Lee Swee Kiat Group Bhd
(Aug 27, 68 sen)
Maintain add with a lower target price (TP) of RM1.21: Second quarter of financial year 2019 (2QFY19) revenue declined 1.1% year-on-year (y-o-y) and 7.4% quarter-on-quarter (q-o-q) to RM22.8 million due to lower export of semi-foam latex, particularly to South Korea which has been impacted by a soft economy. This was despite Lee Swee Kiat Group Bhd (LSK) recording stronger sales of finished mattresses in the domestic market. As a result, 2QFY19 earnings before interest and tax (Ebit) margin declined 1.8% points y-o-y and 2.2% points q-o-q to 7.7%, no thanks to lower economies of scale (reduced production) and higher latex prices. Accordingly, 2QFY19 net profit declined 22.7% y-o-y to RM1.6m.

 
As a result of subpar 2QFY19 results, first half of FY19 (1HFY19) net profit came in below expectations at 32% of our previous FY19 forecast. Note that 1H net profit typically makes up 38% to 42% of LSK’s full-year net profit. 1HFY19 revenue expanded 2.1% y-o-y, mainly from higher domestic sales of finished mattresses. However, 1HFY19 Ebit margin declined 0.8 percentage points y-o-y while net profit dropped to RM3.8 million (-7.6% y-o-y).

For 2HFY19F (forecasts), we expect LSK to record stronger results, premised on: i) increased sales of semi-foam latex to existing and new export markets; ii) higher economies of scale; and iii) lower latex prices. On top of that, we expect LSK to benefit from its efforts to improve cost efficiencies through more automation in its manufacturing process — for example, a new robotic arm and a new vaporiser that can reduce natural gas usage by about 40% to 50%.

In view of the weaker-than-expected 2QFY19 results, we lower our FY19-FY21F earnings per share (EPS) by 8.7% to 8.9%. This is to account for: 1) lower sales of semi-foam latex to its export markets; ii) higher latex prices; and iii) lower economies of scale. Nevertheless, we still expect LSK to record a three-year compounded annual growth rate EPS of 17.4% (FY18-FY21F).

In line with our EPS cut, our TP is lowered to RM1.21, still based on 14.8 times calendar year 2020 forecasts (CY20F) price-earnings (PE), 30% discount to our Malaysian consumer sector CY20F target PE of 22.8 times. Nevertheless, we retain our “add” call as we believe LSK has a strong investment case given: a) its strong earnings prospects; b) attractive valuations (8.6 times CY20F PE); and c) strong fundamentals (higher return on equity and net cash position). Potential rerating catalysts include a decline in latex prices and higher mattress sales. Downside risks are a surge in latex prices and weaker US dollar/ringgit — CGS-CIMB Research, Aug 26