Investment Highlights

• We maintain our BUY call on Guan Chong (GCB) with an unchanged fair value of RM3.12/share, using an unchanged PER of 15x FY22F EPS. There is no ESG-related price adjustment for our rating of 3 stars.

• We expect GCB to show better results in 2HFY21, underpinned by improved EBITDA yields and production tonnage as its combined ratio is boosted by recovering chocolate demand. In the long term, we are optimistic on the group’s Ivory Coast, UK and Germany expansions capability to enter more lucrative western markets.
   
• Here Are Some Key Takeaways From the Results Briefing Held Yesterday:

1. For the second consecutive quarter, total sales tonnage continued falling, this time by 11.8% QoQ (though it rose +1.3% YoY). This is despite a 100% utilisation rate and the group reaching its highest ever production tonnage of 64K MT (Exhibit 1).
   
   The group expects sales to improve by 2HFY21 contingent on demand recovery and an improvement in the freight situation, though we foresee the Delta variant slowing down the process.
    
2. Cocoa butter contributions fell by 12.2% QoQ in 2QFY21, as premium chocolate demand in western continents remains weak. While demand has already been slipping for quite some time, even the resilient cocoa solids sales fell by 13.7% QoQ in 2QFY21. GCB believes that heavy freight costs (a portion of which is usually borne by customers) push potential buyers to seek out regional alternatives that are more competitively priced.
   
   Roughly 70% of cocoa butter volumes are shipped to Europe, the USA and Africa while 30% of cocoa solids are shipped to these regions.
    
3. On a more positive note, GCB’s combined ratio (relative to cocoa bean price) has gradually improved over the course of the quarters. While the still-weak butter ratio saw improvements in 2QFY21, cocoa solid ratios have experienced a steady albeit slow growth over the last two years. A factor to this is that cocoa solids, being shipped primarily to Asian regions, are less affected by freight disruptions.
   
   We expect EBITDA yields to improve in the coming quarters as combined ratio continues to rise, though unstable freight and input costs continue could offset potential gains in the near term (Exhibit 1). The current yield (excluding SHC contributions) stands at RM1,006.8/MT (+9% QoQ, -28%YoY).
    
4. The group’s Schokinag (SHC) facility’s revenue contribution dipped by 6% QoQ in 2QFY21 (base effects make YoY comparisons more favourable). SHC is subject to cyclical earnings, with 1Q of the year experiencing better sales. It contributed to 24% of total revenue. EBITDA contribution is still lumpy due to fluctuating raw material costs not matching with production chocolate ASP, as SHC maintains a very low inventory stock.
   
   We can look forward to more consistent earnings as global demand in raw materials begin to stabilise and as the group improves operational and profitability efficiency with pandemic restrictions are gradually relaxed.
    
5. About 75% of GCB’s workers in Malaysia have been administered with the first dose of the Covid-19 vaccine, with 95% expected to be fully vaccinated by the end of September. About 95% of factory workers in Indonesia have been fully vaccinated. While production shutdowns and workforce restrictions will cut into utilisation rate in the next quarter, we believe that no major hiccups will occur following a 95% vaccination rate.
    
6. We remain extremely optimistic on the group’s UK, Germany and Ivory Coast expansion plans despite continual delays plaguing development (Exhibit 3). Chocolate with a +30% EBITDA yield premium over operations in Asia can be generated in these facilities. Aside from selling directly to confectionary manufacturers, the Ivory Coast facility has the additional benefit of internal production for SHC and future UK and Germany facilities
   
   This provides a crucial opportunity for the group to penetrate the lucrative European and US markets, which have higher premium chocolate consumption than in Asia. The primary concern is commissioning date as there is risk that the pandemic would delay the commissioning date.
    
7. As the group continues to widen its reach in western markets, rising ESG concerns by large customers prompt the group to shift toward more sustainable methods of sourcing. Via its Ivory Coast plant, GCB will be partnering with the Rainforest Alliance, focusing on traceability, lifting the living conditions of farmers and stamping out child labour issues. While these procedures may require resources, customers are happy to bear the brunt of costs.

Source: AmInvest Research - 25 Aug 2021