A number of factors led to share price falling by 20% over the past one month: a) upcoming 1QFY19 results is expected to be weak; b) in hot water with the Perak Municipal; and c) concerns over the Yap family’s move to dispose warrants. That said, we obtained satisfactory responses from management and remain upbeat over its medium- to longer-term prospects. Maintain BUY but with a lower target price of RM0.95.

WHAT’S NEW

• Management update. Lay Hong’s share price has fallen 20% over the past one month. Hence, we caught up with management recently to get some updates and this note highlights the key takeaways.

STOCK IMPACT

• 1QFY19 results preview. Lay Hong is slated to report its 1QFY19 results sometime in late-August. We expect a weak showing with core profit chalking in between RM6m-7m (-40% to -48% qoq/+34% to +57% yoy) given the typical seasonal effect from Ramadan where table egg prices were soft and demand is sluggish. Also, there was a negative impact from higher feed costs where management shared that this rose by 12-15% qoq. Our sensitivity analysis shows every 1% decrease in egg prices could reduce earnings by 1% while every 1% rise in feed costs could reduce earnings by 4-5%.
• Bad things don’t last forever. We are not overly concerned with the unfavourable short-term price fluctuation of feed. In fact, we noticed corn and soybean meal prices have started to decline in May. However, this can only be felt 5-6 months down the road as feed is purchased in advance (note, there is no hedging strategy in place). As for egg prices, it has been climbing again since April (+32%). In the bigger picture, egg prices have been on an uptrend over the past 15 years and should persist moving forward, given resilient demand. Further, Lay Hong is transforming to a fully-integrated livestock farming player and egg prices are turning out to be a minor variable.
• Perak Municipal is looking to drawdown a RM700,000 bank guarantee of Lay Hong, claiming one of its broiler farm is polluting a nearby lake. After more scrutiny and lab testing, management found that they are in compliance, operating in accordance to procedures, and not harming the environment. Hence, Lay Hong is seeking a court injunction. According to management, the risk of seizing operations is quite remote. For now, it is business as usual. No announcement has been made to Bursa as the amount (RM700,000 bank guarantee) is immaterial (1-2% of earnings). Lay Hong does not appear to be concerned.
• Planning to exercise its warrants. An action which spooked investors was the selldown of warrants by the Yap family (also the controlling shareholders and management). We gathered they still have some 52% interest of the total warrants in circulation after disposing 2% over the past two weeks. Management explained they intend to convert some of the warrants to mother shares but needed to raise some funds for the exercise. Besides, they are restricted by the 2% creeping rule under the take-overs code to avoid triggering a mandatory offer. If this is upheld, our calculation shows the Yap family can only convert a maximum 62% of its current warrant stake (or 32% of total warrants in circulation) till Oct 21.
• NH Food also looking to convert their warrants. Management highlighted that its Japanese partner, NH Foods, is also weighing the option of converting a substantial amount of its warrants to mother shares. Notably, it is not restricted by the 2% creeping rule because it owns less than 33% of Lay Hong. Assuming it opts to convert all of its 70m warrants to shares while the Yap family exercise 12m of its warrants, the company stands to raise RM33m in cash. The proceeds will then either used for its Pulau Indah JV plant expansion or to reduce debts (interest savings could be up to RM1-3m per annum).
• Expansion plans intact. The original timeline for its Pulau Indah JV plant to be ready and operational by Sep 18 (capacity of 2,000MT/month) is intact. Based on our estimates, the collaboration with NH Foods will see increasing contribution to PBT from less than 5% currently to 16% in FY21. Separately, the completion of its new pasteurised liquid egg plant at Johor (capacity of 400-500MT/mth) is still on track ie by end-FY19. Recall, this expansion drive is to cater to the growing demand domestically and regionally, where current capacity (at Meru, Klang) is already full utilised.

EARNINGS REVISION/RISK

• Cut FY19-21 bottom-line estimates by 14-15%. Seeing the upcoming 1QFY19 results is likely to be weak, we tone down our FY19-21 net profit forecasts by 14-15% on the back of higher feed costs assumption and also imputing a weaker ringgit against the US dollar in our model.
• Key downside risks include: a) delay in expansion plans, b) surge in feed prices, c) sharp depreciation in the ringgit against the dollar, and d) irrational price competition.

VALUATION/RECOMMENDATION

 Maintain BUY but with a lower target price of RM0.95 (from RM1.10) as we lower our earnings forecasts. For valuation methodology, we are still employing the same price multiple, pegging Lay Hong to an unchanged fully diluted 18x 2019F PE. This is a premium to its 5-year forward mean PE of 13x and we reckon is justifiable given its multi-year growth story. However, our PE multiple is at a discount to the consumer sector (25x), considering its relatively stretched balance sheet (net gearing of 0.7x vs peers’ net cash) and unappealing dividend yield of <1% (sector: 3%).

Source: UOB Kay Hian Research - 1 Aug 2018