· One of its kind. Based in Ipoh, Wellcall Holdings (WELLCAL) is the only listed company which specialises in the manufacturing and distribution of industrial rubber hoses. The company manufactures mandrel hoses as well as extrusion hoses customised for a wide variety of applications, such as automotive, abrasion and welding, and to service oil and gas industries. Recently, the company announced the completion of a new production plant to include spiral hose to cater to customers with less heavy-duty requirements.

· Growing and still expanding. The company is now commissioning two production plants and a new production plant is in the pipeline. In addition to the newly invested spiral hose production line, the new plant will also house seven new mandrel hose production lines to increase the monthly capacity of mandrel hoses from 185,000 linear metres per shift (LMS) to 279,000 LMS (i.e. +50%). Furthermore, two rubber compounding machines will be installed in this facility to allow WELLCAL to perform rubber compounding in-house, a function which is currently outsourced. While there is no guidance on the amount of cost saving, we believe this strategic move will enable WELLCAL to enjoy better margins and to have better control over the quality of their production materials.

· Easing production costs in an export-oriented business. On top of the inhouse rubber compounding capability, WELLCAL is set to enjoy better gross profit margin with the declining cost of latex for its rubber hoses. Latex prices have declined from an average of 474.1 sen/kg in FY14 to 412.0 sen/kg in FY15 (as indicated by the Malaysian Rubber Board). Additionally, WELLCAL is poised to benefit from the recent drop in the crude oil prices as well, as petrochemical is used as an additive in processing rubber compound. Moreover, only a small portion of WELLCAL’s cost of production is in USD-denominated. As such, being an export-oriented business with approximately 90% of revenue generated from export transactions in USD, we expect positive effects to WELLCAL’s income statement from the strengthening of the USD. Nonetheless, as the company has a clientele base from across most regions in the world, with larger customers from North America, other Asian countries, the Middle East and Europe, WELLCAL may need to pass on some benefits from the strong USD back to their clients especially those in Asian countries as these economies also saw their currencies depreciating against USD.

· Strong historical performance with no signs of slowing down. In the past five years, the company has recorded a revenue CAGR, PBT CAGR and average PBT margin of 13.1%, 21.7% and 20.9%, respectively. With 9M15 cumulative revenue, PBT and net profit of RM119.8m, RM37.1m and RM28.4, respectively, it is set to overtake FY14 full-year results of RM146.4m revenue, RM38.7m PBT and RM29.5m net profit. We project FY15 revenue to fall close to RM175.1m (+19.6% YoY) with net profit of RM33.6m (+13.9% YoY). We further project that FY16 revenue of RM223.4 (+27.6% YoY), PBT at RM60.1m (+36.4% YoY) and net profit at RM45.1m (+36.4% YoY). We based our high growth projections to: (i) WELLCAL tapping into spiral hose line market, (ii) increased production capacity from the new production plant, (iii) cost savings from performing in-house rubber compounding, (iv) cheaper raw material costs, and (v) strengthening of USD.

· WELLCAL has been generous with dividend pay-outs exceeding 90% of annual profit after tax for the past five years, a much higher payment from its 50% minimum dividend pay-out policy. Up to now for the three quarters of FY15E, a total payout of 6.9 sen or 80.7% of 9M15 has been declared. Nonetheless, in view of the underlying expansion plan, we would not be surprised to see the dividend payouts being reduced slightly, say 80%, for the next few years. We understand that the Group may require a total of RM55.0m in capex. While we have factored in lower dividend payouts, we further consider a financing of up to RM21.0m by FY16 into our earnings model. As such, our FY15E and FY16E NDPS are estimated at 8.0 sen and 11.0 sen, representing yields of 3.4% and 4.7%.

· Not Rated, however, we believe WELLCAL should be valued within a range of RM2.30-RM2.90 (or RM2.60 on average), implying a FY16E-FY17E PER of 17.0- 18.0x, based on our FY16E-FY17E EPS of 13.6-16.0 sen. Although these valuations at a premium amongst its small cap peers, it is still not demanding, in our view, given WELLCAL’s: (i) high growth potential (15.1% CAGR from FY14 to FY17E), (ii) sustainable profit margins (20.2% average net margin for FY16E and FY17E against 19.3% between FY13 to FY15E), (iii) strong ROE of >30% in FY16E/FY17E, and (iv) decent dividend yield.

Source: Kenanga Research - 22 Oct 2015