We reiterate our NEUTRAL rating on the consumer sector due to the lack of near-term re-rating catalysts and demanding valuations. Given the additional aid packages stimulus ahead, low interest rate environment and essential economic activities to remain open – downside risks are looking to be limited. The major deciding factor to recovery lies in a successful and effective Covid-19 vaccination program. With the herd immunity target to be achieved by end of CY21 a ramped-up vaccination rollout is on the cards. Retail counters (i.e. AEON, AMWAY and PADINI) should see pent-up demand by then, with easing of lockdowns and the usual seasonal end of the year activities. F&B counters, especially those with higher exposure to in-home consumption (i.e. QL, SEM, NESTLE and Dutch Lady) will remain fairly resilient bolstered by the aid packages and re-opening of socio-economic activities. However, given the downside risk of a challenging vaccine roll-out and volatile commodity prices, we maintain NEUTRAL and stay stock-selective as most counters’ valuations remain elevated; favourite pick is PADINI (OP; TP: RM3.60) premised on upcoming end of the year seasonal activities, solid balance sheet, high stable margins and it being a popular house-hold brand for price sensitive consumers.

Neutral but cautiously optimistic. Moving on into 2HCY21, consumer sentiment will likely remain cautious given the prolonged lockdown. The recovery in consumer sentiment which we saw earlier this year has been erased, or largely stalled given the resurgence of pandemic coupled with a challenging vaccine roll-out implementation. However, we see a silver lining ahead with a targeted herd immunity is to be achieved by end of 4QCY21, with the ramping up of vaccine roll-outs. The recent annoucement of further cash reliefs and EPF withdrawals are another welcome boost to consumer sentiment.

Gaps amidst the dark clouds. In our last consumer strategy report, we were upbeat then that the worst of the pandemic could likely be over. The development of vaccines to contain the pandemic coupled with positive roll-outs were expected to see easing of restrictions gradually. Thus, Consumer counters are expected to see a recovery momentum, banking on anticipation of a successful containment of local Covid-19 cases, which would eventually result in: (i) normalization of earnings for the F&B’s HoReCa channels, (ii) return of retail footfall to the malls and stand-alone retail stores, and (iii) the revival of the local tourism scene as inter-state travels restrictions are gradually lifted. On the global front, improvement were visible as as economic activities gradually re-open as restrictions were eased, fuelled by positive vaccine developments. Efficient global vaccine roll-outs saw US and European economies reopening followed by surging demand from China as it succesfully contained the pandemic with its massive vaccine roll-out. Likewise in the last reporting season, the counters in our consumer universe mostly showed positive bias in both top-line and bottom-line results (and within expectations) given the ease of restrictions in travel and recovering economic activities.

We reiterate our Neutral call on the sector as most of the counters in our universe are trading at demanding valuations coupled with the absence of near-term re-rating catalysts i.e. stable commodity prices & logistic costs, and a favourable Ringgit. The 3rd wave of the pandemic is already in full swing, while the vaccination roll-out is still an on-going. However, downside risks looks limited as basic consumption will remain buoyed by the additional aid measures, essential economic activities remain open and most of the counters in our coverage possess the required balance sheet strength to tide over the ongoing crisis. With the valuations for the majority of our stocks remaining elevated and volatile commodity prices still a concern, our sector’s top pick is PADINI (OP; TP: RM3.60) premised on: (i) anticipation for a pent-up demand and robust recovery in the upcoming seasonal year-end activities fuelled by the targeted herd immunity achieved by then, (ii) solid net cash position of c.RM550mm as of this quarter, which would allow the group to weather through these challenging times, (iii) potential higher dividend payout given its strong cash position, (iv) high stable margins, and (v) its brand equity among the price sensitive consumers.

