We attended OLDTOWN’s 2Q18 results’ briefing and came out positive on its growth initiatives. The Café Chain segment could potentially benefit from a larger foreign footprint and new convenience concept store. The FMCG segment is expected to derive growth from its widening reception, particularly in the Greater China Region. Maintain OUTPERFORM with a TP of RM3.15.

Expanding café chains abroad. In 1H18, Café Chain sales saw a decline to RM92.0m (-3%). However, same-store-sales growth (SSSG) only saw a slight reduction (-<1%) from fewer operating outlets (1H18: 232 stores vs. 1H17: 238 stores). We noted that several new openings in Myanmar and Indonesia may have lowered the growth average. Going forward, we anticipate more openings within China following the signing of a territorial license agreement in Aug 2017. On the local front, the group intends to introduce a new store concept with improved convenience, akin to public rest stops. We are positive with this approach as it brings the Oldtown brand away from the conventional restaurant setting to serve more time-sensitive customers. On the recent fire accident in the central kitchen, management commented that disruption of the group’s F&B supply chain was insignificant as contractors were approached to prevent stock shortages. The insurance coverage on fire and consequential lost is also expected to minimise any financial impact.

Manufacturing still booming. To recap, 1H18 FMCG manufacturing sales recorded at RM131.5m (+22%). This was backed by stronger sales in both domestic (+16%) and export (+25%) demand. The burgeoning local demand is likely driven by: (i) its growing e-commerce presence, and (ii) penetration into rural markets through strategic retailers (i.e. 99 Speedmart). In the export market, the Greater China region continued to dominate export proportions, accounting for 50% of total FMCG sales. Given its significantly larger market, we do not foresee the group to rest in expanding potential demand base. Further, the group is expected to perform strongly in the following quarter thanks to their growing participation in the Chinese e-commerce space.

Brewing smoothly. The Oldtown Coffee brand continues to demonstrate encouraging traction in the domestic and foreign market. We believe the group will be well-equipped to cater for the demand growth despite the recent setback in its central kitchen in which certain areas are undergoing safety improvements. In anticipation of greater growth in the medium term, management intends to improve its coffee manufacturing capabilities by investing in new mixing and filling lines. We believe the sell-down of the stock following the fire accident in its central kitchen in September is overdone as fundamentals remained mostly intact.

Post briefing, we maintain our FY18E/FY19E earnings assumptions.

Reiterate OUTPERFORM and TP of RM3.15. Our valuation is based on an unchanged 18.0x FY19E PER (in line with the stock’s +2SD over its 3-year forward average PER). Dividend yields for the stock could possibly register at 4.2%/4.6% in FY18E/FY19E, assuming a pay-out ratio of c.70%, which is closely in line with the group’s 2-year historical trend. This is above the group’s formal minimum pay-out ratio of 50% of net earnings. The re-designation of the stock’s shariah status will also encourage participation of investors seeking such investment requirement.

Risks to our call include: (i) lower-than-expected consumer demand, (ii) slower-than-expected completion of new chain outlets, and (iii) higher-than-expected cost exposures.

Source: Kenanga Research - 4 Dec 2017