We gather that Mega First (MFCB) and its partners have plans in the near-term to unlock the full potential value for some of its new investments, notably the packaging, integrated smart technology and oleochemical businesses. We believe these three will see explosive earnings growth in the coming years given their continuous expansion plans to increase capacity and production efficiency on the back of healthy industry prospects. Meanwhile, management reiterated its receivables collection from the Don Sahong Hydropower plant remains steady despite the weak fiscal position in Laos. Management also guided that they are looking into several merger and acquisition (M&A) activities, which are scheduled to be concluded by end-2022. Maintain Outperform with an unchanged SOP-based TP of RM4.74.

• 5th turbine construction progressing well. The construction of the 65MW 5th turbine is on track with the target completion date of 3Q 2024 with an expected energy availability factor of 41%. Excavation work is complete while ground concreting works are in progress. The turbine is being fabricated meanwhile. Negotiation on 5th turbine power purchase agreement is still ongoing due to slow response from the Laos’ EDL. However, management remains hopeful it will be concluded as Laos is committed to supplying more electricity to Cambodia in the coming years under the Laos Cambodia 700MW contracts signed in 2019. The Don Sahong power plant is geographically located closest to the Cambodian border.
  The continued US rate hikes is expected to increase its borrowing cost by USD1.2m (RM5.4m) based on the outstanding loan of USD108m under the renewable energy segment. However, the higher borrowing cost will be offset by i) favourable USD movements, ii) an increase of EAF by 4.2% to 98% in 2H 2022 due to the ongoing wet season and rescheduling of maintenance to next year and iii) upward adjustment of tariff by 1% to 6.27 US cents effective 1st Oct 2022. Despite the weak fiscal position in Laos coupled with relatively high public debt and weak FX rates, there is no issue on its receivables collection as the Laos government has also clamped down various speculations on the country’s financial position. On a positive note, the Laotian currency (Kip) has now stabilized compared to last few months as the government has clamped down on speculative activities, which saw a wide spread between the off-market and official market rates. For MFCB, the weak Laos currency has no impact on its cash flows as 90% of its electricity sales collection is derived in US dollars.

• Flattish 2H growth in resources. The surge in oil prices this year has pushed the average petcoke cost higher by 75%, up from USD65/mt to USD270/mt. Due to this, petcoke cost, which is used to burn the lime stone, accounted for 60% of total operating costs compared to 20% previously. Encouragingly, prices have softened by 10%-15% in tandem with the retracement in crude oil prices. Despite progressive selling price adjustments (ASP: +16.3%), the limestone business is still under margin pressure.

• Packaging sees slowing growth. The 60%-owned packaging segment is expected to see slower sequential growth in 2H 2022 on the back of intensifying competition and higher cost base due to recent capacity expansion which may exert pressure on overall margin. Raw material prices such as resin and papers have either stabilized or moderated. During the 1H 2022, Stenta’s capacity utilization was almost full at 90% while the Hexachase plant saw capacity utilization of 60%-70%, attributed to recent capacity expansion and slower demand. Meanwhile, the group is finalizing the tender cost for Stenta’s new factory on a 6.7-acre plot of land in Bangi. Upon completion of new factories for both the upstream and downstream operations by 2H 2023, the annual capacity revenue will surge from RM450m to RM1.2bn. Assuming pre-tax margin of 9%, it will contribute an additional 13% to current bottomline.

• Successive quarterly gains from Edenor. The 50%-owned oleochemical business posted net profit of RM18.6m with revenue of RM715m in the 1H 2022 as sales volume (QoQ: +8.2%) continued to rise in the 2Q 2022. Credited to the strong management team, the downstream business managed to see a quick turnaround after registering losses for the last 10 years under the previous owners. The capacity utilization is now running at almost full based on current CPO price of RM3,900/mt. We think the outlook for basic oleochemical and specialty fat businesses will remain robust in the 2H as the recent cut in Indonesian export tax will make it more competitive for Malaysian players. Currently, it is reviewing the entire terms with its JV partners, which we have been made to understand are not at arm’s length commercial basis. It will also need to convince its partners that some capital expenditure is needed to improve plant efficiency and productivity for its fatty alcohol plant.

• Reaping rewards from another fruitful investment. The 28.8%-owned Integrated Smart Technology (IST), which specializes in test handler machine, posted an estimated 2Q 2022 net profit of RM3.5m (contributed about RM1m to MFCB based on equity accounting) on the back of an annualised revenue of RM25m (PBT margin: about 20%). Management expects to see sustainable profit contribution in the second half, underpinned by strong order book. Assuming we annualize the earnings, the automated test equipment company is currently valued at only 2.8x based on MFCB’s invested capital of RM5.5m for a 28.8% stake three months ago. With the integration of testers, it provides testing solutions to various semiconductor players. The functions of test handlers include testing, visual inspection and final packaging. Amid intense competition for local engineers, the Melaka based automated test equipment company, which has a total of 80 engineers, has introduced share option scheme for its employees and the management team has indicated its plans for a public listing in the next 2-3 years.

Source: PublicInvest Research - 14 Sept 2022