Investment Highlights

• We maintain HOLD call on Guan Chong with a higher fa value of RM2.41/share (from RM1.49/share previously based on revised FY24F PE of 12x, at 0.5 std dev below it 5-year mean of 15x, given the volatility of raw materia prices. This also reflects an unchanged neutral ESG ratin of 3-star.

• We increase FY24F-FY26F revenue by 16%-47% to reflect: 2 1
  
  (i) stronger demand from customers due to the fear o 5 supply shortage in cocoa bean and further price hike 6 in cocoa beans, 5 0
  (ii) increase in combined ratio of butter and powder i 5 tandem with increase in cocoa prices, and 3 2
  (iii)gaining more market share from competitors a 6 competitors have insufficient beans for grinding.

• The combined ratio of cocoa butter and powder i improving mainly due to the increase in cocoa prices Notably, Guan Chong sells its cocoa butter forward at a pre determined ratio to cocoa bean prices. The final sellin price of cocoa will be finalised based on the pre-agree ratio on the prevailing cocoa bean spot price befor delivery.

• Thus, there is a time lag for Guan Chong to increase th combined ratio while cocoa price drastically increased Cocoa prices have surged by 128% QoQ in 1QCY24 reaching USD9,766/MT as at end-March 2024, compared t a 22% QoQ increased in 4QCY23.

• However, we forecast a 15% YoY decrease in FY25 revenue due to expectation of cocoa bean prices to b softer given that more new supply in the market and curren th supply issues to be partially resolved. This will adversel affect the combined ratio of cocoa butter and powde 1) leading to a drop of 20% in FY25F earnings. For FY26F, w 9) are projecting a mild 8% growth on capacity expansion an improved combined ratio which supports a 13% earning increase.

• We have raised Guan Chong’s FY24F-FY26F gross margin from 9% to 10% due to:
  
  (i) sufficient cocoa inventory for the year with 4-5 month of lower average cost inventory, and
  
  (ii) ability to protect margins through cost pass-throug mechanism.

• EBITDA yield per production tonnage improved by 24% QoQ to RM1,148/tonne in 4QFY23. We expect EBITDA yiel will continue to rise due to increase in the combined coco ratio and improved delivery of cocoa products t customers.

• Guan Chong has high finance cost which we expect to stay elevated due to heavy borrowings required to support the working capital for expensive cocoa beans. Hence, we are cautious on the likelihood that the high finance cost could erode its profit margin.

• The demand for cocoa and chocolate treats remains strong, driven by consumers' continued penchant for indulgence despite rising cocoa prices. Thus, we also expect that chocolate confectionary manufacturers will lock in orders to secure cocoa products and reduce the risk of insufficient cocoa inventory during a tight supply situation.

• As cocoa prices rise, we anticipate a near-term negative impact on the margins of chocolate confectionary manufacturers. We foresee a potential increase in chocolate product prices, a reduction in product offerings or the introduction of product innovations and reformulations aimed at mitigating cost increases for consumers, particularly those sensitive to price changes.

• We maintain our bullish view on cocoa prices due to a shortage in cocoa bean supply in 2024. This shortage is attributed to several factors, including prolonged diseases such as black pod fungus and swollen-shoot virus, which affect pods and trees, severe climate changes in West Africa and the issue of underpayment for small farmers in Ivory Coast and Ghana.

• According to International Cocoa Organisation, cocoa production is expected to fall short of demand in 2024 by 374k tons compared to 2023 . Presently, Ivory Coast and Ghana are the biggest cocoa producers which are facing supply shortages. Meanwhile, we understand that places like Brazil, Cameroon and Ecuador are targeting to increase output by 2030. However, trees take time to grow, so it will be at least 3 years before new pods provide supply relief.

• The group currently trades at a fair FY24F PE of 13x vs. its 5-year average of 15x due to higher raw material costs, while offering low dividend yields of 1%.

Source: AmInvest Research - 9 Apr 2024