Comments

• As anticipated, revenue of BFood’s Starbucks Malaysia operations is growing steadily. However, Starbucks’ EBIT margin has been depressed due to the weakening of the MYR against the USD. This is due to BFood purchasing certain raw materials from Starbucks Corp (USA) such as coffee beans, frappuccino mix and syrup which are denominated in USD. These materials account for between 40-50% of Starbucks Malaysia’s COGS. Therefore, given the recent renewed MYR weakness to ~RM4.20/US$, Starbucks Malaysia’s margins will remain depressed. This effect is illustrated over the previous six quarters (Figure 1).

• In FY17, BFood has closed one unprofitable KRR Indonesia restaurant and plans to continue to close loss-making outlets. Further closures of will reduce BFood’s effective tax rate as currently losses overseas cannot be offset back home in Malaysia, resulting in an inflated effective tax rate.

• Ready to Drink (RTD) Starbucks coffee beverages have been rolled out and are available at various supermarkets and retail convenient stores at RM12 each. Starbucks is offering a voucher that entitles the holder to a free coffee with every purchase of RTD coffee to encourage sales. Selling of RTD beverages is expected to be loss making initially as BFood struggles with weak ringgit as the product is imported from USA.

Risks

• Nandos superior brand name to KRR Malaysia threatens to take away more market share from a business unit that is already experiencing negative SSSG.

• Further Ringgit depreciation against USD.

Forecasts

• Unchanged

Rating

SELL TP: RM1.55

• Starbucks Malaysia’s top line is growing as anticipated. However, the weak MYR against the USD has depressed margins and will continue to be so until a significant change in USD/MYR exchange rate. We keep estimates unchanged despite the recent weakening of the Ringgit as we have already priced in thinner margins for FY17.
• KRR Indonesia operations are still loss making and time is required to close unprofitable stores.

Valuation

• TP is unchanged at RM1.55 but our call is downgraded from a Hold to aSell due to the recent rise in share price. Target price is derived from 25x PE of FY17 EPS.

• Two factors could trigger rerating; 1) significant MYR appreciating against the USD which would reverse margin erosion of Starbucks Malaysia and 2) speedier turnaround/closure of loss-making KRR outlets in Indonesia.

Source: Hong Leong Investment Bank Research - 14 Oct 2016