Double whammy for F&B companies

Sweet commodity: A worker arranging sugar stock that arrived at a shop in Kuala Lumpur. Raw sugar was traded at about 20.6 US cents per lb at the end of last month – which was 13.2 higher than the average sugar price of 18.2 US cents per lb last year.

Strong US dollar and high commodity prices to weigh on them

FOOD and beverage companies, particularly those operating in the confectionery and beverage industries, are facing a double whammy, hit by high sugar prices as well as the strong US dollar.

Beverage maker Fraser & Neave Holdings Bhd (F&N) is among the large firms that have seen profits dip due to the higher costs of the raw material, which is denominated in US dollar.

The price of raw sugar has spiked by over 50% since February 2016, and resumed its uptrend in December 2016 to trade at about 20.6 US cents per lb at the end of January 2017 - which is 13.2% higher than the average sugar price of 18.2 US cents per lb last year.

Analysts expect global commodity prices, including sugar, to continue to escalate due to unfavourable weather, causing output to lag behind demand.

Prices of agricultural commodities such as skim milk powder, coffee beans and raw sugar have been on the rise since February 2016.

A report by Alliance DBS Research states that raw sugar prices will remain elevated due to the global supply deficit which is estimated to hit five million tonnes this year due to drought affecting sugar production in India, Thailand and Brazil.

It expects the situation for Malaysian F&B players to only get worse in FY17 and FY18 due to the higher production costs, as they will not be able to pass this cost on to consumers.

This is as the average selling price of domestic sugar in Malaysia is still controlled at a ceiling price of RM2.84 per kg.

F&N, in its recently announced results for the first quarter ended Dec 31,2016, saw operating profit from Food and Beverages Malaysia (F&B Malaysia) decrease by 26.1% from RM81.6mil to RM60.4mil as a result of higher raw material costs, particularly sugar.

The company saw net profit for the quarter drop to 16% to RM127.3mil.

In its prospects for the year ahead, the company cautioned that input costs in subsequent quarters are expected to increase in line with the uptrends in commodity prices, and further compounded by the weaker ringgit.

This, it says, is because key commodities like milk and whey powder, aluminium and soya beans are also denominated in the US dollar.

Analysts have noted that F&B Thailand’s EBIT growth of 17.3%, which was boosted by favourable milk-based input costs, was not enough to offset the weaker showing from Malaysia which was dragged down by the higher cost of sugar.

CIMB Research says F&N has hedged its raw material requirements, particularly milk powder, as well as its forex requirements until the end of 2017.

“The group hedges a significant amount of its US dollar exposure on pledged raw material purchases and leaves only a small portion unhedged,” it said in a recent note.

Given the higher sugar cost environment, it says the company’s management plans to explore positive price actions, such as raising product prices.

UOB Kay Hian Research, meanwhile, notes that the full impact on the company from higher raw material prices and the weak ringgit will only be seen in FY18 as it has hedged milk powder prices at a low for FY17 and most of its US dollar requirements are on raw material purchases.

However, it says the high sugar prices will hurt the company’s margins in the upcoming quarters in FY17.

Sugar and milk account for about 25% and 45% of the cost of goods sold respectively.

Another firm impacted by higher commodity prices and the weaker ringgit is confectionery manufacturer Apollo Food Holdings Bhd which saw its net profit slide 55.5% to RM4.3mil for the second quarter ended Oct 31, 2016, compared to a year ago.

In its filing to the stock exchange, the company said the lower profit resulted from a decrease in sales as well as the increase in costs of raw materials.

“In view of the increase in costs of raw materials and the volatility of the ringgit against foreign currencies, the group expects its operating environment to be tougher in both the current and coming financial years.

“The market will continue to remain competitive,” the company said.

On the other hand, refined sugar producer MSM Malaysia Holdings Bhd (MSM), which controls about 65% of the country’s sugar market, also saw net profit slide 63.5% in the third quarter ended Sept 30, 2016 despite revenue rising 15.9% to RM633.1mil.

Net profit halving

For the nine months ended Sept 30, 2016, MSM, which is a subsidiary of Felda Global Ventures Holdings Bhd (FGV), saw net profit drop by half, or 50.3%, to RM106.3mil.

The company said the depreciation of the ringgit against the greenback, higher raw sugar costs and the weak refined sugar pricing structure have affected operating margin.

“For the nine-month period, the group continued to make progress in adapting to the high raw sugar price regime, volatility in the US dollar and increasing natural gas price underpinned by strong operating reliability and prudent capital spending,” it said.

MSM president and group CEO Mohamad Amri Sahari had noted in a statement that the cost of raw sugar had “increased tremendously” to almost 40% since the beginning of 2016 up to the end of Sept 2016, and this had significantly affected the company’s margins.

Following the dip in profit, in November 2016, the company increased the prices of its premium products such as caster, icing, brown and soft brown sugar by up to 30%.

At the same time, the company had also reportedly appealed to the Government to increase the retail ceiling price of refined sugar by 20% to 30%, citing the hike in world price for sugar and foreign exchange losses.

In light of this challenging period, food and beverage special-purpose acquisition company Red Sena Bhd says it currently on the lookout for acquisitions at fair prices.

“These are indeed challenging times for F&B companies in a climate of escalating sugar and other raw material prices and declining consumer demand.

“Packaging and transportation costs will go up over the next 12 months.

“Profitability has definitely peaked for many F&B companies in the Asean region in financial years 2015 and 2016,” the company’s business development director Ian Yoong Kah Yin tells StarBizWeek.

He notes that this represents “an excellent opportunity” for F&B business owners to lock-in the value of their businesses at the peak of their business cycle, noting that the businesses may want to sell part or the whole business.

“Red Sena is on the look-out for good F&B businesses at fair prices.

“We are confident that we have the experience and management ability to bring the F&B business we acquire to a regional level,” he adds.

Despite the rising costs, however, some companies in the confectionary business such as Cocoaland Holdings Bhd remain sheltered from the full impact due to their different operating conditions.

As Cocoaland is a major exporter, it trades sugar in international prices and benefits from the strong US dollar.

For the third quarter ended September 30, 2016, the company recorded a 25.2% increase in net profit at RM8.2mil, while its earnings for the first nine months of the financial year was up 21.5% at RM26.9mil.

The improvement in earnings was mainly due to higher profit margin sales mix, lower freight and forwarding charges, as well as forex gains, the company said.