Mixed 2QCY17 results. Three coverages registered stronger-than-expected performance (CARLSBG, HAIO, PADINI), 5 coverages were within estimates (AEON, BAT, NESTLE, OLDTOWN, QL) while another 5 fell below par (AMWAY, DLADY, HEIM, PARKSON, PWROOT). Revenue was mostly held steady with higher spending habits in conjunction with the Hari Raya season during the quarter, supplemented by promotional strategies. However, cost concerns remained as forex rates were still unfavorable, albeit showing some recovery during 2QCY17. We believe F&B players are still registering high production expenses as the costlier raw material inventory have yet to be cleared.

Trailing industry index. The KL Consumer Index (KLCSU) has slightly outpaced the benchmark KLCI’s YTD performance, registering at 8.3% and 7.9%, respectively, as of our cut-off date. The better numbers were lifted by the large cap players, primarily weighted by NESTLE, which enjoyed constant top-line momentum from an expanding market share. UMW also supported the consumer index arising from the strategic exit from its loss-making oil and gas unit. PPB contributed fairly as its share price held firm on Wilmar’s potential China restructuring and listing announced during the earlier part of the year. We believe investors could seek stocks that suffered from unfavourable forex rates and commodity price averages given their improving trends and laggard impact on the financial results.

Sentiment a tad greener. The Malaysian Institute of Economic Research’s (MIER) 2Q17 consumer sentiment gauge saw another uptick to 80.7 pts (+4.1 pts QoQ). The healthier reading could be attributed to 2Q17 being the second consecutive quarter with major festivities being celebrated (i.e. Chinese New Year in 1Q17 and Hari Raya in 2Q17). Increase in national manufacturing sales and production levels may have also improved the outlook for employment stability and thus better discretionary spending trend. We believe 3Q17 could see further improvement with the influx of public spending from national events (i.e. 29th SEA games, 60th Independence Day celebrations) but may see a slower year-end with the school holiday seasons. Further, as the index levels are still well below the “optismistic” level of 100, the medium-term expectations for the sector may continue to be soft with extended cautionary spending habits.

From over-demand to over-supply? Certain commodities appear to be undergoing a paradigm shift from the perceived global shortage during the beginning of the year, which led to a progressive price increase trend. Global cocoa, coffee and sugar prices appeared to have tumbled close to its CY17-low on the back of aggressive output from South American producers. The present stockpile surplus could benefit most F&B players by averaging down raw material inventory costs. However, the current rates may be a short-lived boon as prices are expected to normalise quickly from prolonged dry weather conditions that could undermine crop yields for the later part of the year. Hence, food manufacturers that are able to leverage on renewed hedging policies during this period may be able to capitalise on the low rates for an extended period.

Retailers’ record healthier sales in 2QCY17, grew by 4.9%. Based on the latest Malaysia Retail Industry Report (August 2017) by Retail Group Malaysia (RGM), Malaysian retailers posted sales growth of 4.9% in the 2QCY17, well within their projection and an improvement over a dismal 1Q17 when overall retail sales contracted by 2.5%. We believe the better performance was attributed to Hari Raya shopping, which helped to boost sales in May coupled with heavy price discounts offered by retailers. Correspondingly, retail sales grew by 2.5% for 6M17, buoyed by improved performance in all retail subsectors in 2Q17. Taking into consideration of the latest results, RGM revised its annual growth forecast downwards from 3.9% to 3.7% for Malaysia retail industry in 2017. Based on this latest revision, the total sale turnover for the Malaysian retail industry in 2017 is estimated at RM101.4b. With successful incentives and promotion strategy, most of the retailers saw a boost in sales and will continue to provide sustainable marketing strategy moving forwards while designing cost management and rationalization strategy to keep the bottom-line afloat and mitigate the compressed gross margin from the unfavourable forex rate. Furthermore, certain retailers may strategically open new outlets at high footfall locations to spread out the operating expenses over a bigger base. We noted that the recovery of retail sales is highly dependent on external economic demand and ringgit performance for the rest of the year.

