This article first appeared in The Edge Malaysia Weekly on October 31, 2022 - November 6, 2022

THE margin squeeze in the food industry, which has already been hit by a surge in commodity prices, has been exacerbated by the weak ringgit, which plunged to a new low of 4.738 to the US dollar last week.

Nestlé (Malaysia) Bhd, for one, saw its net profit for the July-September 2022 quarter decline by 24% year on year to RM112.65 million. Quarter on quarter, it was down by a third.

Is this an indication of a persistent drag on the food industry’s profitability? How will other consumer players fare, and will the recent easing in commodity prices help?

Kenanga Research analyst Ahmad Ramzani Ramli says much depends on the individual company’s hedging policy for input costs.

“Most of them have a hedge of three to six months. Since last year, they have been building up their inventories. As they bought at higher prices, they may not be able to take advantage of the softening of commodity prices,” he tells The Edge.

At the same time, the ringgit’s slide in the past three months has made input costs more expensive. Hence, he is of the view that the food players’ margins and earnings will remain under pressure until the first half of 2023.

Hong Leong Investment Bank Research analyst Syifaa’ Mahsuri Ismail says food and beverage (F&B) companies will have to absorb the price pressure despite several rounds of price increases.

“We do expect there will be some margin compression for staples and F&B names. We expect Nestlé to chart better earnings in FY2023. This is on the back of expectations that commodity prices will stabilise next year. Based on its 3Q2022 briefing, management reiterated the same view, that commodities have peaked and are likely to gradually come down next year.”

Loui Low, head of research at Malacca Securities, believes the consumer sector will be hit for another one to two quarters, before their cost structure stabilises with the passing on of costs to consumers.

“They can do a lot of things to pass on the costs, including the repackaging of products, introduction of value-added products, such as those with organic and low sugar content. This will help with the increase in prices,” he says.

Low observes, however, that inflationary pressures may take five to six months to ease, and that the situation may turn better in 2Q2023.

Ramzani says the subsidies granted to poultry players should help them get through the current challenges. As the government is looking to roll out targeted subsidies, the concern is whether there will be a reduction in subsidies for them. “Whether subsidies are enough to offset the inflationary pressures, it is yet to be seen.”

Despite feedstock costs easing in the past few weeks, Ramzani does not rule out the possibility that prices may trend upwards again, although they are unlikely to hit the highs of mid-2022.

The controls imposed on the selling prices of chicken and eggs have led Low to take a negative view of the poultry sector.

“Although there has been a small dip in feedstock prices, they are still high year on year. At the same time, poultry players cannot sell at higher prices,” he points out, noting that the bigger players stand a better chance of passing on costs as they bulk-buy the raw materials.

While the drop in feedstock costs gives poultry players a brief respite, the benefit has been negated by the shrinking ringgit, which has tumbled 13.38% year to date.

In view of the high input costs, Inter-Pacific Securities Sdn Bhd head of research Victor Wan says the government may have to raise the controlled prices of eggs and chicken after the general election.

“If not, it will lead to supply short­ages. Poultry farmers are not able to make a profit from that kind of selling prices. They have to negotiate with the government to raise prices after the election.”

The ceiling price for chicken has been set at RM9.40 a kg since July 1 — 50 sen more than the previous level of RM8.90, following supply shortages.

According to the Ministry of Domestic Trade and Consumer Affairs, the current national average price for standard round chicken is RM9.18 per kg. Prices are affected by the movement of production input costs, such as grain, corn and soybean meal.

The price of grade A chicken eggs is 45 sen per seed, while that for grade B and grade C are 43 sen and 41 sen respectively.

Feedstock costs constitute about 70% of chicken production costs. Corn makes up about half of feed costs, and soybean meal about a quarter.

Since early this year, prices of corn and soybean meal are still up 25.8% and 8.4% respectively.

Despite price increases, Ramzani is confident the demand for food items will remain robust because of the upcoming festive seasons. Although companies like Nestlé are raising selling prices, he stresses that the quantum is still lower than the rise in food inflation.

“Even when high costs persist, consumers will still have to buy essential food items. I don’t think there will be a slowdown in demand. Moreover, the M40 group still has a healthy balance sheet.”

Even so, Ramzani remains “neutral” on the food industry because of volatile commodity prices and cautions that consumer demand could be affected if inflation expands faster than expected.

The country’s Consumer Price Index eased for the first time in six months to 4.5% year on year in September, against 4.7% in August 2022, driven by lower prices of food and non-subsidised fuels.

Companies with export sales are in a better position, Low observes, pointing to the likes of Power Root Bhd and Kawan Food Bhd.

Pending the release of QL Resources Bhd’s financial results next month, Syifaa’ has a “hold” call on consumer staple companies QL and Nestlé.

“While valuations are expensive, we opine that their current risk-reward profile is fair, coupled with their status as the key consumer staple stocks,” she says.

In an Oct 27 research note, Ramzani sees downside risks to Nestlé’s top-line growth and margins primarily due to the following: consumer down trade, meaning they opt for cheaper brands or alternatives; lingering cost pressures with extended supply chain disruptions; and a seemingly prolonged Russia-Ukraine war. He expects Nestlé to raise the average selling prices of certain products to cope with the elevated input costs.

“Post-results, we cut our FY2022 earnings by 10% but raise our FY2023 earnings by 8%, assuming the easing of commodities prices while the ringgit strengthens. Correspondingly, we tweak our target price downward by 3% to RM115.65 from RM119.75,” he says.

CGS-CIMB Research also believes that Nestlé will raise its selling prices to pass on some of the cost increases, but the price hikes are unlikely to match the cost increases. “Nestlé is likely to be cautious as aggressive selling price hikes could impact consumer demand in view of current inflationary pressures, leading to lower sales volume.

“We raise our FY2022-2024 EPS (earnings per share) forecasts to account for higher sales, resulting in a higher target price of RM135. We reiterate our ‘hold’ call. While Nestlé’s fundamentals remain strong with inelastic demand for its products, current valuations have largely accounted for these factors.”  

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