The Ministry of Domestic Trade, Co-operatives and Consumerism issued a media statement on the enforcement of the Price Control and Anti-Profiteering Regulation 2016. The new regulation (which will be fully effective April 2017) which has no expiration date, dictates that companies are not permitted to unreasonably increase prices through profit margin expansion for food and beverage products as well as non-durable household goods and personal-care products. Revisions in margins from the sales of these goods should be justified by the 3-year historical margins and mark-up trends of the respective products. While the new regulation should benefit consumers with a continued price control mechanism on such basic necessities, we believe it would only be of a short-term impact as it merely delays the price increases of these products, given the margin compressions faced by food producers and traders from rising operational costs during these past few years. We reiterate our NEUTRAL view on the sector in anticipation of a challenging outlook for 2017, mitigated by the resilient and defensive nature of the sector, supported by the healthy private consumption. Our top picks are HEIM (OP, TP: RM18.48), PWROOT (TB, TP: RM2.56) and OLDTOWN (OP; RM2.11).

Price Control and Anti-Profiteering Regulation 2016. In a media statement by the Ministry of Domestic Trade, Co-operatives and Consumerism, the new Price Control and Anti-Profiteering (PCAP) Regulation 2016 was enforced on 1st January 2017, with a 3-month transition period (i.e. fully effective in April 2017). This would succeed the PCAP Regulation 2014 which aimed to deter unreasonable increase in prices by retailers to pass down operation costs to consumers while also restricting profit margin expansions from the aforementioned. 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. The new act, which has no expiration date, now excludes the provision of services and only applies specifically to food and beverage (F&B) products and non-durable household goods and personal care products. Mechanism-wise, companies are required to consider the historical margins and mark-up trends of their products over the last 3 historical years in justifying the reasonability of increase in selling prices by margin expansion.

Beneficial for consumers in the short-run but price increases are still imminent. We had hoped for an easing of regulation on pricing matters with the expiration of the PCAP Regulation 2014, as companies suffered margin compression from the rising production overheads with limited means to pass costs down to consumers via higher prices. While the market could negatively react with a decline in general demand, we believe an uptick in net earnings could still be seen as companies are expected to test their pricing strategies with progressive increments in determining an ideal price point to maximise margin improvements while also ensuring market share remains intact. Though the implementation of the PCAP Regulation 2016 may appear to impede such views, we believe the price control measures would only benefit consumers in the short-run as food producing and trading companies have been seeking avenues to keep margins sustainable against rising operational costs, particularly from recent economic developments (i.e. increase in minimum wages, adverse forex impact on commodity and raw material prices). Our checks with F&B players guided that certain decisions on recent increases in product prices were caused by the aforementioned elements.

We reiterate our NEUTRAL rating on the sector. With an expectation of price increases in the short-to-mid-term in spite of the implementation of the PCAP Regulation 2016, we believe any visible impact will be minor as we do not anticipate an aggressive repricing of F&B and household products in the near future on the back of more cautious and strategic price strategies. That being said, we maintain our view on a challenging 2017 as the cost advantage from the soft commodity market is diminishing, further aggravated by the weak local currency. Meanwhile, consumer sentiment is likely to stay subdued in 2017 in view of the continuing concerns on the state of economy, job market as well as rising cost of living. On the flipside, we have not turned bearish on the sector as we believe the sector is resilient and defensive enough, supported by the healthy private consumption, further evidenced by the recovery in sentiment from the low in end-2015.

Our sector Top Picks remains unchanged. We favour HEIM (OP, TP: RM18.48) for its market-leading position against its peer, CARLSBG (MP, TP: RM14.30), which puts the company in a firm position in the event of a price increase for its products, given the sticky demand of its goods. We also like PWROOT (TB, TP: RM2.56) given its steady growth with proven track records, sturdy balance sheet and attractive dividend yield at 5.7%. 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. Lastly, we see investment opportunity in

OLDTOWN (OP; RM2.11) as we believe the share price weakness following the recent sell-down arising from the exit of the group’s Shariah-compliant status had been overplayed. Furthermore, the group’s strong fundamentals are still intact, especially the visible earnings growth prospect in its Manufacturing of Beverages business segment.

Source: Kenanga Research - 11 Jan 2017