Investment Highlights

• We maintain our HOLD recommendation on Hup Seng Industries (HSI) with a lower FV of RM0.89/share (vs. RM0.92 previously) based on a rolled-forward FY20F PE of 16x, three notches below its 3-year average forward PE of 19x. We trim our FY19F–FY21F earnings forecasts by 5% due to the challenging outlook for the group’s export markets amid expectations of muted global sentiment.
• HSI’s 2QFY19 core profit came in below expectations at RM9mil, bringing 1HFY19 core profit to RM20mil. This accounts for 43% of our full-year forecasts and 42% of consensus’ estimates.
• On a YoY basis, revenue dropped 1% as the growth in domestic sales was unable to offset the decline in exports. Domestic sales grew RM0.6mil (+1%) mainly from HSI’s wholesale channel and East Malaysia, while exports fell by RM2.4mil (-6%) largely due to lower biscuits exports to Saudi Arabia and Thailand. This was despite the stronger USD against the MYR in 1HFY19 (+5%) which would have boosted export sales that make up ~30% of total revenue.

• Meanwhile, 1HFY19 core profit declined 5% YoY due to the aforementioned lower sales, higher operating costs which caused gross margins to fall by 1ppt YoY and higher taxation incurred. Despite the flattish 2QFY19 results, HSI’s 1QFY19 core profit was weaker by 10% YoY due to a decline in export market sales of RM3mil offsetting growth in domestic sales of RM1mil, coupled with lower margins for its beverage manufacturing and trading segments. Furthermore, 1QFY19 also saw a higher effective tax rate of 29% (vs. 26% in 1QFY18) due to under provision of taxes in prior years.

• On a QoQ basis, seasonal factors caused 2QFY19’s core profit to decline 15% QoQ in tandem with revenue falling by 8% due to lower domestic sales owing to the Hari Raya Puasa festivities in the quarter. This was despite export market sales increasing by 1% mainly from higher sales in Indonesia.

• HSI continues to work on improving its margins with efforts to expand its product portfolio, improve product quality and cost management, as well as broaden its distributor networks. The group purchased a new cracker line which is expected to be operational by FY20 and had also converted its two baking lines from liquefied petroleum gas to natural gas which brought about fuel cost savings.

• Despite this, concerns still remain on the uncertainty of the group’s export sales performance amid a highly competitive operating environment. As such, we keep our HOLD recommendation on HSI.

Source: AmInvest Research - 22 Aug 2019