We came away from OLDTOWN’s 3Q16 results briefing feeling more excited over its prospect after Group Managing Director, Mr Lee Siew Heng announced new plans to utilise its sizeable cash pile. The Group will be looking for M&A opportunities to drive earnings growth and proposed to distribute a special dividend to reward shareholders. Both operating segments are expected to improve from lower base due to current weak consumer sentiment and business restructuring exercises, and we think the export business potential in China can provide more upside excitement for OLDTOWN. Post briefing, we maintain OUTPERFORM on OLDTOWN but with a lower Target Price of RM1.72 (from RM1.76) after trimming our FY16E-FY17E net profits by 6.4% and 5.3% respectively.

On the road of recovery. To recap, OLDTOWN registered a net profit decline of 9.1% to RM33.9m on the back of a 3.9% drop in revenue to RM288.9m. However, we understand that the weaker set of numbers on paper was masked by the higher effective tax rate in 3Q16 (36%) due to under-provision and higher operating expenses (+11%) arising from more aggressive marketing initiatives. While the management is committed to investment in brand building in view of the competitive landscape, the tax rate will normalize in the next quarter. Thus, we believe the 9M16 performance is commendable on operating basis, taking into account the persistent weak consumer sentiment. We expect the momentum to sustain with the growth strategies in place.

Brighter days ahead for both divisions. Looking forward, management is optimistic on the continuous recovery in both operating segments. The recovery in the CC division is underpinned by its ‘Low Price Strategy’ and marketing campaigns targeted to attract the children and family customer segment. Meanwhile, the MB export sales continued to recover post distribution restructuring exercise in China with 120% sales growth on QoQ basis. The E-commerce distribution channel has grown from strength to strength and now contributes 60% of the China sales. While we think that CC business is still expected to be challenging moving forward, we think the resilient sales in MB division and the huge potential in export sales to China might paint a more exciting picture on the growth prospect for OLDTOWN.

Unleashing the ultimate weapon in cash coffer. Net cash stood at RM137.3m or 30.0 sen/share as of 9M16. Management has revealed two plans to utilize the cash pile, firstly looking for M&A opportunities more aggressively and secondly the distribution of a special dividend. Management is looking at acquiring reasonably priced businesses in complementing its existing business, particularly in the upstream, i.e. raw material suppliers. Meanwhile, no exact quantum was disclosed but assuming special dividend of 4.0 sen lifting FY16E DPS to 10.0 sen, it would translate into a yield of 6.5% at current price level. We are positive on both plans as the former could drive its earnings growth beyond organic growth, which is expected to be modest; and the latter could stimulate sentiment on the stock.

Reiterate OUTPERFORM with lower Target Price of RM1.72 (from RM1.76). Post-briefing, we trimmed our FY16E-FY17E earnings by 6.4% and 5.3%, respectively, after revising up our effective tax rate assumptions. Correspondingly, our TP is revised lower to RM1.72 (from RM1.76), based on unchanged 14.1x PER FY17E, which implied -1 SD over the 3-year mean.

Source: Kenanga Research - 29 Feb 2016