We downgrade the consumer sector to UNDERWEIGHT from Neutral as e advance into 4Q15, amidst: i) consumers remaining cautious,underpinned by macroeconomic headwinds, and ii) USD-led costs amidst softer commodity prices that may crimp margins. We cannot rule out an excise duty hike for the brewers, while some stocks are attractive from a yield perspective. Our top BUY is Berjaya Food.

2Q15 earnings were below expectations, while revenue performance was distorted by the goods and services tax (GST). A review of 2Q15 consumer sector results reveal earnings were below expectations post GST implementation, especially for the retail and food and beverage (F&B) segments. Meanwhile, that of the consumer staples segment and brewers were in line. 2Q15 revenue growth for the consumer segment at large slowed vis-à-vis the recent past quarters, largely due to direct and indirect consequences of the GST implementation.

Consumers remain cautious. The recovery in consumer spendingcould be more protracted than what was observed in previous instances(typically 6-9 months). The prolonged recovery is due to: i) the impact from lower oil prices on oil & gas investments, ii) lower government spending, and iii) domestic political uncertainties. All factors may likely constrain the growth in domestic demand, which would translate to a weaker economic recovery in 2H15, and iv) elevated household debt being at unprecedented levels, ie 85% of GDP as of end-2014.

UNDERWEIGHT. We downgrade the consumer sector to UNDERWEIGHT from Neutral, due to i) consumers remaining cautious over spending, and ii) USD-led higher input costs that may ultimately see companies risk continued margin compression or depressed sales. We cannot rule out a possible sin tax hike for the brewers in the upcoming 2016 Budget due to be tabled on 23 Oct 2015. We also highlight a yield angle for some stocks such as brewers Carlsberg (CAB MK, NEUTRAL, TP: MYR11.90) and Guinness Anchor (GUIN MK, NEUTRAL, TP: MYR14.20). We like our top BUY, Berjaya Food (BFD MK, TP: MYR3.00) for its more resilient customer base, robust expansion plan, and a venture into fast-moving consumer goods (FCMG). Our SELLS recommendations are underpinned by the aforementioned deteriorating factors, and compounded by company-specific challenges. These are: OldTown (OTB MK, TP: MYR1.16), British American Tobacco (BAT) (ROTH MK, TP: MYR54.90) and AEON (AEON MK, TP: MYR2.50).

2Q15 results below expectations A review of the 2Q15 consumer sector results reveal earnings were below expectations post GST implementation, especially for the retail segment and food and beverage (F&B) segments. Meanwhile, the performance of the consumer staples segment and brewers fell in line with expectations. 2Q15 revenue growth for the consumer segment at large has slowed vis-à-vis recent past quarters, largely due to:i) front-loading of purchases in the preceding quarter (1Q15) – most notably in the retail segment, ii) dampened consumer sentiment post GST implementation, and iii) GST treatment resulted in lower sales value, either through 6% lower sales value or 3-4% lower sales value through reduced cost. The brewers remain the exception to the other sub-segments, supported by more resilient demand.

Retailers face headwinds The retailers largely disappointed, but not primarily due to weak consumer sentime nt post-GST implementation – aside from AEON which reported a sales decline of 7.8% YoY, which weighed down its overall earnings (-67% YoY). Beyond its headline earnings, its retail segment recorded a loss of MYR18.3m while its EBIT margin plunged to 3.2% (2Q14:8.4%). While its property segment was the company’s saving grace, AEON’s retail segment reflects the heartbeat of Malaysia’s retail segment due to its appeal to the middle-to-low income segment. Its results pointed true to the Consumer Sentiment Index (CSI) in 2Q15 falling to 71.7pts, a 6-year low. Meanwhile, 7-Eleven Malaysia’s (SEM MK, NEUTRAL, TP: MYR1.36) GST-adjusted same-storesales growth (SSSG) of -1.5% (unadjusted: -7.3%) appear commendable given the circumstances. However, an unexpected margin compression compelled us to downgrade the stock to NEUTRAL (from Buy). Padini (PAD MK, NEUTRAL, TP: MYR1.47) surprised with better-than-expected earnings (+33.1% YoY), with new store openings, most notably its value-for-money stores that supplemented earnings.

Most F&B players fall below expectations The food & beverage (F&B) sub-sector disappointed. OldTown’s revenue from its fast-moving consumer goods (FMCG) division grew +10.3% YoY while its F&B arm dragged total revenue growth to -6.5% YoY, possibly impacted by down-trading, stiff competition and generally weaker consumer spending. This resulted in earnings falling short of expectations. Our top BUY for the sector, Berjaya Food, experienced deteriorating sales, too, with Starbucks’ SSSG declining 7% as rising operating costsweighed down on earnings as well. However, the prospects of a recovery look promising on the back of its higher-end customer base and aggressive store opening schedule. While independent of consumer sentiment, QL Resources (QLG MK, Neutral, TP: MYR3.64) faced a challenging business environment due to rising feedstock prices (from the strengthening of the USD) and weak CPO prices that impacted its poultry and palm oil divisions. Nestle (NESZ MK, Neutral, TP: MYR68.60) was the exception, as the inelasticity of its consumer demand proved a boon as earnings fell in line.

Consumer staples stapled to expectations MSM Malaysia (MSM MK, BUY, TP: MYR5.90) managed to surprise, albeit withflattish 1H15 earnings growth (0.3% YoY) on the back of a margin expansion as raw sugar prices remain low due to an oversupply in key markets. On the other hand, NTPM (NTPM MK, NEUTRAL, TP: MYR0.75) continues to remain resilient as BAT experienced flattish volume growth despite: i) purchases being front-loaded in 1Q15 in anticipation of the GST implementation, and ii) the 1 Apr price hike of MYR0.30 negatively impacting its competitive position. Net profit margins of the consumer staple players remained largely unaffected.

Source: RHB Research - 29 Sep 2015