F&B players expected to see shrinking margins for next 2 quarters

PETALING JAYA: Food and beverage (F&B) players face challenges in controlling raw material costs in the short term due to the normalisation of commodities prices and the weakening ringgit, while margin compression will continue for at least two consecutive quarters, according to MIDF Research.

“Nevertheless, we are not overly concerned with the commodity prices uptrend in the long term as we believe that local F&B players have taken appropriate measures through product innovation and improvement of internal operating efficiency,” the research house said in a sector update yesterday.

It is maintaining its neutral call on the sector as it believes that measures taken by F&B players are appropriate to combat rising costs.

After experiencing more than a year of declining trend from the beginning of FY15, the price of agricultural commodities such as skim milk powder, coffee beans and raw sugar has surged since February this year, at prices even higher than FY14 price levels.

Nevertheless, the price of cocoa has been dropping due to an increase in supply. In addition, the sector is further facing cost pressured by the depreciating ringgit as these commodities are traded in US dollars.

F&B players like Fraser & Neave Holdings Bhd (F&N), Nestle (Malaysia) Bhd and Dutch Lady Milk Industries Bhd have been benefiting from the subdued commodity prices for the past two years.

Gross profit margin for these players has been on an increasing trend for seven consecutive quarters from Q4’FY14 to Q2’FY16 before declining in Q3’FY16. The reversal of the upward trends of gross profit margins from Q2’FY16 corresponded well to the surge in commodities prices starting from Feb 16.

“We presume that the commodity prices have between three to four months of lagging impact to the companies’ cost of sales, on the back of their average inventory turnover of two to three months. Therefore, we expect that margin compressions will continue for at least another two consecutive quarters. In line with the shrinking margin, share prices have started to fall from July 16,” said MIDF.

As F&B players are limited in their ability to pass on these costs to consumers by raising selling price due to weak consumer sentiment and stiff competition, strategies such as product innovation, improving cost efficiency and productivity are more appropriate.

MIDF said F&N and Nestle have registered mixed earnings results in the latest earnings announcement.

The research house revised its target price downward to RM25.32 for F&N to reflect the slowdown of F&B Malaysia business segment as well as rising commodity prices.