This article first appeared in The Edge Financial Daily on September 26, 2017

OldTown Bhd
(Sept 25, RM2.65)
Maintain buy with a target price (TP) of RM3.15: We maintain our positive stance on OldTown Bhd given that we believe that the selldown last Thursday due to a fire incident was unwarranted, and its current price weakness offers a buying opportunity, and we maintain our investment thesis that its expansion to regional markets, particularly China, offers multi-year growth potential. 

Stronger-than-expected contributions from its regional fast-moving consumer goods (FMCG) sales should provide further upside surprises. On the other hand, management is actively pursuing mergers and acquisitions opportunities to enhance its growth prospects. 

We maintain our “buy” recommendation with a RM3.15 TP, pegged to a 12-month forward price-earnings ratio of 19 times. The stock remains our top pick in the consumer sector. The recent share price weakness offers buying opportunities. 

A key risk to our view is that rising raw material costs could erode its profit margins, and cloud its growth prospects.

Last Thursday, the stock endured a high-volume selling pressure after news broke out that a fire incident occurred at its central food processing centre in Subang Jaya, Selangor. The stock dropped by 6% to a low of RM2.54 before recovering to close at RM2.60 (down 3.4% compared with the trading day before).

We believe that the selldown was mainly due to concerns with regard to a potential temporary shutdown of its FMCG and food and beverage (F&B) operations, and a large financial damage incurred as a result of the fire incident.

We believe that the fears are largely unfounded.

The group’s manufacturing plant for instant coffee powder is located in Ipoh. As such, the fire incident has no impact on its FMCG operations, which we estimate contribute about 80% to group pre-tax profit in the financial year 2018 (FY18).

We understand that the food processing operations in Subang Jaya have ceased temporarily to facilitate the fire and police departments as well as OldTown’s management to investigate and ascertain the cause of the fire incident. 

Nonetheless, we understand that most of its café outlets have on average about two weeks of food inventory. As such, its F&B business should not be disrupted by the temporary closure of its food processing operations.

Besides that, we understand that the group has contingency plans in place where it will outsource the food processing function to a designated third party if the plant is closed for longer than expected.

We gather that the fire incident only affected its production floor, while its operating units and administration office were not affected. Management believes that the damages are adequately insured pending the insurance company’s assessment.

Based on the available information, we believe that the fire incident will not have a significant impact on the group’s operations; neither will it materially affect the group’s near-term earnings prospects. As such, we are keeping our earnings forecasts for OldTown.

FMCG revenue grew by 17% year-on-year in FY17. Management is targeting double-digit growth in FY18 while we assume FMCG sales volume to grow by 15% in FY18 with the China market being the key growth driver.

We estimate that sales to China only represented less than 20% of its FMCG sales in FY17. As such, we are positive that there is plenty of room for the group to boost export sales with the completion of the restructuring of its China distributorship in late 2015.

We also believe that the growth prospects of its F&B business remain challenging. The group was operating 231 café outlets as at March this year, with 191 (83%) based in Malaysia. — AllianceDBS Research, Sept 25