[ANALYST REPORT] F&B: Q2 earnings disappointing

Affected by lackluster 2Q16 results, the domestic F&B industry index plunged on Aug 17. Having suffered from rising COGS-to-sales ratios in 1Q16, F&B players faced growing cost burdens in 2Q16 due to fiercer competition. 

With competition set to heat up further, and with F&B demand likely to remain lackluster, it is difficult to expect sector earnings momentum to pick up over the near term. Also worrisome, the sector’s valuations remain lofty. Finding the sector unappealing for the above reasons, we reiterate our Neutral rating.

2Q16 sector review: Earnings disappoint

The combined 2Q16 sales and operating profit for the top 15 F&B players increased 10.3% y-y and 3.3% y-y, respectively. However, excluding KT&G’s results, the combined operating profit figure slid 3.1% y-y.

Earnings at most F&B players (with the exceptions of KT&G and CJCJ) fell well wide of consensus.

If stripping out KT&G, the average gross margin and operating margin for the F&B sector contracted 50bps y-y (each) on: 1) soft top-line growth; 2) growing cost burdens; and 3) an upsurge in marketing expenses.

Greater marketing costs represent long-term structural problem

With many new products taking the market by storm last year, we expected the F&B sector to benefit from a fresh growth catalyst. However, we have yet to see these new hit products translate into enhanced corporate value (for their manufacturers). In detail, upon the proven success of original new products, competitors rushed to roll out copycats, resulting in: 1) intensified market competition; and 2) shortened product cycles.

Besides the fierce competition between individual products, the following factors have also negatively impacted F&B players’ margins: 1) rapidly changing consumption patterns; 2) a wide range of new substitutes; and 3) an unfavorable channel environment.

To take time for sector to fully restore investment merit

As long as the F&B sector’s earnings visibility remains cloudy, the sector will likely have difficulty restoring its investment merit. Although short-term trading opportunities may occasionally emerge for certain players, we believe that more time is needed for the F&B sector to fully restore its investment merit.

From a long-term perspective, we need to wait until F&B companies improve their fundamentals, a development which could happen via: 1) the easing of intense competition within the industry; 2) significant overseas sales volume growth; and 3) the securing of a dominant presence in the domestic market.

We reiterate our Neutral rating on the sector and put forward KT&G as our top pick, viewing the company as being best suited amongst sector players to defend its earnings.

Source: NH Investment & Securities