Hup Seng Industries Bhd
(Sept 12, 90.5 sen)
Maintain buy with a lower target price (TP) of RM1.03: We met with the management of Hup Seng Industries Bhd (HSI) and came away feeling neutral about the group’s prospects going forward.

 
Despite our forecasted earnings per share (EPS) of 5.4 sen for financial year 2019 (FY19), we do not expect HSI to cut its dividend amount of six sen per annum. Note that HSI had paid out six sen per share in dividend per share in FY17 and FY18, which represented 107% and 111% payout ratio of full-year earnings respectively. We do not doubt the group’s ability to pay out six sen per share for the foreseeable future given its cash pile of RM73.3 million (nine sen per share) as of end-June 2019, coupled with strong cash flow generation from its operations. We are positive on this dividend policy as yields at the current price levels represent attractive value, at 6.6% dividend yield.

Despite crude palm oil (CPO) price averaging RM2,133 per tonne in the first half of 2019  (1H19), which was significantly lower than the average in 1H18 (RM2,442 per tonne, year-on-year: -12.6%), HSI guided that it had been unable to recognise lower palm oil cost as the closure of many smaller palm oil refiners meant that large players can keep refined palm oil prices high despite lower CPO price. We estimate that CPO makes up about 40% of the group’s raw material cost.

To recap, HSI purchased a new oven in late-2018 for €2.5 million to replace an existing one. While we are unaware of how much costs savings will result from the installation of the new oven, we expect it to be positive for the group’s profitability given the new oven is expected to be operated by just 12 labourers (versus 20 and above for the old oven). Furthermore, the new oven is expected to result in a significant amount of raw material and energy cost savings as a large amount of biscuits made with the old oven had to be discarded due to the oven’s uneven cooking process. In the absence of any lengthy troubleshooting issues, we expect the new oven to be operational in the first quarter of 2020.

In light of HSI not being able to realise cheaper commodity costs in addition to weaker-than-anticipated export sales in 1H19, we lower our FY19/20/21 earnings by 6.8%/4.3%/4.3%.

After accounting for our earnings adjustment, our TP falls from RM1.08 to RM1.03 pegged at an unchanged 18 times FY20 EPS. Despite this, we like HSI for its favourable dividend yield (6.6%), healthy net cash position (nine sen per share) and reasonable valuations versus larger capitalisation consumer peers. — Hong Leong Investment Bank Research, Sept 12