• We initiate coverage on Oldtown Berhad (Oldtown) with a NEUTRAL recommendation and TP of RM2.90 per share

• Our valuation is based on PER18 of 20x pegged to EPS18 of 14.5sen

• FMCG segment to drive growth through export

• Synergistic value gain through vertical integration

Company businesses. Oldtown Berhad is principally engaged in the business activities of: (i) Operation of café chain (F&B segment) and; (ii) Manufacturing, marketing and sales of coffee and other beverages (FMCG segment). It invented the White Coffee category in 1999 and since then specialises in the formulation of hot and cold coffee using high quality coffee beans that have been roasted using its own unique proprietary bean roasting process. As of June 2017, the Group has a total chain of 234 café outlets, of which 197 café outlets are located in Malaysia, 25 café outlets in Indonesia, eight café outlets in Singapore, two café outlets in China, one café outlet each in Australia and Hong Kong operating under the brand name of ’Oldtown White Coffee’. While its beverages are sold in more than 8,000 retail outlets in Malaysia, 850 retail outlets in Singapore and 2,800 retail outlets in Hong Kong. Other export market includes the USA, China, Taiwan, Indonesia, Thailand, Brunei, Canada, Philippines, the United Kingdom and Australia.

Key investment thesis

i) FMCG segment to drive growth through export;

ii) Synergistic value gain through vertical integration and;

iii) Strong fundamentals

Key risks:

i) Strengthening of the Ringgit would slow down export sales growth;

ii) Stiff competition in the local F&B market might cause drag on earnings;

iii) Continuous reliance on advertising and promotional expenses to spur consumer spending

The strengthening of the Ringgit would slow down export sales growth. As Oldtown is relying on the export sales of FMCG segment to deliver growth, further strengthening of the Ringgit would have a downward pressure on its bottom line. Recall that contribution derived from overseas from the FMCG segment accounted for 65% total FMCG revenue. While the foreign currencies exposure arises from these overseas trades are mainly derived from the SGD, HKD and USD. Since April 17, all three currencies have shown consistent strengthening against the Ringgit. For instance, the MYR/USD improved to RM4.26 on 14 June 17 from RM4.42 on 30 March 17 (-3.62%) and Ringgit is expected to strengthen further to RM4.20 MYR/USD by year end.

The stiff competition in the local F&B market might further dragged down earnings. Oldtown F&B’s segment constitute a significant 88% of F&B segment total revenue. As local F&B market is undergoing a high operational cost environment as well as stiff competition. Oldtown faces competition from the players in ‘kopitiam’ segment (Papparich, Hailam Kopitiam etc), international coffee chain (Starbucks, Coffee Bean etc) as well as artisan coffee outlets. Nevertheless, it should not be a concern as no one brand can cause direct effect to other since the market volume is very large. Hence, in order to increase market share, Oldtown would have to focus on advertising, pricing and quality of their products. Due to this, advertising and promotional efforts have intensified in 4QFY17 bringing the total selling expenses to increase +31%yoy. Continuous reliance on these will pressure profit margin.

VALUATION

We are recommending a Neutral stance on Oldtown with a target price of RM2.90 per share. Our valuation is premised on FY18EPS of 14.5sen pegged to FY18 forward PE of 20x. Our target PER is based on market capitalisation weighted FY18 forward PE of Oldtown’s peers in the F&B and FMCG segment.

Source: MIDF Research - 16 Jun 2017