We met with HSI and came away feeling positive about the group’s prospects going forward due to the expected minimal impact from a potential increase in minimum wage and widening of margins from cheaper realised palm oil price this year. Maintain BUY call with an unchanged TP of RM1.38 based on 20x FY19 EPS of 16.9 sen.

We met with Hup Seng Industries (HSI) management and came away from the meeting feeling positive about the group’s prospects going forward.

Potential impact from higher minimum wage. HSI guided that they do not expect to see a significant impact from a potential hike in minimum wage. When minimum wage was previously raised in 2016, HSI incurred a cost increase of just under RM200k. Note that Pakatan Harapan’s manifesto states that it intends to increase the minimum wage to RM1,500 (from RM1,000 in Peninsular Malaysia and RM920 in East Malaysia)

Expected gross profit margin expansion from cheaper CPO going into 2018. Lower 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, we estimate 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 RM2,462/MT. HSI guided that they do not practise commodity hedging, and have therefore realised a lower average CPO buying price this year thus far. We project the gross profit margin to increase to 41.3% in FY18 from 37.8% in FY17.

Capex from purchasing of new oven. HSI guided that they may incur RM26m capex cost associated with the purchasing of a new oven to replace an existing oven approaching the end of its usable life. They expect to see increased production efficiency and energy savings from the potential acquisition.

Price adjustment unlikely. Management revealed that they have not increased prices since 2011. We do not expect the group to raise prices for the foreseeable future given the expected favourable commodity prices. Note that Hup Seng cracker prices already dwarf its competitors.

Source: Hong Leong Investment Bank Research - 7 Jun 2018