We are still at NEUTRAL on the consumer sector. The sector still lacks favorable near-term catalyts and furthermore most of the large stocks in our consumer universe are trading at demanding valuations. While we are positive on toplines given the easing of restrictions and the usual end-of the year demand in the horizon, we remain vigilant on the somewhat uneven pace of recovery amidst potential news of contagious variants. As topline improves in tandem with demand, margins will likely face pressure from both elevated input costs and volatile freight charges. We stay stock-selective and prefer F&N (OP; TP: RM33.15) premised on easing of restrictions coupled with year-end activities and pent-up demand plus robust & sustained sales further fuelled by demand from its halal food segment.

Upbeat but cautious. As we move into the tail-end of of 2021, we are positive on pent-demand fuellled by the usual end-of-year demand and lesser restrictions. Consumer sentiment will be upbeat given the high full vacination rate achieved and the easing of restrictions. Retailers will be seeing high footfalls and with the HORECA players seeing surge in traffic beneffiting the F&B players further. However, the industry remain cautious on the possibility of reimposition of restrictions on potential new/contagious variants of the Covid-19 virus.

Challenging margins. In our last strategy report, we were upbeat on the easing of restrictions fuelled by a successful vaccine roll-out 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, improvements were visible as economic activities gradually re start as restrictions eased, fuelled by positive vaccine developments while margins will be largely maintained given hedging activities done beforehand. In the last reporting season, counters in our consumer universe showed dissappointing results for both topline and bottom-line, given the unexpected pandemic surge, tighter restrictions and slow vaccination rate then. Margins also saw slight erosion as supply chain experienced bottlenecks leading to higher freight charges. Moving ahead as topline improves in tandem with demand, margins will likely face pressure from both elevated input costs and volatile freight charges.

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. Top-lines are expected to be robust if not better given the easing of restrictions but bottom-lines will still be challenging given the supply chain issue – leading to volatile input prices and freight charges. The unfavourable Ringgit is also a challenge as predominantly most of the stocks in our consumer universe are domestic players relying on imported supply of raw materials and commodities. Our domestic players are unlikely to pass on higher costs to consumers given the still fragile economy. Most of the large cap stocks in our Consumer stock universe are fully valued in our view and challenging margins are still a concern. Our sector’s top pick is F&N (OP; TP: RM33.15) premised on easing of restrictions coupled with year-end activities and pent-up demand, and we see robust and sustained sales ahead for both the Malaysia and Thailand markets. Its investments into the Sri Nona Group have proven to be a success as evidenced by 3QFY21 results, providing the platform to venture into the halal food segments and new product offerings driving forward growth. A forward FY22E PER of 28.5x (at 5-year mean) places its TP at RM33.15.

Pandemic impact and elevated input prices. The market started brightly for in early 2021 but gradually dimmed as a new wave of the pandemic caused tightening of travel restrictions in the following weeks. The KLCSU ended 1HCY21 with a +5% YoY uptick coming from a lower base (vs. FBMKLCI: +2% YoY) as more economic activities were allowed compared to MCO 1.0 FMCO imposition in June that saw both indexes heading south with YTD KLCSU at +1% (vs KBMKLCI at -6%) as earlier gains were erased by rising pandemic and still elevated input prices & freight charges.

Consumer sentiment choppy in 1HCY21…The MIER Consumer Sentiment Index showed choppy sentiment in 1HCY21 in tandem with rising pandemic and heightened restrictions. We believe the weak sentiment continued throughout 3QCY21 as most states remained under Phase 1 of the National Recovery Plan. We expect sentiments to rebound in 4QCY21 as no more states are under Phase 1 with restrictions eased and more economic activities allowed for those states under Phase 2 and above.

Margins being challenged. We expect a rebound and robust topline ahead for the stocks in our consumer universe as economic activities will be in full swing ahead given that >80% of the adult population have been fully vaccinated with dine-in and outdoor activities allowed. Margins however will be a challenge as global economic recovery accelerates which give rise to a variety of challenges – rising input prices coupled with rising freight costs as supply tries to cope with rising demand.

i) Milk Commodity Prices. Details from Global Diary Trade (GDT) shows prices remained elevated and are still rising. Forward contract prices for all – Anhydrous Milk Fat, Whole and Skimmed Milk Powder continued to rise between +1% to +2% (MoM) at least until Mar 2022. Data from Trading Economics showed global milk prices will remain elevated and likely to rise by another +23% by end of 3QCY22, implying milk commodity prices will remain elevated by end of CY22.

ii) Coffee, Sugar. Arabica coffee futures continued to remain elevated on concerns from lower production in Brazil ( due to drought and frost) with export dispruptions in Vietnam caused by pandemic and container shortages. According to the USDA (US Department of Agriculture) global coffee consumption in 2021 is expected to exceed production for the first time since 2017. Moving forward, coffee prices are expected to rise by another +11% YoY by October 2022. Sugar prices remained elevated boosted by falling supplies from Brazil and rising demand from the USA. Trading Economics expects sugar prices to rise by another +10% by end of 3QCY22.

iii) Corn, Soybean, Wheat. While Corn and Soybean prices showed weakness, wheat prices continued to be on an uptrend. Demand for wheat are expected to continue to rise as productions in Russia, Canada and the EU are expected to take a dip due to unfavorable wheather conditions. Trading at c. USD749/BU wheat prices are expected to rise upwards by another +10% by October 2022. YTD, corn prices saw +12% upswing and are expected to see another +10% upswing by end of 3QCY22 while soybeans prices are expected to rise by another +8% to c. USD1.676/BU for the same period.

Source: Kenanga Research - 4 Oct 2021