Kenanga Research & Investment

Consumer - Elevated Costs Fuelling Risks

kiasutrader
Publish date: Tue, 05 Apr 2022, 08:58 AM

We stay NEUTRAL for the sector given the risks of still elevated input prices ahead. We are positive on toplines given the beginning of the endemic phase easing restrictions for both domestic and overseas travelling and fuelled further by pent-up demand underpinned by incoming festivities. We remain vigilant on the somewhat slow pace of recovery amidst supply disruption, inflationary pressures and geo-political tensions. Although toplines are expected to be robust in tandem with demand, margins will face pressure from both elevated input costs and volatile freight charges. Given these risks, we reiterate NEUTRAL for the sector but there are some undervalued large cap stocks in our universe such as; AEON (OP; TP: RM1.70), F&N (OP: TP: RM34.25), PADINI (OP: TP: RM3.80), and BAT (OP: TP: RM13.10). Our top picks for this round are: (i) AEON and (ii) PADINI - benefiting from: (i) full opening of the economy, (ii) margins looking solid as both are not affected by volatile raw materials prices, (iii) financial muscle to absorb rising costs, and iv) laggard position (AEON).

As we move into the endemic phase, we are postive on surging demand, fuelled by pent-up demand and incoming festivities. MIER’s Consumer Sentiment Index showed sentiment is rising as restrictions have eased, fuelled further by the re-assurance from the accelerated vaccines roll-out and booster shots. The endemic phase will see further influx of foreign travellers boosting the HORECA players.

Margins risk. The National Recovery Phase in mid-September 2021, was a welcome boost to our Consumer Stock Universe as earnings surged 97% QoQ and 42% YoY partly coming from a low base effect. Nevertheless, both Retailers and the Sin stocks saw significant impact from the re-opening phase coupled with better product mix and operational efficiency which mitigated the elevated input costs. Global and domestic economic momentum saw rising economic challenges - rising input and logistics costs as supply tries to cope with rising demand. New geo-political tensions stoked further inflationary pressures as energy prices surged. Global economic indicators showed that input prices are likely to remain elevated, in fact even rising in the coming months which will pose risks to earnings, indicating that pre-pandemic level margins is still a long way off.

We reiterate NEUTRAL stance on the Consumer Sector as margins will still be challenging going in 2022. Top-lines are expected to be robust if not better as the nation moves into the endemic stage starting this month with operating hours back to the pre-pandemic stage for certain business activities, benefitting retailers especially. The endemic phase will see travel restrictions phased out (including those from overseas) boosting further the HORECA channels. Demand ahead looks likely to be supported by incoming festivities boosting sales with food and beverage producers will be up towards full utilization. However, bottom-line are still challenging given the global supply chain issues – leading to volatile input prices and freight charges. Inflationary pressure is also rearing its ugly head as commodities demand outstrips supply coupled with geo-political risks arising from the Russia-Ukraine war. The unfavorable Ringgit is also a challenge as most of the stocks in our consumer stocks universe are domestic players relying on imported supply of raw materials and commodities. While we observe that some producers have started to pass on these rising inputs costs to consumers, the large consumer staple producers are still understandably cautious in doing so. Given these risks, we reiterate NEUTRAL for the sector but there are some undervalued large cap stocks in our stock coverage universe such as; AEON (OP; TP: RM1.70), F&N (OP; TP: RM34.25), PADINI (OP; TP: RM3.80), and BAT (OP; TP: RM13.10). Our top picks for this round are: (i) AEON and (ii) PADINI - benefiting from: (i) full opening of the economy, ii) margins looking solid as both are not affected by volatile raw materials prices, (iii) financial muscle to absorb rising costs, and (iv) laggard position (AEON).

Geo-political tension stoking inflationary pressures. The accelated booster shots coupled with the government plan (then) to move the nation into the endemic phased has boosted the markets since the early weeks of 2022. However, the start of the Russian-Ukranian conflict has ignited new fears over geo-political tension excarbating further global supply woes and inflationary spikes. YTD, the FBMKLCI has retraced back to its level at end of 2021 while the KLCSU fell 3%, hit by on-going concerns of rising inflationary pressures.

Consumer sentiments recovering. The MIER Consument Sentiment Index has showed imptoved sentiments since mid September 2021 as the national Recovery Phase took effect. Driven by the reopening of the economy and pent-up demand, this improved sentiment looks likely to hold ahead. More so with BNM pledging to keep interest rates at an accomodative level to support the nascent economic recovery.

Challenging margins. We are positve on robust top-lines ahead with economic activities accelerating as we move farther into the endemic phase. Input prices will be at elevated levels as global economic recovery accelerates which give rise to a variety of challenges – inflation risks arising from rising input prices coupled with higher freight costs as supply tries to cope with rising demand and upsurge in labor costs arising from shortage and the implementation of the minimum wage. With raw materials prices seen to rise by 10-20% in 2022, it is expected that producers will pass the rising costs to consumers but unlikley at a quantum enough to offset elevated inputs prices.

i) Milk commodities. Details from Global Dairy Trade (GDT) showed prices remaining elevated. The GDT Price Index continued to show an upward trend with the March Price Index ending at 1,579 or 61% above its pre-pandemic levels. Both Anhydrous and Skim Milk Powder saw 40 to 160 bps MoM (to USD 7,111 and USD4,545 respectively) surge in their respective price Index but Whole Milk Powder fell 210bps MoM to USD4,596. Data from Trading Economics showed milk prices remaining elevated and likely to rise by another 26% YoY, implying milk commodity prices will remain elevated throughout 2022 and possibly into 1QCY23.

ii) Coffee, sugar. Coffee futures were seen trading at a low since Nov 2021 and has seen a rise since early 2022 due to concerns of lower supplies and dry weather conditions in Brazil. Data from Trading Economics sees coffee trading at USD235/lbs by 1QCY23 from the current USD226/lbs. Sugar prices which has been rising moderately (+4% YTD) to USD19/lb, is expected to maintain its momentum throughout 2022 and expected to trade at USD21/lb (or +10%) by 1QCY23.

iii) Corn, soybean and wheat. These commodities are seeing elevated prices on supply concerns following the Russian Ukraine war exacerbating further supply constraints. Corn is expected to trade higher by 10% with wheat at +6% and soybeans (+4%) to USD 1,000.6 USD/Bu, USD1,237.8 USD/Bu and USD1,861.4 USD/Bu respectively by end of 1QCY2023.

Source: Kenanga Research - 5 Apr 2022

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