• D/G to NEUTRAL from Buy with new MYR1.23 TP from MYR1.72, 8% upside. The higher-than-expected farm gate prices for the new season is a negative surprise, pointing to a tougher recovery path ahead. With the latest setback, we turn more conservative with our valuation, taking into account the weaknesses in earnings visibility and consistency. That said, we see minimal earnings downside risks moving forward, and the heavy selldown (YTD: -29%) may have largely priced in the weakness.

• Missing a key earnings driver. As opposed to an expected 14% YoY drop in farm gate milk prices, the prices for new season (Jul 2023-Jun 2024) inched down by a mere 1% YoY or 4% vs the prices FFB paid in 1H23. This prompted us to cut our FY23-25F (Mar) earnings by 11-13%, as our previous margin assumption is rendered too aggressive. According to management, there was a surge in demand for milk domestically in Australia since 2H of June, resulting in the higher-than-expected prices.

• Margins to improve from low base. Notwithstanding the aforementioned disappointment, our new forecasts indicate FY24F growth of 42% as margins are still expected to normalise from the exceptionally low 4QFY23 base. This will be driven by rising sales volumes of UHT products on the back of higher contribution from Yarra By Farm Fresh products and the School Milk Program. Margins will also expand due to the lower price (estimated at c.13% lower YoY) of its key raw material, whole milk powder (WMP). Secondly, the 5% price hike for its chilled products effective mid- July is estimated to generate additional sales of MYR10m in FY24F. The HORECA segment’s positive traction should also support earnings growth.

• 1HFY24F earnings should remain under pressure, considering the heightened input costs before a recovery in 2HFY24F. The consolidation of The Inside Scoop’s account will be earnings accretive, whilst the commissioning of consumer packaged goods (CPG) ice cream production lines and the Philippines operations without major hiccups will lend further support to the pick-up in 2HFY24F.

• We slash our DCF-derived TP to MYR1.23, which now implies a lower 28x P/E FY24F (from 35x). This is as we raise our risk premium assumption to reflect the volatile earnings trend following our latest earnings cut (fourth cut since our initiation in Jun 2022). This is warranted as we see lower earnings visibility now with the elevated farm gate prices and higher exposure to the more volatile WMP commodity. Our TP includes a 6% ESG premium based on an ESG score of 3.3.

• Risks to our recommendation include higher/lower-than-expected input costs and higher/lower-than-expected market share.

Source: RHB Research - 5 Jul 2023