• Kawan Food’s (KFB) 1Q17 core earnings of RM5.5m were below our expectations at 11.8% of our full year forecast.

• 1QFY17 core earnings declined 28% yoy due to higher selling and distribution expenses. However, earnings rebounded by 27% qoq following better gross margin achieved.

• We pared down our FY17/18E earnings by 7% respectively to factor in the delay in the opening of its new Pulau Indah plant.

• Downgrade to HOLD (from Buy) with a new TP of RM4.85 (from RM5.20). We are positive on its medium to long-term outlook amidst its capacity expansion but delays in commissioning of the new plant could see earnings coming under pressure.

Earnings dropped due to overall higher operating cost

1QFY17 revenue grew 14.5% yoy on improved sales from all regions except for Oceania and Africa. However, core earnings (after adjustments for forex gain/loss) fell 28.3% yoy to RM5.5m mainly due to higher raw material prices and distribution expenses. As a result, EBIT margin contracted 5.4ppts to 15.5%.

Higher qoq core net earnings

On qoq basis, core earnings gained 26.7% on the back of faster pace in revenue growth which led to higher gross margin achieved. We note that sales from all regions were higher especially from the North America (+29%) and Europe (+80%) regions.

Dividend declared

A single tier dividend of 2.5 sen was declared and paid during the quarter. We expect a total dividend of 8sen for FY17, translating to dividend yield of 1.8% at current levels.

Long term outlook remains positive but...

The new factory is facing teething problems (refrigeration issues) and only expected to be operational earliest by 2H17. Currently, the existing factory has been running at full capacity while demand growth is supplemented by its factory in Nantong. Although the delay in the opening the new facility in Pulau Indah is unfortunate, we are optimistic on the company’s long-term prospects due to the potential structural earnings growth from the new capacity. KFB plans to expand into the ready-to-eat (RTE) market with introduction of new products from the Pulau Indah facility.

Downgrade to HOLD with new TP of RM4.85

We cut our FY17/FY18 forecast by -7%/-7% to reflect the delay in the opening of the new factory, weaker-than-expected sales and higher operating costs. Downgrade to HOLD (from Buy) with a new TP of RM4.85 based on unchanged PER of 30x applied to its FY17 EPS.

Source: BIMB Securities Research - 31 May 2017