We downgrade our call for the consumer sector to NEUTRAL from OVERWEIGHT. We believe part of the M40 group may be cut off from subsidised fuel upon the introduction of targeted fuel subsidy; hence, reducing their spending power. This pompts us to turn cautious on mid-market retailers. However, we continue to stay positive on consumer staples players as their target customers, i.e. the B40 group, will still fully enjoy subsidised fuel without erosion to their spending power. Consumer staples players will also enjoy a respite from easing prices of some soft commodities, ushering in margins recovery. Our sector top picks are DLADY (OP; TP: RM27.00), F&N (OP; TP: RM28.45) and MRDIY (OP; TP: RM1.67).

A downward revision amidst economic stability. After a muted 2QCY23 GDP outcome, we have revised the CY23 private consumption projection downwards to +4.3%, from an initial +6.1%. Despite a slowdown, the steady economy and vibrant job market should continue to back consumer spending. Moving forward, while the upper-income category is anticipated to preserve its financial health, the middle-income group might encounter diminished disposable income due to the impending targeted fuel subsidy. On the other hand, the lower-income group sector will still fully enjoy subsidised fuel and hence there is no erosion to the group’s spending power. In addition, the group will continue to receive financial assistance from the government including cash handouts.

Consumer caution prevails. In the consumer landscape, the MIER Consumer Sentiment Index (CSI) has demonstrated a declining trend for two straight quarters, dropping below the pivotal 100-point mark. This trend indicates that the consumer populace is adopting a more cautious spending stance, influenced by escalating inflationary pressures and augmented interest rates. Concurrently, the Retail Group Malaysia (RGM) has revised their annual growth forecast for the CY23 retail industry downwards to 2.7%, a decrease from the previous 4.8%, following a disappointing 2QCY23 performance with a -4.0% growth rate. This decline is largely due to subdued sales during the Hari Raya season and a high base effect.

Fuel subsidy to be revamped. The government will unveil targeted fuel subsidy during the tabling of Budget 2024 in the Parliament on 13 Oct 2023, to replace the existing blanket fuel subsidy, likely to be effective from 1 Jan 2024. This shift is motivated by the unsustainable financial burden of the existing setup, where a considerable 35% of the RM77.3b subsidy in 2022 was utilized for fuel subsidies that benefitted the wealthier T20 group substantially. Leveraging the new PADU database that integrates data from various government agencies including LHDN and JPJ, the government aims to identify recipients using a “net disposable income” criterion, intending to largely exclude the T20 demographic. We believe part of the M40 group may also be cut off, resulting in reduced spending power of this group of consumers. We therefore turn cautious on mid-market retailers. However, we continue to stay positive on consumer staples players as their target customers, i.e. the B40 group, will still fully enjoy subsidised fuel and hence there is no erosion to the group’s spending power.

Respite from easing prices of some soft commodities. Consumer staples players will also enjoy a respite from easing prices of some soft commodities, ushering in margins recovery. Prices of some key soft commodities have been softening in recent months including milk, wheat and corn, as well as freight costs (see Exhibit 1). Prices of some soft commodities have declined as much as 10%-30% YTD. On the flip side, prices of sugar and cocoa have surged more than 30% 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. We believe the fluctuation of these key commodities prices are likely to echo in the financial performances of industry players within a period of 3-6 months.

Valuation update: We maintain our valuation basis for consumer staples players at 22x, in line with the segment’s average historical forward PER. However, we cut our valuation basis for departmental store/apparel players to 12x (from 15x), at a 20% discount to the segment’s average historical forward PER of 15x to reflect the eroded spending power of their target customers, i.e. the M40 group. We also cut our valuation basis for PWROOT to 15x (from 19x) as we widen its discount to consumer staples players to 30% (from 20%) to reflect the higher earnings risk arising from its export sales given the global slowdown (in addition to the initial 20% discount to reflect its limited product range vs. its consumer staples peers).

Our valuation basis, TP and recommendation for consumer stocks are summarised in Exhibit 2

Our top picks for the sector are:

• DLADY (OP, TP: RM27.00) for: (i) its resilient top line driven by the steady demand for staple food products, even amid the global economic uncertainties, (ii) the prospective growth in its margins from FY23 onwards due to falling food commodity prices, and (iii) its well-established brand and the escalating recognition of the nutritional advantages of its dairy products.

• F&N (OP, TP: RM28.45) for: (i) the robust demand rebound for its products, notably in the beverage and ready-to-drink categories, as economies restart and border restrictions ease, (ii) a resurgence in export sales driven by competitively priced products, (iii) the steady demand for essential food items, and (iv) the expected recovery in the Thailand market, driven by a revival in domestic consumption and a resurgence in tourism.

• MRDIY (OP, TP: RM1.67) for: (i) its dominant position in Malaysia's home improvement market, (ii) its impressive gross margins exceeding 40%, significantly outpacing its peers of 32%, a testament to its advantageous negotiation position with suppliers and benefits derived from economies of scale, (iii) a vigorous store expansion strategy aimed at broadening its national footprint, and (iv) the impending initiation of an automated inventory system in 1QFY24, which could further enhance its operational efficiency.

Source: Kenanga Research - 27 Sept 2023