We remain NEUTRAL on the consumer sector, as we are positive on the food  and  beverage  (F&B)  and  brewery  sub-sectors  while  remaining cautious on retail and tobacco. We believe consumer spending will  still grow  albeit  at a more moderate pace  this year,  given the roll-out of the GST.  We  expect  consumer  spending  to  normalise  within  six  to  nine months. Berjaya Food remains our Top Pick.

Consumers remain cautious.  The consumer sentiments index (CSI) in 4Q14 fell by 15pts QoQ to 83pts due to  an anticipation of higher cost  of living  resulting  from  the  implementation  of  Goods  and  Services  Tax (GST). However, despite the softening sentiment, we continue to believe that  demand  for  food  and  necessities  will  remain  resilient,  given  theirinelastic  nature.  As  such,  we  foresee  companies  that  are  selling  basic items to be less impacted by the shift in consumption trends. While we expect  consumers  to  adopt  a  wait-and-see  approach,  we  think  therecovery  of  consumer  discretionary  spending  could  take  a  little  longer due to more cautious spending by consumers. In view of this, we foresee retailers  to  continue  incurring  more  promotional  expenses  to  stimulate demand, hence impacting their margin.

Consumption trends to normalise.  We expect consumption trends togradually  normalise  over  the  course  of  2015,  with  RHB  economists projecting  consumption spending to grow at a slower 5.2% YoY  (2014: 7.1%)  pace  this  year.  We  believe  that  consumption  should  return  to normal levels within six to nine months, supported by stable employment conditions  and  sustained  wage  growth.  Furthermore,  the  higher 1Malaysia  People’s  Aid  (BR1M)  to  lower  income  households  and  the reduced  income  tax  burden  should  help  to  offset  the  rise  in  living expenses due to GST.

Maintain  NEUTRAL.  Overall,  we  remain  NEUTRAL  on  the  consumer sector  as  we  believe  consumption  will  grow  at  slower  pace  post-GST after advance spending in 1Q15. Sub-sector wise, we like F&B players,given the more resilient demand for F&B products. We also upgrade  the brewery  sub-sector  to  overweight  due  to  its  decent  yield  and  volume growth.  However,  we  remain  cautious  on  the  retail  sub-sector  as  we expect  slower  spending  on discretionary items  post-GST. For  tobacco, we  believe  growth  prospects  are  pedestrian,  given  moderating  sales volume.

Strategy

All eyes on GST
We  foresee  the  implementation  of  GST  from  1  Apr  to  result  in  a  more  moderate increase in consumer spending in 2015, with  RHB economists projecting consumer spending to grow at a slower pace of 5.2% in 2015 (from +7.1%  in 2014). However, we  expect spending trends to normalise  within six to nine  months  after  consumers become more familiar with the new tax. Based on past experience in other  countries,consumption  typically  spikes  ahead  of  the  implementation  of  the  GST  and  then declines  in  the  subsequent  months.  However,  a  quick  recovery  in  retail  sales  hasbeen  observed  within  a  few  months  after  the  GST  implementation.  Australia introduced GST in Jul 2000 at a rate of 10%. The sharp increase in retail sales in the month  preceding  GST  was  followed  by  a  reversal  in  the  month  of  introduction. However, sales  normalised fairly quickly after the introduction,  as Australia  recorded only one month of negative retail sales growth.

