Soda tax is near-term bitter for F&N but outlook remains sweet


THE implementation of a soda tax on all sugar sweetened beverages next April makes the fourth country in Southeast Asia to tackle serious health issues related to excessive sugar intake.

Brunei and Thailand were quicker to implement the excise tax in an attempt to reduce sugar consumption, followed at the beginning of the year by the Philippines.

The recently tabled Budget 2019 proposed a 40 sen tax per litre on drinks containing more than 5g of sugar or sugar-based sweetener per 100ml as well as fruit and vegetable juices with a sugar content of more than 12g per 100ml.

Many expect the proposed tax to primarily hit Bursa Malaysia-listed Fraser & Neave Holdings Bhd (F&N) because an estimated one-fifth of its sales are derived from soft drinks.

Nevertheless, analysts believe the company’s outlook remains intact as any impact will likely be temporary.

“F&N has been talking about a soda tax and preparing for it in recent times. In Thailand (where it also operates), the soda tax is at 6g per 100ml, so the Malaysian threshold is slightly lower,” observes analyst Damia Othman. “Its soft drinks segment will be subject to the new excise duty because there is generally more than 5g of sugar per 100ml in soft drinks.”

Based on her back-of-the-envelope calculations, the effect of the soda tax is only “about 5% of earnings”.

Damia says a more pertinent question is whether the food and beverage company will choose to absorb the cost or pass it on to consumers.

As consumers of F&N’s products tend to be price sensitive and are likely to buy less should they cost more, Damia believes the company will opt to absorb the sugar tax and to maintain current prices given that the cost of refined sugar has come down in recent times.

Since Sept 1, the ceiling price of coarse granulated sugar and refined granulated sugar has been reduced by 10 sen per kilogram. Coarse granulated sugar now costs RM2.85 per kilogram and fine granulated sugar, RM2.95.

Given competitive price pressure and intense competition in the domestic market, MIDF Research analyst Nabil Zainoodin concurs that F&N is likely to absorb the soda tax in order to protect its . “F&N has the ability to do so as it is expected to generate operational cost savings post-restructuring exercise as well as raw material cost savings from the current favourable cost of refined sugar and palm oil.”

Recently, the company undertook an internal restructuring exercise, which included a voluntary separation scheme (VSS) for over 200 employees. It also acquired ware­houses to reduce recurring costs such as rent.

Nabil points out that F&N’s soft drinks division contributes less than 20% to its bottom line, and is not the main driver of group earnings. “In this segment, F&N’s flagship brand 100PLUS is the biggest contributor to earnings, being a leader in the domestic isotonic drinks category with over 70% market share. Back in June, the entire range of 100PLUS was reformulated to contain as little as 4g to 6g of sugar per 100ml in an effort to promote healthier beverages for consumers. Due to this, the latest 100PLUS range that has 4g of sugar per 100ml will not be subject to the sugar tax.

“All things considered, we expect the sugar tax to have a minimal impact on F&N’s earnings.”

RAM Ratings, though, views the tax as a negative development for F&N.

The rating agency believes the company has little room to manoeuvre as it is operating in an environment where margins are razor thin for the soft drinks segment, and expects the additional excise duty costs to be mostly passed on to consumers.

“If the sugar tax is fully passed on, the selling prices of the group’s key beverage products are estimated to rise between 10 sen and 60 sen (based on the existing prices of RM1.20 to RM3.40 for 250ml to 1.5l drinks),” RAM Ratings says in a press statement last Friday.

Under such a scenario, the ratings agency anticipates demand to be negatively affected in the near term owing to consumers’ knee-jerk reaction to the price hikes.

It is worth noting that F&N’s soft drink operations have been affected by competition, weak consumer sentiment and the rising cost of living over the past two years.

RAM Ratings says the implementation of the sugar tax could exacerbate competition, whereby bigger players could try to wrest market share from F&N. “With this new development, we expect F&N to speed up its R&D efforts to reduce the sugar content in its beverages. In June, the group launched a lower-sugar variant of 100PLUS, which falls outside the scope of the imminent sugar tax. Nonetheless, this variant accounts for just a small portion of its overall 100PLUS sales.”

In the ended Sept 30, 2018, F&N saw a 19% improvement in net profit to RM385.1 million from a year ago, on the back of flat revenue of RM4.11 billion.

The company has said that it will be assessing and closely monitoring the impact of the excise duty, and taking appropriate actions as necessary.

Whether the soda tax will be effective in weaning Malaysians off sugary beverages remains to be seen. Nevertheless, analysts believe F&N’s outlook is still intact.

“Future earnings growth will be driven by continued strong export growth and improved cost efficiency as a result of cost optimisation efforts. In addition, we understand that F&N is set to introduce innovative products next year and, hence, we expect this will help it regain some of its lost market share in the domestic market,” says Nabil.

Meanwhile, RAM Ratings takes the view that F&N’s dairy operations in Malaysia and Thailand will support its performance going forward. “Even with a further weakening of its soft drinks business, we envisage the group’s balance sheet and -protection metrics to remain strong with a net cash position and a funds from operations debt cover of close to one times.”

As at Sept 30, F&N’s cash balance stood at RM201.57 million.

Over the last year, its has increased by an impressive 39%, closing at RM34.78 last Thursday.


Source: The edge

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