PWROOT’s export markets are seeing accelerated recovery post pandemic while domestic demand appears to be sustaining despite rising inflation. Input cost hikes look well contained given the forward buying of creamer and coffee beans into March 2023 after which their prices are likely to come off. We raise our FY23F and FY24F earnings by 29% and 11% respectively and increase our TP by 24% to RM2.35. Upgrade to OUTPERFORM.

We came away from a recent engagement with PWROOT feeling upbeat on its prospects ahead. Here are the key takeaways:

1. Sales volume is performing better than expected in both Malaysia and the Middle East. For the Middle East market, specifically in the Gulf Cooperation Council (GCC) countries, PWROOT expects FY23 sales to touch 95% of the pre-pandemic level. In FY22, sales reached up to 75% of the pre-pandemic level. The robust volume is largely attributed to returning foreign workers in the service industry, particularly from India and the Philippines in the GCC markets. PWROOT is also seeing Middle Eastern consumers getting accustomed to the sugar tax.

2. On a blended average, the company expects ASP to be around 5-8% for FY23.The company started to increase selling prices only in Jan 2022 compared to its competitors which started much earlier in June 2021. Despite the price increase, the domestic market has not seen declining sales. Instead, it is seeing robust demand post Raya of 2022. PWROOT is raising its prices gradually, and expects the full impact of its overall hike (c.10%) in FY24. This full impact is on a blended 5% rise in ASP and another 5% in forex. Despite the ASP hike, we note that its coffee prices are still lower than that of its competitors.

3. Input cost hikes are well contained with the supply of creamer and coffee beans being locked in until March 2023 after which PWROOT expects the prices to come off. The company is expecting prices to reduce by 10% from the current US$1.95/lb. Coffee bean prices have been rising since 3QCY21, up by c.31% but PWROOT is sourcing from several markets, notably Vietnam, India (apart from the usual Brazil and Colombia markets) which mitigates the effect of high prices globally. We understand that thanks to this multiple sourcing, PWROOT saw only a 15% uptick in the purchase price of its coffee beans. As per creamer, PWROOT sees coffee bean prices coming down by 10%. Raw material costs constitute 80% of cost of goods sold while the remainder is labour. Coffee makes up 30% of raw materials costs followed by creamer 30%, sugar 25% and packaging 15%.

4. Contrary to our expectation, the demand for coffee mix and drinks locally has remained firm despite high inflation (that is eating into consumers’ disposable incomes). This is evident in PWROOT’s 2QCY22 and 3QCY22 numbers. This gave players room to raise prices again by 5% throughout 1HFY22 after a hike of about 10% in 3Q21. We understand that there will likely be another 5% hike by the market players by the end of CY22. While the Middle Eastern markets appear strong at present, they may slow down post-FIFA World Cup Qatar 2022 during the last two months of the year. Margins will still be under pressure given the volatile inputs and rising inflation but we expect costs to be contained as its major input prices are already locked in well into March 2023.

We raise our FY23F/FY24F earnings by 29%/11% to reflect: (i) robust demand from both the local and export markets (21% from 15% previously for domestic and 24% from 1% previously for the export market); (ii) exports recovering up to 85% of the pre-pandemic level for FY23F (from 75% previously), and (iii) EBITDA margins at 16% (from 15%) on the account of higher ASPs where we have imputed a conservative 6% for FY23F and another 4% for FY24F.

Correspondingly, we raise our TP by 24% to RM2.35 (from RM1.85) based on 19x FY23F. At 19x PER, we value PWROOT at a discount to the average historical forward PER of 22x for the food and beverage sector, to reflect PWROOT’s less extensive product range vs. its peers. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 4).

We upgrade our call to OUTPERFORM from MARKET PERFORM premised on: i) the strong recovery in the export markets; ii) its ability to pass on rising costs to consumers backed by resilient demand; and iii) it is shielded from volatility in input costs via forward buying.

Risks to our call include: (i) sustained high inflation hurting consumer spending; (ii) a further weakening in the ringgit resulting in higher costs for imported inputs; and (iii) rising food commodity prices.

Source: Kenanga Research - 14 Oct 2022