Post a meeting with management, we came away feeling cautious of the group’s near-term prospects. Despite better top-line performance, margins could come under pressure due to rising production costs. In the longer-term, the group is poised to benefit from a new bottling facility and automated warehouse, to be completed by FY19. Maintain MARKET PERFORM but with a lower TP of RM2.40 (from RM2.50) as we trim FY18E/FY19E earnings due to higher cost of sales.

Perkier demand. In the recent 1H18 results, the group registered 10% sales growth. This was owing to a recovery in domestic demand from passive consumer spending in 2017. Likely stimulants are smaller product formats and improving sentiment. On the other hand, the export markets (mainly China) are demonstrating better traction from the shift to more customer-engaging sales strategies.

China operations returning to the black. The group’s trading segment had narrowed its operating losses to RM1.7m in 1H18 (from RM5.2m in 1H17) on cost savings arising from the shift in sales and marketing strategies in China. Previously, foreign operations were heavily focused on physical advertising, which proved costly and ineffective. While management expects a break-even in this segment a medium-term endeavour, we are confident of its turnaround in view of the effectiveness of the new approach.

Pumping through the clogs. On hindsight, the group intends to drive sales of higher margin sparkling water products (for the Spritzer and Cactus brands) which may lead to lumpy marketing expenses. Meanwhile, higher PET resin prices could be a concern for the group in the near-term with the rise in crude oil prices. While the above product variants may provide some relief if reception proves favourable, the group is also investing in a new automated bottling line for their small format offerings (i.e. 500ml or smaller) which could expand capacity and economies of scale for these product variations.

Post discussion with management, we are cautiously optimistic with the group’s medium-term outlook, mainly arising from cost pressures. Based on commodity readings, there could be a possible 15% increment in PET resin prices (Source: Bloomberg). Still, progress of the new automated warehouse continues to be on-track, earmarked to be completed by 2H19. This could ease cost constraints in the longer term. A note on the new sales tax; the group’s range of products appears to be mostly exempted while management expects less tax costs on the matter, hence leading to lower prices. However, prices are expected to remain at lower levels despite cost pressures in the short term, which we believe could be beneficial for demand growth.

Maintain MARKET PERFORM with a lower TP of RM2.40 (from RM2.50). Our TP is based on an unchanged 16.0x FY19E PER, but with lower earnings as we cut our FY18E/FY19E earnings by 8.3%/4.6% in anticipation of higher production costs in the near-term. In spite of this, we believe the group is poised to demonstrate longer-term improvement as most of its investments aim to bear results post-FY19.

Risks to our call include: (i) poorer-than-expected sales, (ii) higherthan-expected costs exposure, and (iii) delay in the construction of the new bottling plant and automated warehouse.

Source: Kenanga Research - 18 Sept 2018