We reaffirmed our NEUTRAL stance on the consumer sector as we remain cautious on the earnings outlook for the retail and MLM sectors due to their dependence on discretionary spending, which will be vulnerable due to the worsening local consumer sentiment. On the flipside, we favour the F&B sector which has stayed resilient and defensive amid the challenging market environment. Hence, we think that investors should look at small to mid-cap F&B companies to tap into their steady growth, ability to preserve or improve earnings margins on the back of favourable raw material prices, and exposure to the strengthening of USD with exports sales. As for stock picks, few small to mid-cap F&B stocks are in our list, including HUPSENG (Not Rated), PWROOT (Not Rated), OFI (Not Rated), and KAWAN (Not Rated) which we plan to roll out as trading ideas. We also reiterate our NEUTRAL rating call on the SIN sector. We think the sector’s growth trajectory is still intact despite the worsening consumer sentiment, supported by the previous round of price increase in end-2014. Besides, the dividend yield averaging >5% is also another attractive point for the sin stocks in view of market volatility. The sustainability of enforcement will be essential to tackle the illegal competitors, while the lack of organic volume growth in the sector and unlikeliness of price increases due to the anti-profiteering law are factors that we consider in maintaining our NEUTRAL view. Our top pick for the SIN sector is GAB (OP; RM15.80) for its market leading position in the local Malt Liquor Market, while the strategy of focusing on premium segment by embarking on aggressive marketing activities will help to sustain earnings growth.

F&B still solid, tough times for retailers. 1Q15 results showed that the F&B sector is still able to register growth in spite of the challenging market environment with consumer sentiment collapsing to a 6-year low. All the F&B stocks with the exception of DLADY recorded earnings within our expectations and we observed that volume growth was still intact as compared to other sub-sectors in the consumer space. On the flipside, retail and MLM sectors delivered uninspiring results as the worsening consumer sentiment took its toll on demand.

Pre-GST front-loading observed. An interesting trend that we observed during the quarter was the stocking up activities in anticipation of the GST implementation in 1st April 2015. The trend was very obvious in the MLM industry as distributors were seen front-loading products pre-GST implementation but was milder in other sub-sectors. We were not surprised by such behaviour as big-ticket products or items with more durability were being stocked up before the GST inflation. Thus, we foresee the sales of companies that benefited from the pre-loading stocking up to normalize in coming quarters. Meanwhile, we are expecting a transition period of 6 to 9 months subsequent to the GST implementation for the consumers to adapt and acclimatize to the new costing environment. Prior to that, sales growth is expected to the subdued.

Consumer index steady despite volatility. The KL Consumer Index (KLCSU) sustained its earlier momentum since the start of the year by raking up 4.7% gain as of our cut-off date of 26 June 2015. The extended solid run was encouraging if compared to the 2.9% decline in the local benchmark index FBMKLCI. The key mover behind the fine performance of KLCSU index was one of the most consistent stocks under our coverage, namely QL with return of 20.9% on the back of its sustained earnings growth, while brewers have also enjoyed a good run so far in 2015 with GAB raking up gains of 18.7% and CARLSBG recording returns of 11.4%. On the flipside, BAT was one of the biggest laggards in the index with negative returns of 4.8% due to the strong competition in the industry flooded by illicit products. Automotive duo UMW (-3.5%) and TCM (- 9.1%) were among the big names in the index that registered negative returns during the period under review, no thanks to the slower TIV growth which can also be attributed to the weak consumer sentiment. 

Source: Kenanga Research - 3 Jul 2015