Coming from a recent management meeting, we slashed earnings estimates and downgrade the stock to MARKET PERFORM with a lower TP of RM1.45 from RM1.90 previously. While we believe the worst is over for its top-line, volatile raw materials costs undermine margins.

Recap. PWROOT’s FY21 earnings came in below expectations as exports were crimped more than expected while the domestic market performed better than expected constricting 7% (vs. our expectation of - 13%). Unfavourable Ringgit and rising operating costs saw PBT margin dropping 5ppt to 11%.

Normal margins remote. FY21 margins continued to be challenging with COGS at 48% (FY20: 46%) underpinned by sugar (making up 25% of raw materials costs) coupled with rising prices for packaging (15% of raw materials). We are cautiously optimistic for easing of sugar prices by end of CY2021 on cooling demand, better weather and favourable ringgit but maintained a conservative view of margins to remain at these levels at least for FY22. We believe PWROOT has been unable to pass the rising cost to consumers as the big players are keeping their selling prices low (slashing 30-35%) due to their high inventory. We understand that these excess inventories are expected to be cleared by 4QCY21 which will see the selling prices returning to normal with PWROOT expecting to pass the rising costs to consumers. On a positive note, we find coffee and creamer (60% of raw materials) are already hedged into June 2022 which should support its FY22E margins similar to FY21A.

Focussing on non-GCC. Sugar tax is affecting mostly the GCC markets with KSA, UAE and Qatar making up 66% of the MENA markets (which alone contribute 80% of PWROOT export markets). While it is understandable for PWROOT to pass the rising costs to consumers, we believe management is unlikely to do so for fear of driving down demand – thus, we expect management to offer alternative solutions such as more sugar-free products or cheaper-priced alternatives to mainstream products which would probably come on stream in the immediate term. In the meantime, we believe management will focus more on the non-GCC markets i.e. Egypt, Uzbekistan to drive margins and top-lines.

Lower capex. We expect capex to return to normal (c. RM7-10m vs. its 3-year’s average of RM7m) which should maintain a healthy balance sheet. However, we view that opex will likely remain elevated (underpinned by marketing and promotions) as it expands into other non-GCC and Asian markets.

Worst is likely over for top-lines. We view the top-line challenges facing PWROOT are gradually receding as the current full lockdown is likely to be shorter in duration vs MCO 1.0. We view that domestic top line could top RM175-180m (in line with current assumption) premised on: (i) returning to its core products i.e. AliCafe, (ii) introduction of three new products, and (iii) efficiency in dealership. We also expect a doable RM160m in topline from the export market (MENA contributing 63%) – an increase from RM144m in FY21 - premised on: (i) aggressive expansion into the non-GCC, (ii) further forays into China, Singapore and Brunei, and (iii) new overseas distributors with emphasis on direct distribution (vs. indirect).

Post results, we slashed our FY22E/FY23E earnings by 30%/15%. No changes to our top-line assumptions but COGS and opex margins are revised to 48% and 38%, respectively (from 47% and 34% respectively).

Earnings and TP downgrades. TP slashed to RM1.45 (from RM1.90) on adjusted FY22E PER of 18.5x (17.2x previously), in line with its 5- year mean (with -0.5SD attach). We feel the stock deserves a higher multiple as more risks are reflected in our new estimates. Nevertheless, with a solid balance sheet and generous dividend payout (3-year average: 95%) with attractive dividend yield of c.5%) it is a MP.

Source: Kenanga Research - 8 Jun 2021