1H18 core PATAMI of RM14.1m (-20%) is below estimates, due to higher production costs (likely stemming from prolonged, unfavourable hedging policies) and marketing expenses. The 2.5 sen dividend announced is within expectations. We believe the group’s hedging positions will be revisited in FY19 to more optimal levels for better margins. Post results, we cut our FY18E/FY19E earnings assumptions by 23.9%/9.2%. Maintain OUTPERFORM with a lower TP of RM2.45.

1H18 below expectations. 1H18 top-line of RM228.9m is within our expectation while the core PATAMI of RM14.1m is below, accounting for 32% of full-year estimates. The negative deviation was due to higherthan-expected raw material prices. An interim 2.5 sen dividend was announced, within our estimate.

YoY, 1H18 sales of RM228.9m grew by 12%, led by a 35% increase in export sales, which was softened by a 5% decrease in domestic sales. However, adjusted EBITDA declined to RM18.6m (-48%) from lower margin at 8.1% (-9.3ppt) due to high commodity price exposures (i.e. coffee and sugar). Further, higher marketing expenses were incurred during the year on more aggressive media participation in the Middle East. Thanks to lower effective taxes at 6.9% (-1.7ppt), 1H18 core PATAMI recorded at RM14.1m (-20%).

QoQ, 2Q18 revenue grew by 10% to RM119.7m, similarly on the back of stronger exports (+24%) against a slightly weaker local demand (-3%). Operating profit expanded c.200%, mainly spurred in part by the heavier marketing costs incurred in the Middle East during 1Q18. This translated to a stronger core PATAMI of RM10.2m (+c.160%) after an effective tax rate of 8.3% during the quarter (+6.0ppt).

Cost pressures undermining perky sales outlook. The group continues to enjoy encouraging demand in the MENA region, likely backed by the group’s new “Alicafe Signature French Roast” variant. The latest export numbers accounted for around 50% of group revenue as domestic sales still proved uninspiring due to soft consumer spending. However, high commodity costs clouded recent earnings despite an overall improvement in global commodity trends. We believe this to be the continuing result of prolonged hedging positions at the beginning of the year, locked at unfavourable levels. To illustrate, average Arabica beans prices, which trailed at c.USD145/mt during the Dec 2016-Jan 2017 period, recently recorded at c.USD125/mt during Sep 2017-Oct 2017 (source: Bloomberg). Nonetheless, we are still hopeful on a shift in the costing landscape of the group in FY19 when its hedging positions incline towards greener levels.

Post results, while we maintain our FY18E/FY19E sales estimates, we tone down our margins assumptions to account for greater production costs. This lowers our FY18E/FY19E net earnings estimates by 23.9%/9.2%. In lieu of the weaker earnings, we also tweak our dividend assumptions to 10.0sen/12.0sen from 12.0sen/13.0sen.

Maintain OUTPERFORM with a lower TP of RM2.45 (from RM2.70, previously). Our new TP is derived from a revised 14.3 sen FY19E EPS against an unchanged 17.0x PER (3-year average Fwd. PER). Although we have trimmed our TP, we believe the stock’s fundamental potential is still intact given that sales numbers have been performing as expected. The stock still commands a strong potential yield of 5.0%/6.0% in FY18E/FY19E, post-dividend adjustments.

Source: Kenanga Research - 29 Nov 2017