1H17 net profit of RM64.2m (-9% YoY) came below expectations due to higher raw materials cost. No dividend was declared, as expected. While we believe there could be potential easing of commodity prices in the near future, prevailing expensive forex rates may continue to keep costs high in the short term. Maintain MARKET PERFORM with a lower TP of RM54.15 (from RM55.44) as we cut our FY17E/FY18E earnings estimates.

1H17 net profit was below expectations. 1H17 net profit of RM64.2m was below expectations, making up 44% of our full-year estimate. The negative deviation was a result of stronger-than-expected impact from rising commodity prices, led by unfavourable exchange rates. No dividend was declared this quarter, as expected.

YoY, 1H17 revenue of RM513.6m improved by 4%, possibly due to higher demand for dairy products on Hari Raya festivities. However, gross profit contracted by 5% to RM205.6m as higher forex as well as milk powder price averages dragged gross margin to 40.0% (-3.4 pts). Operating profit declined further by 11% to RM84.6m, which we believe was aggravated by heavier marketing expenses incurred to stimulate demand in a weaker consumer environment. 1H17 net profit closed at RM64.2m (-9%) following a lower effective tax rate of 24.3% (-2.8 pts).

QoQ, while 2Q17 sales grew by 5% for the similar abovementioned reasons, gross profit levels were flattish due to higher raw material prices in the current quarter. This further translated to only a slight increase in operating profit and net earnings of 2% and 1%, respectively.

Better commodity outlook? While consumer demand for group products appears to be picking up pace, margins continued to experience erosion with the unfavourable forex impact and higher milk powder prices. According to Global Dairy Trade, average Whole Milk Powder price during 1H16 was USD2,092/MT while registered at USD3,112/MT on average in 1H17. In the meantime, the indicative average exchanges rates during the same period were at RM4.10/USD and RM4.39/USD, respectively. However, as current milk prices appear to be moving sideways at a more favourable base, we believe this could help margins to recover to more palatable levels, notwithstanding further weakness in forex exposure.

We cut our FY17E/FY18E assumptions by 3.3%/2.3% as we adjust for thinner profit margins, primarily led by higher average raw materials cost assumptions.

Maintain MARKET PERFORM with a lower TP of RM54.15 (from RM55.44, previously), based on our revised FY18E EPS of 242.9 sen against an unchanged targeted 22.3x PER, which is in line with the 3- year mean. While we have adjusted our FY17E DPS to 220.0 sen from 240.0 sen in line with the weaker results, we believe the pay-out of slightly above 100% of net earnings is possible based on the group’s track record.

Source: Kenanga Research - 23 Aug 2017