Food producers unrattled by possible subsidy removal

Thursday 26 Dec 2024

This article first appeared in Capital, The Edge Malaysia Weekly on October 14, 2024 - October 20, 2024

THE government has been outspoken about the need to overhaul its subsidy system to take on a more targeted approach. Food-related subsidies are seen as top on the list for rationalisation in the federal budget that will be tabled in parliament on Friday.

Last Wednesday, Minister of Agriculture and Food Security Datuk Seri Mohamad Sabu, also known as Mat Sabu, said the government was reviewing the subsidy for chicken eggs (grades A, B and C). According to him, the government is considering ending the egg subsidy to save RM100 million a month, which could be redirected to develop other critical aspects of the agro-food sector.

The minister’s remark sparked some selling of shares in poultry and egg companies last week. However, these companies, as well as cooking oil refiners, are supportive of the removal of subsidies as it would pave the way for the abolition of the price control mechanism.

Leong Hup International Bhd’s (KL:LHI) group chief financial officer Chew Eng Loke says the timing seems right for the government to remove the food-related subsidies given that the prices of raw materials and the ringgit have stabilised.

“The benign cost environment now is timely for the government to alleviate its subsidy pressures and revert things to before 2020 (pre-Covid-19 pandemic) when there was no price control on eggs. The removal of price control is a good thing for the industry as it would allow true market equilibrium. [With lower material costs] farmers can make a profit while prices can be maintained at a reasonable level,” he adds.

Chew does not foresee a big jump in egg prices should the subsidy be removed. He estimates the rise to be less than 10 sen per egg as the competitive operating environment will keep prices low.

Chew points out that some egg farmers are facing cash flow problems as a result of the price control mechanism that comes with the subsidy. “This is because global commodity prices move daily, but the government cannot respond quickly enough to change the price ceiling. Plus, there is a time lag for farmers to receive the cash subsidy from the government,” he says.

“If farmers sell directly without the price control, there will be no cash flow issue,” he adds, noting that raw materials make up about 70% of the poultry farmers’ total costs.

Given the economies of scale and its integrated business model, Chew believes Leong Hup and its subsidiary Teo Seng Capital Bhd (KL:TEOSENG) will be well shielded from any adverse effects.

In their latest annual reports, pure egg players Teo Seng, TPC Plus Bhd (KL:TPC) and LTKM Bhd (KL:LTKM) stated that they received RM105 million, RM49 million and RM25 million in subsidy payments respectively.

As for egg and broiler farmers, Leong Hup and QL Resources Bhd (KL:QL) received RM161 million and RM133 million worth of government funding respectively, while PWF Consolidated Bhd (KL:PWF) and CAB Cakaran Corp Bhd (KL:CAB) collected subsidy payments totalling RM66 million and RM56 million.

Sweet deal for sugar refiners

Being one of only two sugar refiners in the country, MSM Malaysia Holdings Bhd (KL:MSM) sees the removal of subsidy as a blessing as this would allow a floating price mechanism.

“The retail price of sugar in Malaysia of RM2.85 per kg is the lowest in Asia, and capping the sugar price without the present incentive creates a serious anomaly in the economics of refining, losing 88 sen per kg,” says MSM group CEO Syed Feizal Syed Mohammad.

The sugar industry has received an incentive of RM1 per kg for coarse grain sugar and fine sugar since November 2023, with MSM entitled to 24,000 tonnes per month.

“Compared to the actual production cost, the incentive of RM1 per kg is just enough to break even to sustain the sugar refining operation. The best alternative without the incentive will be a price float,” he says.

Wholesale sugar, which is subject to price control, contributes about 35% to 40% to MSM’s revenue.

In the first six months of 2024, the company received about RM144 million in subsidy payments.

Remove price control to plug leakages

Under the cooking oil stabilisation scheme (COSS), the government allocated a quota of 60,000 tonnes per month nationwide for the distribution and sales of cooking oil in the 1kg polybag.

There are 366 appointed packaging companies to supply subsidised cooking oil. One of them is CI Holdings Bhd (KL:CIHLDG), 32.96% owned by Datuk Seri Johari Abdul Ghani, minister of Plantation and Commodities.

Johari is also one of those calling for the current subsidy system of cooking oil to be abolished and to replace it with a targeted subsidy via direct cash transfers to the low income group.

In the COSS mechanism, each appointed company is given a monthly quota and can claim a subsidy payment every month based on the difference between the threshold price provided and the market price of RBD palm olein, times the amount sold in a month.

Hence, if crude palm oil (CPO) prices move upwards, the government will need to fork out more for the subsidy. The allocation for the COSS mechanism was as high as RM2.42 billion in 2022, while it is estimated to be RM1.6 billion in 2023.

CIMB Investment Bank head of research Ivy Ng Lee Fang says companies with a large exposure to subsidised cooking oil may lose out as the captive market landscape will change. But overall, she thinks the removal of price control is a good move to plug leakages in the current system that is aimed at helping the low income group.

The widespread leakages include some wholesalers selling the subsidised cooking oil to micro traders at inflated prices — at a time when Malaysian households are having difficulty buying the product off the shelf.

In the first six months of 2024, FGV Holdings Bhd (KL:FGV) received RM217 million in subsidy payments while Sik Cheong Bhd (KL:SCB) collected RM5 million in its FY2024.

Little impact expected on industrial users, such as F&B manufacturers

The removal of price subsidies will have a minimal impact on industrial users such as food and beverage manufacturers as most have already been buying ingredients — for instance, sugar and flour — at commercial rates that are currently not being subsidised.

Investment analysts do not anticipate a major reaction in the market towards the abolishment of food-related subsidies.

Focus Point Holdings Bhd (KL:FOCUSP) president and CEO Datuk Liaw Choon Liang tells The Edge that the company will usually lock in prices of ingredients for a specific period of time via contracts to ensure consistent profit margins. Focus Point is an optical retailer that also runs a bakery chain and two central kitchens.

“In general, our products maintain a healthy margin when it comes to ingredient costs. For a bakery business, however, managing chef or labour costs may be the most effective way to monitor overall margins, and we are actively working on improving this aspect,” says Liaw.

Both UOB Kay Hian Malaysia director of strategy Vincent Khoo and Tradeview Research analyst Tan Jia Hui concur that food companies are always cognisant of reformulating products to navigate rising costs.

To counter higher sugar prices and to avoid the sugar tax, companies such as Fraser & Neave Holdings Bhd (KL:F&N), Nestlé (M) Bhd (KL:NESTLE) and Farm Fresh Bhd (KL:FFB) have introduced products with lower sugar content, which is also a way to promote healthier choices among consumers.

UOB’s Khoo expects the removal of food-related subsidies to have a neutral financial impact on food companies. “Naturally, companies will plan to fully pass on the costs, which will translate into higher selling prices for consumers.”

In fact, he thinks this could be positive for these companies in the long run as they tend to work towards maintaining profit margins, and thus their absolute profits will rise along with higher selling prices.

Given the limited financial impact, Khoo foresees that consumer stocks will experience minimal market reaction should the government decide to stop subsidising sugar or flour.

While the removal of subsidies will mean consumers will have to pay the full price, MIDF Research head of research Imran Yassin Md Yusof says there may be a possibility of downtrading as consumers who are price sensitive switch from expensive products to cheaper alternatives.

“This could suggest a slight slowdown in consumer spending. The M40 income group in urban areas will likely be the most affected, given the erosion in their disposable income,” he adds.

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