News  QL has proposed a conditional voluntary take-over offer to acquire all the remaining shares it does not already own in Lay Hong Bhd (LHB), for a cash consideration of RM3.50/share.

 LHB is a 26.8%-owned associate of QL listed on Bursa Malaysia which is engaged in the principal activities of integrated livestock farming.

 The offer comes after LHB’s controlling shareholders’ decision to not re-elect QL’s representative on the board of LHB in its AGM concluded recently, which triggers the worries in QL that it may not longer be able to influence the corporate direction of LHB.

 QL is confident that it will create greater value through integration synergy and efficiency improvement if the takeover is successful. 

Comments  We were not particularly surprised with the development as QL has been increasing its stake in LHB since early 2014 to be in line with its growth strategy. To recap, QL first emerged as a substantial shareholder in LHB back in Aug 2010 when it acquired 23.3% stake at the price of RM1.05/share (PE:3.8x, P/BV:0.5x).

 The offer price of RM3.50/share (1.7% premium to last closing price of RM3.44) valued LHB at RM175m, which translates into FY14 PER of 24.3x and P/BV of 1.2x based on its latest audited annual report. The valuation appears to be lofty as compared to poultry sector average of 13.9x but we deem the valuation as fair as it is at a 10% discount to the FY14 PER of 26.9x which QL is trading at, which could be justified with the larger market capitalization. We also believe in the vision of QL’s prudent and experienced management team that had clearer view on the prospect and earnings growth potential of LHB, which could also justify the premium valuation vis-à-vis poultry peers.

 The offer could cost QL up to RM130.2m to acquire all the remaining shares and ESOS options. However, with net gearing standing healthily at 0.2x as of 1Q15, we do not expect the financing to be a major issue for QL. Net gearing is expected to inch up slightly to 0.3x post acquisition.

 We view the acquisition POSITIVELY as QL would be able to consolidate the full earnings of LHB. We estimate the full consolidation of LHB’s account to boost QL’s FY15E net profit by 6.7% and FY16 net profit by 6.1%. Net gearing could rise further to 0.4x after consolidating the high debt level of LHB (net debt: RM162.7m, net gearing: 1.1x) but that is not going to cause too much problem to QL’s sturdy balance sheet

 Meanwhile, we believe the move could create synergistic benefits as well as lifting the efficiency level with the economies of scale. We foresee cost saving in distributing expenses moving forward while also envisage QL to leverage on LHB’s retail presence in East Malaysia through its 18 outlets of G*Mart in Sabah.

Outlook  We maintain our positive stance on QL as we favour the company due to its sustainable earnings growth, at 18.8% and 13.3% projected in FY15E and FY16E, respectively, supported by growth across all its operating divisions while a successful takeover of LHB could lift its earnings further. Meanwhile, due to the less discretionary demand nature of QL’s products, it is expected to be less impacted by the soft consumer sentiments and lower consumer spending.

Forecast  We leave our earnings forecast unchanged pending the materialisation of the takeover.

Rating Maintain OUTPERFORM

Valuation  Maintain our TP of RM3.71 based on 21.8x CY15 PER, which implies +1.5SD over 3-year mean.

Risks to Our Call   Volatility of CPO prices

 Global economic and climatic uncertainties

Source: Kenanga