We  expect  consumer  spending  to  be  dampened  post  GST (gradually normalising  thereafter)  and  RHB  economists  project  consumption spending to grow at a slower pace (+5.2% YoY)  in 2015. However, we maintain  UNDERWEIGHT  on  the  overall  sector  due  to  lofty  valuations with limited earnings growth, compressed dividend yield and earnings risk from spending cuts. Berjaya Food is our Top Pick for the sector. 

Feeling the blues.The consumer sentiments index (CSI) fell to 98pts in 3Q14  (2Q14:  100.1pts,  3Q13:  102pts)  on  a  combination  of  flat employment prospects, and a softening of current and expected income.Despite the softening in sentiment, we believe spending will  be resilient in  1Q15  as  consumers  front-load  their  purchases  of  big  ticket  items ahead of the implementation of the goods and services tax (GST) in Apr 2015.  Historically,  we  note  that  this  momentum  will reverse  post  GST. Rising  inflationary  pressure  from  the  implementation  of  the  tax  and higher  living  costs  from  the  rationalisation  of  subsidies  could  weigh  on spending. We expect consumption trends to gradually normalise over the course of 2015. RHB economists project consumption spending to grow at a slower 5.2% YoY pace next year (2014F: 6.8%). 

Consumers  to  remain  prudent  amid  uncertainties.  We  expect consumers to spend prudently,  particularly on  discretionary  items amid the  rising  inflationary  pressure.  Hence,  we  believe  food  &  beverage (F&B)  companies will be relatively unaffected while retailers like Padini (PAD  MK,  NEUTRAL,  TP:  MYR1.90),  Parkson  (PKS  MK,  SELL,  TP: MYR2.06)  and  Aeon  Co  (M)  (Aeon)  (AEON  MK,  NEUTRAL,  TP: MYR3.67)  may  experience  further  margins  squeeze  from  more aggressive promotions and discounts. 

Maintain UNDERWEIGHT.  We remain UNDERWEIGHT on the  overall consumer  sector  due  to  lofty  valuations  with  limited  earnings  growth, compressed  dividend  yield  and  earnings  risk  from  a  reduction  in spending. We recommend investors to accumulate fundamentally-robust and decent dividend yield consumer stocks on price weakness.

Strategy 
Consumers to frontload spending ahead of GST 
In view of the potential frontloading from the upcoming implementation of the GST in Apr  2015,  cash  assistance  from  the  1Malaysia  People’s  Aid  (BR1M)  and  in conjunction with the festive season, we expect consumer spending in 1Q15 to fare better than in the preceding quarter, particularly  on big-ticket items. Based  on past experiences  in  other  countries,  consumption  typically  spikes  ahead  of  the implementation of a GST and then declines in the subsequent months thereafter from the front-loading of expenditure. This applies to discretionary retail products that are not currently taxed and that could see higher prices from the GST. However, we note that many essential consumer products are now exempted or zero-rated. This could lessen  the  volatility  in  consumer  spending  patterns.  While  it  is  difficult  to  decipher consumer  behaviour  in  this  situation  –  noting  that  flat  growth  in  wages,  rising inflationary  pressure  from  the  implementation  of  the GST  and the rationalisation  of subsidies  may  weigh  down  on  consumer  spending  in  the  near  term  –  we  expect spending  trends  to  gradually  normalise  over  the  course  of  2015.  RHB  economists project consumption spending  to  grow  a slower 5.2%  YoY  pace  next  year (2014F: 6.8%).

F&B relatively untouched 

Due to the inelasticity of demand for basic food necessities and the lower commodity prices YTD, F&B companies like Nestle (NESZ MK, NEUTRAL, TP: MYR67.00) and QL  Resources  (QLG  MK,  BUY,  TP:  MYR3.90)  should  be  unaffected  by  a  shift  in consumption trends. F&B retailer 7-Eleven (SEM MK, BUY, TP: MYR2.00) has strong growth  prospects  on  the  back  of  its  aggressive  store  expansion  and  renovation exercises  that  will  spur  the  group’s  topline  and  bottomline  numbers.  Berjaya  Food (BFD  MK,  BUY,  TP:  MYR4.00)  is  our  Top  Pick  for  the  sector.  We  like  its  strong earnings  growth  momentum  from  its  aggressive  expansion  of  its  Starbucks  Coffee outlets.

