CONSUMER SECTOR - What’s next?

The Consumer sector has been in the limelight since last year, and many consumer stocks have been rerated drastically in the past one year on the back of two main reasons: one being the defensiveness of these stocks as well as their decent dividend yields and the other due to their strong news flows on the Merger & Acquisition (M&A) front. However, due to their current relatively high PER valuations and dividend yield compressions, we believe consumer stocks could take a breather in the near term. That said, with the risks of uncertainties on the global economic conditions and domestic General Election still remaining, we reckon that consumer stocks will still act as safe havens for investors. Hence, while we are more cautious on the sector due to its rich valuation, we are not entirely bearish on consumer stocks. In addition, due to the generally lower liquidity of the highly sought after consumer stocks, we reckon that it would be difficult to accumulate sizable positions again after any disposals by investors. As such, we prefer to maintain our NEUTRAL stance and maintain most of our MARKET PERFORM calls -AEON (TP: RM10.70), BAT (TP: RM58.70), DLady (TP: RM44.60), Nestle (TP: RM67.50), Oldtown (TP: RM2.26) and Parkson (TP: RM4.86) – at this juncture. In fact, we will not hesitate to upgrade their ratings if and when we see any meaningful pullbacks in these stocks. Meanwhile, we are maintaining our OUTPERFORM call on Amway (M) (TP: RM11.68), Eng Kah (TP: RM4.02), GW Plastics (TP: RM0.92), Kian Joo (TP: RM3.00) and QL Resources (TP: RM3.68).

Sustaining or fading off? Consumer stocks are defensive with their attractions typically being their consistent performances to date and their high dividend payouts such as British American Tobacco (BAT), Carlsberg, Dutch Lady (DLady), Guinness Anchor and Nestle. As of 7 September 2012, the capital appreciation of these stocks in the past one year has ranged from 28% to 122%. This has caused their dividend yields (which have an inverse relationship to the PER) to compress significantly in recent months, especially that of BAT, DLady and Nestle. These stocks have been rerated to their all-time high at +3 standard deviation (SD) of their respective 5-year forward PER bands. Their trailing 12 months PER are also higher than +2SD of their 10-year median historical PER. Given such high valuations, their dividend yields have compressed further. For instance, Nestle’s yield has dropped to 3.0% or below compared with about 4.0% from a year ago.

Not spared from General Election uncertainties? Despite the defensive nature of consumer stocks, we reckon that the rising trend in consumer stock prices could take a breather in the coming months due to the upcoming election, which is expected to come before April 2013. This is because we observe that consumer stock prices historically increased higher in the 6 months before the parliament dissolution date and were pretty flattish to negative after the announcement of the Election Day, as well as after it. As such, we have reasons to believe that history will repeat itself and consumer stocks will be facing a minor correction in the coming months.

Small cap consumer stocks to shine still? However, we reckon that the smaller capitalization consumer stocks will still have potential upsides as the current PER (15.9x) of the overall Bursa Malaysia Consumer Product Index is around the +1 SD above the 10-year median historical PER

level of 15.7x, and its dividend yield is still at 3.4% (which is still higher than the big cap consumer stocks, and hence implying that it can compress further to -1 SD at 2.8%).

M&A –A major rerating catalyst. In the current competitive market, companies are not only concerned about growing their profits but also their market shares too. Besides growing organically, M&A would be another way out. Of course, there are various reasons out there that would prompt such M&A activities. These could be the added attraction to push the companies’ PER valuation higher. In past M&A and privatisation deals, consumer F&B companies were valued at 15x PER and as high as 25x PER. However, consumer retail companies were traded at a lower range (9x-15x PER) as there were less M&A activities seen in this sub-segment. Thus, M&A activities could rerate the sector in due course. For instance, we had recently revised Kian Joo’s PER valuation higher from 9.5x to 11.4x as we reckon that there would be positive synergy between Kian Joo and Can-one after the recent change in the management team of the former.

Source: Kenanga