Kenanga Research & Investment

Consumer - Back to Basics

Publish date: Thu, 14 Dec 2023, 09:47 AM

We maintain our NEUTRAL call, expecting subdued consumer spending in CY24 due to sustained high inflation, higher and more taxes, hikes in utility tariffs, and the impending subsidy rationalisation. We believe middle-income earners could bear the full brunt while the lower-income group may be less affected thanks to recurring cash handouts and various subsidies (from the government) which they will continue to enjoy. On a brighter note, the stabilisation of selected commodity prices, MYR and freight cost could alleviate cost pressures, paving the way for margin recovery for certain players. We favour consumer staples players. Our sector top picks are F&N (OP; TP: RM30.70), MRDIY (OP; TP: RM1.78), and QL (OP; TP: RM5.95).

Subdued consumer spending in CY24. We project a 6.2% growth in private consumption in CY24, vs. an estimated 4.8% in CY23. This is fairly consistent in terms of trend with the CY24 retail sales growth projection by Retail Group Malaysia (RGM) of 3.5% in CY24, vs. an estimated 2.8% in CY23. However, we are not ready to interpret these numbers as suggesting that CY24 will be a strong year in terms of consumer consumption.

The CY23 private consumption number is not a good comparison as consumers were still cautiously adjusting to the economy reopening during early-CY23. At 6.2%, our projected CY24 private consumption growth rate still pale in comparison to the 7.7% recorded in CY19 prior to the pandemic. Meanwhile, we believe the higher CY24 retail sales number will be driven by higher prices rather than stronger sales volumes.

We believe cautious consumer spending during the later part of CY23 (after the “compulsive” consumption phase) will extend into CY24 on the rising cost of living due to sustained high inflation, higher and more taxes, hikes in utility tariffs, and the impending subsidy rationalisation. Thus far, consumers have already been hit by rationalisation in subsidies for eggs, rice, and electricity. They are bracing for the imminent water tariff revision, an increase in the SST from 6% to 8%, and the removal of subsidy for RON95 petrol. While we believe the high-income group may not quite feel the pinch, middle-income earners could bear the full brunt. Ironically, the lower-income group may be less affected thanks to recurring cash handouts from the government while they also continue to enjoy various subsidies.

Commodity price shifts to bring margin recovery in CY24. Our commodities prices tracking indicates that most commodities, including milk, wheat, corn, soybean, CPO, cotton, and aluminium, prices are projected to trend lower in CY24, according to Trading Economics (exhibit 1), which should provide support to the consumer staples companies, such as F&N and DLADY, amidst market challenges.

Diverse GP margin trends expected for 4QCY23. Based on our recent correlation study on the commodities prices against the industry players’ gross profit margins, gross profit margins for NESTLE, DLADY, F&N and PWROOT are expected to show mixed trends in their upcoming 4QCY23 results. Over the nine months from 1QCY23 to 3QCY23, key commodities such as coffee, milk, wheat, corn, soybean, and palm oil have seen a price decline of over 10%. This suggests a potential uplift in GP margins for companies like NESTLE and DLADY in 4QCY23. Conversely, F&N and PWROOT might encounter challenges due to rising prices of their critical commodities during the study period.

Having said that, the recent boycott activities against several international F&B franchises with alleged ties to Israel, prompting consumers to shift to Malaysian and other Asian F&B brands. If these boycott activities intensify, the affected international franchises might be compelled to ramp up their advertising and promotion (A&P) efforts to counteract the sales decline. Such increased spending on A&P activities might lead to a decline in their margins, as the added costs could outweigh the gains in revenue.

Targeted petrol subsidy to be rolled out in 2HCY24. The government has updated the timeline for implementing the targeted petrol and diesel subsidy program, now slated for the 2HCY24. The execution of this subsidy, involving a subsidy card system, is aligned with the introduction of the Padu central database system in January 2024. The subsidy distribution will be based on individual net disposable income, household income via social protection schemes, or a combination of individual and household earnings. This targeted subsidy approach might lead to a portion of the middle-income M40 group losing access to these subsidies, which could reduce their spending power and affect mid-market retailers. In contrast, the outlook for consumer staples players remains positive, as their primary customer base, the lower-income B40 group, will continue to receive full fuel subsidies, thereby preserving their spending power.

Valuation update: We have kept our earnings forecasts, valuation basis, target prices, and ratings consistent for all consumer stocks in our portfolio, except for F&N. For F&N, which we have rolled over our valuation base year to FY25 with an unchanged targeted PER of 22x. This adjustment in the valuation timeframe has resulted in an increase in our fair value for F&N to RM30.70, up from RM29.40 previously. Note that, our valuation basis of 22x for consumer staples companies aligns with the sector's average historical forward PER. Meanwhile, our valuation for department store and apparel companies remains at 12x, reflecting a 20% discount from the sector's average historical forward PER of 15x to reflect the eroded spending power of their target customers, i.e. the M40 group. For PWROOT, on the other hand, its valuation basis continues stayed at 15x, at a discount to the average historical forward PER of 22x for the food and beverage to reflect the company less extensive product range vs. its peers.

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

Our top picks for the sector are:

1. F&N for: (i) robust demand rebound for its products, notably in the beverage and ready-to-drink categories, as economies have restarted and border restrictions lifted, (ii) resurgent 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.

2. MRDIY 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.

3. QL for: (i) the consistent high export demand for its marine products, supported by robust fish landings and decreasing input costs, (ii) the high growth potential of its Family Mart convenience store franchise, highlighted by its popular Japanese-themed products and continued expansion, including the new Family Mart Mini outlets targeting petrol stations and highways, and (iii) it growing poultry business in Indonesia and Vietnam, driven by increasing protein consumption as their standard of living rises.

Source: Kenanga Research - 14 Dec 2023

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