We came away feeling more reassured on its brighter earnings prospects after attending OLDTOWN’s 1H16 results’ briefing, which was well attended by 30-40 fund managers and analysts. 1H16 results recorded strong QoQ growth in 2Q16 with net profit surging 40.8% to RM13.4m thanks to improved contribution from both operating segments. Looking forward, 2H16 is envisaged to be a better half for Operation of Coffee Chain (CC) thanks to the school holidays and festivities which is further aided by the string of promotional activities in the pipeline to stimulate sales. As for Manufacturing of Beverages (MB), it will see normalization in sales growth with the completion of distribution channel restructuring in China. We view OLDTOWN as a viable laggard play in the premium F&B sector as it is currently trading at an undemanding 11.5x PER FY17E, close to -2 SD over the 3-year mean. Reiterate OUTPERFORM with unchanged Target Price of RM1.76.

Marked improvement. To recap, OLDTOWN recorded strong QoQ growth in 2Q16 with net profit surging 40.8% to RM13.4m thanks to improved contribution from both operating segments. Although the weakness in 1Q16 played a part in the eye-catching earnings growth, but we think that it was a vital turning point for the Group as the worst might be over particularly in the CC division which was significantly hurt by the persistently weak consumer sentiment and lower consumer spending. Management has painted a positive picture ahead in anticipation of better performance in 2H16 from both operating divisions.

Better days ahead for CC. CC division recorded PBT decline of 15.8% as of 1H16 on the back of revenue amounting to RM93.5m (-28.6%). The weaker sales can be attributed to the GST-led dampened consumer sentiment and spending, the recent haze issues as well as fewer operating outlets as a result of closure and relocation (242 vs 246). Looking forward, 2H16 is envisaged to be a better half thanks to the school holidays and festivities which is further aided by the string of promotional activities in the pipeline to stimulate sales. We made no changes despite the anticipation of more aggressive marketing activities as our PBT margin assumption for CC division is conservative at 11% (FY15: 13.7%).

MB to grow from strength to strength. MB division, the pillar of growth for the Group has grown 17.1% in terms of PBT as of 1H16 owing to the higher sales of RM93.2m (+11.1%). Local market recorded ‘moderate’ double-digit growth driven by aggressive promotion activities as well as the launching of new lesssugar variants, which lifted its market share in both coffee mix segment and white coffee mix segment. Meanwhile, the Group has registered single-digit growth in export market thanks to the healthy growth in key market, including Hong Kong, Singapore and Taiwan. Volume still declined in China due to the restructuring in distribution channels, but we understand that the exercise has been completed in 2Q16 and sales growth should normalize in coming quarters.

Reiterate OUTPERFORM with Target Price of RM1.76. Our TP is unchanged based on FY17E PER of 14.4x, slightly above its -1 SD over the 3-year mean, a valuation we think reflects the risk in the retail-based CC division. The stock is currently trading at undemanding 11.5x PER FY17E, 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 think that the negatives have been priced in.

Cheaper option to premium F&B sector? We observed that F&B stocks have been garnering investors’ interest due to their resilient nature, export exposure and also falling commodity prices, which resulted in valuation re-rating. Thus, we think that OLDTOWN could be a viable laggard play in the premium F&B sector. While we believe that the concern on the more discretionary retail-based CC business might be the reason behind the depressed valuation, its PBT contribution to the Group has shrunk to 32.8% in 1H16 from 44% in FY15 (FY12: 55%) which profiled it more as a growing FMCG play. Besides, its strong balance sheet position with net cash of RM151.0m (32.6 sen/share) provide further room for higher dividend pay-out which we estimated at 6.0 sen/share and 6.5/share (yield: 4.3% and 4.6%) for FY16E and FY17E, respectively, based on a conservative pay-out ratio of c.52% vs 4-year’s average of 55%. Potential dividend yield might exceed 5% if the Group pays 60% of its earnings. 

Source: Kenanga Research - 27 Nov 2015