This article first appeared in Corporate, The Edge Malaysia Weekly, on July 11 - 17, 2016.

JUST 12 months ago, there was growing concern about Fraser & Neave Holdings Bhd’s (F&N) prospects for it had lost the exclusive rights to distribute energy drink Red Bull. This was on top of ceasing the bottling and distribution of Coca-Cola in 2012.

Now, instead of worrying about its earnings growth, investors seem more eager to know if the rally in F&N’s share price — it hit a record high of RM26 last week — has legs. The stock has leapt 40% year to date, outperforming its peers Nestlé (M) Bhd and Dutch Lady Milk Industries Bhd.

Fund managers and analysts we spoke to believe the share price, which has exceeded their target of RM25.34, has factored in F&N’s earnings trajectory.

Though the gloomy outlook for private consumption has cast a pall on the consumer goods-related company, interestingly, it is the tough economic conditions that are in the stock’s favour.

KAF Investment Funds Bhd chief investment officer Gan Kong Yik opines that in the current challenging economic climate, essential consumer product companies like F&N would be much sought after for their defensive nature. “The earnings of these companies will continue to grow and they pay decent dividends [even during tough times],” he comments.

CIMB Research analyst Kristine Wong expects F&N to continue to benefit from low milk prices, which she sees staying at their current levels over the next two years.

According to Global Dairy Trade, the prices of skim milk powder and whole milk powder started to drop in October last year. As at June 15, the prices had fallen to US$1,901 and US$2,118 per tonne from US$2,267 and US$2,824 per tonne respectively.

Global Dairy Trade is a marketplace to buy and sell a wide range of dairy products.

The low milk prices and the integration of F&N’s soft drink and dairy businesses, which has resulted in annual cost savings of RM10 million, have generated a windfall for the food and beverage (F&B) group. Its net profit jumped 72.5% year on year to RM242.23 million in its first half ended March 31 (1HFY2016).

This has prompted CEO Lim Yew Hoe, who took the helm in December 2014, to map out several ways to utilise the bumper profit to generate future earnings.

“We have got a windfall from the low raw material prices. So, how do we make use of it? Maybe, we can create another engine of growth for F&N by acquiring an asset,” he remarks.

While expecting more cost and revenue synergies following the business integration, the 49-year-old Singaporean is scouting around for M&A opportunities in the downturn.

“When we look at M&A, we look at companies that the group can relate to in terms of markets or products,” he says.

Acknowledging that there are good M&A opportunities in the global condensed milk market, Lim says the company may set up a new plant to strengthen its position.

He says though the global condensed milk market is currently worth US$8 billion, F&N has achieved only single-digit growth in this segment.

Despite the big jump in its earnings, F&N’s growth in the Malaysian market is limited, driven mainly by the strong sales of 100PLUS. Lim does not want F&N to be involved in just isotonic drinks and dairy products but also both food and beverage. “For Malaysia, I am talking about non-beverage and dairy, such as food [snacks]. We are an F&B company but food is not in our stable yet.”

In a nutshell, Lim intends to open a new chapter at F&N by expanding into uncharted territory, be it new products or markets.

On whether any M&A will materialise this year, Lim says it will depend on the opportunities that arise. However, he would not reveal any details.

As at March 31, the group was in a net cash position of RM51.82 million, which means it will be able to raise debts to finance any M&A exercise.

Though some quarters were sceptical about the integration of the group’s dairy and soft drink divisions, Lim expects the synergy between the cost and revenue of the two businesses to be fully realised in the next two financial years.

In fact, since the integration process began in October last year, F&N has leveraged the strengths of these businesses. Thus, the company’s distributors are selling all F&N products.

Lim expects a 15% growth in revenue and cost savings of RM10 million a year from the integration. He says the first changes were reflected in the first half of the year and sees further integration over the next 18 months.

F&N achieved a record high revenue of RM4.06 billion in FY2015 while its net profit grew nearly 8% year on year to RM280.1 million. In 1HFY2016, revenue totalled RM2.05 billion while net profit jumped 72.5% y-o-y to RM242.23 million.

Though unwilling to offer any financial guidance, Lim says based on the group’s first six months of performance, the festive season is the key for it to outperform the market.

“Based on our six-month sales, we are doing well. For the next six months, all depends on Hari Raya, which accounts for a big percentage of our annual performance. Thus, these few weeks will be very important to us.”

Lim says as the group is not a consumer staples company and needs cash to grow, it does not plan to adopt a dividend policy. However, management will endeavour to maintain its yearly dividend, he adds.

The group declared an interim dividend of 27 sen for the first half of the year compared with 22 sen in the previous corresponding period. In FY2015, the group paid out a total net dividend of 57.5 sen.

Moving forward, the group will be launching more products. Its own energy drink brand — Ranger, which is in an incubation period — is expected to fill the vacuum left by Red Bull. But, according to Lim, it may be another three to five years before Ranger becomes a significant contributor to the group’s earnings.

The feedback on Ranger has been positive thus far, although it accounts for only 10% of what Red Bull used to bring in, says Lim.

He is also unperturbed by the potential “sin tax” on soft drinks that may be imposed by the government, which will likely lead to a reduction in their consumption. He sees a minimal impact on earnings from this as the group has already lowered the sugar content of its beverages and offers healthier products today.

“It is like GST (Goods and Services Tax). The impact will not be so great that consumers will stop drinking beverages. There will be a reduction in consumption but it won’t be cut by half,” Lim comments.

The group’s best-selling product, 100PLUS, has the lowest sugar content compared with other carbonated drinks. Meanwhile, its aseptic cold-filling polyethylene terephthalate bottle line in Shah Alam, which is expected to commence operations in the third quarter of the year, can produce more innovative drinks with less sugar.

While the group’s annual report shows that soft drinks accounted for RM1.51 billion or 37% of the group’s total revenue of RM4.06 billion in FY2015, Lim says this segment covers all beverages, including water and non-carbonated and energy drinks.

According to him, the group is working closely with the government on the proposed tax. However, he hopes the authorities will weigh the implementation of the tax carefully as it is more viable to take a holistic approach to the diets, lifestyle and nutritional needs of consumers. 

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