We are initiating coverage on F&N with a MARKET PERFORM call and TP of RM24.95 based on FY18E PER of 23.5x. Growing demand and more favourable operating conditions in Thailand could help cushion weaknesses on the Malaysian front while the group’s product development competency bodes well for entry into new markets. Investments to enhance production capabilities and better cost savings could also aid the group in the medium–term.

A house-hold name. Fraser & Neave Holdings Bhd (F&N) is a longstanding FMCG beverage player with a stable of highly reputable brands in the Malaysian market, manufacturing and distributing of soft drinks and dairy products. The group also has a sizable presence in Thailand; manufacturing and distributing dairy products in the country via their wholly-owned subsidiary, F&N Dairies (Thailand) Ltd.

Better prospects in Thailand. While the group’s Malaysian operations (F&B Malaysia) have been registering declining sales from poorer consumer spending, its Thailand operations (F&B Thailand) demonstrated robust sales growth with increasing acceptance of its dairy-oriented products with expanding profits from better product margins and more effective marketing cost returns. YTD, 9M17 results shown that F&B Thailand contributed RM196.4m in operating profit, against F&B Malaysia contribution of RM132.2m, despite lower total sales. In the near term, we expect better performance from Thailand to continue supporting the softer Malaysian performance backed by stronger demand growth and conducive operating environment.

A knack for product development. As a products portfolio company, the group maintains a large stable of product brands with strong competency in product development to expand its offerings to sustain market share. When the group lost its distributorship rights to Red Bull in FY15, the group moved into the manufacturing of its own line of energy drinks (i.e. Ranger brand) to maintain its presence in the energy drink segment. The Red Bull distributorship accounted for c.5% of FY15 sales. With this, the group intends to further extend its export outreach to China and more Muslim-centric countries, primarily in the Middle East with products suited for their local tastes and culture.

Restructuring of operations to minimise expenses. To improve operating cost efficiency, the group is working towards an overhaul in production methods towards a just-in-time production method. As bulk inventories are spread across several warehouses for distribution, a more fluid supply chain could reduce the need to maintain large storage spaces going forward. Management estimates that the present daily inventory storing cost amounts to c.RM1.0m per warehouse.

While we expect FY17 to end weaker with earnings of RM354.4m (- 4% YoY), we believe FY18 could potentially register at RM388.7m (+10% YoY) owing to the above-mentioned prospects and more favourable input costs. Assuming a conservative 55% pay-out ratio (4- year historical low), the group could pay up to 52.0 sen/58.0 sen dividends in FY17/FY18 which translates to 2.1%/2.4% yield.

Initiate coverage with a MARKET PERFORM call and a TP of RM24.95. We derive our TP on an ascribed 23.5x PER (5-year average Fwd. PER) on its FY18E earnings per share of 106.1 sen. This is broadly in-line with DLADY’s targeted 22.3x FY18E PER (5-year average Fwd. PER). While at a slight premium from DLADY despite lower dividend prospects (i.e. FY18E yield: F&N @ 2.4% vs DLADY @ 4.0%), we believe the valuation is justified with F&N’s better debt management, more resilient sales prospects with its regional operations in Thailand as well as a solid growth trajectory with its expansion towards export markets and operational enhancements.

Source: Kenanga Research - 12 Sept 2017