There was no marked sequential improvement in earnings delivery (against our expectations) by the sector in the recently-concluded 2QCY23 results season. We expect a soft 3Q before a pick-up in 4Q during the year-end festive shopping season. We now see greater opportunities in F&B players (consumer staple) that offer top line defensiveness while their margins are poised for improvement as food commodity prices ease. Meanwhile, the outlook of departmental store operators/apparel retailers (consumer discretionary) may be dented by the introduction of targeted fuel subsidy as the subsidy reform will erode spending power of their key customers, i.e. the M40 group. We maintain OVERWEIGHT on the sector with our top picks being DLADY (OP; TP: RM27.00), F&N (OP; TP: RM28.45) and PADINI (OP; TP: RM5.65).

Better reporting numbers. There was no marked sequential improvement in earnings delivery (against our forecasts) by the sector in the recently-concluded 2QCY23 results, with 75% of results aligning with our expectations and 25% below, as compared to 12%/50%/37% coming in above/within/below in the preceding quarter. Of note, PWROOT (TP: RM2.50) and AEON (TP: RM1.33) fell short of expectations, recording softer sales than initially forecasted. For PWROOT, the softening demand from the Middle East market was the main culprit, whereas for AEON, a steeper-than-expected decline in sales post the Hari Raya festive period was the primary factor.

Weak 3Q amid seasonal and political factors. Looking ahead, we anticipate muted 3QCY23 results for industry players, especially the retail department store segment, due to the absence of key festivals, and persistent inflationary pressure which is driving cautious consumer spending. In addition, the general public had already adopted a cautious stance leading up to the mid August conclusion of elections in six states, compounding the pre-existing challenges of a muted market sentiment.

4Q sales recovery on the horizon. However, we anticipate a steady uptick in consumer spending post the conclusion of the recent state elections and extending into the 4Q, bolstered by the government's accelerated implementation of policy initiatives following the recent state elections. Additionally, the traditional year-end festive and shopping season is likely to provide a boost to market sentiment. Our outlook is further supported by a stable job market and indications that inflation has reached its peak.

Key commodities exhibit mixed trends. Based on our observation, we noticed a softening trend in the prices of some key commodities, including milk, wheat, corn and freight costs. These commodities appear to have reached their recent peaks, with prices experiencing a decline of over 20% YTD. Having said that, we also observed that sugar and cocoa prices have experienced a significant uptick with prices surging more than 20% YTD. The robust sugar prices can be attributed to a series of factors including unseasonal rainfall in India, subpar beet crops in Europe, and drought conditions during the summer. Similarly, the strength in cocoa prices is largely due to adverse weather conditions in West Africa, impacting cocoa production.

Preference for F&B players. We now see greater opportunities in F&B players (consumer staple) that offer top line defensiveness while their margins are poised for imporovement as food commodity prices ease. Meanwhile, the outlook of departmental store operators/apparel retailers (consumer discretionary) may be dented by the introduction of a targeted fuel subsidy as the subsidy reform will erode spending power of their key customers, ie. the M40 group. On the retail side, we foresee a potential consumer shift toward more cost-effective products, especially if inflationary pressures continue. This trend could notably benefit PADINI, which has been actively expanding its value-for-money product range.

Our top picks for the sector are:

• DLADY for: (i) its resilient top line underpinned by steady demand for staple food items despite an uncertain global economic outlook, (ii) the upside potential of its margins (beyond FY23) given the softening food commodity prices, (iii) its strong brand recognition and increasing awareness of the nutritional value of dairy products.

• F&N for: (i) a robust demand rebound for its products amid economies reopening and border relaxation, notably in beverages and ready-to-drink categories, (ii) a resurgence in export sales driven by competitively priced products, (iii) steady demand for essential food items, and (iv) a recovery in the Thai market, fueled by domestic consumption and a resurgence in tourism.

• PADINI for: (i) its strong household brands including Padini, SEED, VINCCI and P&Co, (ii) likely to benefit as consumers gravitate toward more value-for-money products in the face of rising inflation, and (iii) its strong net cash position enabling it to purchase inventory ahead of price hikes and potential supply disruptions.

Source: Kenanga Research - 6 Sept 2023