pricing power is one of its most attractive investment merits as compared to other sub-sector of the consumer space, mainly due to the addictive nature and thus price inelasticity. 

Source: Kenanga Research - 6 Apr 2015