Investment Highlights

• We maintain BUY on Power Root (PWROOT) with an unchanged fair value (FV) of RM2.67/share, based on FY24F PE of 18x, 0.5 standard deviation below the group’s 3-year average of 21x and on par to the mean for F&B sector. We make no adjustment to our neutral ESG rating of 3-star.

• We maintain FY24F-FY26F earnings following an analyst briefing yesterday.

• Management guided that 1QFY24 sales volume declined by 11% YoY, which was mostly offset by higher average selling price and forex gain. While management expect FY24F sales volume to decline by 5%, we expect margins to sustain on the back on lower raw material costs and better product mix.

• Management alluded to a softer 2QFY24 sales revenue due to: (i) weaker local consumer sentiments, (ii) shift towards consumer downtrading trends, and (iii) lower sales from GCC (Gulf Cooperation Council) countries as customers have purchased upfront prior to the adjustment in average selling prices in 2QFY24 by 5-10%. However, sales of export markets outside GCC countries remain stable.

• The group is presently distributing smaller-sized packaging instant premix products via retail chain stores such as eco-shops and Mr. DIY. This strategy to capture the mass market aims to attract customers who are downsizing on their shopping. Additionally, the company is actively engaged in ongoing initiatives, including the French Roast brand winning contest and promotional events during festivities. We have factored in a higher FY24F marketing expense of 10% of total revenue vs. 7% in FY23.

• A new product, “Jom Teh”, a 3-in-1 premix tea Teh Tarik flavoured tea series has been launched. Ongoing advertising and promotional activities have been carried out to raise awareness with a competitive pricing strategy. Management has strategically appointed an ambassador, actor Sean Lee, to promote the Ah Huat brand coffee to expand its reach into Malay-centric markets. Presently, the brand dominates Chinese-centric markets.

• PWROOT is gearing up to commence the distribution of Mogu Mogu drinks locally in October 2023, leveraging its substantial 60% stake in a joint venture with Thailand's Sappe. The company plans to gradually introduce the products through a variety of channels, including petrol stations, CU convenience stores, household chain outlets, and food and beverage establishments.

• Meanwhile, the joint venture with Sappe, aimed at selling PWROOT products in Thailand, is set to kick off in the 4QFY24. Currently, the venture is in the midst of commissioning a filling machine and executing its marketing strategy to promote the new product. We anticipate the inaugural contributions from this joint effort in 4QFY24.

• PWROOT has successfully penetrated the Canadian market, met with a positive reception for its coffee products and Ah Huat black sugar milk tea. However, management remains cautious and does not anticipate a significant contribution from this market strategy which currently targets Chinese-centric customers. Conversely, the company anticipates more promising opportunities to penetrate the market in Africa. PWROOT is actively expanding its workforce and introducing a different formula of coffee products to to cater this region’s culture and taste. Notably, Statista projects a robust 5-year CAGR of 10% in the instant coffee market, which is expected to reach USD483mil by 2028.

• Thus, we expect stronger 2HFY24 sales underpinned by (i) festivity celebrations, (ii) new contribution from Thailand market, (iii) new tea series products, and (iv) higher market share from urban areas and newer markets in Africa and Canada.

• We expect FY24F sales contribution from the local market to be higher at 57% vs. 55% in 1QFY24 local. Meanwhile, we anticipate FY24F export sales contribution at 43% vs. 45% in 1QFY24.

• Moving forward, we expect earnings to sustain on the back of:
  (i) enhanced cost control strategies for raw materials such as by sourcing from alternative suppliers and adjusting specific stock keeping units (SKUs) to mitigate the impact of sugar tax on instant premix products;
  (ii) depletion of higher inventory cost resulting in better gross profit margin for subsequent quarters. We have imputed a FY24F gross profit margin assumption of 53% vs. 51% in 1QFY24, and
  (iii) better operational efficiency through streamlining of sales and marketing processes via digitalisation and upgrading of manufacturing processes. This will lead to a lower reliance on labor and higher production output.

• Management guided for a capex of RM20mil for machinery over the next 5 years and RM90mil-100mil for its new building which expected to be completed by 2028. We assume that it will be funded internally and partially through bank borrowings given its substantive operating cashflows and net cash of RM107mil currently. PWROOT recently has purchased a new filling machine which will improve its production output to 60 sachets/min/line vs. the older machine 28-35 sachets/min/line.

• On the ESG front, management is looking into (i) changing the group’s plastic packaging strategy towards a recyclable ecosystem that will not translate into a higher cost structure, (ii) reformulating for lower sugar content with alternative ingredients, and (iii) Expanding solar panels in the factory to save energy costs.

• At a compelling FY24F PE of 14x, PWROOT is substantively trading below its historical 3-year mean of 21x and sector average of 18x, while offering an attractive dividend yield of close to 6%. It has a minimum dividend payout policy of 50% and healthy net cash balance of RM107mil (11% of current market cap) as at 30 Jun 2023.

Source: AmInvest Research - 5 Sept 2023