Navigating Singapore ~ Consumer Sector - CIMB Research 2016-12-05: Overweight

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Singapore Strategy Consumer Sector

Navigating Singapore ~ Consumer Sector - Overweight

Trend #1: earnings growth drives share price 

• Consumer companies typically enjoy steady sales growth, but amid the weak global environment and macro uncertainty, we are seeing sales falter. Four out of the 7 consumer companies under our coverage registered negative sales growth over 9M16. Even staple companies like Sheng Siong were not spared and had a few quarters of negative same-store-sales growth. It is a tough retail environment.
• On the bright side, we posit that cost pressures are somewhat easing. The slowdown in overall consumption has led to retailers commanding better bargaining power over suppliers. In general, we saw gross margins improve across our coverage of retailers (Courts, DFI, and SSG) as suppliers offered higher rebates to spur demand. 
• The weak end-demand also resulted in some retailers being able to negotiate with landlords for lower rents. Other companies also benefitted from lower raw material and/or commodity prices. Accordingly, we saw a broad trend of margin improvements across the consumer sector.
• Across our consumer coverage, we think Dairy Farm is poised to benefit the most from a margin recovery angle as it is only at an early stage of improving its cost structure.
• Given such a backdrop, we think the way to think about the sector is that companies with earnings growth, regardless of whether it is in the form of increased sales or margin improvements, will be rewarded. This is a sector that trades relatively well with earnings. 
• With the exception of Delfi (which trades at lofty valuations of 28-30x forward), consumer stocks under our coverage all did very well in 2016 and registered returns of c.20% and above. We therefore opt for a stock selection strategy based on earnings growth.

Trend #2: companies with high brand equity and depressed valuations represent attractive targets 

• The next trend to look out for comes on the back of the multiple privatisation offers that took place this year. The most prominent ones include Osim, Eu Yan Sang and Super. Common across the three companies were: 
  1. their core businesses were hit by weak retail spending and were struggling, 
  2. valuations were beaten down – they were all trading below their historical mean or around their -1 s.d. levels, and 
  3. they all had strong, established and entrenched brand equity in the markets they operated in.
• We therefore read the privatisations as a belief that the longer-term Asian consumer trend is still very much alive. We make no reservations that we are still in a downcycle and we do not see a recovery in CY17, but this could also mean that struggling companies with strong brands and beaten down valuations will start to become attractive targets. 
• Potential buyers include a bigger foreign brand wanting to enter Asia (in the case of Super), private equity (like the consortium that bid for Eu Yan Sang), or the founding family (Osim).
• Across our coverage, we think Delfi could be a potential privatisation target.

Risks 

• Consumer names have had their operations in developing ASEAN hit by a variety of factors, including: 
  1. a slowdown in discretionary spending, 
  2. a pullback in staples spending as import costs go up and ASEAN consumers tighten their purse-strings, 
  3. weak sales momentum, 
  4. competition, and 
  5. negative forex impact. 
• With global macro still uncertain following Brexit and the US elections, we are wary of this space in 1H17.

Limited scope for yoy margin improvements. 

• We also note that 2016 was a year when corporates grew earnings by better managing margins. We are therefore cautious on the yoy margin improvements, if any, especially in an environment of stagnant topline growth.

Currencies. 

• In addition to weak consumption demand, corporates face the additional whammy of weak regional currencies, especially with an impending rate hike and dollar strength. The impact of weaker currencies is twofold: 
  1. corporates selling to ASEAN customers in S$/US$ had to lower prices to sufficiently discount for the lower purchasing power of its customers, and 
  2. corporates selling in local currency in ASEAN faced weaker earnings upon translation. 
  • That said, the baht and rupiah appear to have stabilised, with only the ringgit still under pressure.

Jonathan SEOW CIMB Research | http://research.itradecimb.com/ 2016-12-05