PWROOT will prioritise margin over volume over the immediate term. It is raising prices, narrowing the discount of its products to competitors’. We believe this could lead to a loss in sales volumes. It is optimising its advertising and promotion (A&P) spending, focusing on high-margin flagship products. We maintain our forecasts, TP of RM1.40, and an UNDERPERFORM call.

We came away from PWROOT’s post-results briefing feeling mixed about its prospects. The key takeaways are as follows:

1. PWROOT is prioritising margin over volume over the immediate term. It is raising prices, which means the discount of its products to those of competitors will narrow. It believes its flagship products, i.e. Alicafe and Ah Huat, which it claims are the market leaders in their respective categories, will enjoy brand stickiness with consumers. However, we believe this could lead to a loss in sale volumes. Prior to this, it priced its products at about a 10% discount to those of its competitors.

2. PWROOT is also optimising A&P spending (which currently makes up about 11% to 14% of total operating expenses). It will spend more on its flagship products, i.e. Alicafe and Ah Huat, which command better margins, at the expense of less popular products like Oligo and French Roast. Recall, in FY24, the group recorded a lower EBIT margin (11.2% vs. 15.2%) due mainly to a thinner GP margin (51.3% vs. 53.1%, attributed to higher input costs) and increased A&P expenses.

3. The Middle Eastern market will remain challenging due to the hefty sugar taxes in UAE, KSA and OMAN, resulting in a 50% hike in the selling prices of Alicafe products. This has halved their sales volumes. On a brighter note, its expansion to the African region is on track, starting with Egypt.

4. The co-investment initiative with Thailand’s Sappe Public Company Ltd (Sappe) went live in Feb 2024 with the introduction of Frenche Roast Indulgence and Frenche Roast Signature Blend premix coffee (17g each, aligning with local market standards) in Lotus’s Makro, targeting three key provinces: Khon Kaen, Rayong, and Phitsanulok. Additionally, the group launched its online e-shops on both Shopee and Lazada in Mar 2024.

Outlook. On the domestic front, we remain cautious on the group's near-term outlook due to subdued consumer spending amid sustained elevated inflation and consumers’ anxiety over the impending fuel subsidy rationalisation. On a brighter note, the 13% salary increase for civil servants effective Dec 2024 should at least partially restore consumer spending power. The ongoing geopolitical instabilities have created challenges in the global retail landscape, particularly impacting demand and causing supply disruptions in the Middle Eastern market. Not helping either, are increased fluctuations in commodity prices and forex making, translating to volatility in margins.

Forecasts. Maintained.

Valuations. We also maintain our TP at RM1.40, based on an unchanged FY25F target PER of 15x, a discount to the average historical forward PER of 22x for the food and beverage industry players to reflect PWROOT’s less extensive product range vs. its peers.

Investment case. We remain cautious on PWROOT due to: (i) the intensifying competition in premix coffee market locally, (ii) its seemingly eroding foothold in its key export market, i.e. the Middle East, and (iii) persistently high food commodity prices and its inability to pass them on. Maintain UNDERPERFORM.

Risks to our call include: (i) a significant recovery in sales in the domestic and Middle Eastern markets, (ii) lower food commodities prices, and (iii) reduced competition as weak players exit the premix coffee market.

Source: Kenanga Research - 6 Jun 2024