We came away from F&N’s FY17 results briefing feeling optimistic on the fruits of the group’s operational restructuring exercise for a more efficient supply chain on the Malaysian front. Furthermore, introduction of new products and revamping of existing brands in FY18 could benefit its market share in the near term. Upgrade to OUTPERFORM with a higher TP of RM27.60 (from RM24.95), following our revision primarily on better margins assumptions.

Investments into F&B Malaysia to pay off. Recall that in the recent FY17 results, the group’s F&B Malaysia operations registered lower sales of RM2.3b (-8% YoY) dragged by weak consumer sentiment. Competition was also highly intense as competitors engaged in a cutthroat price war with the introduction of RM1.00 products to obtain market share. During the year, the group had undergone an operational restructuring exercise to rationalise its supply chain and reduce unnecessary costs. Less the RM48.9m incurred during this exercise with other one-off items, the group would have recorded an operating profit of RM169.6m (-22% YoY) with lower margins at 7.3% (-1.3pts). However, this was in spite of higher input costs and marketing expenses on the SEA games. Management guided that the exercise has been completed in Oct 2017.

F&B Thailand holding its own. The F&B Thailand segment performed better with sales of RM1.8b (+9% YoY) led by stronger export demand for its products. Local sales growth was softer due to national events, but is looking to recover in the near-term. FY17 operating profits further improved by 22% YoY to RM232.8m as stronger margin of 13.1% (+1.4pts) which was achieved by the more favourable input costs there. Going forward, the segment’s prominent export markets (i.e. Myanmar and Laos) are likely to be the main focus of its product expansion plan given the favourable on-going traction.

Following the one-off restructuring exercise, operating levels are currently expected to perform at more favourable levels. Such strategies include rationalising storage systems and manpower requirements. We believe that the improved operating landscape is sustainable as the new structure had been progressively implemented throughout FY17 to optimise production rates. In addition, the rolling out of new production lines in 1Q18 is also expected to solve bottleneck issues and improve production capacity and efficiency.

Excitement in hindsight? The group was at the forefront in advertising the 100 Plus brand during the recent SEA Games. While new products are expected to be introduced in FY18 to the group’s global portfolio, we do not anticipate marketing expenses to amount to the same magnitude. Furthermore, to mitigate the longer-than-expected softness in domestic sales, the group is looking to emphasise export efforts towards the core Halal markets in the MENA region, especially on the group’s more profitable and high-value dairy products.

Post-briefing, we upgrade our FY18E earnings by 10.8% mainly due to the higher operating margins driven by the above. We also raise our FY18E dividends to 70.0 sen from 58.0 sen from the improved earnings estimates. In addition, we also introduce our FY19E numbers.

Upgrade to OUTPERFORM with a higher TP of RM27.60 (from RM24.95, previously). We derive our TP on an unchanged 23.5x PER (5-year average Fwd. PER) on its higher FY18E EPS. The strong operational improvements should provide the group sufficient leverage to weather out the industry-wide bane of unfavourable commodity exposure. The group is also backed by its net cash position shall they require further funding to execute additional operational enhancements.

Source: Kenanga Research - 9 Nov 2017