We believe that Malaysia will likely  experience a similar  general  pattern. We foresee consumption  spending  in  Malaysia  to  be  well  supported  by  stable  employment conditions  and  sustained  wage  growth.  The  unemployment  rate  remained  low  at 3.0% in Dec 2014. We also view the higher amount of cash assistance via BR1M and the  reduced  income  tax  burden  by  1-3  ppts  to  help  mitigate  the  moderation  inconsumer spending. Based  on  the  Treasury’s assessment of the GST incidence for households  with  different  annual  income  levels,  low-  and  middle-income  earners (MYR4,000 and below) will incur an additional tax expenditure of only MYR140-700 per  annum.  Hence,  the  higher  BR1M  assistance  (MYR950  for  households  with  a monthly  income  of  below  MYR3,000,  and  MYR750  for  households  with  a  monthly income  of  MYR3,000-4,000)  is  deemed  sufficient  to  offset  the  higher  GST expenditure to be incurred by the targeted income group. Meanwhile, the reduction in income tax rates will help to reduce the effects of GST on the higher income group. F&B companies to remain resilient

We continue to believe that companies selling basic items will be less affected by the shift  in  consumption  trends  due  to  the  inelasticity  of  demand  for  food  and  basicnecessities.  In  view  of  this,  we  expect  sales  for  such  products  to  remain  stable.

However, we are NEUTRAL on QL Resources (QLG MK, TP: MYR3.90) and Nestle Malaysia  (NESZ  MK,  TP:  MYR68.60)  given  the  stocks’  rich  valuations.  On  other hand, we remain upbeat on the growth prospects for 7-Eleven Malaysia (SEM MK, BUY, TP: MYR1.85) and Berjaya Food (BFD MK, BUY, TP: MYR3.90), as we believe both  companies’  aggressive  store  expansion  plans  could  drive  their  revenue  and earnings  moving  forward.  Not  least,  Berjaya  Food’s  Starbucks  Coffee  is  less susceptible  to  weaker  consumer  spending  patterns  due  to  its  upper-middle  class customer base, strong customer loyalty for its products, and its premium branding. Berjaya Food is our Top Pick within the consumer sector.

Slower discretionary spending to impact retail sub-segment
The  decline  of  Malaysian  Institute  of  Economic  Research’s  (MIER)  consumer sentiment  index  to  83  points  at  end-4Q14  echoes  our  cautious  stand  on  the challenging outlook for the retail sub-segment in   2015. Our concern is further backed by  the  second  downward  revision  of  retail  growth  estimates  in  2015  to  4.9%  from 5.5% by Retail Group Malaysia.

Due to this fact, we believe that consumers, particularly low-  to  mid-income earners, will  remain  prudent  in  their  spending  especially  on  discretionary  items.  We  also expect a potential slowdown in sales post-GST,  due to advance spending in  1Q15, as  consumers  adapt  to  the  new  tax.  In  view  of  this,  we  foresee  the  retailers  to continue incurring higher marketing  expenses and offering discounts to stimulate the market  during this transition period. Hence, margins for retailers like Padini Holdings (PAD MK, SELL, TP:  MYR1.30)  and AEON (AEON MK, NEUTRAL, TP: MYR3.09) could  face  some  pressure  moving  forward.  We  also  expect  conditions  to  remain challenging for Parkson  (PKS MK, TP: MYR1.96) given its earnings uncertainty and negative structural outlook in its core markets (China, Malaysia and Vietnam).

Sin stocks as defensive plays
Brewers  have  achieved  some  success  in  their  strategic  cost  management  efforts which  have  yielded  improvements  in  4Q14  earnings.  The  Government  has  also heightened  enforcement  efforts  against  contraband  beer.  W e  believe  investors should take a look at both Guinness Anchor  (GUIN MK, BUY, TP: MYR14.10) and Carlsberg  (CAB  MK,  BUY,  TP:  MYR14.20)  due  to  their  decent  volume  growth, resilient  earnings  from  the  defensive  nature  of  the  business  and  decent  dividend yields.  However, we note that there are downside risks to our earnings projection for brewers  as  post-GST,  consumer  spending  growth may  be  softer  than  expected  or may take longer to recover.

