We reiterate our NEUTRAL rating on the consumer sector. Recent market buying flow leaned substantially towards large-cap F&B counters despite stretched valuations since the beginning of the year. We believe this to be attributed by high expectations for resilience, especially from the major household brands. The retail sub-segment saw mixed share price performances while brewers rallied, possibly in anticipation of the 2018 World Cup. While current valuations may appear stretch, better macroeconomic indicators (i.e. recovering ringgit, lower commodity averages) may suggest that the market could be applying a longer-term view above our 1-year fwd valuations. In the previous quarter, we hypothesized little correlation between consumer stock price movements with the occurrence of elections and we maintain our view. Our Top Picks for the sector are SEM (OP; TP: RM1.70), HAIO (OP; TP: RM6.00) and HEIM (OP; TP: RM23.30). The closure of non-profitable 7-Eleven outlets to emphasise on heavy foot traffic locations and the launching of new designer style products should helm the short-term prospects of these respective retailers. HEIM is expected to gain traction with the 2018 World Cup, adding to its market leader status.

Macros shifting. The Malaysian consumer landscape appears to be heading towards greener pasture, stemmed by the recovery of domestic currency (Kenanga’s 2018 House estimates: RM3.90/USD from RM4.10/USD, previously). This could potentially lead to bright spots in consumer spending habits with the expansion of purchasing power. Furthermore, a stronger ringgit would be a direct positive to importing retailers (i.e. AMWAY, PADINI) which procure inventories from foreign suppliers. F&B corporations should also see positive impact from this owing to high levels of imports of various commodities for production. On the other hand, companies with sizeable foreign markets exposure (i.e. F&N, QL, PWROOT) should see pressures in topline expansion should the rate of foreign currency weakening outpaces their respective sales volume growth mix. Shorter term focus revolves around the eventual 14th

General Election on which high public spending could arise from widespread political campaigning. Secondly, brewers are likely to gain favor as the 2018 World Cup held in Russia is expected to spur demand in both on-trade and off-trade markets, part and parcel of such international sporting events.

Consumers a growing favorite. Up to our cut-off date at 23 March 2018, the KL Consumer Index (KLCSU) trended above the KLCI with YTD gains of 8.6% and 3.8%, respectively. NESTLE was the key contributor as its share price escalated by c.45% following its inclusion into the KLCI and stronger-than-expected earnings. F&N and PPB followed in the KLCSU top performers list which we believe investors viewed the stocks an alternative safe haven for resilient earnings concurrent with NESTLE. Prevailling illicit cigarette trades led BAT to be the worst laggard during the period. While current expansion in valuations may appear overdone given its short time duration, we believe the growing positivity in macroeconomic outlook could support the present rich valuations. Expectations in the short-term include; (i) recovering consumer sentiment, (ii) lower commodity price averages, and (iii) better forex rates to benefit net importers. All eyes are on NESTLE, whose valuation continued to expand post-inclusion into the MSCI and KLCI indices. We believe the excessive attention garnered by the stock within a short time span could be due to the highly resilient nature of its business and leading market share. However, we are conservative with our medium-term valuation of the stock in anticipation of a correction arising from the hasty rise in its share price.

For the sector top picks, we have SEM (OP;TP RM1.70) for its strong ROE offering (FY18E/FY19E of 75.0%/71.7% including treasury shares) and expected strong turnaround in earnings backed by the operation restructuring exercises, including closure of underperforming stores, overhauling operation supply chain and focusing store opening in high foot-fall locations such as shopping malls and transportation hubs. We also like HAIO (OP;TP RM6.00) for its double-digit earnings growth and margin backed by the sales of high-margin products, especially from its newly launched shoes and leather goods (designed with the consultation of Datuk Jimmy Choo). We position HEIM (OP; TP: RM23.30) as a strategic top pick for the quarter as we draw closer to the 2018 World Cup. While we have accounted for better seasonal sales, valuations are expected to pick up added by the group’s market leader status and stickier demand for its offerings.

We maintain our NEUTRAL view on the consumer sector. Sector-wide fundamentals are supported by the anticipated recovery of consumer spending with F&B players expected to enjoy some easing in production costs as average commodity price exposures soften. A stronger ringgit would also benefit importing retailers from less forex impact. While certain heavyweight counters may presently command high valuations from investors, we believe the optimistic near-term outlook would ultimately materialise to the stronger earnings expectations. On the sin sub-sector, we maintain our NEUTRAL rating. The outlook for tobacco industry remains lacklustre as illicit cigarette trade continued to widen (approached all-time high market share of 59%) despite tighter regulatory actions. Such environment with diminishing legal share could further pressure players into down trading towards a portfolio with less premiums thus compressing margins. On the flip side, we are more upbeat with regards to the brewers as on-going operating improvements and product developments particularly premium products could benefit them through improved product mix and margins, adding to the boost from the 2018 World Cup.

Elevating sentiment. 4Q17 consumer sentiment readings peaked for 2017 at 82.6 pts (+5.6 pts QoQ, +12.8 pts YoY). Better ringgit rates are the likely benefactors, as depressed rates had adversed affected spending decisions in preceeding quarters. The 4Q period typically registers the weakest score during the year likely due to softer spending locally in lieu of the holiday seasons and withholding of big-ticket item purchases (i.e. motor vehicles) until towards festive seasons. Further boost could be expected in the 1H18 period, backed by festivities and the likely general election to spur spending. While present levels are still below the Malaysian Institute of Economic Research’s “optimistic” threshold of 100 pts, we believe that healthier exchange rates could potentially stimulate the consumer spending landscape. Stronger domestic currency would also spell good news for small and medium businesses previously operating as net importers, as this could translate to better contributions on their end.

Source: Kenanga Research - 5 Apr 2018