Results Highlights

• Oldtown’s 2QFY17 net profit fell 5.5% Y.o.Y to RM12.6 mln vs. RM13.4 mln – mainly due to weaker contribution from the operation of its café chain segment as it incurred increased staff costs, higher depreciation charges as well as write-offs from several outlet closures. Revenue, however, rose 7.5% Y.o.Y to RM99.5 mln, from RM92.6 mln.

• Cumulative 1HFY17 net profit was up 16.1% Y.o.Y to RM26.5 mln, from RM22.8 mln, contributed by higher export sales from its manufacturing of beverages or FMCG segment. Revenue also added 8.4% Y.o.Y to RM202.4 mln, compared to RM186.7 mln in 1HFY16. Both the reported earnings and revenue were within our expectations, accounting to 47.9% and 48.9% of our FY17 estimated net profit and revenue of RM55.3 mln and RM413.9 mln respectively. Oldtown has declared a single-tier interim dividend of 3.0 sen per share, which is payable on 16th February 2017.

• Segment wise, the 2QFY17 pretax profit of the café chain operations plunged 15.8% Y.o.Y to RM4.5 mln vs. RM5.4 mln previously – dragged down by higher staff cost and depreciation charges. On the other hand, the manufacturing division’s pretax profit jumped 14.6% Y.o.Y to RM12.1 mln, from RM10.5 mln in 2QFY16, on the back of stronger sales.

• Export revenue contributed about 35.2% or RM35.0 mln of Oldtown’s 2QFY17 sales, from 35.5% or RM32.8 mln recorded in 2QFY16, mainly on seasonal factors.

• Moving forward, we expect the manufacturing and beverages segment to remain the key driver of earnings’ growth amid the soft consumer sentiment. Margins are expected to fall slightly, in-tandem with the hike in raw materials like instant coffee and non-dairy creamer, coupled with higher depreciation charges.

Prospects

The group currently has 238 café outlets in operation and has earmarked 10 additional outlets to be opened from December 2016 onwards. Following the various domestic challenges which included higher minimum wages, foreign labour shortages, rise in the cost of raw materials and subdued consumer market, Oldtown plans to focus its initiatives in its international expansion – mainly into the China, Hong Kong and IndoChina markets. The group is actively seeking potential business partners via international exhibitions, trade match making, as well as appointing regional consultants for the purpose of expanding into the aforementioned regions. The management has guided that there will be some changes to Oldtown’s food and beverages menu moving forward, which could see higher selling prices.

The group will also continue to focus on enhancing its operational efficiency in the manufacturing of beverages. Hence, we expect to see reasonable cost savings from the cost-rationalisation strategies carried out previously, albeit slightly offset by higher depreciation charges and increasing raw material prices.

With the ongoing promotional campaigns, Oldtown has retained its market leader position in the white coffee segment in Malaysia, Singapore and Hong Kong over the 1HFY17 period. The group also aims to grow its sales in the other products offered, i.e. roasted coffee, which contributed about 5.0% to its 1HFY17 FMCG revenue.

On the local front, consumer spending is likely to stay muted – due to prudent consumer spending amid the higher cost of living following the removal of government subsidies in daily necessities like sugar and cooking oil as well as the depreciating Ringgit. Although, export sales fell slightly in the 2QFY17, we expect to see a recovery in the coming quarters - ahead of the holiday celebrations in December and January.

Valuation and Recommendation

We maintain our HOLD recommendation on Oldtown with a higher target price of RM2.10 (from RM2.00) after rolling over our valuation matrix to our FY18 EPS of 12.9 sen and based on an unchanged target PER of 16.5x. The targeted PER is at a discount to the 22x-24x average PER of consumer products market leaders like Nestle and Dutch Lady - mainly due to Oldtown’s smaller market capitalisation.

Risk to our recommendation and target price include inability to replicate identical food quality and services across its café outlets. Any deterioration of its outlets’ service or food quality will result in a negative impression on the group’s overall brand’s image. Failure to meet or exceed customer’s dining expectations will cause Oldtown to lose its existing market share. Any fluctuation on global commodity prices such as coffee beans and sugar – the main raw materials, will also disrupt earnings growth and margins going forward.

Source: Mplus Research - 28 Nov 2016