We upgrade the sector to NEUTRAL (from Underweight), as:

1. The retail subsector, being the bellwether to broad consumer spending,has turned around as it registered positive growth over 4Q15.

2. The sector is currently trading (on average) below its 3-year historical mean P/E of 20.1x.

3. Lifting of the PCAP in July would provide headway for much-needed repricing.

Top Picks: Carlsberg and Guinness Anchor. Spending has bottomed out. We think there may be some headway in consumer spending in 1H16. This is only by virtue of consumer spending and sentiment having bottomed out in 4Q15. The sector and the retail subsector havefinally registered a quarter of positive growth (Figure 1). However, we also think that this translates to the earnings recovery not likely being v-shaped. Rather, we think recovery would be protracted (ie a u-shaped recovery) due to higher operating expenses recorded across the industry.We go window shopping. We took note of prices of consumer goods produced by companies under our coverage and some of their competitors recently, mainly in order to ascertain how average selling prices (ASPs) and product mixesevolve in the lead up to the expiration of the Price Control Anti-Profiteering Act’s (PCAP) on 30 June. Our initial observations include: i) OldTown (OTB MK, NEUTRAL, TP: MYR1.45) conducts heavy discounting for its coffee mixes to drive foot traffic at its lacklustre food and beverage (F&B) outlets. ii) Selective excise duty repricing. It appears only Guinness Anchor’s (Guinness) (GUIN MK, BUY, TP: MYR14.80) beer has been re-priced for theexcise duty hike thus far. Upgrade to NEUTRAL. The lifting of the PCAP restriction from 1 Jul would coincide with the further recovery in spending, and could provide companies with the space to make much-needed price adjustments to offset the increasingoperating expenses. Ultimately, current valuations have priced in the uninspiring earnings growth. On average, companies under our coverage are trading below their 3-year historical average P/E of 20.1x (Figure 4). This underpins our basis to upgrading the consumer sector to NEUTRAL from Underweight.Our Top Picks for the sector include Guinness and Carlsberg (CAB MK, BUY, TP: MYR13.90). The reasonable excise duty hike is likely to have a neutral-topositive impact on the brewers. Aside from that, demand has proved highly resilient for the brewers as well. Our sole SELL call is on AEON, premised on its:i) continued headwinds including higher operating expenses, and ii) long gestation period of up to six years for newly-opened malls, which could likely weigh on its earnings in the near term.

Consumer Spending Has Bottomed Out We think 1H16 may offer some headway in terms of consumer spending. This is only by virtue of spending and sentiment bottoming out in 4Q15. The bellwether for the sector, theretail subsector, has finally registered a quarter of positive growth. However, we believe that this translated to earnings recovery, is unlikely to be v-shaped, but rather u-shaped, implying a protracted recovery - owing to higher operating expenses across the board. This is evidenced by margins on average remaining under pressure (Figure 3) amidst a broad, but flat 4Q15 earnings growth YoY. Going forward, this may be further compounded by: i) hike of between 11%-15% in minimum wage commencing 1 Jul,and ii) increasingly restricted supply of foreign labour. While so, we project for margins to improve by 0.2% largely thanks to the economies of scale derived from improved YoY sales on the back of: i) low 2015 base, and ii) lifting of PCAP from 1 Jul allows greater pricing flexibility.Ultimately, current valuations have been priced in the uninspiring earnings growth going forward with companies under our coverage trading below its 3 -year historical average 20.1x P/E (Figure 4). This, combined with the bottoming out of consumer spending,underpins our basis to upgrade the consumer sector to NEUTRAL (from Underweight).

Eyes on the ground We conducted a price observation of consumer goods produced by companies under our coverage and its competitors. The main objective is to ascertain how ASPs and product mix evolve in the lead up to PCAP’s expiration on 30 June. Apart from that, one-off events such as an excise duty hike on alcohol and its consequent impact on retail prices are observed as well. Our study at hypermarkets includes AEON and Cold Storage at MidValley, would be conducted on every first weekend of each month. Initial observations 1. OldTown bleeds MYR1.50 for every coffee mix sold – At AEON, OldTown’s FMCG white coffee is sold at MYR13.49 but offers a MYR15 meal voucher at its F&B store –(Figure 6). 2. Selective excise duty repricing. It appears only Guinness beer prices at AEON have been re-priced post four days after the implementation of the excise duty on alcohol on 1 Mar. 3. Buy beer at Cold Storage instead. AEON priced beers consistently higher to that sold at Cold Storage.

Recommendation We upgrade the consumer sector to NEUTRAL (from Underweight) on the back of consumer spending and sentiment bottoming out in 4Q15. Apart from that, the lifting of the PCAP restriction from 1 Jul would coincide with the expected further recovery in spending.It could provide companies with the space to make the much-needed price adjustments. Ultimately, while valuations appear cheap, it is a fair reflection of the limited earnings growth for the broad consumer sector in the immediate term.

A reversal of MYR appreciating against USD is likely to see NTPM and Berjaya Food as the two biggest beneficiaries. For a 1% change in the USD/MYR, NTPM and Berjaya Food’s FY17F earnings are positively impacted by 1.5% and 0.7% respectively.

Our Tops Picks for the sector include Guinness and Carlsberg. The reasonable excise duty hike is likely a neutral to positive impact to the brewers (Figure 8). Aside from that, demand has proved highly resilient and the brewers, especially Guinness on its margin expansion on the back of operation efficiency. We like Carlsberg as well for: i) diversified income base through its Singapore sales, contributing ~40% of operating income , and ii) healthier balance sheet with a gearing ratio of 0.16x.

Our SELL call for the sector is AEON. Despite the broad data posting recovery in spending, AEON’s display has been sluggish. We think it is likely to continue to face headwinds including higher operating expenses. A long gestation period of up to six years for newly opened malls would weigh on its earnings in the near term as well.