Challenging retail environment for year 2015 
Retail sales should experience a recovery in 1Q15 in conjunction with the Lunar New Year  and  also  from  the  one-off  pre-GST  implementation  effect.  As  for  the  rest  of 2015, we expect a slowdown in sales growth due to the prevailing higher inflationary pressure arising from the rationalisation of subsidies in addition to implementation of the GST in Apr 2015. As RHB economists project a rise in inflation rate to 3.8% in 2015 (2014F: 3.1%), we believe consumers, especially low- to mid-income earners, will remain prudent in their spending,  particularly on  discretionary items. In view of the  likely  softening  in  consumer  spending,  we  continue  to  believe  that  companies may  have  to  incur  higher  marketing  expenses  to  stimulate  the  market,  pressuring their margins going forward. We continue to remain  NEUTRAL on Padini and Aeon due to their earnings disappointment in 3Q14 and net profit risks from the softening in consumer spending, particularly on discretionary items. Note too that local retailers are also experiencing stiff competition from foreign retail players, which may prompt the former to incur additional marketing and promotional expenses. Meanwhile,  we  expect  conditions  to  remain  challenging  for  Parkson,  given  its earnings uncertainty and negative structural outlook in its core markets. 

A strong 2015 expected for plastic packaging companies

We continue to like consumer packaging companies like SKP Resources (SKP MK, BUY,  TP:  MYR0.85),  VS  Industry  (VSI  MK,  BUY,  TP:  MYR2.95),  Thong  Guan Industries (TGI MK, BUY, MYR2.60) and Scientex (SCIMK, BUY, TP: MYR8.64) due to their earnings visibility. This is on the back of their expanding production capacities and strong orders from the export markets. The sharp decline in crude oil prices YTD will have little impact on them, as most of their business operations are on a cost-plus basis.  Meanwhile,  Daibochi  Plastic  &  Packaging  Industry  (Daibochi)  (DPP  MK, NEUTRAL, TP: MYR4.10) is set to benefit in terms ofmargins expansion from lower raw material prices on the back of the sharp decline in crude oil prices. On the recent strengthening  of  the  USD  against  the  MYR,  we  believe  the  positive  impact  will  be minimal. This is because the exchange rate is takeninto account on a cost-plus basis and  the  companies  have  a  natural  hedge  in  place  as  well,  ie  both  sales  and purchases  are  denominated  in  USD.  As  for  Thong  Guan Industries,  the  recent weakness of the JPY against the USD may potentiallysqueeze its margins moving forward. We noted that in 4Q13, it had to cushion the forex loss from its Japanese customers (~30% of its total revenue comes from Japan) when the JPY depreciated against the USD.

Lacklustre prospects for sin stocks 
We believe that 2015 will be an unexciting year forthe brewers as consumers tighten their belts on discretionary items. However, we arecomforted by the Government’s recent enforcement efforts against contraband beer,which has yielded improvements in brewers’ revenues for 3Q14. We are NEUTRAL on Guinness Anchor (GUIN MK, TP:  MYR13.10)  and  Carlsberg  Brewery  Malaysia  (Carlsberg)  (CAB  MK,  TP: MYR12.80), as the stocks’ valuations are not compelling  at this juncture relative to their  small  earnings  growth.  However,  given  the  recent  retracement  in  Carlsberg’s share  price,  dividend  yields  are  attractive  again  at  5.6%/5.9%  for  FY15/FY16 respectively. However, we do note that the bills ofdemand from the Royal Malaysian Customs amounting to MYR56.1m (29.5% of FY14F earnings) are still under dispute and has not been provided against.

For  the  tobacco  sub-sector,  we  believe  the  decline  in  legal  sales  volume  over  the years will persist, largely due to a steep price hike of MYR1.50/pack in Nov 2014 as a result of a MYR0.60/pack increase in excise duty. Although we understand that the decline in sales volume will be mitigated by the hike in the cigarette prices in order to avoid revenue losses, we reckon that this strategy is not sustainable in the long term, even for a fairly inelastic item like cigarettes. We continue to be negative on British American  Tobacco  (BAT)  (ROTH  MK,  SELL,  TP:  MYR59.60)  due  to  its  rich valuations against its limited growth opportunities– given that the tobacco sector is a mature industry – as well as risk of another duty hike in 2015.

