Contrary to earlier expectations of a record year, APOLLO’s FY16 earnings came in at just RM29.7m (+17.6% YoY) – by a long short of our RM38.4m forecast. 1H17 earnings have shown further deterioration amid lower sales, a sharp rise in costs and foreign exchange volatility. While various initiatives have been made to expand production capacities and improve operational efficiency (via the adoption of fully automated machinery), the efforts were stymied by rising raw material prices, long approval processes and support staffs’ shortfall. Hence, we bring closure to our previous “Trading Buy” recommendation, and believe that with the lack of earnings prospects, APOLLO’s share price is at best fairly valued at current levels of RM5.01 based on 19.3x FY18E EPS.

1H17 performance showed further deterioration. APOLLO reported 1H17 revenue of RM98.1m (-5.4% YoY) and earnings of RM10.0m (- 52.0% YoY). The weaker top line performance was due to lower sales in both local and overseas markets. In particular, we believe that the lower turnover from the overseas market was mainly attributed to a change in policy in Indonesia - a market that accounts for c.80% of APOLLO’s exports. Meanwhile, the increase in costs of raw materials (such as cooking oil and sugar) coupled with lower foreign exchange gains narrowed its 1H17 net profit margin to 10.2% vs. 17.9% a year ago.

With two of the three major raw material prices (>50% of COGS based on our estimation) having risen sharply, we see little chance for gross margins to rebound in the coming quarters. Although flour prices have been fairly stable, other key raw materials, i.e. CPO and sugar have seen their prices climb 34% YoY and 30% YoY, respectively. Material cost pass-through mechanism has been of little help, particularly in the Indonesian market where consumers are more price sensitive. As such, we have assumed gross margins to compress to 22.0% in FY17 (- 5.4ppt) before stabilising at 23% for FY18.

Net cash pile has ballooned to RM127.1m (translating into RM1.59/ share). The large cash pile provides ample room for CAPEX, which we see as necessary steps given the current aging machineries and high dependency on manpower. APOLLO has already earmarked the Larkin site (Johor) for future expansion of newer and modern production machineries that allow for higher output and more automation. However, with uncertainty surrounding the timing of acquiring the necessary approvals and the need for hire a large number of support staffs, we do not expect any contribution from these new capacities within the next 1-2 years.

Decent dividend yield and scope for bonus issue? We have estimated dividend to come in at 19.0-21.0 sen (implied a dividend yield of 3.8-4.2%) based on an 80% pay-out ratio for FY17-18E (FY16: 80%). Nevertheless, we would not be surprised by a higher pay-out given APOLLO’s large cash hoard. We also see scope for a bonus issue, given the tight liquidity and high retained earnings of RM184.2m against a share capital of just RM80.0m.

NOT RATED. We project the group will record RM18.9m (-36.5% YoY) net profit in FY17 before recovering to RM20.8m (+9.9%) in FY18, underpinned by a modest recovery in overseas sales. At the same time, we bring closure to our previous “Trading Buy” recommendation, and believe that with the lack of earnings prospects, APOLLO’s share price is at best fairly valued at current levels of RM5.01 based on 19.3x FY18E EPS (13.2x ex-cash). This is in-line with the valuations for similar sized companies. For instance, OFI is currently trading at 19.4x PE

Source: Kenanga Research - 19 Jan 2017