· Weaker-than-expected 1H15. Although 1H15 NP of RM8.6m came in at 51.0% of our estimate, we consider this to be below expectation. Generally, the first-half periods are stronger, recording between 62% - 77% of full-year earnings over the last three financial years. YoY-Ytd, LONBISC reported 7.3% topline growth to RM177.6m but saw a 7.5% decline in net profit on the back of higher A&P costs and interest cost (possibly due to refinancing reasons). QoQ, 2Q15 saw a 2.7% increase in revenue but CNP fell by 31.1% largely due to significantly higher effective tax rates of 17.2% vs. 9.9% in 1Q15.

· Improving topline from rising orders and stronger USD… Topline was driven by increase in production lines, which has allowed the confectionary segment to secure new clients while orderbook for all segments remains healthy. Its venture into premium products and potato chips has seen strong demand from the market. In addition, LONBISC’s topline is likely to benefit from the stronger greenback as 47% of revenue is derived from export markets, with c.50% sales denominated in USD.

· …but overall profitability mainly affected by taxation. We note there is increasing A&P cost trend resulting in some slight compression in 1H15 EBIT margins by 0.6ppt to 10.6%. However, the more glaring impact arises from taxation. The group has been experiencing lumpy taxation trends where the second-half period’s effective tax rates tend to be much higher than the first-halves. The market may not be realized that LONBISC’s effective tax rates are starting to normalize towards the statutory tax rate of 25% as FY13-14 saw a jump to c.20% compared to the lows in FY11-12 of 3.2%-6.8%. As of the 1H15, the effective tax rate is at 13.2%, which is relatively higher than the 6.1%-6.2% in 1H12-13. This could be largely due to fewer claims for reinvestment allowances and capital allowances.

· Net gearing has improved to 0.57x from 0.73x a year ago. The group has done most of its capacity expansion, which would improve operational cash flow. However, their net gearing remains relatively higher than other consumer F&B players which are currently in net cash position. This could be a reason for the relatively lower dividend yield of 1.2% vs. our in-house consumer F&B player's peer average of 3.4%.

· Lowering FY15E CNP by 14.3%. We have revised FY15E revenue to grow at 8% YoY, considering that 1H15 revenue growth was 7.3% YoY vs. our previous assumption of 12% YoY. However, we also: (i) increased our effective tax rates to a normalized rate of 25% (previously assuming 18%) (ii) increased A&P cost assumptions so that EBIT margins of 10% are more reflective of 1H15, (iii) higher finance cost due to higher shorter term (e.g. hire purchase) loan exposures. Thus, our FY15E CNP will be flattish at RM14.4m. · In our last LONBISC report (dated 15 May 2014), we applied a Fwd PER of 10x, which implies a 10% discount to the FBM Small Cap Index (FBMSCAP) Fwd PER of 11x back then. The applied 10% discount is due to the relatively smaller market cap and lower dividend payout. However, the market had since taken a beating, causing the FBMSC Fwd PER to de-rate slightly to 10x. Considering their aggressive efforts to de-gear their balance sheet, we opt to maintain our applied Fwd PER at 10x.

· Downgrade to TRADING SELL with a target price of RM0.83. We had underestimated the speed of the normalization of their taxation and thus, have trimmed our earnings forecasts. Assuming unchanged Fwd PER of 10x, and rolling forward our valuation basis to an average of FY15-16E core EPS of 8.3 sen, this implies a FV of RM0.83. We also opine that the implementation of GST will affect products in their premium segment (e.g. roll/pie cakes), which adds on to our trading sell call. However, we will continue to monitor the stock closely as we laud their efforts to increase their product offerings and with its high CAPEX phase over, this will improve its gearing position. 

Source: Kenanga