We came away from F&N’s Investor Day cum Plant Visit, at its Pulau Indah dairy plant, feeling cautiously optimistic on its short-term prospects. While domestic demand could be slated to recover, the Thailand market may be challenging on declining consumer spending appetite. Saving graces could come from higher exports, recovering input costs (i.e. sugar, milk) and investment-driven improvements in efficiency. Maintain UP and TP of RM32.15.

Mixed non-export sales performance. In the recent 9M18m, the group recorded flattish sales from both F&B Malaysia and Thailand operations. As management claimed double-digit growth in exports, it is possible that it made up for the poorer performance in both markets. Poorer Malaysian sales during the year could have been attributed to lower consumer spending but is thought to be improving in recent quarters as sentiment improves. Thailand’s market, on the other hand, is likely clouded by an aggressively growing competition, with sales contributions on a steeper decline.

Export growth target on track. Recall that management aimed for total export contributions of RM800.0m (F&B Malaysia: RM500.0m, F&B Thailand: RM300.0m) by FY20. Although a stronger Ringgit may impede exports growth, we believe the group may well be able to achieve this milestone ahead of its target. We expect exports to contribute up to c.RM714.2m in FY18 (+15% from RM623.7m in FY17) which would be driven by increasing volume sales with a growing portfolio of export customers. This could potentially translate into c.20% annual growth in the coming years.

Encouraging shift in input cost. 9M18 gross profit margin appeared to be dampened (-0.6ppt YoY) as raw materials prices were procured at higher levels. However, as lower sugar prices (est. -15% YoY) appear to have been factored in the recent quarter, it is possible that the group could operate in a lower production cost environment in the near-term. Management further believes that the current sugar prices could be sustainable and benefit the coming quarters. Cost pressure exposure to milk prices is also expected to ease as the average rate for AMF and skim milk powders show a 5-10% decline. We suspect these two cost components account for c.60% of the group’s input costs.

Pushing harder. While challenges arise in the domestic sales scene, the group continues with building its product profile by rebranding products and improving on existing formulations to garner consumer support. The group’s 2017 RM500.0m capex plan continues to roll out steadily with further projects such as expanding on condensed milk lines in Rojana and adding to the cold aseptic PET line and warehouse in Shah Alam to be completed in the near future. This should allow the group to further add capacity while introducing further economies of scale.

Post-Investor Day, we make no changes to our earnings assumptions as we believe the abovementioned has been sufficiently accounted for.

Reiterate UNDERPERFORM with an unchanged TP of RM32.15. We derive our TP from an unchanged 28.0x FY19E PER (+1.0SD over 3- year mean PER, applied across large cap F&B stocks). We believe the anticipation of better operational gains has already been priced in. Furthermore, dividend expectations from the stock may continue to be tepid due to its low-yield prospects. Nonetheless, the group’s strong operating cash position could allow for further investments for further operational enhancements.

Risks to our call include: (i) stronger-than-expected sales, (ii) lower- than-expected operating costs, and (iii) favourable currency exchange exposure to the group.

Source: Kenanga Research - 15 Aug 2018