Period  1Q15

Actual vs. Expectations OldTown recorded net profit of RM11.7m in 1Q15, which was a marginal decline of 4% YoY and 2% QoQ.

Meanwhile, the top line enjoyed a healthy growth of 7.3% YoY and 3% QoQ to RM97.9m.

 The result is deemed below expectations; accounting for only 19.1% and 20.2% of our forecast and consensus. The negative deviation can be attributed to the higherthan-expected operating costs as more advertising and promotional expenses (A&P) were incurred to counter the subdued consumer sentiments as well as increased competition, particularly in the manufacturing of beverages division (MB).

Dividends  No dividend was declared, as expected.

Key Results Highlights YoY, revenue grew 7.3% thanks to the 9.6% increase in its MB division and a modest 5.5% growth in its café chain division (CC) on the back of more aggressive A&P activities. However, net profit fell slightly by 4% to RM11.7m as margins were under pressure as new store openings incurred extra expenses.

 QoQ, the top line growth was flattish at 3% but the PBT declined by 10.1% to RM15.3m from RM17m as the PBT margin narrowed by 2.2ppt to 15.7% due to the aggressive A&P activities in its CC division to boost sales on the back of soft consumer spending. Furthermore, higher selling and distribution expenses were incurred in its BM division as we gather that the competition in the market heated up due to the lower consumer spending on the back of higher living costs as well as the entrance of new competitors.

Outlook  Moving forward, the Group is planning to increase its regional presence by opening more café outlets overseas. 2-3 new outlets are earmarked for the Singapore market while another 6-8 new outlets are planned for the Indonesian market. As for the China market, the Group is taking a conservative stance by monitoring the market conditions closely before making further commitment.

 As for the BM segment, we reckon that it will be challenging for the Group moving forward as the raw material prices, particularly coffee beans, continue to trend higher. While we understand that the Group is less affected by the higher coffee bean prices after it locked in supplies at CY13 prices for the FY15 production, we are still concerned as the Group might see sharp increases in raw material costs should the drought in Brazil (which produces c.40% of the world’s coffees) persists.

Change to Forecasts We cut our FY15-FY16 forecasts and impute the higherthan-expected operating costs as we had been too optimistic on our cost assumptions. As a result, FY15-FY16 net profits are slashed by 15.3%-17.6%.

Rating Downgrade to UNDERPERFORM from MARKET PERFORM

 We had turned negative following the disappointing earnings, while the revised forecasts indicated low earnings growth of 3% in FY15. We expect the Group to face a tough time going forward in both its CC and BM division on the back of rising operating costs as well as softer consumer sentiment. DY is unattractive at 3.4% and we think it is not sufficient to compensate for the risk with the imminent implementation of GST expected to put further dent to the discretionary consumer spending as well as the overall outlook of the sector.

Valuation  Correspondingly, our Target Price was toned down to RM1.90 from RM2.25 following the earnings cut. We peg the stock with higher PER of 17.1x (from 16.7x) against the revised FY15 EPS of 11.1 sen as the mean inched higher following the share price movement. The valuation is still unchanged at +0.5 SD of its 2-year mean PER.

Risks to Our Call  Lower-than-expected market competition level.

 Lower-than-expected operating costs

Source: Kenanga