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This article first appeared in The Edge Financial Daily on April 3, 2019

Consumer sector
Downgrade to underweight.
Retail Group Malaysia (RGM) reported a sluggish 3.9% growth in retail sales for 2018, below its expectations of 4.1%. The disappointing performance was dragged by the worst-performing supermarket and hypermarket sales which declined 5% year-on-year (y-o-y) for the year.

It appears that disposable spending has been scaled back, weighed down by rising costs of living and tepid growth in take-home pay. This was offset by pharmacy and personal care sales (+10.2% y-o-y).

Going forward, RGM expects an accelerating retail growth of 4.5% y-o-y in 2019, attributed to an increase in second half of 2019 economic activities; and a 7.6% y-o-y decline in supermarket and hypermarket sales in 2019 due to lacklustre two months of 2019 sales.

This could mean a challenging first quarter ended March 31, 2019 for AEON Co Bhd.

We visited the production facilities of two listed export-oriented consumer companies — Power Root Bhd and Guan Chong Bhd — in Johor. Among the catalysts for Guan Chong lies in its 25% additional capacity in cocoa processing, with output sold out till end-2019. Meanwhile, Power Root aims for a more commercially sustainable strategy to focus on its bottom-line growth instead of market share accretion. Both companies are trading at valuations below peers and their historical price-earnings (PE) mean.

Stocks across the sector are trading well above their historical PE mean.

Despite healthy broad retail sales outlook, outlook is dampened by the lethargic supermarket segment and a spike in dairy milk prices.

The reward-to-risk trade-off is especially uncompelling amid these headwinds. Apart from that, our top pick Heineken Malaysia Bhd saw its shares rally 20% in three months which prompts us to downgrade the stock to “hold” from “buy”.

Meanwhile, we have “sell” on Nestle (M) Bhd and QL Resources Bhd for their stretched valuations at 51.2 times and 41.8 times 2019 PE respectively, which are well above their five-year historical mean PE.

Meanwhile, British American Tobacco (M) Bhd is plagued by stiffening competition arising from alternative tobacco products and significant regulatory risk.

Commodities prices have been stable with palm oil, sugar, cocoa and robusta trading at -10% to +10% from 2018 levels.

Our concern lies with dairy prices that have risen more than 20% y-o-y. Weather conditions at some of the world’s largest milk-producing regions resulting in slowing supply against strengthening demand driven by Asia is expected to sustain current prices.

Fraser & Neave Holdings Bhd (F&N) and Dutch Lady Milk Industries Bhd will be most impacted. By our estimates, every 10% rise in the cost of dairy powder above our assumption of US$2,004 (RM8,176) per tonne would cut F&N’s FY20 earnings per share by 20%. — UOB Kay Hian, April 2

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