We came away from F&N’s 1H18 results briefing feeling cautious on its short-term prospects. Challenges are from slowing demand in both Malaysia and Thailand, diminishing gains from weakening foreign currency and operating cost pressures. Reiterate UNDERPERFORM with a lower TP of RM27.00 (from RM29.10) as we revise our earnings assumptions to account for the above.

Non-export sales hindered. In the recent 1H18 results, the group registered flattish sales from both F&B Malaysia and Thailand operations. However, as management described growth in exports from both segments by c.15%, it is likely that domestic sales have declined. While Malaysian demand could still be affected by intense price competition in the soft drinks market, sales in Thailand could be clouded by softening local spending possibly arising from the rise in fuel prices. While it is possible that these challenges may persist in the short term, management aims to continue staying relevant by ramping up on marketing exercises and introducing new product innovations.

While export volumes are on the rise, total returns could diminish following the recovery of the Ringgit. It is estimated that domestic Malaysian sales account for c.50% of group revenue, while 35% and 15% are derived from sales in Thailand and other exports market, respectively. Normalising for forex, we estimated FY17 export growth to linger at c.25%, without which saw a 32% increase. Unless sales volumes pick up significantly, a stronger Ringgit environment would be less favourable for the group. Our Kenanga in-house’s estimate for the average USD/MYR rate in CY18 stands at RM3.90/USD.

Intruding cost factors. The 2.3ppt fall in 1H18 gross profit margin was attributed to toppish raw material prices (i.e. sugar and milk) and rise in packaging expenses, although management anticipates a recovery in costs by 4Q18. While operating expenses are easing following the restructuring exercise implemented in FY17 and capex plans to resolve bottleneck issues and expand manufacturing capabilities are in place, we believe the inability to regain consumer demand in key domestic segments may lead to cost overrun. On the other hand, marketing spend may continue to be aggressive in order to capture the said demand.

In for the long haul. Despite short-term headwinds, the group is slowly building towards a strong foundation to achieve longer term growth objectives (i.e. new product offerings, better production capabilities). Product innovations are leaning towards healthier options (i.e. 100Plus Less Sugar) which could tap into more conscious consumers. The group continues to aspire to expand its export base to contribute RM800.0m by FY20 and may undertake more aggressive strategies to achieve the milestone.

Post-briefing, we reduce our FY18E/FY19E earnings by 11.2%/7.2% mainly due to the abovementioned factors. In addition, we also reduce our FY18E/FY19E dividends to 60.0 sen/70.0 sen from 70.0 sen/75.0 sen to adjust for the recent earnings miss. The payment is based on a c.60% payout ratio, closely in line with FY17.

Reiterate UNDERPERFORM with a lower TP of RM27.00 (from RM29.10, previously). We derive our TP on an unchanged 23.5x PER (5-year average Fwd. PER) on its lower FY19E EPS. Currently, the stock is trading above +2SD on its 5-year average Fwd. PER, which appears excessive considering the absence of significant short-term growth catalysts. In addition, dividend yield of 1.7%/2.0% in FY18E/FY19E may not be attractive to investors.

Source: Kenanga Research - 7 May 2018