We hosted a private meeting session for our clients with Mr Tan Hai Hsin, Managing Director of Retail Group Malaysia (RGM) and Henry Butcher Retail. During the insightful meeting, Mr Tan voiced his conservative view over the retail sector outlook, which according to him, is not expected to be buoyant due to the current economic headwinds and subdued consumer sentiment. Interestingly, the consumers have turned more conscious in necessity item purchase while the F&B segment has bucked the overall sluggish trend. The hypermarket space is expected to see more challenging times ahead, which support our negative call on AEON while players with value-for-money approach like PADINI is better poised to sail through the challenging times. Post-meeting, we maintain our NEUTRAL call on the consumer sector as we concur that the retail sector outlook is unexciting in the near term barring any stimulants to accelerate economic growth, but we favour F&B sector for to its defensive quality. Our top pick of the sector remains DLADY (OP; RM59.20) as we think that favourable milk powder prices can be sustained and thus support its earnings growth, which is forecasted at 11.5% and 6.5% over the next two years (FY16E-FY17E).

Subdued outlook ahead. Retail sales, according to RGB, grew marginally by 1.4% in 2015 in a year when GST was implemented. 1Q15 was the strongest quarter as it was boosted by pre-GST stocking up, which drove sales growth higher by 4.6% YoY while 2Q15 experienced a slump of 11.9% YoY as consumers front-loaded their spending. Moving forward, RGM is forecasting retail sales growth of 4% in 2016, driven by: (i) low base effects due to flattish growth in 2015, (ii) healthy 2016 GDP growth of 4%-4.5%, (iii) higher selling prices driven by higher cost of business on the back of new minimum wage effective July 2016 and possible toll revision, as well as higher imported costs due to weak MYR. RGM does not foresee strong recovery in retail sales in the near term barring any buoyant catalysts or indicators that signal a strong economic growth as retail sales are highly correlated with the economic growth.

Hypermarket one of the worst hits? Despite having a necessities-oriented product mix, we understand that the hypermarkets were one of the most affected business segments in the retail space as a result of the slump in consumer sentiment. The weak sentiments had induced higher sensitivity and awareness of consumer towards pricing and stronger consumerism, causing the hypermarkets to be unable to raise selling prices. This was evidenced by the performance of AEON (UP; RM2.22) as its FY15 operating profit in retailing segment dipped 62.2% to RM44.5m despite a 3% growth in revenue. Moving forward, RGM does not expect significant change in consumer behaviour and thus foreseeing challenging outlook on the hypermarket, which is in line with our negative stance on AEON.

Consumers looking for value. RGM observed that consumers have turned more conscious, seeking value on their purchases, and thus retailers with value-for-money approach or strategy are better off under the current conditions. In this case, we think that PADINI (MP; RM2.21) has adopted the right strategy with its Brand Outlets initiative, which was justified by its impressive 1H16 net profit growth of 83%. Besides, RGM also noted that F&B business has bucked the overall sluggish trend, particularly coffee-themed cafes that were able to provide ‘feel-good factor’ to consumers with innovative products line-ups. Looking forward, RGM anticipates major retail players to continue the expansion trail by opening more outlets, particularly in the key area which they cannot afford to lose out to competitors in the battle of market share.

Reiterate NEUTRAL on consumer sector. Post-meeting, we are maintaining our neutral view on the sector as we think that the forecast guidance by RGM is not sending out positive message as far as consumer sentiment is concerned. Growth of 4% is not adjusted to inflation, which is forecasted to be at 2.6% according to our in-house economists which was also partially premised on a cost-pull factor basis. However, we think that the consumer sentiment is not sinking any deeper as the gestation or transition period of one year post-GST implementation should be long enough for the consumers to adapt or acclimatise to the new costing environment. While the picture is not rosy over the retail side, we favour the F&B sector for its resilience against weak consumer sentiment and subdued trend of commodity prices. Our top pick for the sector is DLADY (OP; RM59.20) as we think that the favourable milk powder prices can be sustained and thus support its earnings growth, which is forecasted to be 11.5% and 6.5% over the next two years (FY16E-FY17E).

Source: Kenanga Research - 26 Apr 2016