We reiterate our NEUTRAL rating on the consumer sector. The zero-rated GST looks to benefit both consumers and corporations alike from lower prices driving sales and better operating margins. Consumer stocks demonstrated strong resilience in the market against our benchmark FBMKLCI Index which appears gravely affected as the country enters new political grounds. In the near term, the sector also looks to be buoyed by easing macro factors (i.e. appreciating ringgit, stable commodity price) while the ongoing 2018 World Cup should benefit brewers and discretionary F&B spending. Our 3QCY18 top picks include PARKSON (OP; TP: RM0.860) and LAYHONG (TB; TP: RM1.20).

Zero-rating of GST a shake-up to the sector. As of 1 June 2018, the Ministry of Finance enforced the zero-rating of the 6% GST implemented in 1 April 2015 to replace the Sales and Service Tax (SST). Discretionary consumer spending was thought to have softened following its implementation, which was further aggravated by the weakening of the Ringgit in 2015, likely caused by declining oil prices and political issues driving out foreign investments. Certain retailers which absorbed the tax into their merchandising price are expected to benefit from this as it revives their margins. Other players who sought to pass down the tax to consumers could see demand reinvigorated as shelf prices should now be lower by a 6% quantum. This is notably more beneficial to consumers in purchasing big-ticket items (i.e. automobiles). However, not all companies were able to reduce their prices, particularly tobacco players. This is owing to regulations from the Ministry of Health in limiting price reductions despite these companies previously passed on the tax to cigarettes retail prices (refer to Figure 1, Pre-GST and GST period analysis on domestic sales growth and trading valuation for stock within our coverage). The government intends to reintroduce Sales and Services Tax (SST) in September 2018 to resolve its income disparity from zero-ing GST. However, no quantum has been specified at this moment.

Resonating resilience. Up to our report cut-off date at 22 June 2018, the KL Consumer Index (KLCSU) stood firmly with YTD gains of 15.0%. However, the KLCI saw YTD loss of 5.0%, likely provoked by the change of government following the May general election which led to the outflow of foreign shareholders from KLCI component members. NESTLE continued to be the best performer (+44% in share price YTD) of the KLCSU owing to its strong resilience against national headwinds. We believe this could be due to the stock’s lack of exposure to political risk. F&N and PPB also sustained as top gainers, likely for the same reason. While BAT was the leading laggard for the Consumer Index, the stock had recovered by c.55% from a YTD low which also supported the indices performance. Although illicit trades remain at stubbornly high levels, the inability of the company to reduce prices post-zeroing of GST is thought to lead to better margins. Investors could be bullish with this development, hence translating to the recovery in prices. In the near term, we believe the media-dubbed “tax holiday” could translate to better consumer appetite for spending, hence bringing about higher expectations to performance across the sector. This could be further supported if (i) commodity prices remain stable, and (ii) domestic currency progressively strengthens to the benefit of the majority of net importers and food manufacturers.

For our 3Q18 top picks, we look to PARKSON (OP; TP: RM0.860) which is highlighted for an anticipated turnaround, spearheaded by its transformation strategies and improving sales and profits from China operations. We had also issued an On Our Radar piece on LAYHONG (TB; TP: RM1.20) in 20th March 2018, as we believed the stock deserves a mention. While egg prices appear to have normalised, the company’s growth looks to be driven by the commissioning of the new Pulau Indah plant which should kick-start the joint-venture agreement with NH Foods Ltd, Japan.

We maintain our NEUTRAL view on the consumer sector. Fundamental expectations are anticipated to hold up with the recovery in demand as consumer spending looks to improve on top of easing costs led by a stronger Ringgit environment which could supplement the stable commodity prices. In terms of valuations, we look towards a broad-base rerating of large cap F&B stocks within our coverage (i.e. DLADY, F&N, NESTLE, QL) to a standard +1.0SD over a 3-year average forward PER. We previously implemented a 5-year average Forward PER for most of the stocks. We believe the shorter period will be more representative of investor behaviour towards the recent landmark macroeconomic events (i.e. introduction and zero-rating of GST, volatile Ringgit strength, change in government). We apply a +1.0SD on these same stocks on the back of better investor sentiment placed against these stocks as a safe haven for their earnings resilience as compared to other sectors (refer to Figure 2, Valuation & Justification For Calls – F&B sector for changes in calls and TP). We also maintain our NEUTRAL rating on the sin sub-sector. Brewers are likely to benefit from the ongoing 2018 World Cup and such merits are likely to have been reflected in recent share price performances. While tobacco sales volumes are still challenged by rampant illegal activities (+c.60% of total market share), BAT may see better margins thanks to the absence of GST on their retail returns. New enforcement bodies are also seen to be hopeful to clamp down illicits more effectively, although lacking a track record at present.

