Investment Highlights

• We initiate coverage (HOLD) on Hup Seng Industries with a fair value of RM1.10/share based on an FY18PE of 17x. This is nearly on par with its three-year average forward PE of 17.8x.

• The group is known primarily for its Hup Seng Cream Crackers, which we estimate forms at least 65% of total revenue. As a whole, its earnings are derived from biscuits, beverages (the InComix range) and other agent products (Wang Wang rice crackers and Ong Sam Yong Chinese tea, among others).

• While it is able to charge a premium on its cream crackers given the decades-long history of the product, the group's more recent offerings and beverage line are still trying to carve out a name in a very competitive market.

• Consequently, production for crackers is at full capacity given the healthy demand but utilisation for other products such as the oats biscuits introduced two years ago is at a significantly lower rate. The group has built a comfortable cash reserve to prepare for expansion in its production facilities. However, this has been held back for the next 2-3 years due to the continuing softness of the market.

• The group earns nearly a third of revenue from exports. It has 40 export markets with the top 5 being Indonesia, Singapore, Myanmar, Thailand and Saudi Arabia. While sales in both export markets and Malaysia were flat in FY16 due to poor consumer sentiment, revenue from exports had grown faster than the domestic market (at a 4-year CAGR of 7% vs. 4% for Malaysia).

• The group is in early stages of forming a long-term plan to derive more revenue from China. This is targeted to eventually raise export revenue by a fifth from the RM80mil it has chalked up annually in the past two years.

• We highlight the main challenges going forward to be: (1) the group's work to expand production on its main product and simultaneously boost sales for its other products to accomplish revenue growth; (2) its vulnerability to commodity prices, with raw materials such as palm oil and flour taking up 50% of its input costs.

• We deem the growth story to be uncompelling at this stage as the group works to fortify its domestic business beyond the foundation of its cream crackers, and holds back from making a genuine move into China to boost stagnant export earnings.

• We project for net profit to fall further by 3% YoY to RM48mil this year (from RM49mil in FY16), and then softly rebound 5%/4% YoY in FY18/FY19. We expect margins in FY17 to continue to see pressure from high input costs amid limited room to raise selling prices.

Source: AmInvest Research - 6 Jul 2017