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Broker's take: RHB upgrades Food Empire to 'buy'

RHB Research has upgraded its rating on Food Empire to "buy" from "neutral", citing "resilient gross margins". 

The brokerage also raised its target price from 60 Singapore cents to 66 Singapore cents, which represents a 22 per cent upside from the counter's last traded price of 54 Singapore cents on Nov 16. 

Among other things, RHB noted that Food Empire's third-quarter results came in above expectations, and that the group was able to maintain its gross margin despite a weakness in the Russian rouble. 

"Q3 2018 core PATMI (profit after tax and minority interests) came in at US$6.9 million, while the reported PATMI fell 20 per cent year on year (y-o-y) to US$5.9 million," the brokerage said. 

"However, if we stripped out forex losses, core PATMI was only down 4 per cent y-o-y. Gross margin remained at 38.7 per cent, despite rouble depreciation versus the same period last year." 

It added that forex losses for the quarter were reduced to US$1.1 million from US$2 million for the previous quarter.

"According to management, the group saw lower commodity prices in the quarter. New product launches and price adjustments in Russia also helped to hold up the gross margin while improved capital management lowered forex losses." 

Separately, RHB noted that revenue growth could have been stronger. "Q3 2018 revenue grew 4 per cent to US$72.9 million, while revenue in Russia fell 8 per cent y-o-y during the quarter; also we note that the Russian rouble depreciated 12 per cent and the group delivered a positive growth in local currency terms," RHB said. 

Meanwhile, diversification to other markets also aided Food Empire's growth, with the group continuing to focus on expanding its Vietnam market. According to RHB, Food Empire managed to increase penetration of its key product Café Pho and launched new products, leading to a 24 per cent y-o-y increase in Indochina revenue.

Nonetheless, the brokerage highlighted that growth in new markets comes at a cost, with the group's SG&A (selling, general and administrative expenses) increasing 27 per cent y-o-y, largely due to greater advertising and promotions. 

"Moving into FY19-20, we expect SG&A to remain high as the group continues to invest in new markets. With its new instant coffee plant expected to complete in FY20, we also expect depreciation cost to increase. These higher costs should be partially offset by a higher revenue growth and gross margin."

All things considered, the brokerage has upgraded its call on the counter with a higher target price of 66 Singapore cents, pegged to 13 times its FY19 P/E (price to earnings) ratio, representing a 10 per cent discount to its peer average. 

"Long term, we believe the diversification to other markets would reduce the group's exposure to the Russian rouble, and have a positive impact on share price," RHB said. 

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