· Well received in the West. In the industry for more than 30 years, KAWAN is one of the largest frozen food manufacturers in Asia. Frozen ‘roti paratha’ is its signature products (70% of revenue), while other products include spring roll, glutinous rice ball, veat and passion bakes. The Group has a proven financial track record, boasting 3- year net profit CAGR of 13.7% to RM20.9m in FY14. Exports contribute c.60% to FY14 revenue as the Group has penetrated major overseas market such as North American (32% of FY14 revenue) and European (29% of FY14 revenue) while the growth momentum has accelerated particularly in European market with 1Q15 sales surging 78%.

· Aggressive expansion signifying optimism. Aiming to capture the rising demand of the frozen food market, the Group has embarked on a massive expansion plan. New plant in Pulau Indah will boost KAWAN’s production capacity by 3.5x upon completion in end-FY15. The plant costs RM98.7m in Capex, to be funded by borrowings of RM40m and internally generated funds. Apart from strengthening its foothold in the frozen food, we understand that the Group might start producing ready-to-eat (RTE) food products after the new plant commences operations. We are positive on the innovative and horizontal diversification as the Group can leverage on its current network to reduce the phase-in period for the new products as well as broaden its revenue stream.

· Favourable macro environment. The subdued trend in global commodity prices is favourable for KAWAN. As of 1H15, prices of wheat and skimmed milk powder have fallen by 26.5% and 44.7%, respectively. Note that flour (by-product of wheat) is the largest component of KAWAN’s raw material costs at c.50%, followed by margarine (by-product of milk powder) at c.30%. Meanwhile, the weak MYR also bodes well for the Group as it derives c.60% of its sales from export but sources almost of all its raw material locally. Thus, we are projecting the gross margin to expand to 44.5% in FY15E from 42.6% in FY14 (FY13:40.6%).

· Explosive earnings growth projected. We are projecting net profit growth of 19.2% and 57.3%, respectively in FY15E and FY16E. We foresee margin expansion to drive FY15E growth while expect the new plant to catapult production capacity and earnings in FY16E. The Group should be able to stay in net cash position (net cash RM31.1m as of 31st March 2015) despite the heavy Capex for the expansion in view of potential cash proceeds of RM61.4m from the warrants conversion (in-the-money, expire date: 28/7/2016). While the warrants conversion might result in broader share base (+32.4%), we think that the net profit growth in FY16E is strong enough to offset the dilution effect.

· Not Rated with a Fair Value (FV) of RM2.63. Our FV is derived by pegging 18x PER to its FY16E FD EPS, which implied c.45% premium from the small-mid cap valuation (12.5x) we ascribed to stocks under On Our Radar coverage. Our FD EPS is based on enlarged share base of 270m shares after taking the warrant conversion into account. We think that the premium is justified in view of: (i) its proven financial track records with healthy balance sheet, (ii) the massive expansion which boosts capacity by 3.5x, and (iii) its strong position to capitalise on the current macro environment. However, we opine that the positives might have been priced in and thus the limited upside (6.0%) from our FV.

Source: Kenanga Research - 20 Aug 2015