Investment Highlights

• We cut our FY20–21F net profit forecasts by 9% and 1% respectively, and tweak our FV down slightly to RM0.87 (from RM0.88) for Hup Seng Industries (HSI) based on 16x revised FY21F EPS, at a 3x multiple discount to its historical average of 19x to reflect its unexciting growth prospects. Maintain HOLD.

• While we expect quarterly fluctuations due to the altered consumer spending pattern and disruption to the supply chain and logistics throughout the Covid-19 pandemic, we see a stable outlook for HSI’s sales on a full-year basis in FY20F.

• Domestically, we saw a strong 1QFY20 in terms of sales for HSI as consumers stocked up staple food items ahead of the movement control order (MCO). This will have been offset by a soft 2QFY20 as consumers stayed at home and ran down their stock holding during the MCO. Post-MCO in 2HFY20, we believe the shopping behaviour of consumers will gradually return to normal (i.e. no more excessive stocking up).

• Similarly, in terms of export sales, HSI's 1QFY20 numbers were strong, driven by inventory build-up by its overseas distributors ahead of the lockdowns around the globe. This will have been offset by a weak 2QFY20 due to the shutdown of the logistics network globally during the peak of the pandemic in the early part of the quarter. As more borders reopen from 2HFY20 onwards, we expect HSI’s export sales to gradually normalise, also partly helped by better sales incentives offered to its overseas distributors. Typically, export sales (to countries such as China, Thailand, Myanmar, Saudi Arabia, Indonesia, China and Singapore) make up about 30% of HSI’s total turnover.

• Despite a stable sales outlook in FY20F, we forecast lower earnings due to margin pressure arising from higher cost of input palm oil, which typically makes up approximately 40% of its total input cost. We believe HSI will not be able to pass on the higher cost to end users given the intense competition for market share as the economy reopens. Having factored in an 8% YoY increase in palm oil (vs. flattish assumptions previously), our net profit margin projection slips to 13% vs. 15% previously.

• We like HSI for its dominant position in the local cream cracker segment (via Hup Seng Cream Crackers/Biskut Cap Ping Pong). However, the market for the product is saturated and competitive with low entry barriers. It is unable to fully pass on rising costs due to the limited pricing power, resulting in margin squeeze. While the export market offers room for growth, it is even more competitive as it is crowded with low-cost producers from all over the region. To mitigate the challenging operating condition and competitive landscape, HSI plans to strengthen its product quality, expand its product portfolio, costs management and broaden its distributor network.

Source: AmInvest Research - 6 Jul 2020