The sector’s earnings delivery (against our expectations) in the recently-concluded 1QCY24 results season held up despite various challenges. We remain cautious over its near-term outlook given subdued consumer spending on sustained elevated inflation and consumers’ anxiety over the impending RON95 fuel subsidy rationalisation. On a brighter note, a 13% salary increase for civil servants from Dec 2024 should at least partially restore spending power of consumers. We see a limited boost to consumer spending from the new EPF Account 3 withdrawal scheme. We maintain NEUTRAL on the sector. Our sector top pick is F&N (OP, TP: RM38.25).

A decent 1QCY24 report card. The sector’s earnings delivery (against our expectations) in the recently-concluded 1QCY24 results season held up despite various challenges, with 38%/50%/12% coming in above/within/below our forecasts, which were identical to the preceding quarter. F&N (OP, TP: RM38.25), AEON (MP, TP: RM1.21) and KAREX’s (OP, TP: RM1.10)’s results came in above our expectations due to a favourable product mix, margin expansion (on the back of lower input costs) and strongerthan-expected festive sales. Converserly, PWROOT (UP, TP: RM1.40) fell short of expectations due to softer sales in the domestic and the Middel Eastern markets and its inability to fully pass on higher costs.

Seasonally weak 2Q. Looking ahead, we anticipate a seasonally soft 2QCY24, especially in the retail department store segment, due to the absence of key festivals post Hari Raya (in early April) while persistent inflationary pressure will continue to weigh down on consumer spending. Adding pressure to inflation, will be the rationalisation of diesel fuel subsidy from 10 Jun 2024 and RON95 fuel subsidy in 2HCY24. Consumer discretionary players like PADINI (MP, TP: RM3.63), and AEON will continue to face challenging times and may need to sacrifice margins to hold up sales. On a brighter note, the 13% salary increase for civil servants effective Dec 2024 should partially restore consumer spending power.

Not much boost from EPF Accounts 3 withdrawal. Recent news reported that the EPF has approved 3.04m applications to withdraw money from Account Flexible (or Account 3) as of 22 May, amounting to RM5.52b since the option became available on 12 May. It has also received 2.86m applications during the period to transfer funds from Account 2 to Account 3, involving RM8.78b. These suggested that a total of 5.9m applications (or 36.7%) over the total 16.07m (as of end CY23) total EPF members have applied, involving RM14.3b. Although EPF members can still opt to transfer one-third of their savings from Account 2 to Account 3 until August 31, we believe the number of applications is likely to taper off, given the latest application number is closed to an average 5.9m applications received over the past four withdrawal schemes. Due to the smaller withdrawal amounts involved, the boost to consumer spending is expected to be milder than previous schemes.

Mixed commodity price trends. 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 136% and 17%, respectively, on poor crop yields amidst exteme weather conditions in their production areas in Southeast Asia and West Africa. while shipping cost has stayed elevated with no sign of the Red Sea Crisis abating.

Preference for consumer staples player. We still favour the consumer staples players rather than the consumer discretionary names with F&N remaining our top pick for the sector. Note that, our valuation basis of 22x for consumer staples companies is aligned with the sector's average historical forward PER. Meanwhile, our valuation for department store and apparel companies remains at 13.5x, reflecting a 10% discount on the sector's average historical forward PER of 15x to reflect the eroded spending power of their target customers, i.e. the M40 group. For PWROOT, we maintain our valuation basis at 15x, at a discount to the average historical forward PER of 22x for the food and beverage segment to reflect the company’s less extensive product range vs. its peers. KAREX, meanwhile, remains our preferred small-cap pick due to its dominant market position in the global condom industry and strong earnings growth prospects. We have downgraded MRDIY (TP: RM1.97) stock rating from OUTPERFORM to MARKET PERFORM, following the recent share price rally.

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, and (iii) proxy to the recovery of domestic consumption and the return of tourists in Thailand.

• KAREX 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 - 18 Jun 2024