We attended OLDTOWN’s 2Q17 results’ briefing and came out feeling that the concerns over losing its Shariah-compliant status may have been overplayed. OLDTOWN is still on track to grow its earnings with steady performance of Manufacturing of Beverages (MB) business. Upgrade to OUTPERFORM with unchanged TP of RM2.11 as we believe the current weakness offers a good entry opportunity.

More store openings lined up. To recap, 1H17 segmental PBT declined by 10.1% on the back of flattish revenue growth (+0.9%). Moving forward, the Group is targeting another 22 new outlets opening in FY17, having already opened 7 in 1H17, bringing total outlets to 238 (204 local, 34 overseas). Besides, the Group is also banking on strategies including value meals, sponsorship, new product launches to help propel growth in this segment on the back of weak consumer sentiment, showcasing the Group’s flexibility and market awareness in adopting the right strategy.

Headwinds ahead for MB. 1H17 segmental PBT surged 39.7% with revenue jumping 16.0%. Export sales continued to be the growth driver growing 35.3% YoY thanks to the recovery in China post restructuring, as well as growing demand from other export markets. However, management is still conservatively forecasting export sales growth of 10%-15% in FY17 and single-digit growth for its local sales. Meanwhile, management expects the uptick in raw material prices to inflate the costs and gross margin may narrow by 2.5-3.5 ppt but is committed not to raise selling price at least in FY17 in order to remain competitive. We keep our earnings forecast unchanged as we have initially assumed conservative margins for MB and we expect the cost inflations to me mitigated by better production efficiency.

Overplayed concerns. Share price dipped 7.4% post 2Q17 result and deletion from Shariah-compliant list. To recap, the exclusion was triggered by the lower-than-required level of cash investments in Islamic accounts, which had been rectified by the management. Besides, total shareholding by Islamic fund is not overly high at 1.6% or 7.2m shares. Thus, we believe the concern over losing the status may have been overplayed as the potential impact is minimal. However, the company is likely to lose the status for one year as the next revision in May 2017 might be too early with the authority taking annual account as review reference. (OLDTOWN’s financial year-end is on 31st March; annual report by Jul/Aug).

Upgrade to OUTPERFORM (from MARKET PERFORM) with unchanged Target Price of RM2.11. Post-briefing, we made no changes to our earnings forecasts. We also maintain our TP of RM2.11, based on 15.1x PER FY18E which is close to its 3-year mean PER to reflect the mixed outlook of both operating divisions. We upgraded our rating as we believe the share price weakness over the concerns of Shariah-compliant deletion may offer entry opportunity as the Group’s fundamental and growth prospect remain unchanged. Valuation is undemanding in view of the sturdy balance sheet (net cash as of 1H17: RM174.5m or 39.0 sen/share) and strong cash flow, which will allow the company to continue to reward shareholders with dividends.

Source: Kenanga Research - 28 Nov 2016