Investment Highlights

• We initiate coverage on Power Root with a BUY recommendation and a RM2.20 FV – based on 15x CY19F P/E, representing a 57% upside. It is pegged to its historical average P/E. An estimated dividend yield of 6.4%-8.7% is attractive as well. FY18 appears to be a blip year with externalities impacting earnings compounded by a corporate reshuffle, which has been unfairly perceived, in our opinion.

• The fundamentals for Power Root are firmly intact, if not improving. Amongst the catalysts ahead are: i) MENA region, which now accounts for 40% of revenue to spearhead growth as penetration levels remain unsaturated amidst a large captive market. It has consistently grown at an estimated CAGR of 25% over the past 3 years (FY15-FY18F). ii) Realising past sacrifices. The previous commercial strategy was focused on market share accretion, which Power Root has successfully achieved over the years by ploughing into A&P. Management envisions Power Root to transition into realising past commercial investment sacrifices, which we think will benefit the bottom line. It is well within reach as A&P is elevated at 22% of revenue against FMCG companies’ typical range of 10-15%.

• Key developments. There has been some negative perceived uncertainty over Power Root in the last 6 months, which untimely coincided with its soft earnings patch. The fundamentals for Power Root are firmly intact, if not improving. Here, we address a few concerns: i) Redesignation of key personnel does not change status quo ii) JDE consolidation of coffee producers (OldTown and Super Group) likely a non-factor for domestic sales iii) Recent selldown partially due to an institutional investor unwinding its over-concentrated position of >12% iv) Middle East production hub a no-go for now, until it reaches critical mass. For now, we think it is positive while the company focuses on internally driven initiatives v) One-off kitchen-sinking exercise in 4QFY18 likely to see the quarter fall into losses

• Key risks. We see 3 key risks that could potentially undermine Power Root, which are:

i) Potential share overhang. Ex-MD Datuk Low Chee Yen in his capacity owns a 17% stake in Power Root. It is a double-edged sword, which could prove to be a share overhang in the longer run although it simultaneously improves liquidity as management collectively own a tightly controlled 66% of outstanding shares.

ii) Coffee input and sugar costs. Coffee cost has been locked in till 2HFY20 while sugar prices goes through a downcycle, with oversupply concerns. Based on our estimates, a 10% deviation from our coffee bean/sugar/ in USD/MYR assumptions would impact FY20F earnings by -10%/-3%/-15% respectively, assuming ASPs are held constant.

iii) Middle East – volatile operating region. Our immediate concern surrounds regulatory hurdles in the form of hikes to import tariffs. In-place expansion plans would have to be accelerated.

Source: AmInvest Research - 27 Apr 2018