We reiterate our NEUTRAL rating on the consumer sector. The Consumer Sentiment Index tracked by MIER achieved a 21-year high of 132.9 pts during 2Q18. This was possibly backed by the change in government with more consumer-centric and corruption impeding agendas being pushed forward. Consumer stocks continued to hold firmly against our benchmark FBMKLCI Index. Going forward, while 3QCY18 results are expected to be boosted by the “tax holiday” spending, subsequent quarters may ease comparatively due to higher SST-led prices. Our key stock highlight for 4QCY18 sector is AEON (OP; TP: RM2.60).

Talking the SST walk. The “tax holiday” during July and August 2018 is expected to see heightened spending, which further encouraged merchants and outlets capitalising on the event with “GST-free marketing”. In September 2018, the new Sales and Services Tax (SST) system became effective but raised much uncertainty with its implementation, causing some manufacturers to withhold any resulting price increase from the tax. This was also seen amongst certain tobacco players who retracted their SST-due price increases. Eventually, the translated price hikes could abate consumer spending and skew performances, as consumers rushed to capture lower product prices as soon as possible. Adding to this, the food service industry may also resort to higher prices from the service tax imposed to customers. Note that certain establishments may impose percentile service charges, which are separate from the above tax. Retail operators and brands run business models with a high imported product mix may see a higher tax exposure from the 10% sales tax given their less complex supply chain.

Consumer stocks still ahead. Up to 21 September 2018, the KL Consumer Index (KLCSU) registered YTD gains of 12.3%, beating the KLCI’s 0.8% growth. Despite the narrow performance by the benchmark index, we have to recall that the KLCI was demonstrating losses owing to the shifting national political landscape that led to an outflux of foreign funds. As such, the rebound is seen as a positive in spite of the wide gap against the KLCSU. Of the members of the consumer index, NESTLE and F&N remained as the leading contributors (with 45% and 42% YTD share price increases, respectively) being the largest F&B players and proxies of the sector’s resilience. PPB and QL are also notable mentions for their YTD performances within the KLCSU. On the flipside, BAT continued as the key laggard with its price falling 14% YTD as the rampant illicit trade market undermined its sales and outlook. This may be further aggravated by the SST-led price increase. In the near term, strong 3QCY18 results could be registered from the abovementioned “tax holiday” scenario and could potentially lead to better investor appetite. However, we believe trading sentiment could ease subsequently as companies begin to implement the necessary price increases which may clamp on consumer spending. Additionally, while lower-than-expected, the rise in our nationwide minimum wage to RM1,050 (effective January 2019) could translate to some degree of cost pressures to labour intensive business models.

For our 4Q18 top pick, we highlight AEON (OP; TP: RM2.60). We like the stock for its: (i) dual-income streams, which are less susceptible to price changes during implementation of the new SST, (ii) strong brand name with 27 malls in operations all over Malaysia, and (iii) improved margins for both segments namely retailing and business property management services.

We maintain our NEUTRAL view on the consumer sector. Top-line expectations may be held back by a retracement in consumer spending as domestic currency does not appear to be strengthening. Prices for large cap F&B stocks (i.e. DLADY, F&N, NESTLE) appear to be flatlining, possibly on account of the above. Still, there may still be room for earnings to expand in lieu of higher margins secured by better commodity trends. While retailers with high import content may see a dampening impact from sales taxes, the lower forex exposure against CY17 could potentially offset the higher tax function in their respective price model. As such, we do not expect significant reratings in our applied valuations to our coverages in hindsight.

We also maintain our UNDERWEIGHT rating on the sin sub-sector. While brewers resolve to raise product prices reflective of the sales tax rate, consumers could be paying higher prices from an additional service tax with purchases and consumption in food outlets. This could result in either lower overall demand for beverages or a skew towards more off-trade (i.e. supermarket, convenience store) purchases, which command lower margins to the groups. Meanwhile, tobacco players will continue to see mounting pressures from the difficulty in adjusting prices to levels more favourable to consumers. Illegal tobacco products (+c.63% of total industry volume) could potentially see further expansion from the widening price gap against the legal brands. While government channels appear to be working towards more aggressive enforcement to clamp down on the illicit market, its effectiveness could still pose a question mark as previous efforts had not produced materially positive results. While sin stocks may still command fair dividend yields of c.4%, the potential capital downside should raise cautions to yield-seeking investors.

Soaring sentiment. The Malaysian Institute of Economic Research’s Consumer Sentiment Index (CSI) achieved a 21-year high reading of 132.9 pts during 2Q18. This is subsequent to the index maintaining below the “optimistic threshold level” of 100.0 pts since 3Q13 at 102.0 (not including a one-time brushing of 100.1 pts in 2Q14). We believe the recent surge in confidence has to do with the recent political shake-up in the country with the current government pushing for more consumer-centric agendas alongside movements to impede corruption within the country. The recovery of domestic currency could also have a part in this with an average of RM3.949/USD during the quarter. Ringgit strength is particularly sensitive to consumers who intend to make huge spending decisions, such as education (namely for outstation tertiary studies and above), high value imported goods (i.e. vehicles, luxury goods) and overseas travel plans.

Source: Kenanga Research - 3 Oct 2018