We reiterate our NEUTRAL rating on the consumer sector. As commodity prices approach a normalised state, F&B players will seek improvements to keep operations sustainable. In the meantime, consumer sentiment may persist at discouraging levels dampened by the poor job outlook and weaker spending power. Several new regulations were introduced (i.e. PCAP 2016 and amendments to the Trade Descriptions Regulations) to curb price increases and also to better streamline organised sales events by retailers. Nonetheless, we believe the market may still be sustained with the continued resiliency of private consumption and anticipation of higher public spending. In addition, companies with sizeable export exposure may demonstrate promising results as they benefit from stronger foreign currencies and more vibrant export demand. We raise the calls and target prices for certain coverages as we take this opportunity to roll over their valuation base years to FY18. Our Top Pick for the sector is HEIM (OP; RM21.38) as we believe its market leading position and commitment in the brand-building initiative will continue to propel growth in the longer run. We also like PWROOT (Trading BUY; FV: RM2.56) for its solid growth outlook in the export market and generous dividend pay-out.

A mixed quarter with 4 out of 12 coverages (HAIO, HEIM, OLDTOWN, PADINI) recording above expectations earnings, while 5 coverages (AEON, AMWAY, DLADY, PARKSON, QL) performed within and the 3 remaining (BAT, CARLSBG, NESTLE) fell below mark. We saw more aggressive promotions from retailers as a mean to stimulate consumer demand amidst the poor consumer sentiment at the expense of some degree of margin compression. On the other hand, F&B and Sin sector players saw margins being squeezed in the form of higher input costs from recovering commodity prices outpacing the slower volume growth. Export-oriented players such as OLDTOWN, however, benefit from its broader market base together with favorable forex rates.

(This report’s cut off date is as of 10th March 2017)

Good start to the consumer index. The KL Consumer Index (KLCSU) demonstrated an admirable YTD return of 4.5%, closely in line with the benchmark KLCI’s YTD return of 4.6%. The index growth appears to be primarily attributed by PPB, which saw strong trading revenues from Wilmar. BAT saw a boost in trading sentiment likely from stronger-than-expected dividend payments declared despite disappointing financial results and UMW on the back of its announced disassociation with its oil and gas arm. Going forward, we believe investors will be more cautious given adverse indicators such as rising commodities, prolonged weakness in local currency and more passive consumer spending behaviour.

Prevailing weakness in sentiment. The Malaysian Institute of Economic Research (MIER) presented 4Q16 consumer sentiment index at 69.8 pts (-3.8 pts QoQ), being the lowest recording for 2016. The global survey conducted by Nielsen presented similar findings as Malaysia scored 84.0 pts (-5.0 pts QoQ) from their scale. Much of the pessimism could be attributed by the dampened job outlook, rising living expenses and shrinkage in spending power as our exchange rates have yet to show signs of improving. However, as the year-end periods used to be a period of heavier consumer spending for discretionary items and recreational expenses, we believe a dwindling in spending during this time could demonstrate a larger impact against statistical norms.

Mixed trends for commodity prices. While food manufacturers had enjoyed a stint of soft commodity prices in the last 2 years, the progressive price normalisation had begun to reflect in the expanding input costs for F&B players without hedging practices. Though milk powder and cocoa prices seemed to have shown a steep decline in the last recent months, we anticipate little meaningful costs easing for food manufacturers as overall raw material prices seem to be maintained on an uptrend. Coffee and sugar prices, on the other hand, have not shown a reversal on its price movements. Thus forth, we believe food manufacturers will continue concentrating on efforts to enhance operational processes to make up for the loss in margins from higher costs while keeping selling prices stable as to not discourage consumption of their products.

On the retail spectrum, the new Trade Descriptions (Cheap Sale Price) (Amendment) Regulations 2016 implemented on 1st January 2017 will reinforce the Government’s resolution for more efficient and effective special sales by allocating four dedicated times of special sale per year (from five previously). Although competition is expected to intensify owing to the narrower window of cheap sales opportunities for traders to compete in a shrinking market, we believe major retailers such as AEON (MP, TP: RM2.38) and PARKSON (OP, TP: RM0.88) will not likely be significantly affected by the regulatory changes as these retailers have the alternative to exercise more aggressive sales and promotional incentives in the form of members privileged days (i.e. member exclusive sales). In addition, multi-level marketing players such as AMWAY (OP, TP: RM8.98) and HAIO (MP, TP: RM3.21)’s promotions are generally focused on their distributors instead of retail sales.

Anti-profiteering mechanisms persist… To recap, the Ministry of Domestic Trade, Cooperatives and Consumerism had enforced the new Price Control and Anti-Profiteering (PCAP) Regulation 2016 (effective April 2017) on F&B and non-durable household goods and personal care products whereby price mark-ups are limited to over the products’ trailing historical 3-year gross margins or in accordance to its growth trends. The PCAP 2016 is noted to have no expiration date. Though the general consensus from F&B players is to refrain from exercising price increase as consumer sentiment continues to be soft, we believe a prolonged state of cost absorption may be detrimental to their ability to pass down costs in the future as persistent low margins may be perceived as a viable normality in the eyes of the regulators. Biting the bullet for the time being, F&B players have been seeking other avenues to allow business to be continually sustainable for now through operational improvements while rising input costs are yet to have any severe impact. In addition, hedging practices on commodities will still provide some degree of leverage from soft commodity prices for an extended period in the short term.

We maintain our NEUTRAL view on the consumer sector. While input costs are expected to increase following the recovery of commodity prices, companies are also expected to improve operationally as a means to negate a certain degree of margin compression. On the other hand, while consumer sentiment continues to linger a low base from the lacklustre job outlook and rising living expenses, we expect consumer spending to sustain from resilient private consumption with hopes of higher public with several major national events across the horizon (i.e. 29th SEA games, 60th Independence Day Celebration).

Our Top Pick for the sector is HEIM (OP; RM21.38). We are excited for the stock as expanded and sustainable margins are anticipated from the group’s initiatives towards improving cost and operational processes. The group’s leading market position could also be further strengthened with the introduction of new products in the non-beer and stout market. While no price increases are in consideration, for the time being, subsequent to the PCAP 2016, we believe a small degree of price increase may not be detrimental due to its market-leading position and sticky demand for its products. We also favour PWROOT (Trading Buy; FV: RM2.56), as the stock shows resilience in its FMCG products, backed by a growing export market. In addition, the stock offers attractive dividend yields at 4.6-5.3% in FY17-18 as compared to other F&B peers while also maintaining a strong net cash position.

On the sin sub-sector, we reiterate our NEUTRAL rating. The outlook for the tobacco industry continues to be overshadowed by the growing illicit trade, which now accounts for more than 50% of industry market share, with little apparent impact to curb its activities. With regards to the brewers, we present a more bullish outlook given operating improvements and product developments are being sought to counter some degree of compression arising from the increase of input costs due to the restrictions placed by the new price control regulations.

Source: Kenanga Research - 30 Mar 2017