F&N’s 3QFY18 results were within expectations. Despite lacklustre sales growth in both Malaysia and Thailand, core EBIT rose 45.2% yoy and 11.4% yoy respectively due to operational cost savings from the merger of Soft Drinks Malaysia and Dairies Malaysia as well as lower input costs. We expect F&N to benefit further from lower milk and sugar prices in the subsequent quarters. Maintain HOLD and target price of RM33.00, implying a 2019F PE of 27.6x. Entry price: RM31.00.

RESULTS

• 3QFY18 results were within expectations. Despite Fraser & Neave Holdings’ (F&N) 9MFY18 core net profit accounting for 81% of our FY18 earnings forecast, we note that 4Q of its fiscal year is seasonally the weakest quarter. Historically, 4Q accounts for 15-22% of full-year net profit. Our 9MFY18 core net profit forecast excludes a one-off item of RM0.9m (9MFY17: one-off items amounting to RM15.8m). As expected, no interim DPS was declared.
• F&B Malaysia: Flat top-line growth but core EBIT rose 45.2% yoy on: a) operational cost savings and lower overheads achieved from the merger between Dairies Malaysia and Soft Drinks Malaysia since early this year, and b) lower sugar prices. We note that the savings more than offset the negative impact of higher dairy-based input and packaging material costs as well as higher advertising and promotion (A&P) spending during the quarter. Meanwhile, the flat yoy top-line growth was due to lower consumer spending and slower offtake post the Hari Raya festive season, which was mitigated by double-digit growth in export sales.
• Dairies Thailand: Weak sales (-2.9% yoy) but core EBIT rose 11.4% yoy. Although export sales charted growth, domestic sales were lacklustre on the back of challenging domestic market conditions amid stiff competition. Core EBIT rose 11.4% yoy on favourable input costs, which we believe came on the back of lower milk prices and lower packaging material costs.

STOCK IMPACT

• Government to break monopoly on sugar imports to reduce retail sugar prices? Deputy Domestic Trade and Consumer Affairs Minister Chong Chieng Jen said the move to review sugar import licences, that had dragged on for decades, was taken seriously by the government to reduce the burden of the people. The price of sugar is currently based on world raw sugar prices and takes into account the administrative cost, refinery operations-, logistics- and manufacturer-related costs as well as wholesaler and retailer margins. After taking into account these costs, the government feels it is impossible to reduce the retail price of sugar to RM1.50/kg. The retail price in Malaysia now is RM2.95/kg for white coarse sugar and RM3.05 for white granulated sugar, the lowest among prices in ASEAN countries. Comparing the prices of sugar in the country and the region, he said the commodity is priced at RM3.58/kg in Indonesia, RM4.41/kg in Vietnam and RM4.65/kg in Singapore.
• F&N to benefit further in subsequent quarters from the downtrend in global sugar prices since early-18. Against the backdrop of falling global sugar prices (see RHS chart), we expect sugar prices for subsequent quarters to be lower than in 1H18. Our sensitivity analysis suggests that for every 10% change in sugar prices from our base assumption, our FY18-20 net profit forecasts for F&N will be impacted by 6-8%.
• Falling milk prices in 2H17 to benefit F&N in 2HFY18; current milk prices rebounded to >US$2,000/MT from ytd low of US$1,800/MT. Skimmed milk accounts for 45% of F&N’s COGS. Although global skimmed milk prices rebounded to US$2,090/MT currently from this year’s low of US$1,800/MT, we note that it is still much lower than 2017’s high of US$2,600/MT in Jan 17. Although F&N’s dairy division in both Malaysia and Thailand saw margin compression in 1HFY18 due to higher locked-in milk prices, margins should recover in 2HFY18 on lower locked-in milk prices. For every 10% change in skimmed milk powder prices from our base assumption, our FY18-20 net profit forecasts for F&N will be impacted by approximately 10%.

EARNINGS REVISION/RISK

• No change to our earnings forecasts.

VALUATION/RECOMMENDATION

• Maintain HOLD with an unchanged target price of RM33.00, implying a 2019F PE of 27.6x. Our target price is based on a WACC of 7% and terminal growth of 3.5%, We note that its implied PE of 27.6x is at a big discount of 39% to Nestle’s current 12-month forward PE of 45.6x. Dairy product manufacturer, Dutch Lady (with its earnings base that is less than half of F&N’s) is currently trading at 2018F and 2019F PE of 30x and 27x respectively.
• Yields not so appealing. F&N has a dividend policy of a minimum 50% payout. From FY13-15, the group has been paying out more than 70% of its earnings. However, we note that FY16-17 headline payouts fell to 55% and 65% respectively (with absolute DPS maintained at 57.5sen), mainly to fund capex for new projects. Hence, our conservative payout assumption of 55% for FY18-20 represents yields of 1.6-1.9%.

Source: UOB Kay Hian Research - 3 Aug 2018