Packing a punch: Strong fundamentals ensure retail offerings remain attractive

While growth in the Malaysian retail sector was slower in 2013 than in recent years, the industry remains an important driver of local services and ranks as one of the more robust markets in the South-east Asian region. Bolstered by steady economic growth, urban migration, political stability and rapidly developing infrastructure, the sector has attracted interest from numerous large international retailers, while also supporting traditional domestic players.

The common thread underpinning Malaysia’s long-term economic development strategy – to provide economic prosperity across the population – is already beginning to manifest itself in the vibrant retail sector as private consumption continues to surge country-wide. With more than 60% of GDP derived from domestic consumption, wholesale and retail is the fourth-largest contributor to GDP among the 12 National Key Economic Areas (NKEAs) included within the government’s Economic Transformation Programme (ETP).

On The Rise

The increase in GDP is fuelling more disposable income across the country as GDP per capita rose by 50% between 2009 and 2013, from $6700 to $10,600, as per data from the Prime Minister’s office. The government has set a GDP per capita target of $15,000 by 2020, with this greater spending power likely to drive the sector going forward. Indeed, retail spending is already fairly strong in urban centres such as greater Kuala Lumpur (KL), Johor and Putrajaya.

Although the sales expansion of recent years has been a boon for wholesalers and retailers operating in Malaysia, the continued success has also spawned an increasingly competitive marketplace as consumers enjoy greater choice. The country’s prime retail corridor in the Klang Valley continues to draw interest from international retailers, driving the expansion of existing brands as sales expand.

With the addition of several large retail developments in 2013 and a number of new shopping complexes scheduled to come on-line over the next few years this competition shows no signs of dissipating.

Retail Growth

Accounting for 14.5% of national GDP as of 2013, the wholesale and retail sector expanded by 6.4% in 2013 following growth of 7.1% and 4.8% in 2011 and 2012, respectively, according to Central Bank of Malaysia (CBM) data. The wholesale segment continues to outpace the retail market, with the former worth RM62.63bn ($19.55bn) in 2013 compared to RM59.92bn ($18.7bn) for the latter. “As in other countries, the retail market is very cyclical in Malaysia. However, peaks do not correspond to peaks seen in most Western nations. Indeed, Q3 is traditionally the busiest shopping season, with holidays around the year spurring sales,” Nur Qamarina, managing director for retail group Aeon Malaysia, told OBG. Sales for 2013 rose steadily in each passing quarter, recording combined wholesale and retail revenues of RM27.96bn ($8.73bn) in Q1, RM29.1bn ($9.1bn) in Q2, RM31.41bn ($9.8bn) in Q3 and RM34.08bn ($10.64bn) in Q4. Underpinned by higher than usual spending, the sector grew by 8.6% in Q1 2014 year-on-year. As of early 2014 the wholesale and retail trade segment was the largest economic contributor to the services sector, accounting for 26.1% of value. This far outpaced other services including finance and insurance at 16.6%, government services at 15.5%, and real estate and business services at 10.3%.

Demand Side

Buoyed by real GDP growth of 4.2% in 2010, 5.1% in 2011 and 4.7% in 2012, and underpinned by stable employment rates and wage growth, private consumption continued to grow in 2013, posting an increase of 7.6%, according to CBM data. Wages in domestic-oriented manufacturing industries went up by 10.3% compared to 6.6% recorded in 2012, while export-oriented manufacturing jobs increased compensation by 5%, slightly down on 5.2% in 2012. While official government figures show employment hovering at around 97% since 2010, population growth has pushed up the country’s labour force from 11.7m at the beginning of 2010 to 13.7m by the end of 2013.

Consumption was further boosted by ongoing access to personal credit, which jumped by 8.5% in 2013, which was a little down on 13.3% a year earlier, mostly due to tighter lending polices resulting from macro prudential measures introduced by the CBM in July 2013. Credit card spending also continues to climb (see Banking chapter), moving up from RM63.4bn ($19.8bn) to RM98.1bn ($30.6bn) between 2008 and 2013. However, growth fell back from 14.5% in 2010 to 6.8% in 2013. Overall financing for personal use has tailed off since the CBM measures were implemented, growing annually at a slower pace: 4.6% in the second half of 2013 compared with 9.1% in the same period in 2012.

Since 2001 credit expansion has averaged around 9.2%, mostly driven by liquidity in the domestic financial system. Public consumption, meanwhile, also went up in 2013, registering growth of 6.3% for the year, due mostly to higher spending on supplies and services.

Although the widening gap in income has resulted in increased spending by higher earners, government transfers to low- and middle-income households have also bolstered private sector purchases among lower earners. While government aid was less than 2012 levels, handouts in 2013 totalled RM3.8bn ($1.19bn) via a number of social programmes, including Bantuan Rakyat 1Malaysia, Baucar Buku 1Malaysia, and schooling assistance to primary and secondary school students.

