We recommend a “Trading Buy” on OFI with a fair value of RM1.70. Improved commodity trends and inflow of foreign workers should lead to near-to-medium term recovery. On top of expanding capacity, the group is also looking to introduce new biscuit products into the market by 4QCY17. While FY18E is expected to be flattish from spilling over of higher cost from FY17, FY19 could reap the benefits of the abovementioned for a net profit growth potential of c.22%.

Cost trends expected to ease in the medium term. The group’s key raw materials are sugar, wheat and potatoes, in addition to milk, cocoa and palm oil. While cost of sales has been rising from hedging at high material cost levels and unfavourable exchange rates, we anticipate improvements in the medium term. Renewal of hedging policies in the near term is likely to benefit from lower base rates in recent months, on top of the recovery of our local currency (Oct 2017 6-month trailing average at c.RM4.25/USD vs Apr 2016 6-month trailing average at c.RM4.43/USD). Furthermore, we believe ongoing labour shortages may have led to loss in economies of scale. The situation should improve as the group has secured permits for the progressive inflow of foreign labourers in coming months.

Larger capacity and new products lines to cater for higher demand. Potato-based snacks are the group’s largest product segment, estimated to comprise c.50% of total sales. With four existing production lines at 90% capacity, a progressive rollout of two new lines by 4Q18 within a new factory-cum-warehouse facility should provide the group better capabilities to meet expanding demand. We believe that capacity is still ample for other product segments (i.e. cakes, cornbased snacks, wafers) as the average utilisation rate is c.60%. The same facility is presently housing a new baking line for the production of new biscuit type products. While we are unable to quantify the potential contribution of these new products, we are hopeful that the larger capacity of the potato-based snacks will enable stronger sales efforts.

FY17 bummed by input costs and loss in economies of scale.

FY17 revenue of RM256.1m (+5% YoY) grew from better exports (c.65% of sales) amidst flattish local demand due to poorer consumer sentiment. However, operating margins declined to 9.2% (-4.0pts YoY) likely from higher production costs and less optimal production rates from labour constraints. 1Q18 results reflected similarly, with 5% increase in sales from 1Q17 but lower operating margins of 9.4% (- 2.0pts YoY), likely due to the same reasons.

With the above mentioned in mind, we believe FY18E/FY19E sales could record at RM267.1m/RM272.9m (+4%/+4% YoY) on higher sale volumes with wider product offerings. This growth estimate is also broadly within the group’s 4-year sales CAGR of 5%, which are led by exports. We expect net profits to record at RM18.3m/RM22.4m (+1%/22%). FY18 is likely to see continuing pressures from higher raw material inventory prices and selling expenses to promote its new products with FY19 benefitting from the full easing of commodities on top of better economies of scale with its new production lines on board.

While the group has a 35% minimum dividend pay-out policy, we anticipate payments to trend at c.50% based on its 3-year average for payments at 4.0sen/5.0sen or yields of 2.7%/3.4%.

Trading Buy with a fair value of RM1.70, ascribing a 18.0x PER on FY19E EPS of 9.3 sen. The valuation is at a c.30% discount from the average 25.2x big cap valuation, which we think is not excessive as: (i) the valuation is within the stock’s 3-year Fwd. average PER, and (ii) it commands a comparable CY18 dividend yield. Furthermore, we expect the stock to maintain its net cash position at the end of FY18 and FY19.

Source: Kenanga Research - 8 Nov 2017