Meanwhile, we believe the tobacco players will continue to see declines  in their legal sales volume, largely due to a steep  cumulative  price hike of MYR1.50/pack in Nov 2014  (due  to  an  increase  in  excise  duty)  and  MYR0.50/pack  in  Apr  2015  (due  to GST). Although we understand that the decline in sales volume will be mitigated by the  hike in the  cigarette  prices  in  order to  avoid revenue  loss es,  we  think  that this strategy  is  not  sustainable  in  the  long  term,  even  for  a  fairly  inelastic  item  like cigarettes. We  see  some  downside  risks in  British  American  Tobacco  (ROTH  MK, NEUTRAL,  TP:  MYR63.40),  given  that  the  tobacco  industry  is  a  mature  one  with limited growth opportunities.

Maintain NEUTRAL
We  remain  NEUTRAL  on  the  consumer  sector  overall,  as we  are  positive  on  F&B and breweries sub-sectors  but  cautious on retail and tobacco. We like F&B players, especially  Berjaya  Food  and  7-Eleven  Malaysia,  for  their  earnings  resilience  and growth potential. We also like brewery stocks due to their decent volume growth and yields.  However,  we  maintain  our  cautious  view  on  retail  players  due  to  prudent spending on discretionary items. Nonetheless, we believe that consumer stocks will continue  to  garner  interest  from  investors  seeking  defensive  qualities  and  stabledividend  yields,  despite  their  stretched  valuations.  We  advocate  investors  to accumulate fundamentally-robust consumer stocks on price weakness.

4Q14 Results Snapshot
Most F&B players within expectations
During  the  quarter  under  review,  most  of  the  F&B  counters  under  our  coverage continued to deliver results that were in line with our expectations.  Berjaya Food  and 7-Eleven  Malaysia  continue  to  report  growth  in  their  earnings,  in  line  with  their aggressive  expansion  plans.  Although  OldTown’s  (OTB  MK,  NEUTRAL,  TP: MYR1.80)  results  met our estimates,  we  downgraded our recommendation  on it  as we expect growth in both its core segments to be subdued due to stiff competition. We  also  downgraded  QL  Resources  as  we  believe  much  of  its  growth  prospects have  been  priced  in.  Nevertheless,  only  Nestle  recorded  slightly  weaker  results during the quarter, due to lower exports and higher operating expenses.

Retailers continue to face headwinds
Padini’s  results  missed  expectations  again,  as  its  earnings  were  further  dragged down by higher marketing expenses arising from its ongoing aggressive promotional and  discount  activities.  We  downgraded  the  stock  to  SELL  from  Neutral,  as  we
lowered our earnings forecasts to reflect our cautious stance on the challenging retail sector in 2015. AEON’s retail business has also  seen some margin erosion,  resulting from higher advertising and promotional expenses.  However,  its FY14 results were supported by growth from its property management division. Meanwhile, we maintain our  SELL  recommendation  on  Parkson  as  we  remain  pessimistic  on  its  earnings growth  outlook.  Its  operating  trends  remained  weak,  as  same-store  sales  growth stayed  in  the  negative territory for all of its major markets, except for Indonesia. On other hand, we maintain NEUTRAL on NTPM (NTPM  MK, TP: MYR0.67) due to its in-line  results.  We  foresee  the  company  to  continue  adjusting  to  the  rising  raw material prices and stiff competition environment,  with its ongoing cost containment exercises likely to improve its financial position in  the coming years.

Cheer for the beer boys
Both brewers under our coverage, Guinness Anchor and Carlsberg recorded a strong finish  to 2014.  Strong  sets  of  earnings  from  both  companies  were  backed  by  their decent volume growth and ongoing strategic cost management.

Strong finish in 2014 for BAT thanks to the price hike
BAT’s FY14 earnings were within our expectations. Despite the continued decline in its  cigarette  sales  volume,  the  company  reported  higher  earnings  on  the  back  of higher  revenue  (from  price  hikes  in  Sep  2013  and  Nov  2014)  and  productivity
savings.  However,  we  maintain  our  SELL  recommendation  as  valuations  are  not compelling.

Source: RHB