Review

• Farm Fresh Bhd’s (FFB) 1HFY24 core net profit of RM16.6mn missed expectations, came in at 26% and 24% of ours and consensus’ full-year estimates, respectively, after excluding one-off items. The variance mainly attributed to higher advertising and marketing expenses that offset the improvement in GP margin.

• No dividend was declared for the quarter under review.

• YoY, 1HFY24’s revenue experienced a substantial uptick of 25.3% YoY to RM383.8mn, driven by significant sales growth from HORECA (Hotel, Restaurant, and Cafe) distribution channels and commercial UHT assortment. That said, the group adj. EBIT declined by 34% YoY due to higher marketing cost on new product launching and escalating headcount expenses from the acquisition of new subsidiaries (i.e. Inside Scoop, Jom Cha and St David Dairy). We believe that the lagging recovery in GP margin of 22.2% could be also attributed to deliberate depletion of highcost inventories coupled with lower production volume in 1QFY24.

• QoQ, 2QFY24 sales turnover improved by 6.9% QoQ, thanks to price adjustment made in July 2023 for chilled product at c.5% increment backed by resilient demand. In tandem with the topline expansion, its adj. EBIT leapt 3x to RM19.1mn, chiefly contributed by higher GP stemming from significantly easing in key input costs, which evidently shown by 8.6ppt QoQ improvement in GP margin to 26.3%.

Briefing Highlights

• In 1HFY24, the UHT commercial category’s sales volume soared by 44.4% YoY, followed by a 10.2% increase in the Chilled category, while plantbased milk grew modestly by 0.4% YoY. Conversely, UHT school milk and yogurt declined by 22.7% and 11.9% YoY due to compromised production capacities for higher-yield products. The surge in UHT volumes stemmed from amplified HORECA sales and the strategic addition of a new UHT processing line at the Muadzam Shah facility in April 2023, enhancing distribution channels and driving overall growth.

• In 2QFY24, a remarkable improvement of 8.6ppt QoQ in GP margin was driven by procuring a new inventory batch at a lower cost. To recap, the company was reducing production in 1QFY24 to deplete its high-cost dairy materials like whole milk powder (WMP) which priced at c.USD3,800-4,000/MT. Nonetheless, the recent WMP procurement at c.USD3,500/MT in 2QFY2024 - is expected to decrease further to c.USD3,000/MT with secured orders till May 2024 - contributed to margin improvement. Additionally, the 3.8% drop in ex-farmgate price to AUD9.74/kg in July 2023 eased cost pressures for the group.

• The fresh milk market has been maintaining a steady high single-digit annual growth pace, showcasing both market resilience and enduring consumer preference. With an eye on capturing a consistent market share, the company plans to expand by adding more farms in the future to ensure an adequate supply of fresh milk. Despite emerging competition from a major dairy player on the brink of vertical integration into fresh milk provision, FFB remains confident in its high-quality product that will attract and retain a loyal customer base, fortifying their market position despite the competitive landscape.

• FFB has acquired a 70% stake in Sin Wah Ice Cream Sdn Bhd (Sin Wah) in October 2023. Sin Wah, a local ice cream Potong brand with almost three decades of establishment, boasts a robust production capacity of 120,000 ice cream pieces daily and a strong distribution network. This acquisition aims to forge synergies between FFB and Sin Wah, leveraging Sin Wah's extensive distribution channels comprising over 6,000 drop points across Peninsular Malaysia. The strategic move intends to utilize these channels to distribute FFB's CPG ice cream, maximizing the collaborative potential between the two entities.

• Nonetheless, FFB remains cautious due to the anticipated impact of Australia's declining milk production on its GP margin. Recent months have seen decreased production yields in Australia and New Zealand as a result of continuous rainy seasons, potentially escalating costs amidst robust domestic consumption. Additionally, the launch of more competitively priced dairy products in Australia restricts room for price adjustments, posing a risk of thinner margins to the milk farmers and operators. That said, FFB has secured dairy material orders at satisfactory prices until May 2024, offering relief from prolonged cost pressures and mitigating immediate concerns over potential margin constraints.

Impact

• We tone down our FY23F earnings projection mildly by 6.8%, as reflective of slower-than-expected GP margin recovery in FY24.

Outlook

• Moving forward, we foresee robust earnings growth propelled by an accelerating recovery in Gross Profit (GP) margins, fuelled by resilient demand for its products and low-cost inventory procurement. This is substantiated by notable sales volume and earnings growth observed in 2QFY24. Simultaneously, the recent introduction of the new Growing Up Milk (GUM) product and the launch of a favoured milk category in November 2023 are positioned to gain significant traction due to their competitive pricing, further bolstering its market position.

Valuation

• We maintain Buy with a marginal lower target price to RM1.52/share (previously RM1.53/share) based on 28x CY24 EPS.

Source: TA Research - 29 Nov 2023