9M17 net profit of RM96.7m (-13%) came below expectation due to higher input costs while YTD dividend of 280.0 sen is above expectation. While average raw material prices may remain high in the short term, the recent strengthening of the local currency may improve costs in the medium term. Maintain MARKET PERFORM with a lower TP of RM57.00 (from RM58.20) as we trim our FY17E/FY18E earnings assumptions.

9M17 below expectation. 9M17 net profit of RM96.7m is below expectation, making up of 69% of our/consensus full-year estimates. The negative deviation was caused by stronger-than-expected impact from rising commodity costs, likely led by the spike in Anhydrous Milk Fat (AMF) prices. A total of 110.0 sen dividend was declared this quarter. YTD dividends amounted to 280.0 sen, which beat our full-year assumption of 220.0 sen.

YoY, 9M17 sales of RM795.5m grew by 3%, possibly backed by the re- launching of the premium Friso brand. Higher input costs during the year (i.e. higher average milk prices and unfavourable exchange rates) led to lower operating profit of RM127.4m (-14%) and margins at 16.0% (-3.2ppt). It should be noted that distribution expenses have lowered by 8% following the implementation of operational enhancements during the year (i.e. operating software upgrades, staff cost rationalisation). This translated to a 9M17 net profit of RM96.7m (-13%).

QoQ, 3Q17 sales of RM281.8m demonstrated a 7% growth following more aggressive promotional activities conducted. Operating profit of RM42.8m was flattish, as higher raw material costs during the quarter were offset by operational cost savings, likely the abovementioned enhancements. Net earnings during the period tipped marginally to RM32.6m (+1%) on slightly more favourable taxes.

Milked by cost pressures. Note that the primary production cost factors of the group include skimmed milk powder and AMF. While global skimmed milk prices have shown a c.10% recovery since Jan 2017, AMF prices on the other hand rose by c.30% (source: Global Dairy Trade). That said, given that these ingredients are imported, we believe there could be an easing in the way of the strengthening of our local currency though the offsetting impact is minimal. On the other hand, production matters aside, we believe that the group’s longstanding brand equity is able to keep its product offerings relevant to the market. Furthermore, we view milk products as relatively inelastic in demand to consumers as they are essential for the physical development of infants and toddlers.

Post results, we trim our FY17E/FY18E earnings assumptions by 9.1%/6.2%, primarily led by higher average raw materials cost assumptions. Subsequently, we reduce our FY18E dividend expectations to 230.0 sen from 240.0 sen on lower earnings.

Maintain MARKET PERFORM but with a lower TP of RM57.00 (from RM58.25, previously). This is based on a revised FY18E EPS of 227.9 sen. In addition, we ascribe a higher 25.0x PER (from 24.0x, previously) as we relook at the group’s 5-year mean PER. The 5-year average PER valuation is in line with the larger cap F&B players, such as NESTLE and F&N, given their status as market leaders.

Source: Kenanga Research - 29 Nov 2017