FY18 core net profit of RM24.2m (+2%) and dividends of 3.5 sen are below estimates, as earnings were dragged by higher-than-expected PET resin prices. We believe the high cost pressures may continue to linger in the near-term, dragging profits. Still, strategies set in motion could place earnings growth on track in the long term. Downgrade to UNDERPERFORM with a lower TP of RM1.90 (from RM2.30) as we cut our FY19E earnings estimates.

FY18 below. FY18 net profit of RM24.2m came below our/consensus estimates, making up only 88%/91% of respective full-year estimates. The negative deviation was mainly due to higher-than-expected input costs, namely PET resin and packaging materials. A final dividend of 3.5 sen was declared, also missing our expectations (6.0 sen) following the weaker earnings.

YoY, 12M18 sales grew by 11% to RM347.7m, on higher volume and average selling prices. However, group EBITDA was stagnant with diminishing margins of 13.9% (-1.6ppt) owing to the manufacturing segment impacted by the rise in raw material costs (i.e. PET resin, packaging). The group’s trading segment continued to be unprofitable, albeit with losses narrowing as operations progressed to a leaner state. 12M18 core net profit closed at RM24.2m (+2%) following adjustments for one-off items in 12M17 of RM1.7m.

QoQ, 4Q18 revenue of RM85.5m (-11%) was weaker possibly due to higher consumer spending and sentiment during 3Q18 “tax holiday” season. However, following the abovementioned higher production costs, 4Q18 earnings of RM3.4m translated to a 54% sequential decline.

Flowing through the rough times. Sales performance for the group’s products appears resilient given their less elastic demand as compared to generic bottled water offerings. Hence, we believe there could be minimal impact arising from the imposition of sales tax against these products in Jan 2019, which were previously exempted in the initial SST schedule. PET resin and packaging materials may continue to dent the group in the near-term, as their prices are likely benched against the swings in crude oil prices, being by-products. Still, the group is poised to benefit from the fruition of its long-term strategies, such as; (i) the construction of its automated warehouse by FY20, (ii) cost rationalisation of it Guangzhou operations, which could soon break even, and (iii) aggressive marketing of higher margin products (i.e. sparkling water products).

Post results, we slash our FY19E earnings by 17.3% as we lower our margin assumptions in anticipation of higher PET cost pressures. Additionally, we introduce our FY20E numbers.

Downgrade to UNDERPERFORM (from MARKET PERFORM) with a lower TP of RM1.90 (from RM2.30, previously). Our TP is based on an unchanged 16.0x FY19E PER. This is currently within -1.0SD over its 3-year mean, which we believe is reflective of the pessimistic outlook painted by near-term cost pressures. Sentiment could improve with the commissioning of the group’s automated warehouse to drive efficiency, but is presently a long-term positive catalyst.

Risks to our call include: (i) better-than-expected sales, (ii) lowerthan-expected costs exposure, and (iii) faster-than-expected completion of the new automated warehouse.

Source: Kenanga Research - 27 Feb 2019