FW: Implementation of sugar tax a negative development, but no immediate impact on F&N Holdings’ ratings

 

Published on 09 Nov 2018.

RAM Ratings views the recently announced excise duty on sweetened beverages as a negative development for Fraser & Neave Holdings Berhad (F&N Holdings or the Group). However, we do not expect it to have an immediate impact on the Group's ratings. 

As announced in Budget 2019, a 40 sen tax per litre will be imposed on drinks containing more than five grams of sugar or sugar-based sweetener per 100 ml, as well as fruit and vegetable juices with sugar content of more than 12 grams per 100 ml. The "sugar tax" will take effect on 1 April 2019. This will affect F&N Holdings' soft-drinks operations, which contribute almost 30% of the Group's revenue. Most of F&N Holdings' wide array of beverages (i.e. isotonic beverages, carbonated soft drinks, Asian soft drinks, tea, green tea, juice and water) in the ready-to-drink (RTD) market will be subject to the tax. This includes 100 Plus (regular variant), the largest sales and profit contributor in the Group's soft-drinks division. 

The razor-thin operating margins of F&N Holdings' soft-drinks business leave little room for it to absorb cost increases without affecting its profitability. As such, we expect its heftier costs to be mostly passed on to consumers through higher product prices. 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-RM3.40 for 250 ml to 1.5 litre drinks).

Despite the fairly minimal quantum of price increases, we expect demand to be negatively affected in the near term amid consumers' knee-jerk reaction. This will partly negate the impact from the generally more upbeat sentiment since the Pakatan Harapan government came into power in May 2018. Over the longer term, we expect the growth of the RTD market to stay subdued and largely driven by sales of bottled water, in line with consumers' increasing health awareness. Notably, the bottled-water segment is the only RTD sub-segment that registered a positive volume growth (+2.1%, by litre) in 2017. This contrasts against the overall RTD market's 5.5% contraction last year (2016: +3.8%) amid muted consumer sentiment and the spiralling cost of living.  

F&N Holdings' soft-drinks operations have been significantly affected by the competitive operating landscape, weak consumer sentiment and rising living costs in the last two years. The implementation of the sugar tax may exacerbate competition; big players such as The Coca-Cola Company possess deep pockets and have launched aggressive campaigns to wrest market share in the last few years. Given this, we do not expect the operating performance of F&N Holdings' soft-drinks division to improve meaningfully anytime soon. That said, the Group's dairy operations in Malaysia and Thailand are anticipated to anchor its performance, as was the case in fiscal 2017 and 2018. Even with a further weakening of its soft-drinks business, we envisage the Group's balance sheet and cashflow-protection metrics to remain strong, with a net-cash position and a funds from operations debt cover of close to 1 time. 

With this new development, we expect F&N Holdings to speed up its R&D efforts to reduce the sugar content in its beverages. In June 2018, the Group launched a lower-sugar variant of 100 Plus (which falls outside the scope of the imminent sugar tax). Nonetheless, this variant accounts for just a small portion of its overall 100 Plus sales.

F&N Holdings' RM750 million MTN Programme (2013/2028) and RM750 million CP Programme (2013/2020) are issued by its funding conduit (i.e. F&N Capital Sdn Bhd) and carry respective ratings of AA1(s)/Stable and P1(s). The debt facilities are backed by full, unconditional and irrevocable corporate guarantees from F&N Holdings. As such, the issue ratings reflect the credit profile of the Group.

Analytical contact
Amy Lo 
(603) 7628 1078
amy@ram.com.my

Media contact
Padthma Subbiah
(603) 7628 1162
padthma@ram.com.my

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