SFH is involved in the processing and sale of rubber block, an intermediary material for tyre manufacturing (mainly to China). SFH is currently optimizing its capacity by +16.9%, driven by the increasing demand from China, the world’s largest vehicle market. Furthermore, the commencement of new solar and biomass systems over FY22-23 will improve SFH’s cost structure. We take comfort of SFH’s cost-plus business model, protecting its gross margin from the increasing raw material and distributional costs. We derive a FV of RM1.00 for SFH, based on 11x PER FY23, given its healthy balance sheet, stable business model, earnings growth and attractive dividend yield.

Background. Seng Fong Holdings Bhd (“SFH”) is involved in the business of processing and sale of natural rubber of various grades, principally SMR grade and Premium grade block rubber. Its customers are mainly tyre manufacturers. SFH also trades block rubbers as required by customers.

Optimizing capacity. Post exiting its 60% owned loss-making Cambodia plant in FY20, SFH is currently optimizing its production capacity (+16.9%) for Plant 2 and 3 over the next two years, in view of increasing demand from its customers, especially from China. The exercise can easily be done by increasing the working hours of Plant 2 (from 12 hours to 17) and Plant 3 (from 10.5 hours to 17), requiring additional 93 workers (currently 150 workers). Overall capacity will increase from 141.5k MT to 166.0k MT in FY23.

China market. SFH exports 100% of its products out of Malaysia, with majority 70- 90% into the China market. China is the world largest automotive market with annual sales and productions of over 26m units and current motor vehicle population has reached 402m units (as of Mar 2022). We expect continued growth for the demand of SFH’s products in view of China’s ever increasing demand for tyres for new cars and replacement markets.

Installation of Solar and Biomass. SFH is currently installing two units of solar systems of combined 4.3MWp under approved “Net Energy Metering” scheme. The overall capex is RM12.6m, and is entitled for Green Investment Tax Allowance for 100% of qualifying capex. The solar systems are expected to commence operation in 4QFY22. Concurrently, SFH is installing two units of biomass systems of combined capacity 12kCal for heating purpose, which will reduce the utilization of diesel costs. The biomass systems costs RM6.3m and is expected to commence operation in 1QFY23. Both installations are estimated to cut operational costs by RM6.1m (13.3% of FY21 PBT) and improve overall margins upon commissioning.

Cost pass-through. Despite the increasing cost of raw materials (i.e. cup lumps, semi-processed rubbers and value-added additives), SFH’s gross margins are relatively protected under the cost-plus business approach. SFH purchases the raw materials at discounts to SMR and SCICOM quotes and sells its finished product at a premium to SCICOM quote. Furthermore, the recent surge in distributional costs is also included as part of the cost pass-through computation.

Financial growth. SFH is expected to register earnings CAGR of +10.0% for FY22- 24 driven mainly by capacity optimization and cost savings exercises following the commencement of solar systems and biomass systems in FY22 and FY23 respectively.

Fair value of RM1.00. We derive a fair value of RM1.00 on SFH based on PER 11x FY23 earnings. We opine that the valuation is justifiable by: (i) healthy balance sheet with minimal net gearing of 4.7% by end FY22, and turning net cash in FY23-24; (ii) stable business model; (iii) 10% earnings CAGR; and (iv) attractive dividend of 5 sen/share (6.7% yield) in FY23-24.

Source: Hong Leong Investment Bank Research - 7 Jul 2022