CLSA INDO: consumer sector, headwinds looming

We have been talking about extreme weather patterns around the world where implication to commodity prices and inflation (especially in EM where food its a bigger portion of spending CPI) could be very significant.  In some parts of Indonesia there is risks of crop failures brought on by nearly a year of heavy rain, which are threatening jobs and pushing up food prices for families when global food prices are already on the rise.

In an interview with a local farmer by a local newspaper, he pointed to rows of rotting chilli peppers, tomatoes and egg plants as clouds gathered again over his fields, already water-logged by incessant rain.  As much as 80 per cent of his chilli crop failed, he explained, powering a battered pickup truck over a washed-out country road an hour outside the capital, Jakarta. “The rain is killing my vegetables.”  Unfortunately with the rapid shift from El Nino to La Nina weather conditions, it appears that impact to agricultural markets will not get any better in at least for the 1H of 2011.  

2009 was an extraordinary year for Indonesia consumer companies.  Consumer like Indofood, Mayora, Charoen Pokphand saw their margins expanded massively over that period.   This is a function of a couple factors in a broad sense;

During the soft commodity price spike in 2007-2008, everyone raised their prices to maintain their margins.  Note margins was still compressed to record low levels. Indofood noodle business was making just over 1% EBIT margin just when wheat price peaked in 2008
Then came the credit crisis.  Although commodity prices collapsed, the rupiah depreciated from 9000 to 13,000, so in local currency terms, their input cost remained high.
The sweet spot in the last 12-18 months is when the Rupiah strengthened slowly while commodity prices remained low.  All these consumer companies where happy to maintain their newly established prices enjoying record high margins.
On rising input cost, it will be very difficult for margins to be maintained even though some maybe able to raise prices.  

On Swati's latest consumer sector report - see research, Swati is cautious on the Indonesian consumers for 2011. Double whammy: rising input costs and potentially softer consumer demand.

As such, we prefer consumer companies which are more resilient to inflation, such as GGRM and MAPI.  We also like diversified product producers with excellent track record such as Unilever and Mayora.

Swati has just written a report on the consumer sector highlighting the emerging headwinds in the sector.

Consumer companies face double whammy:

Rising cost pressure as we move into an inflationary year with soft commodities, packaging material and transportation cost inching up
Consumer demand will be softer as consumers feel inflation pinch.

Changes in recommendation:

- GGRM upgrade: now BUY with 55,000 target (from OPF 55,000).
- KLBF downgrade: now UPF with 2700 target (from OPF 2700)
- ACES downgrade: now OPF 3100 (from BUY 3100).

 Key points from the report:

·         Prefer companies that are more resilient to inflation. We prefer companies which are more resilient to inflation such as Gudang Garam (GGRM IJ) as 70% of cogs is excise and 15-20% is clove and tobacco. It is also a beneficiary of rising commodity prices as it has 30% market share in outer islands as per industry sources.
·         Upgrading GGRM from OPF to BUY, with TP of Rp55,000.
·         We like diversified product producers with excellent track record such as Unilever (UNVR IJ) and Mayora (MYOR IJ).
·         UNVR’s key agenda is growth going forward and this will come from growing existing categories, entering new categories and acquisitions.
·         MYOR is our long term pick in the small caps as it has registered more than 30%+ earnings cagr in past five years and revenues will reach US$1bn by 2012, half of Unilever Indonesia.
·         High end retailer Mitra Adiperkasa (MAPI IJ) is also an interesting name to watch out for as it is a high end retailer and therefore less prone to rising inflationary concerns.
·         Downgrading Kalbe Farma (KLBF IJ) to UPF.
·         Downgrading Ace hardware (ACES IJ) to OPF (from BUY) on valuations.
·         Maintain UPF on Indofood (INDF IJ) given rising costs pressure and less than 10% growth this year. This is after incorporating 9% increase in noodle prices and assuming 8% flour margins.