Power Root Bhd
(July 16, RM1.83)
Maintained buy with a higher target price (TP) of RM2.19: New management initiatives to rationalise and improve operations have borne fruit. New product launches, restructuring in distribution network, and the adoption of new technology should propel financial year 2019 (FY19) to FY22 forecast (FY19-22F) earnings compounded annual growth rate to 13%. We like the stock for its earnings recovery momentum, generous dividend payout and sturdy balance sheet. It is unjustifiably trading at 16.5 times 2020 forecast price-earnings (PE), below sector average even after a greater than 30% year-to-date (YTD) share price gain.

We recently met up with the management and came away feeling more reassured of Power Root’s prospects as earnings recovery momentum remains firmly on track. Financial year ended March 31, 2019 [FY19 (March)] core net profit more than doubled year-on-year largely thanks to the sound strategies implemented by the new management, which took over in early 2018, further aided by the easing of key raw material prices including coffee and sugar. Among the changes, the company has restructured some of its underperforming distribution networks, and has moderated advertising and promotion (A&P) spending to be more targeted and return on investment-driven.

Looking forward, the management is targeting 10% top-line growth in FY20, with both local and export sales expected to chip in. This should be driven by new product launches, and continued restructuring in distribution and dealer network. Meanwhile, the company is banking on a more effective tracking system to improve the efficiency of ordering system and inventory management. Margin expansion should be underpinned by the favourable movement of key raw material prices, while the management remains prudent in A&P investment. Post-meeting, we raise FY20F-FY22F net profit by 4%-6%, which is broadly in line with management guidance.

Commensurate with our earnings upgrade, we raise our discounted cash flow-derived TP to RM2.19. The stock is trading at 16.5 times 2020 forecasts PE, a discount to the Bursa Malaysia Consumer Index FY20F PE of 17.5 times. Note that there is no close comparison to Power Root given its relatively small market capitalisation. Listed companies that manufacture and distribute fast-moving consumer goods products include Nestle (neutral, TP: RM132) that trades at more than 40 times PE, while the brewery sector commands PE of 21 to 23 times.

Despite the more than 30% YTD share price rally, we believe the run still has legs. Essentially, we expect Power Root to continue delivering earnings growth, as new management stays committed to restructuring and rationalise operations. In addition, dividend yield is attractive at more than 5%, supported by a healthy cash-flow generation and sturdy balance sheet. Having written down RM6.7 million of receivables in fourth quarter FY19, we believe the amount could be reversed in the near term as the sum in fully insured. — RHB Research, July 16