■ We upgrade BFood to Add from Reduce with a higher GGM-based TP of RM1.00 as earnings are set to improve on higher sales and margin recovery.

■ Key re-rating catalysts: i) robust store expansion to drive sales growth, ii) margin expansion as input costs ease from 2HFY24F, iii) rebound in tourism.

■ We switch to GGM model (prev. 12x CY24F P/E) to better reflect future profitability – 21% ROE, 9.5% COE, 4% long-term growth.

Margins poised for recovery on easing of key input costs…

Based on our analysis (Figs 3 and 5), we believe the 3.5%-pt yoy drop in Berjaya Food Berhad’s (BFood) core net profit (CNP) margin in FY23 (Fig 6) was due to elevated raw material costs at its Starbucks operations (90% of BFood’s revenue; Fig 13), particularly the higher Arabica coffee input costs locked in at peak prices (Jan-Jun 2022). However, we think BFood’s CNP margin likely bottomed in FY23 (9.3%) and is poised for a recovery from 2HFY24F onwards to 9.4-10.3% in FY24F-26F (Figs 5 and 6), in our estimates. This is premised on Arabica coffee prices having declined by c.36% in Aug 23 (Fig 3) from their peak in Aug 22 and the impact of the price hike undertaken in Dec 22. As such, we expect BFood’s CNP margin to show a gradual improvement in 1HFY24F before a more accelerated recovery from 2HFY24F onwards, given the typical lag effect of c.6 months for the lower-priced raw material inventories to roll over (Fig 5). We estimate that key raw materials (coffee, a major component) account for c.30-40% of BFood’s COGS.

…and robust store expansion plan to drive future earnings growth

We estimate that BFood will revert to net profit growth of 5%/11%/10% yoy in FY24F/25F/ 26F, driven by revenue growth of 3-8% yoy (Fig 2) via higher Starbucks Malaysia (MY) store openings (35-45 p.a., vs. average of 26 p.a. in the past 5 years) in FY24F-26F (Fig 1) and a recovery in margins as raw material costs fall. Based on our observations, Starbucks MY has room for more store expansion in untapped catchment areas (such as offices, universities, hotels, residential areas, etc.) in the urban, sub-urban and rural regions as well as in East Malaysia. Coupled with the strong brand equity of Starbucks, expanded store network presence and effective marketing campaigns, we believe BFood is well-positioned to benefit from rising coffee consumption in Malaysia, seasonal festivities, and a rebound in tourism from seasonally stronger 4QCY23 onwards.

Upgrade to Add with a higher GGM-based TP of RM1.00

We upgrade BFood to an Add from Reduce, with a higher TP of RM1.00 based on a Gordon Growth Model (GGM) to better capture BFood’s medium term profitability and growth trajectory. Our GGM assumes a recurring 21% ROE (based on FY26F; Fig 9), a 9.5% COE and a healthy 4% long-term growth. At RM1.00, BFood would be trading at 17x CY24F P/E which is still at a 19% discount to our CGS-CIMB consumer discretionary sector average CY24F P/E of 21x (Fig 16). A return to recurring ROEs of 25% (avg. of FY22-23) would take our fair valuation to RM1.20. Key downside risks are prolonged input cost pressures and intense competition resulting in weaker sales.

Source: CGS-CIMB Research - 28 Sep 2023