We maintain NEUTRAL on the sector. After strong festive sales in 1QCY24, the retail sector, especially the discretionary sub-segment, is bracing for tougher times ahead as consumers tighten their belts on sustained elevated inflation that is unlikely to ease over the immediate term on the back of subsidy rationalisation, particularly RON95 fuel subsidy rationalisation. On a brighter note, the 13% salary increase for most civil servants from Dec 2024 should at least partially restore their spending power. Our sector top pick is consumer staples player F&N (OP, TP: RM38.25).

Cautious spending outlook. We project stronger private consumption growth of 5.6% in CY24 (vs. 4.7% in CY23). Similarly, despite cutting its forecast retail sales growth in CY24 to 3.6% (from 4.0% it projected back in Mar 2024), Retail Group Malaysia (RGM) also forecasts stronger retail sales in CY24 (vs. 2.2% in CY23). However, we are mindful that the growth may be driven more by higher prices rather than increased sales volumes.

According to RGM, retail sales in Malaysia started the year with a bang with a 7.8% YoY growth in 1QCY24, turning around from a 0.2% YoY contraction in 4QCY23. This surge was fueled by strong festive spending and a month-long school holiday, boosting apparel sales. Looking ahead, the association cited the primary challenge for Malaysia’s retail sectors remains the escalating cost of living affecting consumers across all income brackets. Addtionally, the weak MYR also continues to impact import-dependent businesses, leading to higher prices for consumers. RGM expects more moderate growth at 1.7% and 2.5% in 2Q and 3Q, respectively, but year ending on a high note with a 3.2% increase in 4Q from a low base a year ago.

Seperately, despite strong retail growth in 1QCY24, consumer sentiment – as measured by the Malaysian Institute of Economic Research (MIER) Consumer Sentiment Index – dipped to 87.1 from points from 89.4 points in 4QCY23. This decline suggests that rising living costs have made consumers more cautious with their spending, even during festivities.

All in, we concur with RGM’s view and believe current cautious consumer spending will persist throughout the remainder of CY24 and potentially into early-CY25 amidst sustained elevated inflation that is unikely to ease over the immediate term on the back of subsidy rationalisation, particularly RON95 fuel subsidy rationalisation.

Seasonal weakness expected. Looking forward, we expect seasonally weak 2Q and 3Q, particularly in the apparel segment in the absence of major festivities. Consumer discretionary players like PADINI (MP, TP: RM3.63) and AEON (MP, TP: 1.21) may need to sacrifice margins to maintain sales. On a brighter note, the 13% salary increase for most civil servants effective Dec 2024 should partially restore their spending power.

Commodity price fluctuations. Prices of key commodities like sugar, cotton, and soybean, which have declined more than 8% YTD, are likely to stay soft due to strong global supply as a result of bumper crops in the key production areas, such as Brazil, India and Argentina. In contrast, prices of coffee and cocoa have surged 20% and 137%, respectively, on poor crop yields amidst exteme weather conditions in their production areas in Southeast Asia and West Africa. Additionally, the higher shipping cost as reflected in a 91% YTD increase in the Shanghai Shipping index will weigh on PADINI and MRDIY (MP; TP: RM1.97) that source a large portion of their products from China.

Our top picks for the sector are:

• F&N for: (i) its earnings defensiveness given the stable demand for essential food items despite high inflation and an uncertain global economic outlook, (ii) the rising popularity of ready-to-drink products where F&N has a strong presence, (iii) proxy to the recovery of domestic consumption and the return of tourists in Thailand and (iv) its long-term growth prospects driven by its investment in a sizeable diary farm in Gemas, Negeri Sembilan.

• KAREX (OP, TP: RM1.10) for: (i) its leading market position and global reach in the rapidly growing condom industry, projected by industry experts at a CAGR of 8% to 9% over the immediate term, (ii) its strong R&D and product innovation, (iii) its adherence to international standards and certifications, (iv) its strategic shift in moving up higher the value chain, and (v) growing preference for high quality innovative condom products.

Source: Kenanga Research - 10 Jul 2024