We reiterate our NEUTRAL rating on the consumer sector. Sentiment index is relenting at a low base which could suggest that domestic spending will stay sluggish. Nonetheless, declining commodity prices and the recovery on the Ringgit may bring some near-term relieve to certain retailers and food manufacturers which suffered inflated costs for the past few years. Across the horizon, the coming 14th General Election may bring investors some reason for strategic portfolio positioning. However, our study conducted on consumer stocks suggests little correlation on their stock price movements with the occurrence of elections. Our Top Pick for the sector is AMWAY (OP; TP: RM8.30), given its significant exposure of forex (i.e. 90% of product cost) which we believe would see a meaningful turnaround from the strengthening of the Ringgit and larger market presence against its peer, HAIO (c.250k distributors vs. 140k). We also like F&N (OP; TP: RM28.85) for the high cost savings potential from their recent operations transformation programs. However, its illiquid shares may be unsuitable for liquidity-seeking investors.

Onwards in 2018, the recovery in forex rates (Kenanga’s 2018 House estimate: RM4.10/USD) may provide some relieve for raw materials importers who have seen some degree of cost inflation. We believe that this would benefit certain retailers (i.e. AMWAY, PADINI) while being overall beneficial to food manufacturers. On the flipside, the lower forex advantage could dampen earnings of exporters (i.e. OLDTOWN, PWROOT) and companies with significant regional operations (i.e. F&N, QL). Nonetheless, we are confident that this would not be detrimental to their respective performance as they are buoyed by strong organic demand growth potential and increasing market penetration. Post-Budget 2018 announcements, several initiatives should play a part in reinvigorating the soft consumer sentiment and discretionary spending primarily from tourism, a boon for retailers. Such initiatives include tourism-focused plans of RM2.0b in soft loans for SME Tourism Fund, RM1.0b in soft loans for Tourism Infrastructure Development Fund, RM500.0m to upgrade infrastructure facilities, and tax incentives for investment in 4-star/5-star hotels and for tour operators until assessment year 2020. Near-term excitement may arise from the highly anticipated call for the 14th General Election in the first half of the year. While investors may seek to leverage on the national event to enter into strategic positions, we have conducted an analysis to suggest that prices movements for consumer stocks, in particular, do not display any clear beneficial or disadvantageous co-relation to General Elections. (refer to Appendix: Figure 1)

For Top Picks, we choose to highlight AMWAY (OP; TP: RM8.30). With the conclusion of ABO’s Performance Year 2016 and 40th Anniversary programmes, sales momentum has slowed down for FY17 with insufficient incentives and marketing programmes to boost up sales to suppress the unfavourable forex (90% of its products costs are in USD). Nonetheless, with the start of a new ABO performance year 2018 and the expected strengthening of MYR against USD), bodes well for AMWAY with Kenanga’s 2018 House estimate: RM4.10/USD from 9M17 average of RM4.35 (every 1% change in USD impacts our FY18E earnings assumption by 10%). Moving forward, the group will continue to proactively focus on strategies to effectively manage operating costs to offset pressure on profitability and implement various sales and marketing initiatives to boost sales. In comparison, we find AMWAY more favourable than with listed peer, HAIO (MP; TP: RM5.60) for its higher distributor base (currently at c.250k vs 140k), higher revenue per distributor (5-year historical mean at 7% vs -6%), and higher dividend pay-out (5-year historical mean at 99% vs 85%) supported by the higher dividend pay-out policy ratio (80% vs 50%) which translate into a steady dividend yield of 4.1%. We also like F&N (OP; TP: RM28.85) as recent operational transformation and rationalisation programs should yield high cost savings as a solid buffer against uninspiring domestic consumer demand. Its Thailand operations continue to demonstrate favourable traction with the market there from their solid product mix, which caters well to local tastes. However, the stock is illiquid in nature, and thus may present difficulties for investors intending to hold larger positions.

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 ratings undermining organic growth potential in addition to most stocks already trading at our perceived fair values on their limited medium-term prospects, we maintain our weightage for the sector. The sin sub-sector is also maintained with a NEUTRAL rating. 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. In the meantime, we are not expecting any changes in excise duties for 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

Source: Kenanga Research - 4 Jan 2018