Highlights

• Hup Seng crackers, a Malaysian icon: Hup Seng Industries (HSI) core business involves the manufacturing and selling of crackers, biscuits, oat cookies and beverage mixers. Hup Seng’s epochal cream crackers have been a mainstay in the Malaysian food scene for close to 60 years. Currently, crackers constitute approximately 65% of the group’s sales.

• Expected gross profit margin expansion from cheaper CPO going into 2018 and stronger ringgit: Weaker CPO prices going forward should result in stronger gross profit margin for HSI. Our analysis shows that as the CPO price decreases YoY, the group’s gross profit margin increases significantly, and vice versa (note that CPO and flour cumulatively makes up over 70% of the group’s raw material costs). Analysing the previous six years, the two are strongly negatively correlated (at -0.7). Going forward, HLIB estimates the price of CPO to average RM2,500/MT in 2018 vs the 2017 average price of RM2,715. To date, the CPO price has averaged RM2,495/MT. HSI guided that they do not practise commodity hedging. We project the gross profit margin to increase to 41.3% in FY18 from 37.8% in FY17.

• Strong dividend yield: At current price, we expect HSI to return a dividend yield of 5.5%. Despite the group’s mandated minimum dividend payout ratio of 60%, we expect the group to pay out 90% of earnings in FY18 as has been the case over the previous three years (Figure 9).

• Net cash position: As of end-FY17, HSI had a net cash position of RM99m or 12 sen/share. The group shared that they plan to use the cash to acquire new ovens should they need to increase production capacity in the event of significant demand increases.

• Capacity: HSI shared that the group’s capacity for producing crackers are at full capacity. The group has since purchased two plots of land adjacent to their factory with a view of increasing capacity in the future. HSI’s oat cookie production capacity currently stands at around 30%.

Risks

• Volatile commodity prices (CPO, wheat, full milk powder, sugar).

• Rise in foreign worker levy, minimum wage.

Forecasts

• The group’s PAT declined from a high of RM54.7m in FY15 to RM44.5m in FY17 as a result of weaker ringgit strength impacting the cost of raw materials. We forecast HSI’s PAT to rebound by 14.3% in FY18 to RM50.9m. We project the gross profit margin increasing from 37.8% in FY17 to 41.3% in FY18 in tandem with lower expected CPO price in FY18.

Rating

Initiate with BUY, TP: RM1.38

• We like HSI for its strong dividend yield, healthy net cash position and expected margin expansion going forward. Despite this, we do not expect significant top-line expansion.

Valuation

• We initiate HSI with a TP of RM1.38 based on 20x FY 19 EPS of 6.9 sen pegged to its domestic peers trading average.

Source: Hong Leong Investment Bank Research - 27 Mar 2018