We are initiating coverage on ULICORP with an OUTPERFORM call and TP of RM5.60 based on a PER valuation of 16.0x. We like the stock for its leading market position and strong rooting against unfavorable economic conditions, coupled by its solid growth prospects and margin expansion from the progressive commissioning of production facilities in its new plant.

From strength to strength. The group registered sales of RM179.2m (+4% YoY) in FY15 and closed FY16 at RM201.1m (+12% YoY). The slower growth in FY15 could be attributed by the group nearing production capacity. Backed by better product mixes and economies of scale, operating margins expanded to 19.6% (+1.8 pts YoY) and 21.4% (+1.8 pts) in FY15 and FY16, respectively. As such, the group saw respectable growth in its bottomline for the last 2 years. FY15 and FY16 net profits were recorded at RM26.0m (+12% YoY) and RM31.1m (+20% YoY).

Broad clientele continues to support against economic slowdowns.

The group is exposed to a wide range of customers from various sectors, both locally and internationally. While mostly involved in public infrastructure projects, the products of ULICORP are widely used in various sectors due to their wide-based application. This may indicate a low risk of a significant slowdown in overall demand in short-to-mid-term. Exports, on the other hand, have been supported by increasing development in Singapore.

Completed plant in Nilai to expand production capabilities. Prior to the operation of its Nilai plant in 2H16, the group had a phase of undercapacity where its plants' utilisation rates were close to their maximised levels and were at the risk of bottlenecking orders. With the new plant, which could potentially to double the group’s total capacity, product delivery rates could be improved as more production lines are being commissioned. In addition, the expanded output potential would allow the group to undertake larger order volumes, which may have been rejected from the earlier lack of capacity.

Increase in capital-intensity and automation to expand margins. As more production lines are being introduced, we anticipate a stretch on the group’s economies of scale brought about by greater output for relatively lower overhead costs. Following this, the expansion of the group’s powder spray line in the same plant could further boost cost savings potential. In addition, we do not discount the possibility of the group to outsource certain aspects of its production capabilities to external parties in the event excess capacity arises.

Much hope for earnings growth. With the abovementioned, we forecast revenue for FY17E/FY18E to expand by 15%/19%. Along with the anticipated expansion of operating margins to c.22%/c.25% (from c.21% in FY16), we expect net earnings to grow by 25%/31% to RM39.0m/RM51.0m in FY17E/FY18E. For dividends, the group has exercised dividend payout ratios between c.56%-67%. Assuming a c.60% payout ratio for its future dividends, we could potentially see dividend payments of 16.0 sen/21.0 sen, which implies dividend yields of 3.5%/4.6%.

OUTPERFORM call with a target price of RM5.60, which is based on our ascribed targeted 16.0x PER, closely inline with +1SD above the stock’s 5-year average Fwd. PER. We believe the valuation is undemanding given the stock’s: (i) leading market position; (ii) strong growth prospect (of 2-year Forward CAGR of 28%); (iii) expanding profit margins; (iv) decent dividend yield; and (iv) net cash position

Source: Kenanga Research - 25 May 2017