1H19 CNP of RM372.4m (-6%) came in below expectations due to costlier raw materials and higher operating expenses. Meanwhile, it declared dividend of 70.0 sen, deemed to be within expectations. Moving forward, sturdy top-line growth could be undermined by the impact of volatile forex fluctuations against commodity prices. Downgrade to UP with lower TP of RM128.00 (from previously RM137.00) following earnings revision of -8.5%/-6.5% for FY19E/FY20E.

Missed expectations. 1H19 core net profit of RM372.4m (arrived at after stripping off one-off disposal gain of RM19.7m) came in below expectations at 51% each of our and consensus forecasts. Note that 1H historically formed up to c.60% of full-year’s earnings due to festiveled buying. We believe the deviation is largely due to higher-thanexpected raw material cost and higher operating expenses (likely from aggressive marketing to fuel new launches). A declared dividend of 70.0 sen is deemed to be within expectations.

Dragged by higher costs. 1H19 CNP plunged 6% YoY to RM372.4m. We believe the decline largely stemmed from: (i) inflated raw material costs in tandem with unfavourable forex fluctuations, which depressed gross margins by 0.8ppt to 37.7%, (ii) diminishing core EBIT margin of 18.3% (-9.0 ppts), likely due to higher marketing spends, and (iii) higher ETR of 23.4% (+1.4 ppts) following the expiration of tax incentives. For 2Q19, CNP declined by 18% YoY to RM137.2m similarly due to the aforementioned reasons.

QoQ, 2Q19 CNP dropped 42% to RM137.2m, similarly due to: (i) higher commodity prices which saw gross margin sequentially contracted 3.0 ppts to 36.2%, and (ii) higher operating costs for its new product launches. As usual, 2Q19 sales declined by 8% owing to slower demand during the fasting season and stronger 1Q demand helmed by CNY festivities.

No escape from global headwinds. In terms of sales, we are still confident that the group could register solid top-line growth, backed by its market-leader position with backing from its product innovations. Additionally, the ongoing consolidation of its Milo plant in Chembong could boost its longer-term outlook from better economies of scales and production capabilities. However, recent global developments have caused a sense of uncertainty on macroeconomic factors, most evidently on forex where rising USD rates are putting pressure on commodity prices. We estimate that 50% of the group’s raw materials are imported, while c.20% of sales is exported. We anticipate this cost pressure on commodity to linger at least for the medium term.

Downgrade to UNDERPERFORM with a lower TP of RM128.00 (from RM137.00). This is following a -8.5%/-6.5% downwards adjustment to our FY19E/20E earnings forecasts post-results, after accounting for more conservative gross margin assumptions and higher opex. Our call is based on an unchanged 42.0x FY20E PER, closely in line with the stock’s +0.5.0SD over its 3-year mean. The persistently steep valuation is largely attributed to the defensive quality of its business model and positioning as one of the very few large cap F&B stocks, as well as being a FBMKLCI index member, warranting abovemean valuations for now. Nonetheless, we believe the aforementioned merits have been largely priced in, given the projected downside to our TP and its uninspiring dividend yield of c.2.0%.

Risks to our call include: (i) stronger-than-expected sales, (ii) more favourable commodity prices, and (iii) lower-than-expected operating costs.

Source: Kenanga Research - 28 Aug 2019