1Q17 net profit of RM31.9m (-6% YoY) was below expectations due to higher raw materials cost. YTD dividends of 170.0 sen declared exceeded expectations. With the prevailing weakness of the market, the group may have to incur steeper marketing expenses amidst high input costs to stimulate spending. Downgrade to UNDERPERFORM with a lower TP of RM55.44 (from RM59.74) as we cut our FY17E/FY18E earnings estimates.

1Q17 net profit was below expectations. 1Q17 net profit of RM31.9m was below expectations. The negative deviation was a result of wider-than-expected impact from the recovery in commodities prices. YTD dividend of 170.0 sen declared was above our expectations, with 110.0 sen declared as special dividend. We estimated a full-year dividend payment of 240.0 sen.

YoY, 3M17 revenue of RM250.1m was flattish as compared to RM249.8m for 3M16. Although prevailing weakness in consumer sentiment continued to hamper spending habits, we believe the stable sales were backed by new product launches to support demand. Gross margins fell to 41.0% (-2.5 pts) owing to higher milk prices (indicative milk powder prices have shown a c.40% increase between 1Q16 and 1Q17 prices. Source: Global Dairy Trade). While operating profits declined by 7.4%, operating margins only declined by 1.4 pts to 16.7%, possibly as a result of the system upgrades invested by the group as part of its cost savings initiative. With the above, net profit declined by 6% to RM31.9m.

QoQ, 1Q17 declined by 8% due to seasonality from the Chinese New Year festivities during the quarter, resulting in fewer business days and also the possibility of forward buying in 4Q16. Despite a 6% decline in gross profits, its margins improved by 0.6 pts arising from probably better product mix during the quarter. Ultimately, the lower sales volume dragged 1Q17 net profit by 16%.

A rough patch. Though there appears to be some easing of commodities prices recently, unfavorable forex may continue to be a thorn to their overall production costs. Furthermore, as the market continues to demonstrate softness, greater expenditure may have to be invested towards promotional efforts alongside product developments. Nonetheless, we still believe the strong presence of the group in the market will continue to keep the brand relevant to consumers despite a potential decline in spending.

We cut our FY17E/FY18E assumptions by 11.5%/7.2% as we adjust for thinner profit margins arising from higher average raw materials cost as well as higher marketing expenses amidst the soft market.

Downgrade to UNDERPERFORM with a lower TP of RM55.44

(from RM59.74, previously), based on our revised FY18E EPS of 248.7 sen against an unchanged targeted 22.3x PER, which is in line with the 3-year mean. While YTD dividends appear to be presently at a high base from the special dividends declared, we maintained our targeted 240.0 sen DPS for the full-year as the group has a history of paying out slightly above 100% of net earnings.

Source: Kenanga Research - 28 Apr 2017