FY17 core NP of RM120.8m (-19%) came below expectations on higher commodity costs. FY17 dividend of 280.0 sen is within estimates. Toppish milk prices are expected to continue hampering profit potential and offset gains from forex recovery. Still, top-line should be supported by the group’s brand equity. Downgrade to UNDERPERFORM but with a higher TP of RM61.15 (from RM57.00) as we rollover to FY19E earnings with a higher PER of 26.0x (vs. 25.0x previously).

FY17 below expectations. FY17 core net profit of RM120.8m is below expectation, making up 94%/92% of our/consensus full-year estimates. The negative deviation is due to lower-than-expected sales and higher cost of sales, likely led by the rising Anhydrous Milk Fat (AMF) prices. No further dividends were declared for FY17 on top of the total 280.0 sen already paid, as expected. A 110.0 sen dividend payment was declared for FY18 during the quarter.

YoY, FY17 sales of RM1.06b grew by 2%, likely driven from the relaunching of the premium Friso brand. Operating profit stood at RM157.4m (-20%) with an average operating margin recorded at 14.8% (-4.0ppt) due to higher AMF prices and unfavourable exchange rates. Cost savings from lower distribution expenses could be attributed to operational improvements through software upgrades and manpower rationalisation. FY17 net profit came to RM117.7m (-21%). After adjusting for losses on derivatives, core net profit registered at RM120.8m (-19%).

QoQ, 4Q17 sales of RM269.1m (-5%) was lower, likely following a heavy marketing-driven 3Q17 performance. While production costs slightly improved, higher operating expenses led operating profit to decline to RM30.0m (-30%), likely driven by year-end consolidations. With higher effective taxation of 30.0% (+6.2ppt), 4Q17 core net profit finished at RM24.1m (-26%).

Peakish commodity prices. While the group is looking to benefit from the recovery in domestic currency, persistently high milk commodity prices may suggest that the group may not see a turnaround in the short term. As of Feb 2018, the 6-month average prices for AMF lingered close to its all-time high of USD6,626/mt (source: Global Dairy Trade). Cost matters aside, the group has been successful in capturing a growing market share thanks to its strong brand equity. 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 FY18E earnings by 13.4% to account for higher production costs. Subsequently, we reduce our FY18E dividend expectations to 220.0 sen from 230.0 sen on lower earnings. We also introduce our FY19E numbers.

Downgrade to UNDERPERFORM but with a higher TP of RM61.15 (from RM57.00, previously). This is based on a higher 26.0x PER (from 25.0x, previously) as we re-look the group’s 5-year mean PER. We also roll over our valuation base year to FY19E with EPS of 235.1 sen. 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 - 28 Feb 2018