Outlook for Profit Improvement Upbeat
The author is an analyst of Shinhan Investment Corp. She can be reached at hpark@shinhan.com. -- Ed.
Initiate coverage with OVERWEIGHT: top picks are CJ Cheiljedang and Orion
We initiate coverage of the food/beverage sector with an OVERWEIGHT view and CJ CheilJedang and Orion as sector top picks. By segment, we favor foods the most, followed by confectionery, alcoholic beverages, and tobacco. Investment points are: 1) earnings improvement backed by downward stabilization of raw material prices; 2) relatively stable share performance; and 3) share price momentum driven by growth in market share.
In 2019, the consumer price index increased by 0.4%, domestic fertility rate by 0.9%, and private consumption expenditure by 1.9%. The fertility rate, which will determine future domestic consumption, dropped below 1% in 2018 and has continued on a downtrend over the past two years. Expectations for a boost in demand from population growth are thus limited. Meanwhile, product price hikes are also unlikely in the near term, considering the drop in oil prices, downward stabilization of raw material prices, and government policies. However, the outlook for profit improvement remains upbeat on the downward stabilization of raw material prices.
The food/beverage sector index recorded a return of 50.1% over the past ten years, outperforming the KOSPI by 35.8%p. Excluding 2020 to factor out the impact of the COVID-19 pandemic, the food/beverage sector still outperformed the KOSPI by more than 15%p through 2019. We find that the stability of staples shines through in the long run. Moreover, the outlook remains positive for the remainder of 2020, backed by the surge in food demand and profit gains from improvement in cost ratios.
Companies reporting market share growth in certain categories such as alcoholic beverages and ramyeon have been enjoying stronger share price momentum since 2019. While keeping an eye on valuations, investors should continue to focus on companies recording a steady uptrend in market share. Overseas momentum, which weakened from 2017, should recover gradually going forward. Exports of mainstay products such as ramyeon and confectionery to China have been steady, and companies are making progress on expanding into other overseas markets such as Vietnam and the US. The overall outlook thus remains upbeat on a mid/long-term view.
Prefer foods > confectionery > alcoholic beverages > tobacco
Foods: The consumer sentiment index on future expenditures for dining out fell 22pt MoM in March. However, retail food sales grew more than 10% through February, driven by surging demand for HMR products. We favor the food segment the most in the food/beverage sector in view of profit gains from cost savings and cost ratio improvement as well as mid/long-term growth potential backed by demographic changes.
Confectionery: The confectionery market as a whole has limited growth potential, with the declining population of the target age group adding to mid/long-term negatives. However, top-tiers in key product categories remain attractive in our view. Overseas momentum, which weakened from 2017, should recover gradually on expansion into new regions. Earnings momentum is also seen intact on the surge in demand in 1H20.
Alcoholic beverages: Share price momentum backed by market share growth should continue from 2019 through 2020. We will need to check up on the impact of new product launches and marketing competition from 2H20, but the outlook remains bright for the remainder of the year for companies reporting improvement in market share.
Tobacco: Growth momentum is limited for the tobacco market as a whole. KT&G, however, should see share price momentum upon a rebound in export volume and growth in non-tobacco earnings. Investors will need to watch for further growth drivers from non-tobacco businesses going forward.