1H19 core earnings of RM52.7m (-16%) missed expectations from poorer sales and higher cost environments, alongside the lack of dividends. Near-term outlook for the stock is challenged by: (i) lower sales from key segments, (ii) lower pricing to hold volume growth, and (iii) higher cost pressures based on commodity and forex trends. As we slash our earnings, we downgrade to UP (from MP) with a lower TP of RM54.60 (from RM62.90).

1H19 disappointed. 1H19 core net profit of RM52.7m missed both our and consensus expectations, making up 43% and 39% of respective full-year estimates. The negative deviation is led by declining revenue as volume growth came at the expense of lower ASPs. Higher operating expense was also incurred, likely to support the abovementioned volume growth. The lack of dividends is deemed to be a miss too.

YoY, 1H19 revenue of RM508.6m declined by 2%, likely dragged by: (i) weaker sales in the premium Infant and Toddler Formula segment, and (ii) lower ASPs on other products from the group’s re-pricing strategies. Operating profits fell by 20% to RM70.0m, while raw material costs were slightly better, higher marketing and distribution expense was incurred. This could be to drive higher volumes from the abovementioned lower prices. Subsequently, core earnings registered at RM52.7m (-16%).

QoQ, 2Q19 turnover fell by 8%, similarly due to change in product mixes. Sequentially, higher raw material costs and lower product pricing pulled margins. Furthermore, no thanks to the same reasons above, operating profit declined to RM26.0m (-41%) with core net profit at RM18.4m (-46%).

Necessary evils. Continuing with its strategic pricing strategies, the brand appears to still generate positive volume expansion. The apparent weakness in the premium Infant and Toddler Formula market could indicate tighter consumer spending amidst the current uncertain macroeconomic headwinds. However, the adoption of consumercentric pricing to hold market share could be a costly endeavour at present. This comes from our anticipation of higher raw material prices in both skimmed milk powder and anhydrous milk fat, based on ongoing price trends. While we gather that prices could be supported by the Friesland Campina group’s global procurement network, the present rise in USD rates may spell further pressure to cost management in the near-term.

Post-results, we slash our FY19E/FY20E earnings by 15.6%/13.2% on more wary raw material cost and operating cost assumptions. With this, we also narrow our dividend expectations to 160.0/175.0sen from 190.0/200.0 sen, maintaining a payout ratio of close to 100%.

Downgrade to UNDERPERFORM (from MARKET PERFORM) with a lower TP of RM54.60 (from RM62.90). Our valuations of 31.0x FY20E PER remains unchanged, being closely in line with the stock’s -0.5SD over its 3-year mean. While the stock still commands the highest ROE of c.100% amongst its large cap F&B peers, investors might be cautious given the sales and earnings risks. Additionally, lower-thanexpected dividend yield of <3% may not excite investors.

Risks to our call include: (i) better-than-expected sales, (ii) lowerthan-expected commodity prices, and (iii) better-than-expected domestic currency.

Source: Kenanga Research - 28 Aug 2019