KUALA LUMPUR (Dec 28): MIDF Research has maintained its "neutral" rating on the food and beverage (F&B) sector and said due to the normalisation of commodities prices, F&B players face challenges in controlling raw material costs in the short term on top of weakening ringgit.

In a sector note today, the research house said it expects the margin compression will continue for at least two consecutive quarters.

"Nevertheless, we are not overly concerned on the commodity prices uptrend on the long term as we believe that local F&B players have taken appropriate measures through product innovation and improvement of internal operating efficiency," it said

MIDF Research said after experiencing a declining trend from FY15, the prices of agricultural commodities such as skim milk powder, coffee beans and raw sugar have surged since February this year, at prices even higher than FY14 price levels. However, the price of cocoa has been dropping due to an increase in supply.

Yet in view of increasing commodity prices, the sector still faces cost pressures due to the depreciating ringgit as these commodities are traded in US dollars, said the research house.

As such, Malaysian F&B business segments have also slowed down and suffered consequently due to lower revenue and high operating costs, it said.

MIDF Research said this was the case for Fraser & Neave Holdings Bhd (F&N) whose latest earnings came in lower than expected by the research house.

The research house maintained its "neutral" rating on F&N with a lower target price of RM25.32 (from RM28.35).

In slight contrast, it said the latest earnings for Nestle (M) Bhd were in line with forecasts and as such MIDF Research maintained its earnings forecast with a target price of RM82.82.

The research house explained that in light of slower business performance, these F&B players have turned to improve strategies such as through product innovation, improving cost efficiency and productivity.

"Nestle and F&N has been benefiting from its product innovation initiative with introduction of products which utilise less sugar, [which] indirectly moderates the impact of higher refined sugar price," it said.

Furthermore, it said Nestle has planned to launch a global procurement hub in Malaysia which, amongst others, will assist in management of procurement for raw materials while F&N has been working on an internal consolidation exercise as well as launching a new polyethylene terephthalate (PET) bottling manufacturing line to improve its operational efficiency and service levels.

MIDF Research said F&N and Nestle had been benefitting from subdued commodity prices for the past two years with an increasing trend in gross profit margin for seven consecutive quarters from 4QFY14 to 2QFY16.

F&N shares remained unchanged at RM22.86 while Nestle shares were also trading unchanged at RM77.40 in this morning's share price reading.