- We re-affirm our HOLD recommendation on Fraser & Neave Holdings (FNH), with an unchanged fair value of RM19.18/share based on a sum-of-parts valuation.

- New Zealand milk production continues to be impacted by the drought conditions on the North Island and overall dry weather. The current drought in New Zealand has curbed supply and has resulted in surging global milk powder prices (refer to Charts 1 to 4).

- The average skim milk and whole milk prices have recently spiked to US$5,142/MT and US$5,100/MT, respectively, since its lows in 2009.

- New Zealand’s Fonterra Co-operative Group Ltd (Fonterra) accounts for c.40% of global trade in dairy products. Major products include whole, butter and skim milk powder (SMP), dried milk fat, butter, cheese, lactose and casein. Some of Fontera’s key brands are Anchor, Anlene, Annum, Mainland and Tiptop.

- The surge in the global milk powder prices has yet to have any immediate impact on FNH cost structure, as pointed out by management.

- If the drought in New Zealand worsened, FNH would be well positioned to source dairy products from other countries. FNH imports raw materials and milk for its dairy products from New Zealand, Australia, the US and Europe.

- All in, prices of milk products are expected to remain strong in FY13, underpinned by a continued underlying global demand. The higher feed costs associated with the drought has also resulted in worldwide tightening of milk supply.

- We believe the continued upward trend in milk prices would result in some margin compression at FNH dairies unit, particularly if a significant shortage of milk worldwide were to occur. Hence, a greater spike in global milk prices would be envisaged.

- Meanwhile, the cost outlook for the other raw materials such as palm oil, sugar and aluminium are expected to remain favourable for FNH.

- Nonetheless, no change to our estimates at this juncture. For FNH’s 1QFY13, the soft drinks and dairies divisions account for 43% and 57% of revenue, respectively.

- The stock is trading at 31x PE for FY13F, higher than its 5-year historical peak of 28x. Valuation is at an 11% premium to Nestle Malaysia Bhd (Nesz Mk Equity, Non-rated) at 28x. Hence, our HOLD call.

Source: AmeSecurities