- We initiate coverage on Teo Seng Capital Bhd (TSC) with a BUY and a fair value of RM2.40/share, based on a fully-diluted PE of 13x on FY15F earnings. TSC is a Shariah-compliant stock.

- TSC is a well-managed modern poultry farmer focusing primarily on the production of eggs. With a daily output of 3.1mil eggs, it is the third largest egg producer in Malaysia. About one-third of its production is exported to Singapore.

- Our investment thesis is built around five key factors:-

1) Favourable industry dynamics with stable growth of 3%- 5% p.a.: The industry is largely recession-proof as eggs are a consumer staple and is a small ticket item in household spending. The inelasticity of demand for eggs was demonstrated during 2008, when consumption increased by >6% YoY despite a price increase of 17%.

2) Strong management track record and parentage, backed by regional poultry giant Leong Hup (LH): TSC’s earnings CAGR of 35% over the last three years – FY12 to FY14 – is a testament to its management expertise.

As part of LH, TSC has first pick of the top layer breeds, which ensures the quality of its eggs. It also enjoys bulk discounts from scale economies on its raw materials as these are purchased by LH at the group level.

3) Scarcity of good consumer stocks trading at low PEs: Based on FY15F’s earnings of RM61mil, TSC is trading at an attractive PE of 11x, versus the average consumer sector’s PE of 18x. Its high ROE of 23% also stands out.

4) Robust earnings growth: We forecast earnings to expand by 16%-26% over FY15F-FY17F, underpinned by production capacity expansion (+400,000 eggs/day p.a. to 5.1mil eggs/day in five years) and steady demand growth. Operating margins are expected to remain intact at about 20%, thanks to soft commodity prices, namely corn and soya, which are feedstock for its layers. The addition of biogas plants would also help lower operating costs.

5) Expanding dividend payout: Capex of RM70mil would peak in this fiscal year, and thereafter normalise to RM25mil p.a. Given its steady average FCF of RM50mil over FY15F-FY17F and an under-geared balance sheet (net gearing: 24% but would revert to net cash in FY16F), management is targeting to raise its dividend payout from its historical rate of ~20% to 35% within the next three years. Based on its last traded share price of RM1.98, a payout of 35% would see yield rising to 5% in FY17F.

- TSC lacks an institutional following as it is presently under-researched. We believe that this would change given improved corporate access, steady earnings and dividend track record.

Source: AmeSecurities