Investment Highlights

• We downgrade our recommendation on Kian Joo Can (KJC) from HOLD to UNDERWEIGHT with a lower fair value of RM1.67/share (previously RM2.15/share), pegged to an FY19F PE of 11x. We have cut FY18F-FY20F forecasts by 22-40% to account for cost pressures due to rising raw material costs and higher anticipated labour costs, on top of intense competition in the corrugated carton space.

• KJC’s 3QFY18 results came in markedly below our expectations at RM3mil, bringing 9MFY18 to RM19mil. This accounts for only 46% of our full-year forecasts.

• 9MFY18 net profit tumbled 57% YoY due to: 1) turnover falling 1% amid a change in sales mix as lower sales of tin cans in Vietnam, aluminum cans and contract manufacturing offset higher sales in the cartons division;

2) higher aluminum, tin plate and paper roll costs which escalated by 12%, 5% and 8% respectively (Exhibit 2);

3) a loss on derivatives of RM0.9mil in 9MFY18 vs. a gain on derivatives of RM5mil;

4) incurring YTD RM9.4mil of pre-operating expenses in Myanmar.

• Segmental analysis:

• The can division: Revenue declined 7% due to a decrease in demand for tin cans in Vietnam and aluminum cans overall despite upwards adjustments in selling price to absorb higher raw material costs. Segment EBIT sunk 51% amid higher costs of tin plate and aluminum.

• The carton division: Revenue rose 13% as higher sales volume in both Malaysia and Vietnam as well as higher average selling prices (ASPs) to absorb higher paper costs while segment LBT narrowed from -RM13mil to - RM2mil due to higher revenue and lower general and administration expenses for 9MFY18.

• The contract manufacturing division: KJC recorded LBT of RM5mil in 9MFY18 vs. EBIT of RM2mil in 9MFY17 due to 25% lower revenue mainly due to a decrease in export sales in beverage manufacturing.

• The trading division: Revenue fell marginally by 0.3% while EBIT declined 28%.

• Impacted by higher material prices despite stronger MYR: The MYR appreciated against the USD by 8% from US$1:RM4.3466 in 9MFY17 to US$1:RM3.9892 in 9MFY18. However, KJC’s margins were still impacted by higher raw material costs. We estimate 20%/36% of KJC’s revenue/costs are USD-denominated, whereby a stronger MYR would positively affect the group’s earnings.

• Rising labour costs: In Malaysia, minimum wage increased from RM1,000 to RM1,100 monthly and an increase in Vietnam minimum wage by 5.3% in 2019 are expected to add cost pressure to KJC, especially as its manufacturing businesses and contract packing services are labour-intensive.

• Update on KJC’s Myanmar ventures: Construction of the group’s new plants are underway, expecting to commence production in 2HCY18, with facilities set up to manufacture two-piece cans and corrugated cartons in Myanmar. This will increase production capacity by an additional 500mil cans per year and 3kt/month respectively, which are already imputed in our forecasts.

• KJC’s short-term profitability will be impacted amid initial losses despite its topline potential — we do not foresee positive bottom line contributions within the first 2 years of operations due to high marketing expenses, production efficiencies due to lack of economies of scale, and language barriers. Although management expects a better 4QFY18, we anticipate a lacklustre FY18 overall.

• Better long-term prospects ahead as its Myanmar ventures are expected to be boosted by Myanmar’s young demographic profile, manufacturing cost advantage (~US$60-70/month in Myanmar vs. ~US240 in Malaysia) and Myanmar Foreign Investment Law Incentives (MFIL) incentives. However, we note that stiff competition looms in Yangon (near KJC’s planned Myanmar operations) but believe that the country’s demographic profile augurs well for Myanmar’s FMCG industry which could partially offset negative impact from more competition.

• We recommend UNDERWEIGHT on KJC despite its positive long-term prospects due to the following challenges:

i) Long gestation period (3-5 years) for Myanmar ventures a drag to the group’s profitability for the next few years, ii) escalating raw material prices and intense competition eating into margins, and iii) rising production costs, especially that of labour costs in both Malaysia and Vietnam.

Source: AmInvest Research - 26 Nov 2018