We came away feeling cautiously optimistic on OLDTOWN’s prospect after attending its 1Q16 results’ briefing, which was well attended by 30-40 fund managers and analysts. 1Q16 results were dragged down by underwhelming numbers from its Café Chain (CC) division, which was hit by the weak consumer sentiment and cautious spending but mitigated by the solid growth in Manufacturing of beverages (MB), thanks to the strong robust sales as sales and marketing strategy bore fruits. All in, we Reiterate OUTPERFORM on OLDTOWN with unchanged Target Price of RM1.65. We view itscurrent low valuations unjustified with earnings growth still intact while higher earnings prospect from FMCG business will diversify the risk in the challenging retail F&B business.

FMCG to the rescue. To recap, OLDTOWN was off to a soft start in 1Q16 as net profit fell 18.9% to RM9.5m on the back of lower revenue of RM94.1m (-3.9%). The key factor behind the decline was the 19.1% drop in revenue contribution from CCbusiness, which in turn caused the huge decline in segmental PBT (-46.4%). MBrecorded healthy growth with revenue increasing 10.3% and PBT surging 29% which mitigated the weak performance in CC division.

Sales growth to be subdued in CC. GST implementation took a big toll on the CC division while lower revenue was also partially due to the timing of fasting month (June in FY16, July in FY15). PBT margin eroded by 5.6ppton the back of the lower revenue with some of the outlet sales unable to cover the fixed costs. Moving forward, management expects the 2Q16 sales growth to be flattish YoY but anticipates growth starting 3Q16 with the gradual recovery in consumer sentiment and spending. The Group is targeting the family & kidssegment with a joint movie promotion being lined up as one of the penetration strategies while the 10th Anniversary promotion has also garnered positive response. All in, we view the division cautiously as we think that the consumer spending in the retail space might not be recovering fast enough.

Steady growth in MB. Management indicated that local sales surged 28% YoY due to aggressive post-GST promotion and the effective appointment of new distributors to expand distribution channel. Meanwhile, export sales shrunk by 5.2% with Hong Kong market being disrupted by the influx of parallel imports while China was in transition where the Group was looking to rationalize its chain development and distribution channel. However, we understand that the issues in Hong Kong have been dealt with while the rationalization in China should pay dividends starting 2Q16. As for the impact from stronger USD, management revealed that the forex gain only accounted for <10% of PBT due to local sales contribution as well as the importation of raw materials. Moving forward, we foresee the strong local sales momentum to be sustained while the export sales to normalize from a temporary blip and forecast the division to grow by 8.7% in FY16E.

Reiterate OUTPERFORM with Target Price of RM1.65. Our TP is unchanged based on CY16E PER of 14.1x. The stock is currently trading at 11.5x PER CY16E, close to -2 SD over the 3-year mean which we deem as unwarranted considering the expected positive earnings growth of 1.7% and 9.3% in the next 2 years and we expect the MB division to drive growth. Worth noticing, the contribution of MB division to group PBT has grown to 56% in FY15 from 45% in FY12 while we forecast the contribution to further expand to >60% in FY16 with the resilient demand for FMCG products. As such, we believe investors should angle OLDTOWN as a growing FMCG play, which can offset the earnings volatility risk of the more challenging retail F&B sector. 

Source: Kenanga Research - 1 Sep 2015