Analysts positive on F&N’s dairy farm venture

This article first appeared in The Edge Malaysia Weekly, on October 28, 2019 - November 03, 2019.
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EARLIER this month, Fraser & Neave Holdings Bhd surprised the investing community with its plan to venture into dairy and crop farming in Perlis. It is acquiring the tract called Ladang Chuping from MSM Malaysia Holdings Bhd’s wholly-owned subsidiary, MSM Perlis Sdn Bhd.

“The announcement took me by surprise but I believe it is a good plan for them going forward. Most of the fresh milk that is available in the local market currently is reconstituted milk imported from either Australia or New Zealand. This could help them cut cost and expand their fresh milk production,” says a market observer.

Analysts covering the stock view the proposed venture as a positive for F&N, although on a more medium to long-term basis. “While this acquisition and the related nature of business will represent a distinct deviation from F&N’s fast-moving consumer goods (FMCG) nature, we are positive over the long-term strategic values it offers. It represents a constant supply of fresh dairy milk as opposed to reconstituted milk and insulates itself from fluctuating dairy prices,” says UOB Kay Hian Research in an Oct 9 report.

The research house adds that F&N’s earnings are highly susceptible on dairy milk prices, where there is a 20% impact to earnings per share for every 10% movement in prices.

In a press statement, F&N CEO Lim Yew Hoe said that for the first phase, there is an indicative financial commitment amounting to RM650 million, which would include the cost of purchasing Ladang Chuping and land clearing. The plan is to import 4,000 milk cows with a potential output of 40 million litres of fresh milk. “In the longer term, Ladang Chuping will be capable of hosting 20,000 milk cows to produce 200 million litres of fresh milk yearly, giving us the capacity to export fresh milk.”

By increasing fresh milk self-sufficiency, Lim said the country will become less reliant on milk imports to meet the nutritional needs of Malaysians.

F&N expects to commence its upstream milk production within 24 months of possession of the land in the second quarter of 2020.

UOB Kay Hian Research estimates that Ladang Chuping could satisfy up to 90% of F&N’s internal production needs. Currently, it imports almost all of its milk products.

“If the plans come to fruition, it can be really positive for them. There will be cost savings and they can reduce their exposure to foreign exchange fluctuations from [buying] milk. However, it is still too early to estimate additional earnings from the venture,” says an analyst.

TA Securities Research believes that the move into dairy farming is positive for the company in the medium term as it would mean a new income source — from farming — and strengthening its value chain, which could expand margins and profitability besides improving sustainability of supplies to its existing downstream production.

“We find Vietnam Dairy Products JSC — an affiliate of F&N involved in farming, production and distribution of milk alongside dairy-related products — operates with a hefty gross profit margin of 45%. Therefore, we believe the proposition of an improving profitability is likely to occur upon successful vertical integration given that F&N is currently operating at a lower gross profit margin of 29% to 31%,” says TA Securities in its report.

While the plan for a farm has the universal agreement of analysts as being a medium to long-term catalyst, UOB Kay Hian notes that there is an immediate issue that the company will have to deal with. It says F&N has hedged its raw material costs until the end of FY2019. It rolled over its dairy purchases in September.

“By our estimates, every 10% rise in the cost of dairy powder above our assumption (US$2,229 per tonne), would cut F&N’s FY2020 EPS by 20% — this assumes no cost pass through — as F&N’s net margin is relatively thin at about 10%.

“However, a mitigating factor that we anticipate would be for F&N to raise the average selling price of its dairy sales by 5% to fully pass through a 10% rise in the cost of dairy powder,” notes UOB Kay Hian.

The price of milk powder has been inching up over the last 12 months, with skimmed milk powder gaining 37% from US$1,997 per tonne on Nov 6, 2018, to US$2,743 per tonne on Oct 15. Whole milk powder prices gained 18% over the same period, trending up from US$2,655 per tonne to US$3,133 per tonne.

For the cumulative nine months ended Sept 30, 2019, F&N’s net profit increased to RM114.94 million from RM104.5 million a year ago. Revenue gained 10.85% to RM1.07 billion from RM961.9 million previously.

Over the last year, F&N’s share price has remained flattish, shedding 72 sen to RM34.60 on Oct 24 from RM35.32 on Oct 18 last year.


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