Short-term outlook could be greener. The coming Budget 2018 announcement is expected to continue with providing government assistances to the lower income bracket population. The allocated allowance to BR1M recipients had progressively increased with the last Budget 2017, raising the allowance for households with a monthly income below than RM3,000 to RM1,200 from RM1,050. A subsequent increase would be a welcomed change as consumer spending has been suppressed by the rising cost of living and the added assistance could reinvigorate consumption. At the meantime, we believe corporates could potentially register better earnings for the 3QCY17 on the back on lower forex and average commodity price exposure to expand profit margins. In the meantime, we are not expecting any changes in excise duties towards brewers and tobacco players in light of the rampant illicit trades from goods being more inaccessible, price-wise. Hence, we believe further deterrents through pricing may further escalate the issue.

We recently initiated four new stocks coverage. In the retail space, we introduced BISON (OP; TP: RM2.50) which operate stores that carry the brand of myNEWS.com, MAGBIT, newsplus and The Front Page. BISON’s profitability is head and shoulders above its local peer 7-Eleven Malaysia (SEM) and regional peers as we expect BISON to command stronger net profit margins (c.7% to 8%), higher than the peers’ net profit margin range (c.2% to 5%), attributed to aggressive expansion and higher margin products mix. BISON is targeting to open at least c.70 new outlets per year over the next two years (FY16: 294 stores) with expected long-term growth to be unlocked with the expected commissioning of its sub-DC in Johor by end-2017 and expected completion of their in-house food-processing facility by end-2018. On the other hand, the new money changing services (Travelex : currently available at 3 outlets) and Money Transfer services (Western Union, currently available at 2 outlets) are added value to the outlets, and we foresee a gradual increase of c.3 outlets offering such services per year, subject to BNM’s approval. SEM (OP; TP: RM1.70) was also initiated during the quarter. The 7-Eleven brand is commanding the convenience chain store market with further stores expansions leveraging on its strategic relationship with 7-Eleven International, USA and Berjaya Group to access prime locations and provide value-added services. SEM has been working towards an overhaul in its stores operations to mitigate the high operating expenses and expected to improve profitability in FY18.

For the F&B sub-segment, we began coverage on F&N (MP; TP: RM24.95), which helms the longstanding F&N brand of products. While the stock performance is expected to be flat in the short term due to softer Malaysian operations, we believe there is long-term growth potential from better performance of its Thailand operations, cost savings via restructuring plans and efforts to tap into larger export markets. Coverage on SPRITZER (MP; TP: RM2.20) was also initiated as we believe the mineral water bottler will benefit from the pending construction of its new automated warehouse by 2020. Additionally, its market-leading position in the local market is expected to keep its products relevant to consumers while marketing push into the export market could bear fruit in the medium term.

For Top Picks, we choose to highlight OLDTOWN (OP; TP: 3.15). The temporary closure of its central kitchen from a gas leak accident has caused weakness in its stock price. However, we are not overly concerned by the incident as we believe the stock’s fundamentals remain intact. Insurance coverage should alleviate any damages and the low utilisation rate of the central kitchen should make up for loss in production time during the accident. Additionally, the group’s FMCG plant is unaffected as it is located in Ipoh. On a separate note, we find OLDTOWN more favourable than its peer, PWROOT (OP; TP: RM2.70) for its higher liquidity (free float: 46% vs. 26%), better growth projection (2-year NP CAGR: 12.8% vs. 7.0%) and ample capacity for expansion given lower plant utilisation (c.55% vs. c.85%). However, PWROOT’s better dividend returns of c.6% (vs OLDTOWN’s c.4%) could be an alternative for investors seeking a yield-play.

We maintain our NEUTRAL view on the consumer sector. The softer commodity prices could alleviate cost pressures while easing inflationary pressures and better macro environments could potentially translate into perkier consumer spending in the medium-term. However, as sentiment levels remain at a low ebb undermining organic growth potential in addition to most stocks already trading at our perceived fair values on their limited medium-term prospects, we maintained our weightage for the sector.

The sin sub-sector is also maintained with a NEUTRAL rating. The outlook for the tobacco industry may see a turnaround with the first recorded decline in monthly illicit market share. However, illegal trade still accounts for more than 50% of the industry market share and requires extensive efforts to bring about meaningful outcomes. The outlook for brewers is more favourable with the general increase in operating efficiency and product developments continuing to spur demand.

Source: Kenanga Research - 5 Oct 2017