• Dutch Lady’s 9M16 earnings of RM111.3m came in below expectation, making up only 68% of our full year forecast.

• Earnings fell 3.9% YTD mainly due to higher cost of sales and continued investments in support of the brand.

• Uptrend in milk prices putting pressure on company bottom line.

• We revised our FY16 and FY17 earnings forecast downwards to RM150.4m and RM163.7m respectively.

• Hold call retained with new target price of RM56.20. YTD earnings drop. Dutch Lady recorded a 9M16 revenue growth of 6.2% to RM776.1m due mainly to launch of the newly improved formula for Friso powdered milk which is specially targeted for children and introduction of Ready to Drink (RTD) UHT 125ml milk with Disney Marvel and Frozen character packaging. However, earnings dropped 3.9% YTD to RM111.3m from RM115.8m driven by i) higher costs of sales, and ii) greater advertising and promotion expenses in support of the brand as well as for new launches. This is reflected in the compression of EBIT margin by -2%.

Higher revenue pushed up qoq earnings. Earnings for 3Q16 improved 10.7% qoq to RM40.7m from RM36.7m. This is due to higher sales, up by 13.3% to RM279.6m as well as lower operating expenses incurred in this quarter.

Constant dividend paid. Dutch Lady had declared a standard single-tier interim dividend of 50 sen and special single-tier interim dividend of 60 sen for FYE 31 December 2016. As to date, a total of 110 sen DPS had been declared. We estimate that the whole year dividend would come to a total of 220 sen. This translates to a dividend yield of 4%.

Uptrend in milk prices is impairing earnings. Dutch Lady earnings are expected to be affected in the near future not only due to the current poor consumer sentiment but also to the uptrend in global milk prices. Milk prices have increased by 18% YTD to USD2150.4 from USD1916.5 per metric ton. We believe that the uptrend in milk prices is due to curtailment of production in New Zealand as a result of previous oversupply in world markets and higher demand from China. The rise in milk prices increases the input costs of Dutch Lady products. Continued advertising and promotion investments to maintain brand name would further increase costs to the company.

Hold recommendation maintain on lower earnings forecast. We revised our earnings forecast for FY16 and FY17 to RM150.4m (-8%) and RM163.7m (-9%) by factoring in our view of the diminished outlook brought about by higher raw material prices. We have derived a new target price of RM56.20 (previously: RM59) based on DCF methodology with WACC of 10%. Maintain Hold.

Source: BIMB Securities Research - 30 Nov 2016