OldTown’s share price has corrected >20% from its high of MYR2.22  in the  past three months. Although we expect growth to remain muted for the  remaining  three  quarters  after  its  weak  1QFY15  performance,  we believe  its  growth  momentum  will  gain  pace  thereafter.  Maintain  BUY with a revised TP of MYR2.15 (from MYR2.30), implying a 25.7%  upside. The stock is currently trading at an undemanding FY16 P/E of 12.8x.

Recent share price  retracement. OldTown’s share price has corrected by >20% from its high of MYR2.22 in the past three months. We believe the  retracement  was  due  to  a  combination  of:  i)  weak  1QFY15  (Mar)results, ii)  the  weak  performance  of  its  food  and  beverage  (F&B)  arm,which  reflects  the  current  challenging  operating  environment,  and  ii) slower-than-expected  growth  in  its  key  earnings  catalyst,  ie  its  fastmoving consumer goods (FMCG) arm.   

Counting on its FMCG arm.  Moving forward, we expect growth from its F&B arm  to remain  soft amid  stiff competition  and  consumers’ cautious discretionary  spending.  Its  FMCG  arm,  on  the  other  hand,  should recover and underpin growth ahead. The weak performance of its FMCG arm  in  1QFY15  was  due  to  seasonal  factors  as  well  as  higher-thanexpected  selling  and  distribution  spending.  We  note  that  sales  have picked up in the subsequent quarters after the delay in promotions  of its FMCG products in China in 1QFY15. Hence, we expect earnings from its FMCG arm to normalise in the second half.  In the medium to  long  term, we expect earnings for its FMCG arm to grow by double  digits, driven by: i)  growth  in  local  sales  from  improving  consumer  sentiment,  and  ii) growth in its export markets, particularly in Asean.

Risks.  Key risks  include: i) weaker-than-expected consumer sentiment, ii) a change in consumer preference, and iii) rising raw material prices. 

Maintain  BUY  with  a  revised  TP  of  MYR2.15.  We  trim  our  TP  toMYR2.15  (from  MYR2.30),  based  on  a  revised  FY16  P/E  of  16x  (from 18x) to reflect the challenging operating environment for its F&B division. However, we remain optimistic that its FMCG arm should start to reap the fruits from an expanding regional distribution network next year .  The stock  is currently trading at an undemanding  FY16 P/E of  12.8x relative to its peer target valuations of 19-22x. 

Fundamentals Still Intact

Market leader in white coffee despite stiff competition.  The white coffee market sub-segment  comprises  more  than  one-third  of  the  local  total  coffee  mix  segment. Although competition in the white coffee market has intensified in recent years,  with big  players  like  Nescafé  and  Power  Root  (PWRT  MK,  NR)  entering  the  market  in 2012-2013,  OldTown  still  commanded  33%  of  the  white  coffee  market  share  in Malaysia  as  of  end-2013.  We  also  note  that,  similar  to  its  competitors,  OldTown’s spending on advertising and promotion increased significantly in 1QFY15 to maintain its foothold in the increasingly competitive market.

Counting  on  its  FMCG.  Despite  the  slowdown  in  its  FMCG  arm  in  1QFY15,  we believe  this  division  may  be  able  to  record  decent  growth  in  subsequent  quarters ahead, driven by sales in both the local and export markets. We also note that in Jul 2014,  OldTown  incorporated  Shenzen  OldTown  White  Coffee  Trading  Co  Ltd, whereby its sole  investor is Advance City Ltd (a subsidiary of  OldTown), to take back the reins in dealing with the sales, marketing and di stribution of the company’s FMCG products in China. We believe the move will strengthen OldTown’s presence in Chinathrough  direct  participation  in  the  marketing,  branding  and  pricing  strategies.  In 1QFY15, OldTown appointed PT Sukanda Djaya in Indonesia and Dranix Distributors in the Philippines  as key distributors in the respective countries. We deem this piece of  news  positive,  as  these  two  companies  are  also  the  key  distributors  of  variousmultinational brands in their respective countries. As such, OldTown would be able to leverage  on  their  wide  distribution  networks.  Management  indicated  that  currently, these two markets comprise less than 5% of total FMCG sales, but moving forward to FY16, the mix could grow to a double digit.

Challenging  operating  environment  in  the  F&B  segment.  The  local  F&B landscape is crowded with new entrants in the market and the challenging operating environment was reflected in the performance of OldTown’s F&B arm in 1QFY15. On a brighter note, we understand from its  management that the existing 108 franchise outlets had renewed their franchising licenses for another five years in end-Aug 2014.Moving  forward,  management  said  that  OldTown  will  shift  its  focus  to  expand  itsGrand  and  Signature  outlets  in  Malaysia  while in  other  regions,  we  expect  organic growth via the expansion of its outlets.  We are mindful that the operating environment will be challenging in the near term ,  as consumers remain cautious on discretionary spending amid rising inflationary pressure.

Maintain  BUY,  with  a  TP  of  MYR2.15.  We  trim  our  TP  to  MYR2.15,  based  on  a revised FY16 P/E of 16x (from 18x) to reflect the challenging operating environment for its F&B division. However,  we remain optimistic that its FMCG arm should start to reap the fruits from an expanding regional distribution network next year.  Our TP of MYR2.15 implies a 25.7% upside from the current share price. The stock is currently trading at an undemanding FY16 P/E of 12.8x.

Source: RHB