Guan Chong Bhd
(Sept 30, RM3.98)
Trading buy with a fair value (FV) of RM4.85: The tailwind from favourable cocoa prices is the global cocoa supply volume has finally normalised after Ebola-inflicted shortages in 2014. In financial year 2014 (FY14), cocoa commodity prices rose to an all-time high of US$3,100 a tonne due to global supply shortages triggered by an Ebola outbreak in Africa, where 70% of global cocoa producers are based, negatively impacting Guan Chong Bhd’s Indonesia plant by about 60% of FY14 capacity.  Worse still, grinding activity surged in the region, upon the implementation in export tax on the country’s cocoa beans in 2010.

As a cocoa refiner, this greatly inflated Guan Chong’s production costs and led to a sharp decline in FY14 earnings before interest, taxes, depreciation and amortisation (Ebitda) margins to just about 1%, leading to a loss after tax and minority interests of RM17.3 million or -300% year-on-year. With the supply progressively normalising prices towards FY18’s US$2,300 a tonne, boosting its Ebitda margin to 11.6% and profit after tax and minority interest of RM190.1 million. We believe this long-term average could be sustainable as we gathered from the International Cocoa Organisation’s forecast that global cocoa production still outpaces demand and is expected to persist.

Guan Chong is highly exposed to global demand through supplying to some of the largest global blue-chip multinational corporations (MNCs) such as Nestle, Mars and Hershey’s in supporting their downstream businesses — manufacturing and distributing finished goods. With global MNC customers making up over 50% of Guan Chong’s revenue, we see the company as a beneficiary of a stable, diversified and growing international consumer market.

In dealing with these MNCs, the risk is not only reduced through diversification that a global market brings, it also enjoys a long order visibility of six to 12 months forward at a predetermined price. With this, the management is able to project that FY19 and FY20 orders are 100% and 60% filled based on its existing capacity of 250,000 tonnes a year.

The group has also announced plans to build a new facility in Ivory Coast, earmarked to be commissioned by the first quarter of FY21 for an additional capacity of 60,000 per tonne a year. The estimated capital expenditure of €50 million to €60 million (RM230 million to RM276 million) will be funded by internally generated funds, bank borrowings and proceeds from a private placement. We favour this initiative which could ease access to materials, provide a cheaper logistics cost for its exports and enjoy savings as tariffs are waived between Ivory Cost and the European Union.

Our revenue estimates for Guan Chong are RM2.85 billion (+26%), RM2.92 billion (+2%), with Ebitda at RM312.7 million (+19%) or RM315.4 million (+1%) as production inches closer to its maximum levels. This led to our net income forecasts of RM226.8 million (+19%) or RM231.6 million (+2%). Its dividend prospects are expected to remain low at two sen or 2.4 sen on a 5% payout ratio from a three-year average of 11%, on the management’s emphasis on reinvesting earnings to support operations and the aforementioned expansion for now. This translates into dividend yields of 0.5% and 0.6% for FY19 and FY20.

We call a “trading buy” on the stock with an FV of RM4.85 based on a 10 times FY20 price-earnings ratio (PER) valuation. Our targeted forward PER is above the stock’s three-year average as well as the current trailing level of nine times. We anticipate an expansion in valuations, warranted by the group’s enlarged grinding capacity catering to the defensive international consumer market, and a more stable operating environment after FY14’s supply shortage debacle, which is seen maintaining.

Additionally, our PER expansion could be viewed as conservative when compared with 16 times forward PER of its indirect peers — Cocoaland Holdings Bhd, Apollo Food Holdings Bhd and Oriental Food Industries Holdings Bhd. Guan Chong looks to provide a stronger three-year net profit compound annual growth rate of 9% versus -2%, and a better three-year return on equity of more than about 20% versus 9%. Further, Guan Chong could see brighter prospects in the longer term as its Ivory Coast plant contributes from FY21 estimates. The added liquidity from a pending bonus issue could also be seen as a positive. — Kenanga Research, Sept 30