Following  OldTown’s  analyst  briefing  yesterday  when  management provided  an  update  on  its  business  operation  YTD,  we  maintain  our BUY recommendation and TP of MYR2.00 (25.8% upside). We  reiterate our view that growth from its F&B  division  will  likely   remain soft amid stiff  competition  and  tightening  of  consumer  spending.  Its  FMCG division will likely  be its earnings driver moving forward. 

Overview  of  its  business  operation.  Management  stated  that  for 1HFY15  (Mar),  its  flattish  sales  from  its  food and  beverage  (F&B) arm have  been  affected  by  lower  operating  days  from  renovations  and upgrades.  Meanwhile,  sales  from  its  fast-moving  consumer  goods (FMCG)  arm  should  pick  up  in  2HFY15  after:  i)  the  shipment  of  a delayed  order  in  end-Sep,  ii)  launch  of  a  new  FMCG  variant  and  iii)  completion  of  the  transition  to  new  distributors.  Expansion  of  café outlets for the year is on track. As of 1HFY15, the number of café outlets stood at 245, an additional seven outlets from end-FY14. 

A better 2HFY15 for F&B. Despite the poor performance of its F&B arm in  2QFY15,  management  was  upbeat  on  its  outlook  in  2HFY15  as  itanticipates  a  recovery in sales in its café outlets from  Ramadan  as well as  normalisation  in  the  operating  days  after  the  completion  of  the renovation and upgrades of the outlets. It also stated that there will be no more renovations and upgrades to be done from Nov 2014 till Mar 2015. 

FMCG  division  still looking good.  Despite the intensified competition in the  instant coffee mix market,  OldTown is still the market leader in the white-coffee market sub-segment in Malaysia as well as in major exports markets like Hong Kong and Singapore. We believe that the launch of its new FMCG variant of 25% less sugar since Nov 2014 will  resonate  well with consumers, in view of increasing consumer health awareness. 

Investment  case.  Although  we  expect  growth  in  F&B  to  remain  soft amid stiff competition and tightening in consumer spending, we believe OldTown’s key earnings driver will come from FMCG,  which will reap the fruits  of  its  expansion  in  the  regional  distribution  network  next  year. Maintain BUY with an unchanged TP of MYR2.00, based on a FY16 P/E of  16x.  The  stock  is  currently  trading at  an  undemanding FY16  P/E  of 12.6x relative to its peer target valuations of 19-22x.

A mediocre  2QFY15.  Despite the 6.3% slide  in revenue QoQ, 2QFY15 earnings of MYR11.3m fell  by  just  3.8% QoQ. Its FMCG  business  was the saving grace for the quarter  under  review,  with  PBT  up  36.1%  QoQ,  mitigating  the  34.2%  QoQ  PBT decline at its F&B division. The significant decline in F&B’s PBT was due to negative operating leverage from lower average sales per outlet while the leap in FMCG PBT was due to lower selling and distribution expenses incurred vs the preceding quarter. A  better  2HFY15  ahead  for  F&B.  Management  stated  that  the  poor  2QFY15 performance  of  its  F&B  division  was  due  to  the  negative  operating  leverage  from lower average sales per outlet. This is attributed to the: i) Ramadan period, as well as ii) lower operating days due to the renovations and upg rades of its café outlets in the quarter under review. Management stated that there will be no more renovation and upgrades to  be done from  Nov 2014 till Mar  2015,  and sales have picked up since Oct 2014 in its café outlets. As of 1HFY15, the number of OldTown café outlets stood at 245, an additional seven outlets from end-FY14.

FMCG the  main  earnings driver.  For 1HFY15, FMCG recorded a 1%  YoY  drop in sales as the 11% increase in domestic sales mitigated the 8% decline in export sales. However,  1HFY15  PBT  dropped  by  a  larger  quantum  of  7.1%  YoY  due  to  higher selling  and  distribution  costs  recorded  in  1QFY15.  We  note  that  the  selling  and distribution  costs  were  normalised  in  2QFY15  as  PBT  leaped  by  36.1%  QoQ. Management also stated that the decline in the export sales was due to a delayed order  which  was  supposed  to  be  shipped  in  Aug  2014.  We  understand  from  the management that shipment for the order has started since end-Sep 2014.

FMCG  still  looking good.  Despite  the  intensified  competition in  the instant  coffee mix  market,  OldTown  still  retains  its  leadership  in  the  white  coffee  market  sub segment in Malaysia, Hong Kong and Singapore. Its 9M14 market share by value in the  white  coffee  market  sub-segment  stood  at  35.3%,  whereby  its  closest competitor’s market share was half of OldTown’s. OldTown has also launched a new FMCG  variant  of  25%  less  sugar  in  Malaysia  and  Singapore  since  Nov  2014  and targeted to be rolled-out to other markets by Mar 2015. We believe the new product will resonate well with consumers in view of increasing consumer health awareness.

Source: RHB