• We initiate coverage on Oriental Food Industries Holdings Berhad (Oriental Food) with a HOLD call and a target price of RM1.61, based on 17.7x FY2019F PE. Oriental Food is a long-established household name in the local snack food industry. The Group is also one of the leading snack and confectionery manufacturers and exporters in Malaysia.

• A financially sound company with defensive business nature. Oriental Food has been enjoying constant topline and bottomline growths in the past few years. The Group chalked up 4-year compounded annual growth rate (CAGR) of 4.8% and 4.9% in its respective revenue and core net earnings from the period of FY2013 till FY2017 (reported net profit CAGR of 9.3%). Besides, Oriental Food commands a healthy balance sheet with current net cash/share of 2 sen or 0.03x, which allows it to have ample room to gear up for future capacity expansion. Meanwhile, the Group also boasts strong operating cash flow as evidenced by its capability of declaring dividend every quarter of the year.

• Export markets gain traction to underpin future earnings growth. Oriental Food’s current sales are mainly contributed by export markets with 63% topline contribution to the Group, of which, Asia Pacific region constitutes 43% of sales whilst Middle East, Europe, America and Africa amount to 20%. Meanwhile, local market only contributed 37% of total sales. Over the years, we have witnessed rising topline contribution from overseas market to the Group from 50% in FY2013 to 63% in FY2017. We understand that the average selling prices for exported products are 10-15% higher than products that are sold to the local market. Going forward, we envisage export markets revenue contribution to continue its growth trajectory to 67% by FY2019F in view of stagnant growth in the domestic market. To recap, the domestic market has experienced a sales drop of 12% in FY2016 and sales were flat since then in FY2017 no thanks to implementation of GST on 1st April 2015.

• New products and expansion plans to spur growth. Oriental Food is currently focusing on four main categories of snack food, confectionary and bakery products which are: 1) snack, 2) potato snack, 3) cake, and 4) wafer. We understand that the Group will introduce new biscuit products in a few months’ time. Types of biscuit products to be introduced are cream crackers, sandwich crackers, round crackers and black crackers to cater for different customer tastes and preferences. Besides, the Group also undertook the construction of two additional production lines for potato crisps to meet rising demand of potato snack food. We believe the biscuit and potato crisps production line could contribute a respective 10,800MT (1.8MT/hour) and 3500MT (0.7MT/hour) of annual capacity with operations targeted to commence in 2HFY18. However, management reckons that it will take 3-5 years for the new products, particularly the biscuits products, to reach their full capacity in view of time taken for marketing efforts, publicity of the products and acceptance of consumers in order to gain market share in a highly competitive biscuit business, as opposed to industrial products which have ready demand and less sensitive to brand name and health considerations. Should this new product venture turn out to be successful, it will further lift the Group’s gross margin in the long run as biscuit margin can fetch as high as 30-40% (vs snack food, bakery products of 20-30%) due to lower raw material costs.

Earnings Outlook

• We estimate the Group’s FY2018F and FY2019F reported net profits to grow moderately by 6.7% to RM19.5m and 11.5% to RM21.8m, on the back of higher toplines, +7.5% yoy and 7.0% yoy respectively. Core net earnings wise (after excluding unrealised and realised forex gains of RM4.2m in FY2017), we envisage the Group’s FY2018F performance to surge by 29.3% yoy. Margin wise, we estimate the Group’s operating margin to stabilise at current level of 9.2% for FY2018F (vs FY2017: 9.2%) before ticking up to 9.6% for FY2019F amid fall in current raw material prices for RBD Olein, sugar, wheat and processed potato

• We have imputed the contributions of the 2 new lines of potato snacks and 1 new line of biscuit production, which will commence operations in coming months, into our earnings forecasts.

Valuation/Recommendation

• Initiate coverage on Oriental Food with a HOLD call and a target price of RM1.61, based on 17.7x FY2019F PE. The target PER is at the upcycle PE of the stock, i.e. +0.25 standard deviation (SD) above its 3-year mean PE of 16.7x.

• While we favour the Group as being a defensive stock that provides consistent dividend and stable earnings, coupled with its less cyclical nature of business, we opine that the stock is fully valued at this junction and renders limited upside with its unappealing dividend yield of less than 3.5%.

Source: JF Apex Securities Research - 15 Aug 2017