We are turning more positive on LHI’s earnings prospects, on the back of recent recovery in poultry product prices in the SEA region and its aggressive downstream expansion plan (via the expansion of The Baker’s Cottage (TBC) outlets). We raise our FY20-22 core net profit forecasts by 7.2%, 3.3% and 2.8%, respectively, mainly to account for slightly higher broiler price assumptions (following the sharper-than-expected demand recovery). We upgrade our rating on LHI to BUY with a higher TP of RM0.90 (based on revised 18x FY21 EPS of 5.0 sen).

We are turning more positive on LHI’s earnings prospects, on the back of recent recovery in poultry product prices in the SEA region and its aggressive downstream expansion plan (via the expansion of The Baker’s Cottage (TBC) outlets).

Downstream venture (via expansion of TBC outlets) to add stability to LHI’s earnings stream. LHI’s downstream venture, via the expansion of TBC outlets (from 53 outlets currently to 80 outlets by end-2020, and 300 outlets by end-2023) allows LHI to mitigate the volatile poultry product prices, and hence stabilising earnings at Malaysian operations over the longer term. Based on our estimates, LHI’s downstream segment will consume at least 30% of its broiler supply by 2024, which at the same time, indicates that at least 30% of its broiler supply in Malaysia will no longer subject to price volatility.

Unfazed by intense competition among bakery businesses. Despite the intense competition among the bakery businesses, management is confident on its business model, as TBC has remodelled its business and repositioned itself to “hybrid concept’’ bakery, with roast chickens being its anchor product. LHI will embark on its outlet expansion in the suburban areas of Klang Valley and Southern region (where rental is cheaper and competition is less intense vis-à-vis the urban areas), and the prices of its products (in particularly, chicken products) are priced more affordably relative to most other (if not all) bakeries and/or quick service restaurants.

Capex of RM35-40m p.a. from downstream venture. The aggressive downstream expansion plan will incur an additional capex of RM35-40m p.a. over the next 4 years, and we believe LHI will not have issues in funding this, as LHI has already delayed part of its group expansion plans in FY20-21.

Poultry product prices recovered since mid-May. New venture aside, we note that poultry product prices have recovered swiftly in SEA region since mid-May, thanks to easing lockdown measures (which have resulted in a strong demand recovery for poultry products) and supply chain adjustment. While it remains questionable if current high poultry product prices could be sustained over the longer term, we believe it is unlikely for poultry product prices to revisit their previous lows, as economic activities have started showing signs of normalising (unless second wave of Covid-19 infection and lockdown happen).

Forecast. We raise our FY20-22 core net profit forecasts by 7.2%, 3.3% and 2.8%, respectively, mainly to account for slightly higher broiler price assumptions (following the sharper-than-expected demand recovery). We have yet to reflect earnings contribution from its downstream venture, as we await better clarity on its expansion plan progress.

Upgrade to BUY, with higher TP of RM0.90. Higher core net profit forecasts aside, we took the opportunity to (i) roll forward our valuation base year (from FY20 to FY21), and (ii) raise our target P/E to 18x (from 15x earlier), as we believe LHI deserves a higher valuation multiple following its downstream venture (which will in turn stabilise its earnings base over the longer term). Correspondingly, we upgrade our rating on LHI to BUY (from Hold), with a higher TP of RM0.90 (from RM0.56 earlier) based on revised 18x FY21 core EPS of 5.0 sen.

Source: Hong Leong Investment Bank Research - 3 Jul 2020