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Malaysia's consumer sector seen slowing [12-03-2013]  
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MOST fast-moving consumer goods (FMCGs) which we monitor experienced moderately weak revenue and earnings growth in the fourth quarter of 2012.

The year 2013 could see further slowdown, especially for the consumer discretionary space with the absence of pre-election handouts, particularly in the second half of 2013. We maintain “market weight” its defensive stance, although we foresee likely underperformance for some of 2012's high-flying small caps that are being impacted by the current slowdown.

Although the sector no longer offers exciting valuations, with dividend yields being compressed to less than 5% from historically more than 6%, tobacco companies can still enhance their yields via capital management, given their sub-optimal capital structure. Other companies that may benefit from mergers and acquisitions (M&As) include Carlsberg Brewery Malaysia Bhd.

However, some smaller cap FMCGs could be vulnerable to de-rating, as their valuations have jumped to the high-teen price-to-earnings, with their stock prices surging 2% to 100% in 2012 and has continued on the uptrend year-to-date but earnings have started to disappoint. Meanwhile, minimum wages will impact food and beverage (F&B) retailers.

QL Resources Bhd remains our top pick (Buy, Target Price: RM3.67) as we expect its second half 2013 earnings to accelerate as it begins to reap harvest from its Indonesian investments.

A review of the fourth quarter 2012 results season shows that the overall consumer sector has cooled (even taking into account delayed shipment timing for the Chinese New Year period) and is showing general signs of a slowdown, based on various corporate guidances.

Revenue growth in the quarter for both the consumer staples segment (which includes tobacco, brewery and F&B) and consumer discretionary segment (retail and the numbers forecast operators) slowed versus its past three quarters saved for the tobacco sub segment which continued to see recovery in the total industry volume.

Margins have also compressed by two to four percentage points as 2012, particularly for the consumer staple segment, was impacted by higher cost of raw materials and increase in advertising and promotion expenses.

Overall, we expect the FMCG companies in our coverage to feature slowing earnings growth (3% to 15% versus 1% to 13% in 2012) and revenue growth (7% to 10% versus 8% to 12% in 2012).

While we note that the Malaysian Institute of Economic Research's consumer sentiment index remains firm, we expect domestic consumption to be dampened particularly in the second half of 2013 with the absence of the ongoing pre-election handouts and the likely withdrawals of various food and energy subsidies.

Despite the slowing volume growth, we believe that the consumer staple companies should be able to largely defend their margins in 2013 as soft commodity prices have trended down in first half of 2013. Soft commodity prices have come off 2012's peak by 7% to 12%. However, the margin trends in the consumer discretionary segment need to be monitored, such as consumption downtrading which impacted Padini Holdings Bhd's margins, and the implementation of minimum salaries which could substantially raise costs of the fast-food industry such as Ipoh Old Town.

Consumer discretionary segment growth could see further contraction as we expect consumers to cut down on discretionary spending as the government handouts have waned. This segment registered both revenue and profit before tax contraction in the traditionally strong fourth quarter.

The retail segment has been the worst hit as consumers have reduced discretionary spending. We understand that both Padini reported a negative slower same-store sales (SSS) growth while Parkson Holdings Bhd registered a much slower SSS growth of 2.8% in fourth quarter of 2012 (versus the targeted range of 7% to 9%). Meanwhile, the number forecasting operators also saw an unusual 3.1% y-o-y contraction in revenue.

FMCG stocks under our coverage will be able to sustain their dividends, such as JT International Bhd (5%) and Carlsberg (5.2%). In addition, we think British American Tobacco (M) Bhd could be a potential capital management candidate as it has a net cash per share of 27.3 sen, has significantly reduced its net debt from over RM650mil to the current RM420mil level (BAT could also easily gear up again to distribute dividends), and strong operating cashflows of RM750mil to RM800mil annually and low capital expenditure requirement.

Risks include declining consumer demand and rising raw material costs.

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