· Forex to accelerate export sales growth. Export sales, which contributed 39% of the Group’s total revenue (ex-property) in FY15, recorded impressive 4-year CAGR of 43.9% from RM29.8m in FY11 to RM127.7m in FY15. Currently, the Group exports its products to 38 countries with the Middle East region being the main market, which contributed 70% of the total export sales in FY15. Moving forward, the Group expects the robust export sales to be sustained on the back of the strong demand, particularly in the Middle East region. With the USD standing strong against MYR, we think that the strong momentum in export sales bodes well for the Group.

· A&P normalization to spur instant growth. PWROOT has been allocating 15%- 20% of revenue as Advertising and Marketing expenses (A&P) during the past few years, which played a vital role in penetrating new markets or gaining market share in existing markets. The Group embarked on aggressive marketing campaigns in FY15, spending 22.2% of revenue or RM72.4m in order to strengthen its market position but the efforts have failed to bear significant fruits. Moving forward, management guided normalization of A&P expenses of 15%-20%, which we estimate will shave off RM12m (21.3% of FY16E EBIT) from its expenses assuming a lower 17.5% or RM60.4m in marketing expenses in FY16.

· Longer-term excitement in planned UAE plant. PWROOT has planned to set up its manufacturing plant in Middle East once the sales milestone of RM130m is achieved. With export sales of RM127.7m recorded in FY15, we think that the Group will proceed with the overseas expansion plan. The construction is projected to cost USD14m-15m in CAPEX, provides initial capacity of 80k cartons/month vs 150k cartons/month in existing plants in Johor Bahru. We understand that the expansion plan is still in early stage but we think it offers a longer-term prospect for investors looking beyond the near-term earnings growth driven by the factors mentioned above. Based on the Group’s 77% stake in the Middle East subsidiary, the expansion is expected to cost CAPEX of c.RM44m over a 2-year period.

· Sturdy balance sheet to sustain dividend pay-out. PWROOT is in a net cash position (net cash: RM54.2m or 17.9 sen/share as of 4Q15) and has been paying out 61.1%-73.5% of its net profit to reward its shareholders in the past three years. Even after taking into account the CAPEX requirements, FCF remains well above RM40m p.a. over the next two years and thus, the payout can be sustained. Thus, we are projecting DPS of 10.5 sen and 11.0 sen in FY16E and FY17E, respectively (FY15:10.0 sen), assuming a pay-out ratio of c.70% of net profit. The dividend translates into yields of 4.8%-5.0% based on the closing price.

· TRADING BUY with Fair Value of RM2.58 (23.1% upside including dividend). We derived our FV by pegging 17.5x PER on FY16E earnings, 40% premium from the valuation ascribed to small-cap stocks (12.5x) under our On Our Radar (OR) coverage which is justifiable based on our recent research study on the F&B stocks (refer to Consumer 3Q15 Strategy dated 3rd July 2015). We think that the valuation is attractive for investors seeking exposure to the defensive and resilient F&B sector as it also represents a discount of c.30% from the large-cap F&B stocks under our core coverage.

· Resilient despite local headwinds. We project earnings growths of 11.8% (calculated based on annualized FY15 net profit) and 7.4% in FY16E and FY17E respectively, which is commendable for a consumer play considering the current soft local consumer sentiment. More importantly, PWROOT possesses the resilient and defensive nature of the F&B industry and thus justifies our premium valuation thesis. In a nutshell, the stock should be viewed from the valuation and earnings rebound angles rather than on just earnings growth alone due to its matured earnings base.

Source: Kenanga Research - 21 Jul 2015