The resilient consumer

Malaysian Business, Jul 1, 2008 by Zahir Ramley

DESPITE THE ALL-TIME HIGH petrol and diesel prices and a hike in electricity tariffs, consumer stocks remain a top pick for many analysts. Research and rating houses feel that while consumer spending may likely soften, it will remain resilient as the impact of the energy price hike would only be temporary.

Thus, consumer companies in retail, fast-food and healthcare would likely be spared long-term damage while tobacco and brewery firms would be experiencing shrinking demand as consumers curtail their drinking habits or downgrade to value-for-money or exceptionally low-priced cigarettes.

The Government early last month raised the petrol price by nearly 41% to RM2.70 a litre from RM1.92 a litre previously, while diesel now costs 63% or RM1 more to RM2.58 a litre.

Resilient consumption

Consumer spending grew a healthy 11.8% year-on-year in the first quarter of 2008 as subsidised fuel prices continued into the period. But food price inflation has emerged more visible since then.

RAM Rating Services anticipates some softening in the performances of consumer-related companies over the near to medium term, as consumers react and adapt to the new environment.

`Nonetheless, businesses vis-a-vis non-discretionary consumer goods/services (eg food and healthcare) are expected to fare relatively better,' it adds.

The rating agency says while the increase in fuel prices does not come as a surprise, the scale of the adjustment is unprecedented, with the `double whammy' of a hike in electricity tariffs scheduled this month.

`The domino effect on various cost items (eg, heftier transportation charges and overheads) may compel businesses to further raise the selling prices of their products (to protect profits), in turn forcing consumers to become increasingly more discerning in their purchases,' RAM notes.

Even before the latest round of fuel hikes, it says, the prices of some commodity-based essential goods including staples such as rice and bread had already risen as producers responded to the rising costs of raw materials.

RHB Research Institute says though some slowdown in growth is inevitable, consumer spending should be relatively resilient. This is due to the recent pay rise for civil servants, additional disposable income from the monthly withdrawals of the Employees Provident Fund for payment of housing loans, and firm commodity prices that have boosted rural household income.

RHB Research says the consumer sector will remain a preferred sector for investors who pursue a defensive investment strategy, given the decent earnings visibility, strong balance sheets and hefty dividend payouts.

`In fact, investors have focused more attention on the consumer sector over the past few months as a counter-measure to the external uncertainties brought about by the United States subprime mortgage crisis,' it says.

Energy hike impact

AmResearch says the fuel hikes will lead to higher transportation costs and raw material prices. This will cause higher selling prices and potentially lower margins for goods and services. In addition, the resultant inflationary pressure will lower the disposable incomes of consumers.

The research house says the impact on sales and earnings of consumer companies would depend on their ability to pass on this higher cost of production and the impact of lower disposable incomes going forward.

AmResearch points out that in the last round of fuel increase in 2006, Kian Joo Can Factory Bhd and Fraser & Neave Holdings Bhd recorded flat sales. In Kian Joo's case, failure to pass on the higher raw material prices (and incidentally losing a key customer) led to a 44% fall in earnings.

`Coupled with higher taxes, cigarette consumption also fell 5% in 2006. Sales at Aeon Co (M) Bhd and KFC Holdings Bhd were flat too,' it adds.

RHB Research says there will be minimal impact on retailers and fast- food chain stores as their products are mainly small-ticket items. For tobacco and brewery companies, it says regulatory constraints and intensifying competition will limit their earnings growth, but strong free cash flow would ensure that dividend payments are at least sustained.

`The impact of the increase in fuel prices on the healthcare sub- sector is negligible as the demand for quality healthcare services is rising in tandem with increasing uptake of insurance products,' it says.

Valuation and recommendation

RHB Research says while most of the bigger cap stocks such as Malayan Banking Bhd, Tenaga Nasional Bhd, Malaysian Airline System Bhd and IOI Properties Bhd had missed RHB's forecast or market consensus in their recent results, most of the consumer stocks delivered the performance expected of them.

`Investors' interest will thus likely remain on defensive high yield stocks for capital preservation purposes,' it adds.

RHB Research maintains its `neutral' stance on the consumer sector and continues to favour the retail and food-related stocks within its coverage. They include Parkson Holdings Bhd for exposure to the China retail market and KFC for its aggressive network expansion and growing market share.