Investment Highlights

• We maintain HOLD on Hup Seng Industries (HSI) with an unchanged FV of RM1.05/share based on an FY19F PE of 17x. This is nearly on par with its three-year average forward PE of 17.8x.

• The 1Q18 results were in line, meeting 23% of our FY projection and consensus estimate. HSI continued its theme of revenue growth countered by a net profit decline, as it still struggles to manage operating and input costs.

• Gross profit fell on higher input costs (dominated by raw material such as palm oil, flour and sugar) while operating costs continued to be massive (with admin and marketing expenses taking up to a fifth of revenue).

• We believe that HSI is spending substantially to boost its sales but the quantum of sales growth is still too insignificant to compensate for the higher costs incurred. Sales have picked up pace on better results from modern stores and the upsizing of its distributor network, HSI said. The plans to open up the China market by nurturing its own distribution network has not taken off.

• We believe the current market conditions will make it difficult for HSI to push sales of its biscuit sales (other than the cream crackers) and beverages (the In-Comix range), for which production is well below its full capacity. Growth plans have been stalled until HSI can accomplish this.

• We have projected a conservative single-digit net profit growth for FY18-19 premised on a gradual improvement in margins and consumer sentiment, following two consecutive years of net profit decline.

• While dividend yields have been decent at above 4%, we caution that HSI’s generous dividend payouts (of nearly or tipping 100% of its net profit in the past 3 years) have come at the expense of holding back growth. HSI had acquired land two years ago to expand its factories but this was held back indefinitely due to the softness of the biscuits market.

• We reiterate that the growth story is uncompelling at this stage as the group works to fortify its domestic business while holding back from making a genuine move into China.

Source: AmInvest Research - 16 May 2018