Fluctuating commodity prices a concern

Kenanga Research said there were distinct patterns in gross profit margin sensitivities across Dutch Lady, Nestle, F&N and Power Root.

PETALING JAYA: Despite enjoying relatively resilient demand for staple-related products, consumer companies will likely see their margins come under pressure due to volatility of commodity prices.

Kenanga Research, which maintained its “neutral” stance on the consumer sector, noted in its recent study that commodity prices and their influence on input cost have a significant impact on the profit margins of consumer staple firms with varying time lags.

“Over the past decade, a strong correlation has been observed among the prices of staple grains like wheat, corn and soybean, which has intensified in the last five years,” the brokerage said.

It noted that after examining the correlation among commodities over the past five to 10 years, it also found a similar strengthening relationship has emerged between cotton, aluminium and crude palm oil (CPO), likely influenced by shared global economic factors such as regional trade and industrial growth in emerging markets.

In addition, its study indicated that West Texas Intermediate crude oil has shown a positive and increasingly strong correlation with a range of commodities, including soybean, cotton, corn, coffee and aluminium, suggesting that global economic dynamics and inflationary pressures are driving these relationships.

According to Kenanga Research, there were distinct patterns in gross profit margin sensitivities across Dutch Lady Milk Industries Bhd, Nestle (M) Bhd, Fraser & Neave Holdings Bhd (F&N) and Power Root Bhd.

Its analysis revealed that Dutch Lady and Nestle’s gross profit margins were most influenced by sugar, corn, crude oil, coffee and soybean prices, with a nine-month lag effect.

F&N’s gross profit margin, conversely, showed a three-month lag correlation with sugar, aluminium, the Baltic dry index and CPO, while Power Root would be immediately impacted by fluctuations in sugar, coffee, aluminium and the Baltic dry index.

“In summary, the prevailing commodity price environment corroborates our gross profit margin projections, with Dutch Lady and Nestle likely to oscillate within a narrow range due to mixed commodities price trends,” Kenanga Research said.

“F&N, on the other hand, could see a short-term margin uplift in the third quarter of 2023, although this could be neutralised by subsequent commodity price hikes,” it added.

As for Power Root, it said, despite immediate cost pressure, the company’s robust brand and pricing leverage should help it weather these challenges.

Following the correlation study and the latest trends in commodity prices, Kenanga Research revisited its initial gross profit margin assumptions for the four companies and found that its earlier projections for Dutch Lady and Nestle were likely optimistic.

As such, the brokerage lowered its gross profit margin forecasts for both companies by 0.5% to reflect a more conservative stance.

Its revised gross profit margin projections for Dutch Lady now stands at 28.8% and 29% for the financial year ending Dec 31, 2023 (FY23) and FY24, respectively, while that for Nestle now stands at 31.2% and 31% for FY23 and FY24, respectively.

These adjustments resulted in lower net profit forecasts for Dutch Lady and Nestle by up to 1.7% and 1.5%, respectively.

Post-review, Kenanga Research retained its “outperform” rating on Dutch Lady, with a slightly reduced target price of RM26.60, compared with RM27 previously, while Nestle remained at “underperform, with a discounted cash flow-derived target price of RM115.

Its forecasts and ratings for F&N and Power Root remained unchanged.