We came away from F&N’s FY18 results briefing feeling cautious on its near-term prospects. While we anticipated the softer demand from Malaysia (with sugar taxes) and Thailand to be alleviated by easing production costs and operational savings, the group will see higher tax exposure from Thailand with the lapse of incentives. Maintain MP but with a lower TP of RM33.30 (from RM34.45) as we adjust earnings, mainly from the higher tax.

Exports continue to hold the fort. In the recent FY18, the group saw flattish sales due to stagnant performance from both F&B Malaysia and Thailand segments. However, it appears that the domestic segment is in a decline as total group exports (guesstimated at c.RM700.0m, +16% YoY) bolstered double-digit growth thanks to efforts to widen market reach. Malaysian sales performed weaker likely on lower consumer spending during the earlier periods of the year. Thailand was also depressed by soft economic conditions but is anticipated to recover on improving unemployment rate. Management maintains its target to achieve RM800.0m revenue contribution from exports by 2020, which we believe is achievable with the favourable reception of group’s products abroad.

Balance in costs. Excluding one-off restructuring expenses, the group improved its FY18 PBT margins to 10.3% (+0.4ppt YoY), thanks to better production cost positions and improvements in production capabilities following the group’s streamlining efforts. To recap, the group had incurred an expense of RM52.7m in FY17 to rationalise storage systems and manpower requirements. Management anticipates that the improved operation landscape will provide the group some support against any slowing top-line performance, backed by more favourable hedging positions. Although, we believe the shift in commodity prices may cause this to only be a short-term boon.

Macro challenges incoming. In response to the coming sugar tax to be implemented in April 2019, management expressed the intention for more R&D efforts to introduce beverages, which are below the taxable criteria. However, it is likely that any new products from this may not hit the market before April 2019. The guided beverage portfolio affected by the tax could be up to 80% of existing products, which we believe could translate to up to 40% of total group revenue. In addition, tax benefits enjoyed by F&B Thailand have lapsed and they would have to pay the full corporate tax rate of 20% going forward. This would cause a sizeable dent to the group’s overall effective tax exposure, which stood at below 10% in FY17-FY18.

Post-briefing, we reduce our FY19E/FY20E earnings by 3.2%/5.6% mainly due to the higher tax exposure. This also leads to a cut in our dividend expectations to 66.0 sen/70.0 sen from 70.0 sen/75.0 sen, based on a c.60% pay-out ratio (within the 3-year average).

Maintain MARKET PERFORM with a lower TP of RM33.30 (from RM34.45, previously). We derive our TP on an unchanged 30.0x PER (+1.0SD on its 3-year average Fwd. PER) on its lower FY19E EPS. While the stock had traded at a +2.0SD on its 3-year average Fwd. PER valuation during early 2018, we believe sentiment has softened in anticipation of the above. Hence, upside may be limited. Further, dividend yields of 2.0%/2.1% in FY19/FY20 may not be attractive to investors.

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

Source: Kenanga Research - 13 Nov 2018