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RESULTS NOTE : ROTI : Transition-led earnings disruption
Friday, March 15, 2019       17:14 WIB

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Transition-led earnings disruption
  1. Earnings outperformance (+19% yoy) furnished by lower return rate.
  2. Lower return rate prompts a decelerated gross sales growth.
  3. Recent market enlargement lacks of strategic viability.
  4. Downgrade to SELL due to low profitability prospect.

Above-consensus FY18 earnings was due to lower return rate. Nippon Sariroti () reported FY18 net profit of Rp173bn (+19% yoy) which was both above our (104%) and market estimate (109%). This earnings outperformance hinges on lower return rate of 17.6% in FY18 (vs. FY17: 18.2%) and lower minority interests' loss attributable to of Rp46bn (+3x yoy) due to an increased stake in Prima Top Boga to 51%. Though, adj. operating profit (incl. scrap sales) came lower at Rp195bn (-23% yoy). Gross sales grew relatively slower to Rp3.3tn (+10% yoy vs. 5-yr CAGR of 14%) and net sales was at Rp2.7tn (+11% yoy) as driven by lower return rate. Production costs increased moderately to Ro1.2tn (+8% yoy) while operating costs hiked to Rp1.2tn (+23% yoy) due to spiking logistical cost (+18% yoy) as operating salary (+19% yoy) and A&P (+36% yoy) surged. Thus, we witnessed divergence in profitability margins with GPM/OPM/NPM gauged at 53.9%/7%/6.2% in FY18 (vs. FY17: 52.5%/10.2%/5.8%). On quarterly basis, 4Q18 net profit was ay Rp70bn (+11% qoq, +43% yoy) driven by lower 4Q18 sales return of 13.6% (vs. 4Q17: 17.3%).
New systematic pattern unveils on return rate and sales growth. We see idiosyncrasy between sales growth and return rate pattern vis--vis its historical pattern (fig. 1). In the last four quarters, gross sales growth tends to move in parallel with return rate unlike the past pattern that demonstrated no correlation between these variables which is particularly bad for as lower return rate entails with slowed sales growth. This might be reasoned by several points. First, competition from packaged private bread labels live on as partly attributable to 's premium price (avg. 16%) to its competitors. Second, our view concurs with Euromonitor where we see unpackaged baked goods saw strong growth in tourist regions such as Jakarta, Surabaya and Bali. In turn, we forecast moderate gross sales growth (3-yr CAGR FY18-21F of 12%) and lower sales return of 15% in FY19F/20F (vs. FY18: 17.6%) to account for systematic pattern change in pertaining variables spurred by competition.
Strategy viability on new business plans are on absence. We are critical on 's initiative to enlarge market coverage (to small bakery segment and offshore market). First, small bakery market is a well-saturated market with fierce competition landscape as this market is resided by many players and lack of customer brand loyalty. Second, the demand from small bakery market is highly elastic (i.e. price sensitive). Third, the expansion to Philippines market soared operating expenses with its profitability remains blurred in foreseeable sight. Thus, we assume higher opex-to-sales of 48.9%/48.5% in FY19F/20F to account for 's new product dropping policy that hikes transportation cost (FY19F/20F: 8% vs. 5-yr avg.: 7% of sales) and A&P spending (FY19F/20F: 7.5%/8% vs. 5-yr avg. 5.5%) due to market expansion.
Downgrade to SELL due to degraded earnings quality. In the lights of a persisted competition, we believe has transitioned to new regime where we can expect low-double digit growth on sales and profitability margin. Given this prospect and current demanding valuation, we downgrade our recommendation to SELL with lower TP of Rp910 (from Rp1,010). Our new TP implies P/E FY19F of 31.3x, in-line with small-cap FMCG valuation (avg. 31x).


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