On a downtrend. The market started 2021 on a negative note but has gradually showed improvement with the KLCSU ending 1QCY21 with +5% uptick (vs FBMKLCI; -3%) spurred by expectations of a succesful nation-wide vaccine roll-outs. However, both have turned south YTD (FBMKLCI at -4% and KLCSU at -1%) and QoQ (FBMKLCI; -1% and KLCSU; -6%), erasing the earlier gains given the resurgence of the pandemic and reimposed restrictions. Subsequently, both indices have remained choppy dictated by the developments of the vaccine rollouts.

Consumer sentiment likely dipping…the MIER Consumer sentiment index showed rising sentiments at the end of 1QCY21, premised on the economic reopening, vaccination roll-out and seasonally festivities. We believe this has dipped since, given the on-going pandemic, further restricitions and challenging vaccination rollouts undermining consumer sentiment. Given that the herd immunity target is expected to be achieved by the end of CY21 (depending on the efficacy of the vaccine roll-out) we expect sentiment to gradually improve which should lend support to the usual seasonal end of the year demand, expected in 4QCY21.

Volatile margins likely to prevail into 2HCY21. Margins are still challenging given the rising commodity prices since early this year as the global economy roars to life given vaccination roll-outs globally. In tandem with the global economic recovery and acceleration in the reopening phase, global commodity prices are rising. The steady uptrend in global dairy prices is primarily supported by sturdy demand from Asian markets (i.e. China) which have kept the current global pandemic relatively under control, lower inventories over at European and U.S, unfavorable weather conditions and supply shortfalls from China. These challenges are further exacerbated by an unfavorable Ringgit. Our economist’s view of a favorable Ringgit by year-end with the World Bank expecting commodity prices to stabilize in 2022 - as global food commodity markets remain adequately supplied, by historical standards – which should see improved gross margins by then.

The last reporting season (1QCY21) saw a mixed bag of results with a positive bias. Both top-line and bottom-line for the sector remained positive despite the prolonged and volatile movement restrictions. 69% of the stocks in our consumer universe reported above/within expectations. AMWAY outperformed while MYNEWS, PADINI, PWROOT and 7-Eleven underperformed. The rest were within expectations. AMWAY came in above given strong growth from its health products underpinned by strong growth in ABOs. Even for those below expectations, top-line saw healthy growth QoQ and YoY with the exception of PWROOT which reported declines both QoQ and YoY on account of a weak export market. The stocks in our consumer universe saw a +5%+6% uptick in top-line in both QoQ/YoY.

The industry EBIT has remained stable despite rising freight charges and raw materials costs, growing at 12% QoQ/YOY thanks to better cost discipline and product mix which helped to mitigate rising COGS. Industry’s bottomline still maintained a healthy growth with margins stable despite the on-going challenges. Overall, the consumer sector is resilient despite the ongoing pandemic on account of easing restrictions.

Despite healthy growth in the last reporting quarter, the sector’s outlook looks challenging as lockdowns remained prevalent coupled with challenging vaccine roll-outs. On the premise of resurgence in the pandemic, challenging vaccination roll-outs and volatile global commodity prices, we maintain the sector at NEUTRAL. Gross profit margins remain challenged ahead as demand outstrips supply on global economy recovery driven by more successful vaccine rollouts world-wide. Despite the rising pandemic, the government’s target of 80% fullyvaccinated population by end of 2021 gave renewed optimism of a fully opened economy by year-end or early 2022. While risk of a slow vaccine roll-out is a concern, we are cautiously optimistic on pent-up demand in 4QCY21 premised on easing of restrictions coupled with historically strong seasonal end-of- the-year activities in 4QCY21. Moving ahead, we have an OP call for AMWAY (TP: RM5.90), F&N (TP: RM33.15), QL Resources (TP: RM6.90) and PADINI (TP: RM3.60) premised on gradual recovery, robust demand, solid balance sheet and diversified earnings stream (QL). Our preferred stock is Padini given its brand equity catering the price sensitive customers, solid balance sheet and ability to ride on seasonal pent-up demand end of CY21 and seasonal activities in 1Q and 2Q of CY22. Furthermore, its gross margins are solid; 38% - 40% and not affected by challenging commodity prices.

Source: Kenanga Research - 2 Jul 2021