Investment Highlights

• We maintain our BUY call on Power Root with a lower FV of RM2.08 (from RM2.20) after trimming FY19F, FY20F and FY21F earnings by 9%, 6% and 11% respectively largely due to lower sales growth estimates. Our FV is based on 15.0x CY19F P/E, which is in line with its historical average P/E.

• We came away from a recent visit to the company feeling generally positive. The key highlights are: 1. We believe the company is getting the hang of maximizing its advertising dollar, an on-going effort to boost margins while not eroding its brand value; 2. The company has been able to grow its export markets, mainly the MENA region as planned; 3. At present, input costs are generally in its favour, partially eroded by a weakened ringgit; and 4. It has decided to pass on the higher cost due to the recent implementation of SST to protect its margins.

• A&P optimization. The management will be more selective in its A&P spending moving forward as they will be scrutinizing the incremental sales for every advertising dollar spent. The group will also reduce its promotional spending i.e., “Buy 3 free 1” promotion instead of “Buy 2 free 1” and reducing premium freebies. The group is looking to reduce it from current levels of 23% of revenue to circa 18% of revenue. Previously, management’s focus was on increasing its market presence where sales grew at a 4-year CAGR of 7%. Now, the focus is moved onto streamlining the group’s spending process to maximize its return on spending. By our estimates, for every 1ppt of A&P saved, it impacts the bottom line by up to 9%. We have seen PBT margin improvement in the 1QFY19 results where it grew by 9-ppt.

• We believe the initial causal effect of this optimization is a muted growth in topline as seen in the 5% revenue drop in 1QFY19. However, this will be offset by management’s plans to revamp its current offerings as well as introduction of new products. Power Root will be introducing a new tea range with two new SKUs under its Ah Huat brand to cater to the local market by 3QFY19.

• The MENA Region makes up circa 80% of export sales. Power Root was able to maintain its export sales despite poorer consumer confidence in 1QFY19 (Saudi Arabia: -4 points; UAE: -8 points; Overall MENA Region: -1 point). As shown in Exhibit 1 and Exhibit 2, consumer confidence has since rebounded in Saudi Arabia by 12 points and in UAE by 6 points. We believe that this bodes well for the group as Saudi Arabia and UAE contributes 14% and 8% to total revenue, respectively.

• To further improve their presence, the management has identified the Cappuccino range as the bestselling range in the MENA region. Subsequently, the group introduced 3 new SKUs in 2QFY19 in their Cappuccino range namely; (1) Alicafe French Roast Cappuccino; (2) Alicafe French Roast Skinny Latte; and (3) Alicafe French Roast Salted Caramel with Cheesecake Flavour Latte.

• We remain convinced that the MENA region will continue to be the growth driver for Power Root where the group holds a large market share in the 3-in-1 coffee industry. We see potential in Power Root’s ability to expand their market share in the MENA Region which has a much larger captive market compared to Malaysia. Moving forward we expect export sales to contribute around 51%-54% to topline with circa 5% growth for FY19-FY21, driven by the MENA region.

• The implementation of SST will impact Power Root’s topline growth as management has indicated that they will pass on the cost to its customers in order to protect their margins. We believe this will hurt the group’s sales growth as their products are already selling at a premium price. However, we expect Power Root’s competitors to take similar actions hence reducing the impact on its market share which is currently at around 18%-24% for its coffee products and around 26%-32% for its energy drink segment.

• Raw material costs are expected to remain favorable to the company as coffee and sugar prices has continued to decline. As shown in Exhibit 3 and Exhibit 4, coffee price in MYR has declined by 14% while sugar prices declined by 18%, since Jan-18. Based on our estimates, every 5% drop in coffee and sugar price will improve earnings by 7% and 5%, respectively. However, management has locked in coffee input costs until 2HFY20 which means costs for coffee will remain flat in the immediate term. Power Root is exposed to movement in USDMYR with 50% of total sales and 35% of raw material denominated in USD. Based on our estimates, a RM0.10 weakening in RM against USD will improve earnings by 3%. In other words, Power Root is a net beneficiary of a weak ringgit.

• Key risks to our forecast include: (1) slowdown in export sales; (2) higher raw materials prices; and (3) potential share overhang. Ex-MD Datuk Low Chee Yen in his capacity owns a 17% stake in Power Root. However, it could improve liquidity as management collectively owns a tightly controlled 66% of outstanding shares.

• We continue to like Power Root because of: (1) Strong earnings recovery from streamlining of costs and growth in its exports sales; (2) Scarcity premium for exposure to the instant coffee segment as Power Root is the closest to a pure-play in the segment; (3) Steep trading discount to its historical and peer average valuation; and (4) Attractive estimated dividend yield of 6.4%-7.8%. We also remain convinced that Power Root will key in a full recovery in FY19 following its kitchen sinking FY18, which was weighed down by elevated input costs.

Source: AmInvest Research - 14 Sept 2018