In addition to these programmes and wage increases, the new minimum wage policy also commenced on January 1, 2013. By the end of that year, fears that higher wages would have a detrimental effect on employment proved largely unfounded, with only minimal adverse effects incurred and limited primarily to Q4 2012 when retrenchments spiked temporarily as companies began to implement the new policy.

Holding Its Own

Political stability, relatively low risk and sustained retail growth have all combined to allow Malaysia to establish itself among the region’s retail leaders, with the country performing well at a global level.

According to global consulting group AT Kearney’s 2013 “Global Retail Development Index”, the country ranked 13 out of 30, placing it above India (14), Sri Lanka (15) and Indonesia (19), but behind China (4) and Mongolia (7). Malaysia’s ranking fell two spots from the 2012 index, which ranks the top 30 developing countries for retail investment based on several macroeconomic and retail-specific variables. Of the four categories contributing to the index ranking – market attractiveness, country risk, market saturation and time pressure – Malaysia fared the best in country risk, scoring 95.8 out of 100. A victim of its own success, the country’s weakest link was market saturation, with a score of 22. Market saturation and time pressure scored at 39.8 and 55.3, respectively.

Bricks & Mortar

Keeping pace with solid rates of economic growth and retail performance, retail real estate stock continues to expand across the country, with a total 391,190 shops operating at year-end 2013, according to the National Property Information Centre. This was up from the 389,050 units the previous quarter after a total of 9286 units were completed over the past year. At the end of Q4 2013 the country’s existing retail space totalled 12,390,753 sq metres among 873 commercial complexes, up from 362,738 sq metres among 853 shopping complexes in 2012.

Within the sector’s primary hub of the Klang Valley, the cumulative stock of retail space expanded to around 44.9m sq feet in the second half of 2013, according to global property consultancy Knight Frank. Growth for the period, roughly 1.7m sq feet, was primarily attributed to the openings of several new retail centres, including Sky Park @ One City, Cheras Sentral, Setia Walk and Bangi Gateway Shopping Complex. This is set to increase further in 2014 with six major new shopping centres with a combined net lettable area of 1.93m sq feet scheduled for completion in the first half of the year: Nu Sentral, D’Pulze Shopping Mall, Encorp Strand Mall, The Main Place, The Place @ One City and G Avenue.

In spite of the continued influx of new retail space, Malaysia and KL in particular still boast some of the highest rents within the Asia-Pacific region. Prime shopping centre retail rents in KL averaged $581/sq ft in mid-2013, ranking it in the top-three cities in the region, as per data from global research and consulting company CBRE. Rents in KL were exceeded only by the $672/sq ft charged for prime retail space in Beijing and the $592/sq ft levied in Guangzhou. Other economic centres including Singapore, Shanghai and Bangkok, which all maintained lower rents of $465, $497 and $114.

Growing Competition

While the strong levels of economic growth in recent years has been a boon for domestic retailers, it also has a downside which has become increasingly apparent in recent years. A victim of its own success, the sector has caught the interest of foreign companies as large established global brands continue to expand their footprint in Malaysia. With the full weight of their economic and logistical resources behind them, these businesses are able to compete on price and service levels, something smaller brands may not be able to do given their scales of efficiency. For domestic outlets, this means an uphill battle against the influx of large overseas brands, covering a range of issues such as efficiency, branding and marketing.

In spite of these challenges, domestic retailers do hold a trump card in the form of local market knowledge, which is an especially valuable asset given Malaysia’s diverse population, which includes Malay, Chinese, Indians and a significant number of expats. Due to the variability of the unique cultural, religious and social traits of each population sub-set, each group must be targeted differently as they will purchase more at certain times of the year, or prefer to buy in small, single serve packages verses in bulk quantity. Other key aspects to consider are lifestyle, eating habits and family size, which differs greatly between the three predominant ethnicities. This knowledge will also serve retailers well when looking to expand beyond the domestic 28mstrong population into other countries or regions.

Small Versus Big

In addition to these less quantifiable advantages, the government is also tilting the playing field towards small family-owned businesses by restricting the activities of hypermarket chains. Falling under the Guidelines on Foreign Participation in the Distributive Trade Services Malaysia 2004 (revised in 2010), foreign hypermarkets are subject to a series of restrictions. These include requirements for any store with a floor space larger than 5000 sq metres to be located outside of the 3.5-km radius of a town centre, with only one foreign hypermarket permitted for every 250,000 inhabitants. In addition, hypermarkets are not allowed to operate around-the-clock, with business hours mandated from 10am to 10pm on weekdays.

In spite of efforts to protect traditional small retailers from being priced out by large multinationals, supermarkets and hypermarket chains continue to make inroads in Malaysia. There are currently three major hypermarket players operating in Malaysia: Giant, Makro and Carrefour, with British supermarket operator Tesco expanding in the country as well. The segment also experienced some consolidation in November 2012 when Japanese grocer Aeon bought out French retailer Carrefour’s Malaysian assets for €147m.

The acquisition marked another step in Aeon’s plan to establish its South-east Asian headquarters in Malaysia, where the company also plans to expand its coverage in the country to some 100 outlets by 2020.

