Sector poised for an upcycle upon reopening
? We turn more positive on the outlook for consumer sector, driven by i) pent up demand, ii) selling price hikes, and iii) greater economies of scale.
? The surge in input costs should be well-mitigated by counter efforts, in our view, setting the path for margin expansion beyond the next two quarters.
? Hence, we upgrade the sector from Neutral to Overweight. Our sector top picks are Berjaya Food, Bonia, and QL Resources.
Upgrading the consumer sector to Overweight; expect better times
In our view, earnings for consumer stocks likely bottomed in 4QCY21, as pent-up demand from the economic reopening should drive stronger topline growth (via price hikes and higher sales volume), which could further expand core net profit (CNP) margin as we factor in a 150-190bp increase on average for FY22-23F. This should drive sector core EPS growth of 13.8% yoy/15.5% yoy in FY22/23F. This is underpinned by higher economies of scale, selling price increases to more than offset rising input costs, and leaner operating models. Also, we believe that consumer companies under our coverage have higher pricing power due to strong brand equity and target customers in higher-income bracket. Consumer items (staples and food and beverages [F&B]) are daily necessities as well.
To benefit from pickup in economy and strong pent-up demand
With higher vaccination rates and easing of lockdown measures in Malaysia since 11 Oct 2021 where interstate travel is allowed, we believe that consumer staple stocks should benefit from a pickup in demand, mainly from the hotel, restaurants and café (HORECA) segment. Consumer discretionary stocks stand to benefit from higher consumer footfall and increase in consumer spending too. Google Mobility data corroborated that movement trends have recovered close to or exceeded the pre-pandemic level, alongside an improving macroeconomic outlook and various stimulus (i.e. larger cash-handouts) in Budget 22. We expect easing of lockdown measures to allow consumer companies to beef up sales/production which should result in higher revenue and greater economies of scale.
Expecting margin expansion ahead despite rising input costs
In our view, current rise in input costs should be well-mitigated and not weigh down on margins beyond 2QCY22F. This is the result of ongoing initiatives by consumer companies such as: i) gradual product price hikes (average 10-15% rise), ii) greater economies of scale, and iii) cost-saving initiatives (i.e. reducing overheads, more effective marketing costs and automation). In addition, our proprietary analysis indicates that rising input costs do not directly translate into erosion of operating margins (Figures 38-45). Meanwhile, we are of the view that raw material prices should taper off from 2H22F as output normalises
on higher production volume and easing of supply chain disruptions. This would augur well for consumer stocks, resulting in margin expansion.
Valuations have turned appealing on stronger earnings prospects
The overall consumer sector’s valuation is currently trading at 30.7x 1-year forward P/E, below its 10-year mean of 31.3x. We opine that the overall consumer sector should trade higher, at least +1 s.d. above 10-year mean (40.9x), given the expected stronger CNPCNP growth 2022F (+13.8% yoy) as compared to pre-Covid period of 2018 (+9.7% yoy) and 2019 (-2.2% yoy). We think the staples sub-sector should continue to trade at a premium to discretionary, premised on i) scarcity premium of staple stocks, ii) resilient demand, and iii) strong brand equity. We also expect valuations of the discretionary sector to rise, anchored by higher growth rate and as beneficiary of higher retail spending.
Sector top picks are Berjaya Food, Bonia and QL Resources
We upgrade the consumer sector from Neutral to Overweight, supported by better earnings prospects and more appealing valuations. Our top picks in the sector are Berjaya Food (defensive play), Bonia (strong turnaround play) and QL (value play). Re-rating catalysts include stronger sales and lower input costs. Key downside risks: higher-than-expected rise in input costs and rapid resurgence of Covid-19 cases affecting consumer sentiment.