Maintain UNDERWEIGHT. 
Overall,  we  remain  UNDERWEIGHT  on  the  sector  due  to:  i)  lofty  valuations  with limited earnings growth, ii) compressed dividend yields, and iii) earnings risk from a reduction in spending. Despite the stretched valuations of the consumer stocks, we believe they will continue to garner interest from investors seeking defensive qualities and  yields,  and  we  recommend  investors  to  accumulate  fundamentally-robust consumer stocks on price weakness.

3Q14 Results Snapshot 
F&B counters within expectations 
For  the  quarter  under  review,  all  F&B  players  under our  coverage  like  Nestle,  QL Resources,  OldTown  (OTB  MK,  BUY,  TP:  MYR2.00)  and  Berjaya  Food  delivered results that were in line with our expectations. This is on the back of the stable and inelastic demand for basic necessities.

Retailers continued to disappoint 
Aeon  and  Padini  recorded  yet  another  set  of  disappointing  results  for  the  quarter. Although their 3Q14 sales rose 4.2% (Aeon) and  4.4%YoY (Padini), earnings slid 23.7%  (Aeon)  and  30.5%  (Padini),  owing  to  the:  i)  higher  operating  costs,  and  ii) higher  promotions  and  discounts  given.  Meanwhile,  we  maintain  our  SELL recommendation  on  Parkson  due  to  yet  another  poor  quarter  and  the  challenging retail  landscape,  which  sees  no  immediate  re-rating catalysts.  Its  lower-thanexpected  earnings  were  attributed  to  the:  i)  negative  same-store-sales  growth (SSSG) across most markets, ii) operation deleveraging, and iii) losses incurred by new  stores.  7-Eleven’s  earnings  were  in  line  with  expectations,  with  its  3Q14 earnings  up  109%  YoY  on  higher  ASPs  and  stronger  other  operating  income. Meanwhile,  NTPM  (NTPM MK,  TP:  MYR0.67)  earnings  missed  expectations  again for the quarter under review, largely due to surge  in raw materials, labour and utility costs. We believe the recent strengthening of the USD against the MYR will squeeze its margins further as some of its raw materials purchases are denominated in USD. Given  the  recent  retracement  of  its  share  price,  we upgrade  NTPM  to  NEUTRAL (from Sell), as we believe most downsides have beenpriced in.

Plastic packaging sector a mixed bag 
The 3Q results of two out of five consumer packaging companies under our coverage –  SKP  Resources  and  Scientex  –  were  in  line  while  Daibochi  and  Thong  Guan Industries missed expectations. VS Industry beat our earnings estimates. The latter’s earnings  for  the  quarter  under  review  were  up  268.4%  YoY  on  the back  of:  i)  a  24.5%  YoY  rise  in  sales  –  largely  contributed  by  Keurig coffee  machines,  ii)  EBIT  margin  expansion  from  higher  utilisation  rate and  improved  product  mix,  and  iii)  tax  incentives  relating  to  the  enhanced export  initiatives.  We  continue  to  like  the  consumer  packaging  sub-sector  as  the industry outlook remains bright on the back of the  resilient demand from the exports markets and decline in raw material prices.

A good 3Q14 for the beer boys 
For  the  quarter  under  review,  Guinness  Anchor  reported  results  that  were  in  line while Carlsberg trumped expectations. The latter recorded a strong set of  earnings for  3Q14,  on  the  back  of  higher  sales,  particularly from  its  Singapore  unit,  and margins expansion from its ongoing strategic cost management. Better-than-expected earnings by the tobacco playerBAT’s  3Q14  earnings  came  in  above  our  expectations. Although  sales  volume continued to decline, we note that the negative effects were mitigated by higher ASPs from  a  hike  in  cigarette  prices  by  MYR1/pack  on  8  Sep  2014.  The  hike  was  then reversed on 23 Sep 2014 to maintain competitiveness.

Source: RHB