CB Industrial Product (CBIP)’s 1H16 Core Net Profit (CNP*) of RM32.7m missed our (33%) and market (34%) forecasts as margins thinned in the Palm Oil Mill Equipment (POME) segment due to higher steel costs. No dividend was declared, as expected. After accounting for lower POME margins, FY16-17E earnings were reduced by 13-14% for lower TP of RM2.15 (from RM2.35). Downgrade to MARKET PERFORM on softer margin outlook.

Below expectations. CBIP’s 1H16 CNP at RM32.7m came in below consensus’ RM95.5m forecast at 34%, and below our RM199.4m forecast at 33%. This was largely due to higher tax rates post-pioneer status and weaker POME segment margin as steel prices rose c.20% QoQ. No dividend was announced, as expected.

Higher raw material cost. YoY-Ytd, 1H16 CNP declined 12% on higher tax rates (32% against 1H15’s 17%) and weaker POME segment PBT (-21%). After excluding investment and forex losses, core POME PBT declined 2% to RM50.5m as core margin thinned to 24% (from 26%) due to higher raw material prices (largely steel). This was slightly offset by doubled (retrofitting special purpose vehicle) RSPV segment PBT (+206%) on the commencement of new projects. QoQ, 2Q16 CNP rose 32% as Plantation losses reversed to PBT of RM2.5m. RSPV PBT also jumped 108% on new projects. POME PBT improved 10% on lower investment losses, but Core PBT declined 14% to RM23.3m on lower Core margins (22% from 27%) due to higher steel prices.

Rising cost risks. We remain positive on CBIP’s prospects with POME order book at c.RM 500m, which should sustain revenue for the next two years. With current supportive CPO prices, we expect good demand heading into 3Q16. However, as steel prices have turned increasingly volatile in recent months, we think the main earnings risk lie in raw material costs.

Reduce FY16-17E CNP by 13-14% to RM87.1-97.7m as we adjust POME margin lower in line with higher steel cost assumption.

Downgrade to MARKET PERFORM with lower TP of RM2.15 (previously RM2.34). We lower our TP to RM2.15 as we account for lower earnings and roll forward our valuation base year to FY17E (from average FY16-17E) for lower applied EPS of 18.4 sen (from 20.0 sen). Our Fwd. PER is maintained at 11.7x, reflecting the strong order book status and two-year earnings visibility. However, we downgrade our call to MARKET PERFORM (from OUTPERFORM) in light of increasing risk of volatile margins.

Source: Kenanga Research - 29 Aug 2016