Cost pressures seen to compress Hup Seng margins

TheEdge Thu, Nov 15, 2018 10:06am - 5 years View Original


Hup Seng Industries Bhd
(Nov 14, RM1.08)
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Following our recent meeting with management, we find that Hup Seng Industries Bhd’s financial year 2018 (FY18) top-line growth is expected to be stable year-on-year (y-o-y) at 4.4%. This would be driven by strong domestic sales growth of estimated 9.8% y-o-y on the back of higher disposable income within the bottom 40% group from generous cash allocations from the government and the reduction in income tax rates by 2% for the middle 40% group taxpayers in 2018.

 
However, the strong domestic sales are expected to be partially offset by weaker export revenue, which is expected to reduce by 8.5% y-o-y on the back of the ringgit’s appreciation against the US dollar in 2018. Note that the ringgit’s appreciation has an adverse impact on export revenue due to translation loss. We have projected the average ringgit value to be at 4.05 per US dollar for 2018, which is 24 basis points stronger than 2017’s average of 4.29 per US dollar.

For FY19, top-line growth is expected to be lower at 3.4% y-o-y to RM323.6 million, underpinned by softer growth in domestic sales at 3.4% due to continuous pressure from the high cost of living among consumers and stronger export sales growth at 3.4% mainly from translation gain. Our projections are premised on stable consumer spending in Malaysia and weaker average ringgit value at 4.15 against the US dollar in 2019 and 2020.

Profit margins for FY18 are expected to be stable at the 14.5% level as increases in transportation cost and staff cost are likely to be offset by decreases in the cost of skimmed milk powder and chocolate chips on account of the stronger ringgit. Despite the weakness in crude palm oil price, the refined palm oil price is expected to remain steady above RM3,000 per tonne in 2018 due to robust demand for the soft commodity.

However, for FY19, we expect the profit margin to reduce by 1.4 percentage points y-o-y to 13.1% due to the surge in flour price, increase in packaging and transportation costs, and rise in staff cost. Based on our channel checks, flour price is expected to rise by up to 5% in end-2018 and this would dampen the profit margin as flour accounts for roughly 25% of production cost. Meanwhile, the packaging cost, which we believe account for 20% of production cost, is also expected to increase due to rising carton prices.

Furthermore, the impending rise in petrol pump price from the second quarter of 2019 onwards would put further pressure on the profit margin. Staff cost is expected to rise in tandem with the rise in minimum wage to RM1,100 per month from RM1,000 per month in Malaysia. Note that Hup Seng has over 200 workers, whereby we believe up to 60% of them are currently earning the minimum wage in Malaysia. On a brighter note, the cost pressure would be partially mitigated by lower coarse sugar price of RM2.85 per kg from RM2.95 per kg.

Recently in September 2018, Hup Seng announced its plan to purchase an oven for €2.5 million (RM11.83 million) from Italy. This oven is expected to increase the group’s production capacity by 15% from 33,000 tonnes per year. The installation is expected to be completed in the fourth quarter of FY19 and the commission of operation would likely begin in the first half of 2020. Note that the current wastage rate is up to 4% and the new oven is expected to reduce wastage rate down to 3%. We are positive on this purchase as this is in line with the group’s long-term sustainable growth objective.

We reduce our earnings forecasts by 3%, 14.2% and 5.7% for FY18, FY19 and FY20 respectively on the back of rising cost pressure which is expected to compress profit margins. — TA Securities Research, Nov 14

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