Sentiment recovering from tailwinds. The Malaysian Institute of Economic Research’s Consumer Sentiment Index (CSI) scored 91.0 pts (+8.4 pts QoQ, +14.4 pts YoY) in 1Q18. We view this as the normalisation of confidence levels, which were previously daunted by depressed spending habits. Recall that since the first announcement of the implementation of GST in October 2013 in conjunction with the tabling of the National Budget 2014, CSI readings had only held above 100.0 pts once in 2Q14 but failed to recover to such level since. The prolonged weakness in the index was likely fuelled by the depreciation in Ringgit, which affected discretionary spending, especially for imports. As these factors appear to have returned to previous grounds, we believe the consumer spending landscape should be reinvigorated in the near term barring any unforeseen unfavourable macroeconomic developments. Businesses could also see positive marks to their financial results as operating costs ease with lower import prices.

Commodity swings may be eminent. Based on global monthly rates, certain key commodities (i.e. dairies, coffee) seem to be flat lining as demand and supply meet at a temporary equilibrium. However, the same could not be said for cocoa and wheat as international refiners seek to leverage on low prices to maximise profits, thus exerting demand pressures. At the meantime, food producing countries also seek methods to elevate prices to support their own economic interest. We believe this could eventually trickle down to the general agricultural commodities market and reintroduce production cost concerns to our food manufacturers. Nonetheless, hedging practices utilised by most local players should provide an extended visibility to input cost exposure.

Retail prospects. Historically, 2Q is generally the better quarter compared to 1Q buoyed by the biggest Malaysia festivities, Hari Raya Aidilfitri and the current year’s 2Q was boosted by the implementation of zero-rated GST starting 1st June 2018 as well as pre-discounting activities in the second half of May. However, with the expected implementation of SST from 1st September 2018, there will be a slight revision in pricing depending on the new mechanism which may largely affect the retailers that have direct relationship with the local manufacturer, while other retailers will only experience a knee-jerk reaction. This was in line with the Retail Group Malaysia’s (RGM) adjusted sales growth estimate of 2QCY18 to 6.3% (from 3.7%) and 3QCY18 to 6.8% (from 5.2%) to take account expected major purchases during the tax holiday period from 1st June 2018 to 31st August 2018 as well as Hari Raya celebration in the middle of June 2018.

1QCY18 results dented by disappointments. Of the 17 stocks within our coverage, only 1 stock came above expectation (DLADY), 8 stocks were within (AEON, CARLSBG, HAIO, HEIM, NESTLE, PADINI, PARKSON, SPRITZER) while 7 stocks were below (AMWAY, BAT, F&N, MYNEWS, SEM, QL, PWROOT). Most of the retailers posted lower sales in 1QCY18 due to the seasonally stronger sales in 4QCY17 from the usual year-end promotions. However, this was cushioned by the CNY festive season sales. Concurrently, retailers continued to draw lower margins impacted by promotional and discounting activities to remain competitive in the ever-changing retailing business landscape which are gradually shifting toward the e-commerce environment. This was in line with RGM’s 1QCY18 retail sales growth at 2.6%, which is below RGM’s 4QCY17 sales growth of 3.1% as shoppers were still careful in their spending on festive goods during the Chinese New Year period. Specifically, under department store-cum supermarket sub-sector, AEON’s (OP; TP :RM2.60) sales growth of 3.5% and PARKSON’s (OP;TP RM0.860) Malaysian retail sales growth of 9.7% outperformed the average sub-sector sales growth of 2.6%, attributed to their better marketing strategy. Whereas, PADINI’s (MP;TP: RM5.25) sales growth of 13.8% also outperformed fashion & fashion accessories sub-sector sales growth at 2.8%, which we believe was due to the higher sales of affordable brands outlets merchandise and customer loyalty purchases. F&B results were relatively mixed, as non-performers were mainly dragged by lower-than-expected export sales. This could be due to the recovery in Ringgit, which affected returns. Players with high brand equity and market share continue to hold steadfast thanks to stickier demand for their offerings and stronger product development and marketing capabilities.

Source: Kenanga Research - 5 Jul 2018