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This article first appeared in The Edge Financial Daily on November 14, 2018

Fraser & Neave Holdings Bhd
(Nov 13, RM33.50)
Maintain market perform with a lower target price (TP) of RM33.30:
We came away from Fraser & Neave Holdings Bhd’s (F&N) financial year 2018 (FY18) results briefing feeling cautious about its near-term prospects. While we anticipate softer demand in Malaysia (due to a sugar tax) and Thailand to be alleviated by easing production costs and operational savings, the group will see a higher tax exposure in Thailand with the lapse of incentives.

 

In FY18, the group saw flattish sales due to a stagnant performance from the food and beverage (F&B) Malaysia and Thailand segments. However, it appears the domestic segment is in a decline as total group exports bolstered double-digit growth thanks to efforts in widening market reach. Malaysian sales performed weaker, likely on lower consumer spending during the earlier parts of the year. Thailand was also depressed by soft economic conditions but is anticipated to recover on improving unemployment rate.

Management maintained its target to achieve RM800 million in revenue contribution from exports by 2020, which we believe is achievable with the favourable reception of the group’s products abroad. Excluding one-off restructuring expenses, the group’s FY18 profit before tax margins improved to 10.3%, thanks to better production cost positions and improvements in production capabilities following the group’s streamlining efforts. To recap, the group incurred an expense of RM52.7 million in FY17 to rationalise storage systems and manpower requirements.

Management anticipates an improved operation landscape will provide support for the group against any slowing top-line performance, backed by more favourable hedging positions. However, we believe a shift in commodity prices may cause this to be a short-term boon only. In response to the sugar tax to be implemented in April 2019, management expressed the intention for more research and development (R&D) efforts to introduce beverages below the taxable criteria. However, any new products from this may not hit the market before April 2019.

The guided beverage portfolio affected by the tax could be up to 80% of the group’s existing products, which we believe could translate into up to 40% of total group revenue. Additionally, tax benefits enjoyed by the F&B Thailand have lapsed; they would have to pay the full 20% corporate tax going forward. This would cause a sizeable dent to the group’s overall effective tax exposure, at below 10% in FY17 and FY18.

After the briefing, we reduce our FY19 and FY20 estimated earnings by 3.2% and 5.6% mainly due to the higher tax exposure. This also leads to a cut in our dividend expectations to 66 sen and 70 sen from 70 sen and 75 sen, based on some 60% payout ratio. We derive our TP on an unchanged 30 price-earnings ratio (PE) on its lower FY19 estimate earnings per share. While the stock traded at a two standard deviation on its three-year average forward PE valuation during early 2018, we believe sentiments have softened in anticipation of the aforementioned. Hence, the upsides may be limited. Further, dividend yields of 2% and 2.1% in FY19 and FY20 may not be attractive to investors. The risks to our call include lower-than-expected sales, higher-than-expected operating costs, and an unfavourable currency exchange exposure to the group. — Kenanga Research, Nov 13

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