• Kawan Food’s (KFB) 1Q19 core profit declined 76% qoq and 68% yoy to RM1.6m, coming in substantially below forecasts. This was due to higher-than-expected operation and depreciation cost of its new Pulau Indah plant.

• Revenue fell 4.7% qoq to RM50m reflecting weaker overall sales, although on yoy basis there was an increase of 8.7%, coming mainly from sales volume increase in export market.

• Overall, 1Q19 core profit lagged our full year estimates and consensus at 7% and 5% respectively. We lowered our 2019/20F earnings by 54%/48% (Table 3) on higher operation and depreciation costs.

• Downgrade to Sell (from Hold) with a new TP of RM0.70 (from RM1.50) based on PER24x.

Earnings dropped due to higher depreciation cost

KFB 1Q19 revenue increased 8.7% to RM50m compared to 1Q18, emanating from higher sales volume in rest of Asia and North America by 20% yoy and 14% yoy respectively. However, core net profit fell a hefty 68%, making up only 7% our full year forecast. The poor performance was primarily due to higher operation costs by 13% and additional depreciation cost of RM2.6m versus RM1.5m in 1Q18. As a result, PBT margin and net profit margin fell to 4.1% (-6.2% yoy) and 3.1% (-7.4% yoy).

QoQ performance eroded on high cost

On qoq basis, 1Q19 core net profit fell by a substantial 76% due to additional depreciation cost of RM2.6m (RM1.5m: 1Q18) and higher operational costs (+8% qoq). We note that the overseas sales were suppressed at 5% qoq which saw revenue from North America falling 23%. Overseas sales contributed 60% towards KFB revenue. The decline in sales volume implies KFB was unable to utilise the additional capacity from its new plant, in our view, causing higher fixed costs to decimate its operating profit.

New plant operation has commenced, but visibility is poor

As guided by the management, the new plant in Pulau Indah has completed yet we are unable to determine whether it is fully operational. Moving forward, we are cautious on the utilisation rate of the additional new capacity of its new plant and has factored in only slight growth. Risk to our revenue forecast remains however, if KFB were unable to extract and optimise the added production volume.

Downgrade to Sell with new TP RM0.70

In view of the poor quarter profit, we have lowered our FY19 and FY20 forecast to RM23m (-14%) and RM28 (-25%) with the view that there will be a lag time before the Pulau Indah will be running at its most productive. At the moment, we are maintaining our assumption that new plant benefits are expected to be derived from 2H19 onwards. This is also taking into account the difficulties they have been facing in increasing costs. Following the earnings downgrade, we have derived a new TP of RM0.70 (from RM1.50 previously) based on unchanged PER 24x. Downgrade to Sell.

Source: BIMB Securities Research - 31 May 2019