· Established cracker manufacturer. Being the local market leader in cream cracker segment, HUPSENG has recorded 3-year net profit CAGR of 27% according to FY14 figures. The Group got off to a good start in FY15 by clocking net profit growth of 37.5% on the back of 10.2% revenue growth which the Group attributed to the benign growth in demand for biscuits in both local and overseas market. The net profit growth is deemed impressive as compared to the average of 12.8% we are forecasting for the F&B stocks under our coverage universe while 3- year average ROE of 23.4% is close to double of the average ROE (12.3%) we gathered from small-mid cap F&B stocks in Malaysia.

· Rapid sales pick-up. We spotted the spike-up in sales starting from 4Q14, with the revenue in the last 6 months (4Q14-1Q15) surging 10.3%. While we believe the stronger export sales could be partially due to the effect of weaker MYR, the local demand has also picked up, which resulted in more production shifts in order to capture the surge in demand. We think that the Group might have indirectly benefited from the plunge in consumer sentiment, which induced consumers to focus more spending on small-ticket staple food products. Besides, the Group is also banking on innovation to drive the demand growth moving forward as it aims to launch new products (oat cookies under ‘Naturell’ brand) in 3Q15.

· Margin expansion to drive growth. The Group recorded gross margin of 40.6% in 1Q15, which was an improvement of 2.9ppt from 1Q14. We believe the margin expansion was achieved on the back of favourable raw material prices as well as better operating efficiencies. Note that the key raw materials include flour, palm oil and sugar. We understand that the Group has undergone internal restructuring exercises that would boost its efficiencies in terms of production, procurement and logistics. As such, we are projecting further expansion in gross margin to 43% in FY15E-FY16E. With that, we project net profit to grow 36.2% and 9.4% respectively in FY15E and FY16E.

· Leeway for higher dividends? The Group is currently adopting a dividend policy of paying out >60% of the net profit. However, we foresee higher pay-out in starting FY15, supported by its cash of RM95.2m or 12 sen/share as of 1Q15 and strong operating cash flow (RM46.8m in FY14). Moreover, we also understand that capex moving forward will moderate after a total amount of RM8.4m being incurred in FY14 for its new oven. Thus, we are projecting DPS of 5sen/share and 5.5sen/share in FY15E and FY16E respectively, representing a pay-out ratio of c.80%. That would translate into decent dividend yield of 4.0% and 4.4% respectively.

· Recommendation and valuation. We rate HUPSENG as ‘Not Rated’ as our Fair Value of RM1.37 offers limited upside of <10%. Our FV is derived by ascribing 19.4x PER to its FY16E EPS, which is at steep 55% premium over the valuation we pegged to other small-mid cap stocks (12.5x) featured in On Our Radar (OR) reports. We think that HUPSENG deserves premium valuation as compared to other F&B peers in view of its: i.) Superior profit margin as well as ROE, ii.) Strong balance sheet position with no borrowings, and iii.) The resilience nature of its products as small-ticket food necessities. The stock is currently trading at 17.6x FY16E PER, based on the last closing price of RM1.25. 

Source: Kenanga Research - 11 Aug 2015