We maintain a NEUTRAL stance on the sector. Retail Group Malaysia (RGM) remains cautiously optimistic, projecting a 3.6% YoY growth for CY24, driven by increased tourism and civil servant salary hikes. However, consumer spending is likely to remain subdued due to the persistently high cost of living and the upcoming fuel subsidy rationalisation. That said, consumer sentiment could improve if Budget 2025 effectively addresses concerns over the subsidy plan. Additionally, the stronger MYR may ease these pressures by reducing fuel price increases and stabilising retail prices. Our sector top picks are F&N (OP; TP: RM38.25), MRDIY (OP; RM2.27) and KAREX (OP; RM1.12). Amid the strong MYR, those that may see more near-term uplift include MRDIY.

Retail sales faltered in 2QCY24, cautious optimism for year-end boost. RGM reported weaker-than-expected retail sales growth of 0.6% YoY in 2QCY24, missing the 1.7% target and a significant drop from the 7.8% growth seen in 1QCY24. The lower 2Q growth was largely due to softer festive sales, bringing the overall 1HCY24 retail growth to 4.6% YoY. Looking ahead, RGM expects retail sales to grow by 3.6% YoY in 3Q and 3.2% YoY in 4Q, while maintaining its full-year growth forecast of 3.6%. This outlook is supported by an expected rise in tourist arrivals from China and India, driven by the new visa-free entry policy. Additionally, the increase in civil servant salaries starting December 1 is likely to boost retail spending during the year-end holiday season. However, RGM remains cautious, as the rising cost of living and the prolonged conflict in the Middle-East may lead consumers to continue being cautious with their spending.

Cautious sentiment persists but… We share RGM's view and anticipate that consumer spending will remain muted throughout the rest of CY24 and potentially into early CY25, as many consumers are bracing for higher costs due to the upcoming fuel subsidy rationalisation. The expected reduction or elimination of fuel subsidies will likely lead to higher fuel prices, which will directly increase daily living costs, particularly for transportation. Additionally, we believe that the EPF Account 3 withdrawal scheme amounting to RM7.8b (as of June 2024) will have a limited effect on retail spending. The remaining funds available for withdrawal from this account are unlikely to significantly boost discretionary spending, especially for larger purchases or high-ticket items.

…could ease following Budget 2025. Despite the current subdued consumer sentiment, there is a possibility that the impact of fuel subsidy may not be as severe as expected. The recent strengthening of the MYR could help mitigate the impact of subsidy cuts, potentially lowering the expected increase in fuel costs and easing consumer concerns. With Budget 2025 to be tabled on 18 October, further details on fuel subsidy rationalisation could be revealed, addressing uncertainties around the timeline and magnitude of the changes. This could allow the financial impact to be eased gradually, and as financial pressures reduce and a perceived rise in purchasing power, consumers may be more inclined to spend on discretionary items, providing a lift to retail spending. We reckon consumer discretionary players like MRDIY, PADINI (MP; RM3.24) and AEON (UP; RM1.21) could stand to benefit from this potential boost in consumer confidence.

Additionally, a stronger MYR could lower the costs of imported raw materials, helping to ease the pressure from recent price increases in key commodities such as coffee and cocoa beans. This would reduce business costs, limiting the need for significant price hikes, contributing to stable retail prices. As a result, the financial burden on consumers would lessen, allowing them to maintain their purchasing power and support continued retail spending. We believe MRDIY is likely to be one of the key beneficiaries of the strengthening MYR, as it sources raw materials primarily from China at lower costs, while its sales (predominantly in MYR) remain unchanged.

Price swings in commodities. Prices of wheat, corn, soybean, cotton have dropped more than 10% YTD and are likely to remain soft due to strong global supply driven by abundant harvests in their major production regions. In contrast, prices of coffee and cocoa have surged 39% and 85%, respectively, on poor crop yields amidst severe weather events in their production areas such as Brazil, Southeast Asia and West Africa. Notably, sugar prices surged 27% in the past month due to concerns that ongoing drought in Brazil may reduce sugar production. Nevertheless, above-average monsoon rains in India and a weaker Brazilian real are expected to normalise prices. Additionally, the doubling of shipping costs as indicated by 100% YTD increase in the Shanghai Shipping index could put pressure on PADINI and MRDIY, both of which depend largely on importing goods from China.

Valuation update: Our earnings forecasts, valuation methodology, target prices, and ratings remain unchanged for the consumer sector portfolio, except for NESTLE (OP; RM114.90), PWROOT (MP; RM1.28) and QL (UP; RM4.20). While we maintain the earnings forecasts and TP for NESTLE and PWROOT, we upgrade NESTLE to OP (from UP) and PWROOT to MP (from UP) following the recent share price correction. Additionally, we adjust our TP for QL to RM4.20 (from RM6.25 previously) following its one-for-two bonus share issuance, while keeping our valuation basis unchanged. With that, we downgrade QL to UP (from MP) due to the recent surge in its share price.

Our TP and recommendation for consumer stocks are summarised in Exhibit 2.

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, (iii) proxy to the recovery of domestic consumption and the return of tourists in Thailand, and (iv) its longterm growth prospects driven by its investment in a sizeable dairy farm in Gemas, Negeri Sembilan.
   
• MRDIY for: (i) its dominant position in Malaysia's home improvement market, (ii) its size that translates to strong bargaining position vs. its suppliers, and economies of scale, (iii) its ample headroom for growth in terms of store count, and (iv) its continued efforts to improve operational efficiency such as the introduction of an automated inventory system.
   
• KAREX for: (i) its leading market position and global reach in the rapidly growing condom industry, projected by industry experts (such as Global Market insights and Extrapolate) 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 - 3 Oct 2024