Post a discussion with management we came away feeling assured that our outlook of the stock remains intact. Its China operations may still face challenges from slow customer conversion and increasing PET prices that may erode margins. Nonetheless, better sales outlook from recovering spending and new affordable products should support earnings. Maintain MARKET PERFORM but raise TP to RM2.50 (from RM2.40) on our rolled over blended valuations to FY19E.

Stronger domestic demand? Recall that FY17 recorded revenue of RM313.8m, which was slightly weaker by 1% YoY. Despite the support from the SEA Games in 2H17, management shared that demand during the year was uninspiring from the highly cautious consumer spending while they are expecting a positive shift in 2018. We concur with this view as we believe high forex levels (averaged at USD/MYR of 4.30) in 2017 likely worsened discretionary spending behaviour. Hence, the recovery in Ringgit (house estimate for CY18 of USD/MYR of 3.90) should lead to better consumption going forward. This could potentially be boosted by the introduction of new products (i.e. 300ml bottled water variants, rebranded niche products).

Shaking up the China market. Its operations in the Guangzhou, China continued to register losses in FY17, as profits were sunk by high advertising expenditure. Management aims to shift sales strategies in favour of stronger frontline presence as opposed to wider marketing exposure. This is with hopes of improving customer conversion through more personal association. Arising from lower advertising cost to be incurred, we believe the segment should benefit from the lower costs but also enjoy better topline. Management also guided for aspiration to improve export sales contribution to 10% of FY18 total sales while FY17 exports sale is guided to contribute 8% of total sales.

Seeing cost pressure. The group’s cost of sales mainly consists of packaging (i.e. water bottles, carton boxes). Despite expectations for better Ringgit exchange rates, the unfavourable rise in PET resin prices could potentially undermine savings in the coming period. Nonetheless, the commissioning of newer bottling machines since 2017 is expected to promote economies of sales to buffer operating performance.

Outlook intact. Post discussion with management, we feel assured that our medium-term view of the stock remains intact. Our sales growth projections are in line with better consumer sentiment expectations in FY18, but are expected to be less upbeat in FY19 due to tighter production utilisation rates. Nonetheless, the new automated warehouse which is expected to be completed in 2H19 should alleviate production constraints in the longer term. Recall that the group had received funding via private placement to finance the project. Further, narrowing losses from foreign operations should also lead to better bottomline.

Maintain MARKET PERFORM but with a higher TP of RM2.50 (from RM2.40, previously). Our TP is derived from an unchanged blended PER/PBV ratio of 13.0x/1.3x (both based on average 3-year PER and PBV) on FY19E. We believe the improving fundamentals of the stock are yet to be reflected in its share price, possibly due to the soft trading sentiment. Current valuations also appear inexpensive as the stock appears to be trading at an implied 14.7x PER on its FY19E earnings.

Source: Kenanga Research - 27 Mar 2018