This article first appeared in The Edge Malaysia Weekly on July 17, 2023 - July 23, 2023

AT a glance, it appears to be attractive to accumulate Farm Fresh Bhd shares after the recent sell-off as investors were spooked by news of supply constraints in the Australian milk industry. But analysts do not think so, noting that the dairy company’s valuations remain elevated.

After its debut on Bursa Malaysia’s Main Market at RM1.72 on March 22 last year, the stock hit a high of RM1.78 on April 13, 2022. However, the counter has declined 32.3% year to date and closed at RM1.09 last Friday. Compared with its initial public offering (IPO) price of RM1.35, the stock is down 19.3%.  

As the company’s recent earnings came in lower than market expectations, analysts point out that Farm Fresh is still trading at a high price-earnings ratio (PER) than its consumer peers.

“As the current share price is close to my target price, I don’t see any attractive upside to the current level,” an analyst who covers Farm Fresh tells The Edge.

“There could be further earnings disappointments over the next one to two quarters. If there is any further downside, I think then will be a better time to buy into Farm Fresh shares.”

While the dairy company’s valuation is in line with that of its peers and offers better growth compared with Dutch Lady Milk Industries Bhd and Fraser & Neave Holdings Bhd (F&N), the analyst says the market has priced in some kind of execution discount. That is because ever since its IPO, Farm Fresh has disappointed investors in terms of financial guidance. “That’s why I think there is not much upside over the medium term,” the analyst adds.

Nonetheless, with a 5% rise in the prices of chilled products from this month, he expects Farm Fresh’s margin to improve slightly in the second half of the year.

The IPO price of RM1.35 valued the group at a PER of 36 times, based on its adjusted profit of RM69 million in the financial year ended March 31, 2021 (FY2021), after taking into consideration factors such as one-off tax liability expenses, which were not part of its core earnings. Still, its 12-month trailing PER remains elevated at nearly 40 times, behind Nestlé (Malaysia) Bhd’s 50.3 times.

Forward PER-wise, it is trading at about 23.4 times, which is slightly higher than F&N’s 20.3 times but lower than Nestlé’s 43.3 times and Dutch Lady Milk’s 32.6 times.

Another analyst deems the recent sell-off of Farm Fresh shares as “panic selling”, blaming it on the management’s failure to achieve its guidance, and not because of rising raw material prices.

In response to the sell-off, Farm Fresh stated on July 4 that the selling pressure stemmed from Australia-listed Bega Group’s warning that it could be facing a non-cash impairment of between A$180 million (RM559.5 million) and A$280 million on the back of a decline in milk production volumes and rising dairy ingredient prices.

Farm Fresh explained that its exposure to falling milk production is less in Australia, with its purchase of milk ingredients from third-party farmers in Australia expected to account for about 14% of its total milk ingredients for FY2024.

The analyst believes Farm Fresh should have raised product prices way before the recent shock, which saw a lower-than-expected drop in the farm gate milk price. “Despite raising prices of chilled products, I don’t think the margin will return to the previous level because the cost has not come down as much as expected.

“They don’t have to maintain the low pricing strategy, they are the market leader. It is okay for them to raise prices to improve margins, though they may lose a bit of market share. It is logical to pass on the additional cost to consumers because you need to be responsible to your shareholders.”

Farm Fresh is the top chilled ready-to-drink milk player in Malaysia, with a 49% share of the market in 2022.

The analyst observes that local funds have been the sellers of Farm Fresh shares, while retail investors and foreign funds have been mopping up the stock.

Compared with a year ago, Khazanah Nasional Bhd, via Agrifood Resources Holdings Sdn Bhd, has pared down its stake to 11.71% from 11.8% but the Employees Provident Fund’s shareholding has risen to 7.46% from 5.58%.

Rainforest Capital Sdn Bhd is the largest shareholder of Farm Fresh with a 30.5% stake, followed by FarmChoice Foods Sdn Bhd with 12.43%. Farm Fresh co-founder and managing director Loi Tuan Ee, and his family are shareholders of both these companies, along with others.

Of the nine analysts covering Farm Fresh, only three reviewed their calls and target prices on the company following the recent sell-off, according to Bloomberg data.

RHB Research downgraded the stock to “neutral” from “buy” with a lower target price of RM1.23 compared with RM1.72 previously, as the higher-than-expected farm gate prices for the new season were a negative surprise, pointing to a tougher recovery path ahead.

“With the latest setback, we turn more conservative in our valuation, taking into account the weakness in earnings visibility and consistency,” the research house says in a July 5 note.

Nonetheless, it sees minimal earnings downside risks to Farm Fresh going forward with the recent selldown having largely priced in the weakness.

With a “hold” call, UOB KayHian had the lowest target price of RM1.05 for Farm Fresh, while BIMB Securities’ target price of RM1.80 was among the highest as it calls a “buy” on the company.

The consensus target price of RM1.53, however, suggests a 40.4% upside potential in the stock.

Farm Fresh’s net profit fell 37.3% to RM50.08 million in FY2023 from RM79.89 million in FY2022, owing to higher dairy raw material costs.

A compilation of analysts’ forecasts by Bloomberg shows that Farm Fresh is estimated to register bottom-line growth of RM82.8 million and RM106.9 million in FY2024 and FY2025, respectively.

On May 31 this year, Farm Fresh completed the acquisition of a 65% stake in The Inside Scoop Sdn Bhd for RM84 million, comprising the adjusted purchase consideration of RM68.5 million and the subscription consideration of RM15.5 million. 

Of the purchase sum, RM64 million was paid in cash while the remaining RM20 million was satisfied through the issuance of 13.16 million new Farm Fresh shares at an issue price of RM1.52 per share.

The Inside Scoop shares were acquired from the ice cream chain’s co-founder Edmund Tan Jun Hua as well as shareholders Derrick Wu and Harsh Rajpal. It is worth noting that the deal was completed before the sell-off of Farm Fresh shares. 

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