- We re-affirm our BUY recommendation on Cocoaland Holdings, with a lower fair value of RM2.80/share vs. RM3.00/share previously based on our DCF valuation following an earnings fine-tuning.

- Our company visit gives us reassurance about Cocoaland’s growth trajectory. Earnings will be driven by an increase in sales of fruit gummy and hard candy. This is well supported by capacity expansion, an enlarged portfolio mix and a wider customer base.

- More importantly, Cocoaland is well-positioned to benefit from new lines, which will translate into the introduction of new products, such as liquid-filled hard candy and gummy as well as alleviate supply constraint.

- Negotiations are presently on-going to secure another two franchise agreements. One merchandise licence agreement was inked earlier this year for the Angry Bird trademark.

- Angry Bird hard candy is a new product. Sales will begin in 2QFY13 via its domestic distribution network. It will be sold at a premium of >RM2 for 60 grams in retail stores. Underpinned by a minimum guarantee of RM2mil in revenue p.a. and royalty fee of 7.2%, gross margins are at c.30% higher compared to the average gross margins for hard candy of c.30%.

- Given the group’s intention to focus on promoting the Angry Bird hard candy at this juncture and the complexity involved in the creation of an Angry Bird mould, management highlighted that the Angry Bird fruit gummy and pudding are likely to only kick-in earliest in FY14F.

- All in, we now expect Cocoaland’s earnings to grow at a robust CAGR of 13% over the next three years, from RM23mil in FY13F to RM31mil in FY15F, following a high earnings base from FY11 onwards.

- Nonetheless, earnings will be weighed down by:- (1) Minimum wage scheme, which in turn translates to additional staff costs of c.RM2mil; and (2) One-time commissioning costs arising from new fruit gummy lines to be incurred in FY13F.

- Recognising its strong balance sheet and debt-free status, our dividend assumption is premised on a consistent historical dividend payout ratio averaging over 40%. Cocoaland is considering dishing out a special dividend. Our forecast suggests free cash flow turning positive in FY13F, standing at 2.6% of after-tax FCF yield, and rise meaningfully from FY15F onwards.

- The stock had retraced from its historical high of RM2.61/share last year and by 11% YTD. We view the weakness in share price as a good buying opportunity. Valuation wise, the stock is trading at trough levels of 15x PE, below its 3-year historical mean of 22x.

Source: AmeSecurities