With the saturation of primary urban growth areas now reaching its peak, many retailers are now moving into secondary markets to increase their reach. Relatively high population densities located in secondary cities along the eastern seaboard of the peninsula, which have previously had to journey to larger cities, are now attracting malls and hypermarkets of their own. While there is some movement in Sarawak and Sabah, many developers are holding out due to the relatively low population densities in those territories.

Regulation

While the slowdown of many regional economies towards the end of 2012 and 2013 has dampened growth expectations as trade to crucial export markets has been curtailed, the financial pinch has also provided additional momentum for the government’s economic reforms. Faced with a widening trade gap and decreasing surplus of foreign reserves, the government has had to restart its (politically unpopular) energy subsidy reduction plans, revamping of its tax structure to include a goods and service tax, while at the same time reforming its labour policies. A point of contention prior to implementation, the effects of these new measures on the retail sector as of mid-2014 has so far been fairly limited in scope.

While the erosion of energy subsidies is not a new concept in Malaysia and is generally considered a necessary, if not painful, move in order to increase efficiencies and reduce government debt, implementing the policy has proven more difficult due to its social and political ramifications. The subsidy reduction was first brought up in 2011, but was put on the back burner in the run up to elections due to its sensitive nature but is now proceeding with a new government mandate. In September 2013 the state added an extra RM0.20 ($0.06) per litre to RON95 petrol diesel for a market price of RM2.10 ($0.66), with additional increases planned in the coming years.

Labour

In the same vein, the reliance on cheap and often imported labour similarly fosters inefficiencies and must likewise also be addressed. Seeking to address this challenge, the government endorsed a minimum wage policy starting January 1, 2013 (implementation for foreign workers was delayed until December 2013). The monthly minimum wage is now set at RM900 ($281) in Peninsular Malaysia and RM800 ($250) in Sabah, Sarawak and Labuan. In order to lessen the burden on small businesses, co-operatives, societies and associations, and to encourage compliance, the government has also passed further tax deductions to cover the wage differences paid by employers for the period of January 1, 2014 to December 31, 2014.

Although this move could have some effect on the cost of locally produced goods (primarily if the law is applied to foreigners who often work overtime and holidays), the direct effect on retail operations in terms of business costs will be limited. With employees working in large retail centres such as KL already receiving wages on par with or in excess of the minimum wage, the new pay increase will generally only have an effect on smaller rural towns for retailers.

So far, fears that the retail industry would be crippled by greater costs due to the fuel price hike and the rise in wages have been allayed. Although the price of goods and services has gone up moderately since these policies were commenced, growth has so far been in line with the incremental increases experienced prior to their implementation.

The annual percentage change in the consumer price index (CPI) remained modest at 2.1% in 2013, although it did rise above the 1.6% recorded in 2012. The CPI continued to climb in 2014 and averaged at 3.4% in Q1 2014 due primarily to higher inflation in the housing, water, electricity, gas and other fuels and transport categories. Producer prices as measured by the producer price index (PPI) also indicated that the fuel price increase was contained, with the PPI declining by 1.9% in 2013 before increasing 3% in Q1 2014 compared with the same quarter the previous year.

The employment rate grew by 4.8% in 2013, while total retrenchments decreased, according to the CBM, suggesting that most firms were able to adapt to the minimum wage policy. During the year, the unemployment rate also remained low at 3.1%.

Tax

The other major regulatory change which could have a significant impact on the sector is the planned roll-out of a new goods and service tax scheduled for implementation in April 2015.

The 6% consumption tax will replace the existing 10% sales tax currently levied on manufacturers or importers who have annual revenues of at least RM100,000 ($31,210) and a 6% service tax. Intended to broaden the overall tax base, the move is taking place in conjunction with a one percentage point cut in both corporate income tax to 24% and for small and medium-sized enterprises to 19%.

Buying power is expected to go up significantly prior to implementation of the tax change, which as a result has created the possibility of a downward trend in purchases shortly afterwards. Nonetheless, such a scenario is not likely to have detrimental long-term consequences for the retail sector or the government.

Outlook

As economic growth continues to bolster the ranks of the middle class and push up GDP per capita, demand for food and beverages should remain strong, particularly for goods such as confectionaries, functional foods and high-value imports. Complementing increased spending power, domestic trends of a growing and increasingly urban population will likely concentrate 80% of Malaysians in cities, further increasing demand for modern retail.

Looking to capitalise on this projected demand, retailers will continue to invest in new outlets concentrated primarily in urban centres. With a number of new malls scheduled to open their doors in the next two to three years, the retail market is likely to remain competitive, with existing grade-A malls expected to sustain their current high occupancy and rental rates in spite of market saturation. Growth outside primary populated centres is also likely to stay on track, albeit at a slower pace. Although modern large-scale retail outlets will continue to gain market share, traditional grocery outlets, wet markets and produce vendors will remain the most popular grocers for the time being.

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The Report: Malaysia 2014

Industry & Retail chapter from The Report: Malaysia 2014

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