Investment Highlights

• We maintain our BUY call on Power Root with a lower FV of RM2.78/share. Our FV is based on a PE of 20x CY21F EPS (rolled over from FY21F). Our PE multiple is a slight premium to Old Town’s 2-year average forward PE.

• We continue to like Power Root because of: (1) its strong earnings recovery from streamlining of costs and expected growth in its exports sales; (2) its scarcity premium for exposure to the instant coffee segment as Power Root is the closest to a pure play in the segment; and (3) a decent estimate dividend yield of 4–5.5% from FY20F to FY22F.

• 9MFY20 core net profit of RM38.9mil (+68.6% YoY) was above our and street’s expectations. It accounted for 85% of our and 80% of consensus’ full-year earnings forecasts. The variance was mainly due to the reversal of impairment loss on trade receivable amounting RM6.2mil and lower effective tax rate as Power Root utilized around RM1.3mil deferred tax income in 3QFY20.

• We lower our FY20F, FY21F and FY22F earnings forecasts by 1%, 8% and 3% respectively. We expect softer subsequent quarters as we take into account the full year impact of the sugar tax imposed in the UAE and Saudi Arabia as well as the Covid-19 impact in affected countries.

• 9MFY20’s revenue grew 14% YoY to RM295.7mil. This was on the back of an 8.6% increase in local sales and 19.9% YoY rise in export sales. We believe the growth in its export sales was largely driven by the MENA region, specifically in Saudi and Qatar due to more sales touch points and better demand in bigger stores. We believe the increase was also due to higher demand during the year-end festive season.

• Gross profit climbed 20.2% YoY as gross margin improved 2.6ppt to 54.3%. We believe this was on the back of favourable raw material prices. Power Root has locked in favourable coffee prices for the rest of FY20F.

• Raw material prices remained low YoY in 9MFY20 (Arabica -7% and robusta -18%, sugar +3%) as shown in Exhibit 1.

• EBITDA surged 56.4% YoY on the back of a 4.6ppt increase in EBITDA margin to 17.3%. We believe the enhancement in EBITDA margin was driven by Power Root’s continuous efforts to optimize and develop its distribution networks and implementation of cost management measures like tightening its procurement system and establishing guidelines to instill capital expenditure discipline.

• We are expecting a weak FY21F due to the impact of sugar tax excise duty in the UAE and Saudi Arabia (the MENA region makes up around 40% of total sales) as well as the Covid-19 outbreak in affected countries. In 9MFY20, the UAE and Saudi Arabia contributed to 9% and 15% of total sales respectively.

• Saudi Arabia imposed a 50% excise levy on sugar sweetened beverages (SSB) starting 1 December 2019 while the UAE will apply a 50% excise tax on SSB as of 1 January 2020. Power Root’s beverages are impacted by the recently expanded sugar tax. We believe the higher cost will be passed on to customers hence negatively affecting the demand for SSB due to the higher price point. However, Power Root is in the midst of introducing a product that is priced at previous levels in order to sustain its market share.

• We believe Power Root’s exports to China will be impacted by the Covid-19 outbreak. Power Root’s exports to Asia ex SEA is around 4–6% of total sales. A prolonged outbreak will deplete the circa 2 months’ worth of stock currently in China.

• To mitigate the negative impact of these issues, Power Root will be focusing its efforts in other countries to reduce the group’s reliance on affected countries and at the same time introduce products at affordable price points.

• Amidst the Covid-19 outbreak and economic uncertainty, Power Root is putting its expansion plan in Dubai on hold. Recall that the group planned to establish a factory in Dubai, with an estimated capex of RM30mil in order to penetrate the non-GCC market. The delay will not impact our earnings forecasts as we did not impute any earnings contribution from the planned expansion previously.

Source: AmInvest Research - 28 Feb 2020