We attended the analyst briefing for OldTown Berhad (OldTown) which saw a solid crowd of approximately 30 analysts and fund managers. We came away comforted by management efforts to ensure business sustainability although near term catalysts are lacking. OldTown is embarking on aggressive advertising campaigns to maintain local market share in a very competitive space. Its cost efficiency should also improve as they are revamping and expanding distribution networks. We also gather that the sharp rise in international Arabica coffee prices will unlikely affect FY15 margins as costs has been locked in for the year. However, new store openings in both the local and foreign market have been soft while its expansion into Australia is unlikely to be substantial in the near term. Growth from China is also unlikely to unfold this year as the group is restrategizing its positioning of its concept. There are no changes to our earnings estimates. We reiterate our MARKET PERFORM rating and maintain our TP of RM2.25 based on an unchanged Fwd P/E of 16.7x over FY14 EPS of 13.5 sen.

Maintaining market share via aggressive advertising campaigns. To maintain its brand presence in the Malaysian market, the company has embarked on aggressive marketing through multiple media channels to promote its café and Fast-Moving Consumer Goods (FMCG) businesses. OldTown sponsored an advertisement in collaboration with actors from the movie “The Journey”, which aired on Chinese channels in 1Q14, to promote its café operations. In terms of print media, the company released editorials in various languages across multiple national newspapers, in addition to its online editorials and sponsoring onthe-ground campaigns in KL, Johor and Terengganu.

Expanding local and foreign distribution networks. OldTown has restructured its distribution system in Malaysia by appointing a different distributor in East Malaysia which now also covers Brunei instead of only Sabah and Sarawak previously. In West Malaysia, OldTown has now appointed a distributor which is able to cover approximately 80-85% of its target locations versus 4-5% under the self-distribution method. Internationally, OldTown has also appointed PT Sukanda Djaya (Indonesia) and Dranix Distributors (Philippines) which are both key distributors for popular MNC brands in their respective countries. We view the move to employ external distributors favorably as OldTown will be able to take advantage of wider distribution networks in a shorter timeframe and in a more cost-effective manner.

Margin unaffected by sharp rise in Arabica coffee prices. Despite a sharp increase in Arabica coffee prices in 1H14 (averaging USD3,450 per metric ton (MT) YTD vs USD2,730/MT in CY13), we expect impact on OldTown to be less severe as they have been able to lock-in at CY13 prices for FY15 production. However, if the drought in Brazil (which produces about 30-40% of the world’s coffee) persists beyond 2014, the higher coffee prices may start to affect OldTown’s FCMG margins.

Slower-than-expected new store openings. In the latest quarter, net new outlet openings were 4 stores (or 13-17% of the group’s full-year target of 24 – 32 stores). 6 new outlets were opened in Malaysia but 3 stores were closed for re-location, for a net growth of 3 outlets. Internationally, 1 store was closed in China, while in Indonesia, 3 new outlets were opened but 1 outlet was closed for re-location, resulting in net international outlet growth of 1 store. We are not overly concerned on the lower net store openings as we believe it would be more prudent for management to carefully optimize new store locations rather than rush into opening new outlets. Although the central kitchen in China is now operational, management is now rethinking its strategy to account for cultural perception of the brand as a coffee outlet (ala Starbucks) rather than a full-service F&B restaurant. As such, we believe new restaurant openings in China will be slow. Hence, we maintain our FY15 assumption of 22 net new store outlets for both the local and foreign market. Thus, no changes to our earnings estimate.

Australian expansion in early stages. We are long-term positive on the news of OldTown expansion into Australian F&B market, with the company planning to open at least 44 stores in the next 10 years. However the expansion is currently in its early stages, with the first outlet to open in 9-12 months (1QFY15). Thus we do not expect a significant impact from Australia in the near term, although earnings prospects are favorable in the long term.

Maintain Market Perform and Target Price. We maintain our TP of RM2.25 based on a Fwd. P/E of 16.7x over its FY14 EPS of 13.5 sen. Our target P/E implies a +0.5SD to its 2-year historical average P/E of 15.3x, and is in line with regional peers valuation in the consumer F&B subsector. Our current TP of RM2.25 reflects a total return of 4.5% (upside 1.4%, dividend yield 3.2%). Thus we maintain our MARKET PERFORM rating at a total return of less than 10%.

Source: Kenanga