Investment Highlights

• We maintain HOLD on Hup Seng Industries (HSI) but cut our FV to RM0.92/share based on a lower FY19F PE of 16x from an FV of RM1.05 and PE of 17x previously. This is three notches below its three-year average forward PE of 19x.

• We cut our FY18-20 projections by 7-9% on lower sales for the group’s key products and higher operational costs. 1HFY18’s net profit of RM19.9mil came below expectations, making up 42% of our forecast and 41% of consensus. We believe the group is heading for a third consecutive decline in its annual net profit, stemming mainly from the challenge to raise its topline given an unexciting product range amid persisting high costs.

• HSI saw significant erosion on a QoQ basis in its 2QFY18 with revenue falling 10% and net profit dropping 21%. This was its worst quarterly net profit in at least 3 years. Both domestic and export sales were weaker. We note that both major product segments — biscuits and beverages — have demonstrated flattish topline growth in nearly 3 years with the exception of the seasonal spike in 4Q.

• We believe HSI could be losing the price leadership on its key biscuit products as the segment’s operating margin has come down from its peak of 25% in 2015 to 13% recently. Its beverages segment could still be finding its place in the market and may still be optimizing its sales structure which relies on distributors, as margins here have been volatile at best.

• 1HFY18 revenue grew 3% YoY but net profit dropped 4% YoY. The small revenue growth came on the back of stronger domestic sales, which were ultimately dragged by poorer exports to markets such as Indonesia, Mauritius and Japan. The latter chalked up weaker demand partly due to a stronger ringgit. HSI does not provide a breakdown by markets but it previously guided that exports accounted for a third of revenue and the growth from exports had surpassed the domestic growth in the past.

• We reiterate that HSI is spending substantially to boost sales but the quantum of sales growth seen is too small to compensate for the extra costs involved. Its admin and marketing costs have taken up an average of 20% of group revenue in the past 5 years and the corresponding revenue growth has varied from year to year. Furthermore, its gross margin fell in 2Q despite lower average CPO prices.

• HSI declared a dividend of 2 sen/share for 1HFY18. This was a similar amount and payout (about 80%) to the previous period. We reiterate that its generous dividend payouts have come at the expense of staying with the status quo. HSI has held back from the plan to expand its production for an indefinite period due to the softness of the biscuits market.

Source: AmInvest Research - 16 Aug 2018