We remain assured of Ajinomoto’s medium-term growth prospects, led by a healthy increase in exports and steadfast domestic business. In particular, we continue to see robust demand from the Middle East for its Halal-certified products amid a developing consumer base. Despite a 3-year forecast core earnings CAGR of only 5%, we like the stock for its undemanding valuations, defensive earnings and Halal export-driven upside potential to growth. Maintain BUY on Ajinomoto, albeit with a lower 12-month TP of RM19.80.

Bright start to FY20; export sales +33% yoy

To recap, Ajinomoto posted a robust set of 1QFY20 results (core net profit +29% yoy). Revenue growth of 6% yoy was lifted by a surge in exports to the Middle East (+55% yoy) and other Asian countries (+24% yoy), aided by a recovery in industrial products sales and a stronger US$ (+5% yoy). We expect a similarly good showing for the rest of FY20 on a healthy domestic private consumption, strong export momentum and stable forex, which should contain raw material procurement costs.

New plant to contribute positively to group’s long-term prospects

Despite the c.4% drag on earnings over the near term due to lower investment income from the group’s high cash pile (14% of FY19 PBT) following its new plant’s construction, we are nevertheless positive on the benefits to be reaped from its plant relocation, which should better position Ajinomoto to tap into the burgeoning Halal food market with improved production capacity and capability to develop new product lines. There would be no production constraint issues during the interim, as the company is able to rely on its regional affiliates’ production facilities.

Maintain BUY, but with a reduced TP of RM19.80 (from RM21.80)

We make no changes to our earnings forecasts. Although earnings growth would be muted by the new plant’s construction and commencement, there could be potential upside to growth given the group’s Halal-driven export momentum. We reaffirm our BUY rating on Ajinomoto albeit with a reduced TP of RM19.80, based on a lower CY20E PER of 20x (from 22x), in line with its 3-year average. At a 17.3x FY20E PER, the stock continues to look attractive due to its undemanding valuations within the F&B staples space. Downside risks: (i) weaker export sales; (ii) higher-than-expected raw material costs; and (iii) a decline in global macro conditions.

FY19 Review

Positive FY19 performance despite external headwinds

In FY19 and especially 1HFY19, Ajinomoto faced a tough external operating environment which had an impact in its export sales performance, due to a weaker US$ (-2.2% yoy) and slower demand for industrial feed products from other Asian markets. The resulting impact which was seen with the industrial segment’s weaker sales (-3% yoy) was nonetheless mitigated by a better gross margin owing to lower procurement costs of a key raw material, alongside improved domestic sales which drove the consumer segment’s decent 5% growth yoy in revenue. All in, the group still managed to register a decent core PBT growth of 7.6% yoy on the back of a 2.6% revenue growth and EBIT margin improvement (+0.7ppt yoy), although core net profit growth was relatively flat due to lower tax incentives.

5-year revenue CAGR of 5%; earnings CAGR 14%

The decent FY19 results despite external headwinds underscore the company’s defensive business and management’s prudent cost control, in our view. On a 5-year CAGR basis from FY14-FY19, revenue grew by 5.3% while core EBIT grew by 11.8% owing to progressive margin expansion (+3.5ppts from FY14-FY19). Core net profit grew at a quicker 5- year CAGR of 14.4% to RM56.4m, boosted by the surge in investment income due to cash proceeds of RM166m from its land disposal in FY17.

Past-5-year export growth lifted by sharp Ringgit depreciation

From FY14-19, export sales grew at a 5-year CAGR of 8.9%, with both revenue from the Middle East (10.5% CAGR) and Asian region (8.6% CAGR) outpacing domestic sales (CAGR of 3.4%) over the same period. A sharp fall in the Ringgit against the Dollar, the primary export currency, was a key factor for the export outperformance, as US$/MYR rose from 3.203 in FY14 to 4.077 in FY19 (+27%). On a US$-adjusted basis, Middle East and Asian region export sales registered average annual growth of 5% and 4% respectively from FY14-19.

Earnings Outlook

1QFY20: encouraging surge in export sales

Despite an 8% yoy dip in domestic sales during 1QFY20, we are encouraged by the 33% jump in export sales yoy, driven by a surge in exports to the Middle East (+55% yoy) and Asian region (+24% yoy) – representing a multi-year high of +27% yoy even on a US$-adjusted basis, and culminating in total sales growth of 5.6% yoy during the quarter. Aside from the stronger US$ (+5% yoy), we believe the strong export performance could be attributed to management’s efforts in strengthening its regional distribution network.

