■ Farm Fresh’s (FFB) presentation at the CGS-CIMB Consumer Conference 2023 suggests that its earnings have troughed. Maintain Hold.

■ Higher selling prices, new product launches and easing costs are positives but earnings repair could take time; 3QFY3/24F the key test, in our view.

■ Our 16% FY26F ROE estimate supports GGM-based valuation of RM1.37/sh with each 0.5%-pt change equating to RM0.06/sh change in valuation.

Key takeaways from CGS-CIMB Consumer Conference 2023

CFO Mr Khairul Mat Hassan represented FFB at CGS-CIMB Consumer Conference 2023 on 6 Sep 2023. We see the following as key takeaways: 1) FFB’s earnings bottomed in 4QFY3/23. 2) FFB expects earnings to improve sequentially from here, thanks to a) the increase in its selling prices effective Jul 2023, b) lower farmgate prices for raw milk in Australia (-4% yoy), and c) lower whole milk powder prices (-24% yoy in Aug 2023). 3) It will take a few quarters before the full impact of the above will be seen in reported profits. 4) Most importantly, management expects to revert to its previous earnings trajectory which we interpret as heading back above RM100m p.a. in net profits, albeit post FY03/24F.

Lower raw material prices and mix to help

Lower raw material costs for both farm gate (fresh milk) and whole milk powder, and an increased proportion of whole milk powder in its raw material requirements for FY24F (see Fig 1) will drive down costs in the coming quarters, in our view. There will be a lag in these costs filtering through inventories, but the trajectory is clear i.e. downwards. Management has also been hedging FFB’s US$ exposure with RM/US$ rates of RM4.53-4.55 locked in till end-2023. We estimate FFB’s gross margins will rebound in the coming quarters, helped by lower costs as well as the average 5% price increase effective 1 Jul, with a 26% gross margin for FY3/24F vs 1QFY24’s 17.7%.

Confirmation of profit trajectory key to valuations

We maintain our Hold recommendation on FFB, with an unchanged target price of RM1.37, based on a Gordon Growth Model (GGM). Our GGM assumes a recurring 16.0% ROE (based on FY26F), an 8.5% COE and a healthy 5% LT growth, resulting in a target FY3/25F P/BV multiple of 3.1x. At RM1.37, FFB would be trading on 22x CY24F P/E which is comparable to -0.5sd of peer Fraser & Neaves’s (FNH MK, Add, CP RM25.60, TP RM28.30) 15-year mean P/E. A return to recurring ROEs of 20% (similar to FY22’s) would take our fair valuation to RM1.87, while only delivering a 12.5% ROE would result in a fair valuation of RM0.93. FFB’s earnings trajectory in the coming quarters will be key to setting expectations for medium-term earnings and ROEs and thus its share price trajectory. Failure to deliver on investor expectations of a margin recovery will be the key downside risk, in our view, while surpassing those expectations will drive a re-rating, hence an upside risk.

Source: CGS-CIMB Research - 11 Sep 2023