- A well-established consumer player. London Biscuits Bhd (LONBISC) is a small cap consumer stock, which has registered 12 consecutive years of profitability since it was listed in 2002. We reckon that this is in line with the stable nature of consumer-based business, which is generally profitable. Note that LONBISC is the largest manufacturer of confectionery such as assorted cake, candy, wafers and snack in Malaysia with manufacturing facilities located in Ulu Tiram (Johor), Pasir Gudang (Johor), Seri Kembangan (Selangor) and Telok Panglima Garang (Selangor).

- Earnings reached inflection point. LONBISC earnings have improved by 11% to RM12.36m in FY13 after 3 consecutive years of earnings decline. More importantly, the earnings improvement trend is sustainable as its 1H14 net profit jumped 25% YoY to RM9.26m. Historically, LONBISC earnings decline from FY10 to FY12 is caused by its high investment to upgrade its capacity and expansion to modernise its equipment and machinery. However, the period of high capex should be coming to an end as its FY13 capex of RM22.01m was 61% lower than the previous 3-year average level of RM56.27m. Overall, we expect strong FY14E and FY15E earnings growth of 15% and 14%, respectively. Note that this is stronger than other Food & Beverage (F&B) consumer stocks under our coverage with earnings growth estimates, which is limited in the range of 5% to 12%.

- Good prospect for FY14. We expect FY14E net profit to improve by 15% to RM14.2m as LONBISC is poised to reap the benefit from its investment in the last 4 years. Management mentioned in its latest quarterly result announcement that the increase in production line (confectionery segment) has allowed new business opportunities to be secured. We are positive on this as we think that LONBISC earnings recovery is still at its early stage and hence its long-term prospects should be brighter as it secures more new business opportunities, possibly from the export market.

- Undervalued; Rare Malaysian consumer gems at below 10x Forward PE (FPE). LONBISC is currently trading at 9.2x FPE which is at a 16% discount against its peers which trades at an estimated FPE of 11.0x. Note that our 11.0x FPE for LONBISC’s peers is derived by assuming 5% earnings growth onto their historical PE of 11.9x due to lack of consensus forecast for its peers. In addition, LONBISC is trading at only 0.42x of its book value of RM2.17. We believe the discounts are not justified due to its earnings recovery in FY13 and 1H14 as well as comparable profitability within the consumer sector.

- Improved balance sheet. LONBISC’s net gearing declined to 0.63x in 1H14 which is lower than 0.67x in FY13 and is also significantly reduced from its recent high of 0.77x in FY11. Although LONBISCs net gearing is higher than other consumer F&B peers, we are positive on its reduced net gearing level as it signals that its cashflow has improved and is now being used to pare down debt to a healthier level. This may also be a sign that LONBISC’s high capex era has ended and the Company should enjoy better cashflow from its prior investment to increase efficiency and raise production capacity.

- TRADING BUY with a Target Price of RM1.18 based on Fwd. PE of 10x on its FY15E EPS of 11.8 sen. Our Fwd. PE of 10x is based on a 10%-discount to current FBM Small Cap Fwd. PE valuation of 11x. The 10% discount is applied due to its relatively smaller market cap and lower dividend payout. Overall, we expect a potential total return of 30.6% from here (Upside 29.0% and dividend yield 1.6%).

Source: Kenanga