New product to boost domestic sales; operational improvements to support margins

Aside from the improved export sales momentum, we expect the domestic launch of a new stir-fry seasoning product, “Rasa Sifu”, to ride on the rising trend of urban households favouring quick-fix meals and drive FY20’s top-line growth, while local private consumption spending remains healthy. On the other hand, we expect margins to be stable despite forex fluctuations possibly affecting raw material costs, as management remains focused on profitability enhancement through continual improvements along the value chain, in addition to supply chain efficiency gains. All in, we expect the group to register decent earnings growth of 3% in FY20, arising from better sales performances from both the domestic and export front, or +7.1% if investment income stayed constant from FY19.

Plant relocation plans will have minor impact on earnings…

In our previous report, we had trimmed our earnings forecasts due to the invariable loss of investment income from cash reserves utilised to partially fund the construction of the new plant in Techpark@Enstek in Negeri Sembilan, slated for completion by FY22. As a result, we project the FY19-22E earnings CAGR to be lower than its 5-year CAGR of 14.4%. After the new plant is constructed, the group would shift its entire operations there from the current base in Kuchai Lama. With a larger land area and expected built-up space to accommodate an initial 20% increase in production capacity, we also expect higher depreciation and interest costs to kick in from FY23 onwards (assuming 33% debt funding for the RM355m plant capex). Meanwhile, management has yet to decide on the purpose of the Kuchai Lama land (end-FY19 net book value of RM27.1m) upon the relocation of operations.

…but nonetheless spur the group’s long-term growth prospects

Nevertheless, the new plant is likely to sustain the group’s business expansion plans for the next 10 years, while driving operational efficiency improvements. An upgraded machinery set-up alongside its strategic location in Techpark@Enstek, also known as a Halal hub, will provide the infrastructure to strengthen its production and development of Halalcompliant products, supporting both its local and Middle East sales prospects, plus an expanded product portfolio.

Near-term exports growth undeterred by production constraints

Over the interim period leading up to the new plant’s FY22 completion, we understand that Ajinomoto Malaysia is able to tap into its neighbouring affiliate companies’ production facilities to meet increasing export demand, such as the Indonesian plant, which is the only other Halal-compliant factory within the Ajinomoto Group. Sales transactions to the Middle East would still be recognised by Ajinomoto Malaysia – the only other listed entity besides the parent company listed in Japan.

ESG agenda could attract sustainability-driven investing

Furthermore, the new plant would see reduced carbon emission by switching energy sources towards natural gas and renewable energy such as solar power, thereby strengthening its ESG profile within the rising sustainable investing space. We note that Ajinomoto is only one of three F&B producers incepted into the FTSE4Good Bursa Malaysia index – alongside Carlsberg and F&N.

Valuation & Recommendation

Core FY20-22E net profit CAGR of 4.6% on lower investment income

We leave our FY20-22 EPS estimates unchanged, although we note there is upside potential to earnings should 1QFY20’s strong export sales momentum be sustained. At this juncture, we project core net profit to grow from FY19-22E at a 3-year CAGR of 4.6%, which lags projected revenue and EBIT 3-year CAGRs of 4.8% and 7.5% respectively due to lower investment income from cash committed to the new plant’s capex. Our revenue projections are underpinned by Middle East export sales CAGR of 5.3%, which is slightly above domestic and Asian export sales CAGRs of 5.0% and 4.0% respectively, while the US$ is expected to stabilise against the Ringgit at 4.10 in 2020E.

Maintain BUY, but with a lower TP of RM19.80

We reaffirm our BUY recommendation on Ajinomoto, albeit with a reduced 12-month TP of RM19.80, pegged to a lower 20x PER to the CY20E EPS (from 22x) in line with the stock’s average 3-year forward PER. This is to reflect the stock’s moderating earnings growth, alongside elevated risks of prolonged global trade tensions which could affect export demand. Nevertheless, we still favour the stock for its defensive business, Halal products’ growth potential and undemanding valuations in relation to other F&B producers in the consumer space, in addition to its listed parent company in Japan trading at a 25% PER premium at 21.7x FY20 consensus EPS. Downside risks to our call include: (i) weaker export sales; (ii) higher-than-expected raw material costs; and (iii) a decline in global macro conditions.

Source: Affin Hwang Research - 23 Sept 2019