We maintain our NEUTRAL rating on the consumer sector. Although consumer sentiment has recovered from the low in end-2015, we are not expecting it to turn bullish in view of the absence of catalyst and ongoing concerns over the economy and job market outlook. The cost advantage from favourable raw material prices led by the soft commodity market may also gradually diminish, but we expect players to pass through the additional costs or improve production efficiency to protect profitability. We believe the lapse in the anti-profiteering mechanism may benefit companies offering products with sticky or inelastic demand, including the brewers (HEIM and CARLSBG) and premium coffee chain operator (BJFOOD with Starbucks). Meanwhile, we are anticipating another ‘rakyat’-friendly Budget to continue lending a hand to sustainable private consumption. Our Top Pick for the sector is PWROOT (TB; FV: RM2.56). We like the stock for its steady growth path with proven track record, sturdy balance sheet and generous dividend pay-out. As for the sin sector, we reiterate our NEUTRAL rating. We are positive on the brewers as we expect their healthy growth momentum to be sustained thanks to the effective cost management, brand building exercise and more favourable product mix, but we are bearish on the outlook of the tobacco sector as volume is unlikely to recover significantly in view of the dented affordability and threat of illicit cigarettes.

2Q16 results offer little surprises. 9 out of 12 companies under our coverage recorded results within expectation. Coincidentally, the big boys in retail sector, namely AEON and PARKSON disappointed with their earnings, showcasing the general weakness in sentiment. Meanwhile, the smaller-cap fashion retailer PADINI surprised positively with stronger-than-expected sales growth, indicating that the retailbased companies can still do well with an accommodative strategy. All of the companies apart from BAT recorded positive sales growth during the period, suggesting that the sentiment was still on a recovery path. Notable downgrades during the quarter include NESTLE and DLADY, as we believe the rally on the back of favorable commodity trend might not be sustained due to the normalization or price trend.

Steadier against broader market. The KL Consumer Index (KLCSU) again outperformed the KLCI with return of 1.8% vis-à-vis the latter’s negative 2.3% returns as of our report cut-off date of 15th Sept 2016. The benchmark consumer index has shown the defensive nature with brewers, including HEIM and CARLSBG and staple food giants F&N and DLADY spearheading the list of index leaders thanks to resilient sales and favourable cost environment while on the flipside automotive players UMW and TCHONG were still the index laggards which we think might be due to the shrinking car sales and higher import costs.

Sentiment still uninspiring. According to Nielsen Global Survey of Consumer Confidence and Spending Intentions, consumer sentiment in Malaysia has inched up in 2Q16, continuing the rebounding trajectory from the low in end-2015. The survey also revealed that the sentiment is recovering as consumers believed that the economy is more resilient after Malaysia weathered the currency devaluation and moved past the first year of the implementation of the goods and services tax (GST) without the economy going into a significant downturn. However, from our channel checks with several consumer companies, we gathered that the local sentiment is still fragile as the spending pattern of consumer remain cautious and selective, and most of the companies do not foresee the sentiment turning bullish in the near term barring any emergence of strong catalyst. As such, we maintain our neutral stance on the sentiment outlook as we believe the movement of the sentiment might stay flattish moving forward, having recovered from the low base. Further climb in sentiment to show confident is unlikely in our view as economy and job security outlook remain ongoing concerns.

Raw material cost advantage diminishing. The favourable raw material prices led by the soft commodity market have been the helping hand for most of the food manufacturers over the year, resulting in lower operating costs and expanding profit margins. However, with some of the key commodities, including milk powder, sugar and coffee prices normalizing or recovering from the low level, we think that the advantage may gradually diminish. As such, we think that companies might resort to raising prices or improve operating efficiency in order to protect profitability moving forward.

Floodgate to be opened? The Price Control Anti-Profiteering Act 2011 (PCAP) will be expiring come January 2017 after the extension from 31st June 2016 to 31st December 2016. To recap, the act was introduced in conjunction with the GST implementation (on January 2015 for an initial period of 18 months) in order to deter traders from indiscriminately raising prices of goods or services by profiteering from GST. As the initial expiry date coincided with the implementation of minimum wage, we were positive on the extension as it will be able to put any inflationary pressure under control. However, we believe if no further extension is sanctioned, the lapse of the anti-profiteering mechanism might benefit companies offering products with sticky or inelastic demand, including the brewers (HEIM and CARLSBG) and premium coffee chain operator (BJFOOD with Starbucks).

Accommodative Budget to be mildly positive. Cash hand-outs are expected to be continued in coming Budget, and together with income tax reliefs, if introduced, might provide support to the private consumption. However, we are not expecting another megascale stimulus to be introduced that is capable of overwhelmingly buoying the sentiment. We are also not expecting an announcement of sin tax hikes in Budget according to the recent trend and the introduction of hikes earlier this year. As such, we are anticipating another ‘rakyat’-friendly budget, which would continue to lend hand to sustainable private consumption.

All in, we maintain our NEUTRAL rating on the consumer sector. The consumer sentiment, as expected has not deteriorated and rebounded from the low in end-2015, as evidenced by the healthy growth in sales. We believe that consumer sentiment may stay flattish moving forward, having recovered from the low base, but the event of sentiment turning bullish is unlikely in the absence of catalyst and the ongoing concerns over the economic and job market outlook. The cost advantage from favourable raw material price led by soft commodity market may also gradually diminish, but we expect players to pass through the additional costs or improve production efficiency to protect profitability.

Our Top Pick for the sector is PWROOT (TB; FV:RM2.56). We like the stock for its steady growth with proven track record, sturdy balance sheet and generous dividend pay-out. The stock offers upside of 27% with compelling valuation at 12.6x PER FY17E as compared to other mid-cap F&B counters and dividend yield is attractive at c.6%. The resilient nature of FMCG products and robust export sales will be able to drive top line growth while margins are expected to be stable. A&P expenses are expected to normalize in coming quarters after heavy spending in 1Q17 in relation to new product launch and thus we expect stronger QoQ earnings.

As for the sin sector, we reiterate our NEUTRAL rating. We are positive on the brewers as we expect their healthy growth momentum to be sustained thanks to the effective cost management, brand building exercise and more favourable product mix, while the expiry of anti-profiteering mechanism might provide the brewers the opportunity to raise prices for better profitability. On the flipside, we are bearish on the outlook of the tobacco sector as the volume is unlikely to recover significantly in view of the dented affordability and the threat of illicit cigarettes.

Source: Kenanga Research - 6 Oct 2016