Results Highlights

• Oldtown Bhd‘s 3QFY17 net profit jumped 119.3% Y.o.Y to RM24.4 mln, with the outperformance of its FMCG segment on higher sales, forex gains, as well as lower selling expenses. Revenue for the quarter also expanded 13.3% Y.o.Y to RM115.8 mln against RM102.2 mln in 3QFY16.
   
• Cumulatively, the group’s 9MFY17 net profit soared 50.0% Y.o.Y to RM50.9 mln, while revenue rose 10.2% Y.o.Y to RM318.2 mln. The reported earnings came in above our expectations as it accounted to 91.9% of our previous full year estimated net profit of RM55.4 mln, while the reported revenue came in within our expectations, accounting to 74.0% of our FY17 revenue forecast of RM430.3 mln. The variance in its bottomline is mainly due to higher margins on the back of stronger sales revenue from its export market and forex gains, in view of the sharp depreciation of the Ringgit in the quarter under review. Oldtown has declared a second interim dividend of 3.0 sen per share.
   
• 2QFY17’s pretax profit from the café chain operations fell 9.0% Y.o.Y to RM14.9 mln, from RM16.4 mln previously – mainly on higher expenses incurred from outlet closure, increasing staff cost and depreciation charges. The manufacturing segment’s pretax profit, however, soared 68.1% Y.o.Y to RM51.5 mln, from RM30.6 mln in 3QFY16, attributed mainly to forex gains and stronger export sales.
   
• Export revenue continued to gain traction, contributing about 45.1% or RM52.2 mln to the group’s total sales in 3QFY17, from 38.8% or RM39.6 mln recorded in the previous corresponding quarter, backed by strong growth in sales revenue via e-commerce platforms in China.

• We expect to see improving margins, backed by higher sales volume, although the improvements could be limited due to higher raw materials and other operating cost. We also think that the group will focus its attention on international expansion to counter the headwinds from the depressed consumer sentiment in the local market.

Prospects

The group currently operates 234 café outlets, down from 238 outlets in the previous quarter due to outlet closures in its local operations as the group gradually shifts its focus to international expansion in order to offset the difficult environment in the domestic café chain segment that is affected by higher cost of raw materials and stagnant consumer sentiments.

To mitigate some of the rising cost, there is a strong possibility that Oldtown could raise selling prices on its outlets’ F&B from FY18 onwards. The group will continue to adopt lower cost outlet models or ‘Oldtown White Coffee Basic’ outlets as part of its growth strategy in Malaysia, while looking for expansion opportunities in overseas markets via franchising. Oldtown has recently inked a Licensing Agreement with Nikmat Mujur Sdn Bhd to develop its café outlets chain in Yangon, Myanmar. Tentatively, the first outlet is expected to commence operations in the 1QFY18.

Meanwhile, we expect to see a steady growth in Oldtown’s FMCG segment as the group capitalises on its established position as one of the leading white coffee manufacturers and wide distribution networks to expand its market share in key Asian markets like China, Singapore and Hong Kong. We note that the group’s FMCG export contribution overtook the local sales as the segment’s main revenue contributor, after posting a 363.0% Y.o.Y jump in flagship store sales (i.e.: Taobao and Tmall China) for the quarter, driven by significant promotional events in November and December last year.

Through its strong partnership with DKSH, a renowned market expansion services provider, the group has also successfully penetrated the Netherlands market in FY17 as Oldtown rides on DKSH’s expansion into the aforementioned market.

Moving forward, we think that contribution from Oldtown’s export segment will boost the group’s revenue, alongside new café outlet openings in overseas markets and solid performance of its FMCG products across its key Asian markets, as well as emerging markets like Myanmar. Margins is expected to improved, albeit on a more moderate pace, mainly due to unabated increase in raw material prices which will offset Oldtown’s stronger topline growth. Advertising costs is also expected to put a dampener on margins as Oldtown continue to invest in advertising and marketing activities, in a bid to maintain its ‘’Oldtown’’ brand name.

Valuation and Recommendation

As the reported earnings came in above our estimates, we raised our earnings estimates for FY17 and FY18 by 19.2% and 24.4% to RM66.0 mln and RM72.2 mln respectively, to reflect improvements in revenue and margins. However, we maintain our HOLD call on Oldtown, albeit with a higher target of RM2.50 (from RM2.10), in view of the recent rally in Oldtown’s share price by 15.7% to RM2.43, which we believe has largely reflected its potential earnings improvement over the next two years.

Our target price is derived from ascribing a revised target PER of 15.5x (from 16.5x due to an industry-wide decline in valuations) to our revised FY17 net EPS of 16.0 sen. The target PER is based on a discount to the 21.0x-24.0x PER of consumer products bellwethers like Nestle and Dutch Lady 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 Feb 2017