Highlights

• F&B: The deterioration in revenue per store has eased in 1QFY17 as Oldtown replaced non-performing stores with new stores and lower store count in 1Q17 (240 stores) vs. 4Q16 (245 stores). For the rest of the year, the group aims to open 26 new stores, with 15 net stores targeted for Malaysia. We can expect better 2Q17 as management guided for yoy improvement in Jul and Aug sales.

• Domestically, stores in Penang are struggling while those of south and central regions are doing well. Internationally, management expects operations to commence in China by September, HK airport by October whilst another store is penciled to open in Melbourne Australia in FY17.

• The government’s ban on foreign worker intake for F&B sector, coupled with rising raw material costs are near term challenges. The extension of the anti profiteering act till December makes it difficult for management to navigate price increases till 4QFY17.

• FMCG: Exports to China increased by 240% yoy on the back of a lower base in FY16. Sales in Malaysia dropped 22% yoy on the back of the lower demand from traders that operate in the parallel export market. Oldtown has been able to work with Alibaba group to convert parallel import sellers into official Oldtown sellers on their Tmall platform. We are positive on this as we expect the group to regain their pricing power in the long run.

• We can expect some margin pressure moving forward as raw material contracts are usually rolled over in the 3Q-4Q. To note, sugar, coffee and non-dairy creamer prices have increased yoy. Management guided that there is a strategy to increase the promotional pricing by 5-10% to mitigate the margin pressure.

• In 1HCY16, Oldtown gained market share in the coffee mix segment in key markets (HK, Singapore & Malaysia) to the vicinity of 2ppts yoy and maintained their #2 position. In the white coffee segment, Oldtown maintained #1 position with circa 40%-51% share of market in key markets.

Risks

• Domestically, risks to this stock stems from the persistently low consumer sentiments, which affects scalability of its F&B operations. For the FMCG segment, risk stems from import bans or changes in regulatory requirements, which could hamper sales.

Forecasts

• We raise our forecast to reflect stronger contributions from the FMCG business moving forward. Our FY16/17 EPS is increased by 3%.

Rating

• BUY

• Positives: 1) Market leader under the white coffee business; 2) Decent dividend policy and yield; and 3) Resilient earnings and low capex requirements.

• Negatives: 1) Competitive industry with low barriers of entry; and 2) Global economic slowdown could jeopardize group’s sales and earnings.

Valuation

• Maintain our BUY call with a higher TP of RM2.09 based on P/E multiple of 16.8x based on FY3/18 EPS or circa 25% discount to regional peers’ average of 22.5x (which are much larger in terms of market cap)

Source: Hong Leong Investment Bank Research - 29 Aug 2016