Kenanga Research & Investment

Consumer - Back to Basics

Publish date: Fri, 05 Apr 2024, 10:08 AM

We maintain NEUTRAL on the sector. Over the immediate term, consumer spending will be weighed down by elevated inflation, a higher Sales & Service Tax (SST), increased utility bills and impending fuel subsidy rationalisation. On a brighter note, softening food commodity prices will ease margin pressure on consumer staples players. However, higher freight cost in the aftermath of the Red Sea conflict has reverberated throughout the sector. As consumers prioritise spending on essential items particularly food over apparel, appliances, furniture, etc., we expect more resilient earnings from consumer staples players as compared with consumer discretionary names. Our top sector picks are F&N (OP: TP: RM33.80) and MRDIY (OP; TP: RM1.95).

Cautious consumer spending. We project private consumption to grow at 5.8% in CY24 vs. 4.7% in CY23. This is in the same vein with the retail sales growth projection by Retail Group Malaysia (RGM) of 4% in CY24, vs. 2.2% in CY23. We are mindful that the higher growth could be driven by higher prices rather than sales volumes.

We believe cautious consumer spending will persist throughout CY24 and may even extend into the early months of CY25 on the back of escalating cost of living due to sustained high inflation, subsidy cuts for essential items such as chicken and rice, along with hikes in water and electricity tariffs, not to mention the increase in the Sales and Service Tax (SST) from 6% to 8%, which now encompasses a broader range of services including maintenance, and repair work. These changes are likely to elevate manufacturing costs for businesses, potentially leading to a reassessment of product pricing across various industries. We believe the biggest blow has yet to come, i.e. fuel subsidy rationalisation.

While the impact on high-income earners might be minimal, the middle-income group is expected to experience the most significant financial strain as at least some of them will no longer enjoy subsidised fuel. Ironically, the lower-income group might find themselves somewhat shielded from these economic pressures, thanks to ongoing government cash handouts and the continuation of subsidies, especial fuel subsidies.

A balancing act for consumer staples margins. Consumer staples companies are poised to benefit from the recent decline in prices for certain soft commodities, which is expected to facilitate a recovery in margins. Notably, prices for key commodities such as wheat, corn, soybean, and aluminium have been decreasing in recent months, with wheat, corn and soybean prices dropping over 6% in 1QCY24. Conversely, the prices for cocoa and cotton have been on an upward trajectory, with cocoa prices soaring by 133% in 1QCY24 due to reduced supplies from West Africa, exacerbated by adverse weather conditions and strong demand. Cotton prices, meanwhile, have also risen by 13% in 1QCY24, attributed to decreased planting areas and low stock levels in major production countries. Furthermore, the Shanghai shipping index has witnessed a nearly 33% increase in 1QCY24, primarily due to ongoing conflicts in the Red Sea region. Given these dynamics, companies like NESTLE (UP, TP: RM115.00) and PADINI (UP, TP: RM3.20) may face margin pressures in the upcoming quarters due to the rising costs of cocoa and cotton. Additionally, the increase in the Shanghai Shipping Index suggests that shipping costs for PADINI and MRDIY are likely to escalate, especially since a large portion of their products are sourced from China.

Valuation update: Our earnings forecasts, valuation methodology, target prices, and ratings remain unchanged for the consumer sector portfolio, with the exception of AEON, DLADY, and MRDIY. For these, we have updated our valuation base year to FY25, maintaining the targeted P/E ratio. Consequently, our revised target prices are RM1.01 for AEON (previously RM1.00), RM27.65 for DLADY (up from RM26.90), and RM1.95 for MRDIY (increased from RM1.75). While our recommendations for AEON and MRDIY stay the same, we have downgraded DLADY from OUTPERFORM to UNDERPERFORM given the valuation has become rich following its recent share price surge. 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 13x, 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.

As consumers prioritise spending on essential items particularly food over apparel, appliances, furniture, etc., we expect more resilient earnings from consumer staples players as compared with consumer discretionary names. Our top picks for the sector are:

1. F&N for: (i) the robust demand recovery in beverages and ready-to-drink products post pandemic, (ii) strong export sales from competitive pricing, (iii) the steady demand for essential food items, and (iv) improved outlook in the Thailand market, driven by a revival in domestic consumption and tourism.

2. MRDIY for: (i) its dominant position in Malaysia's home improvement market, (ii) its size that translates to strong bargaining position vs. its suppliers and economies of scale, (iii) its ample headroom for growth in terms of store count, and (iv) its continued efforts to improve operational efficiency such as the introduction of an automated inventory system.

Source: Kenanga Research - 5 Apr 2024

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