INVESTMENT HIGHLIGHTS

• FY18 core earnings of RM35.1m came in below ours and consensus expectations

• The lower-than-expected earnings was attributed to lower ASP and reduced domestic and export sales

• Unfavourable government policies have threatened the status quo of the group

• Nonetheless, FY18 earnings returned to black compared to the same period last year due to lower raw material costs

• Maintain NEUTRAL with lower TP of RM2.19

FY18 earnings came in below expectation. MSM Malaysia Holdings Berhad’s (MSM) FY18 core earnings of RM35.1m came in below expectations. This translated into 59% and 60% of ours and consensus earnings forecast respectively. The poorer-than-expected results was mainly exacerbated by the first quarterly losses experienced in 4QFY18 results of RM-10.4m (-212.0%yoy) since June 2017 as the group incurred a loss at -RM10.5m in its Johor operations and higher finance cost. In addition, MSM was also grappled with the lower average selling price in FY18.

Sales volume and revenue dwindled. On a year-on-year basis, FY18’s sales volume declined by -5.0%yoy to 947,848mt. This was predominantly due to the fall in the domestic and export segment sales volume by -7.4%yoy and -21.4%yoy to 440,000mt and 398,000mt respectively. Coupled with a lower average selling price as increased domestic competition seen in FY18, total sales revenue has decreased by -17.2%yoy to RM2,145m. We view that the domestic competition and lower exports was in view of: (i) cheaper smuggled refined Thai sugar as substitute (ii) temporary approved permits (AP) to import refined sugar were awarded to meet shortage in FY18 and, (iii) oversupply of sugar globally which weigh on price.

Profit margin improved. MSM’s FY18 gross profit margin and net profit margin have both improved by +213%yoy and +220%yoy to 8.49% and 1.63% respectively. This was premised on the cost of sales contracted at a faster pace at +21.1%yoy than the drop in revenue of - 16.0%yoy. This was due to the deterioration of the price of raw sugar amid oversupply conditions, coupled with stronger ringgit against USD making the cost of production considerably low. However, on a quarterly basis, 4QFY18 swung into red with earnings slid by - 212.0%yoy. 4QFY18 revenue declining at a faster pace than a drop in cost of sales as the price of raw sugar on a recovery mode amid optimism that supply might get tighten in FY19.

Unfavourable government policies. Under the Pakatan Harapan (PH) Government, food and beverages (F&B) manufacturers in Malaysia can apply for sugar import permits. Recently, a Sarawak manufacturer received first AP to import sugar directly from other countries and a few other applications are being assessed by the Government. This AP would act a battering ram to new avenue in purchasing refined sugar directly from markets that potentially offer cheaper rate and MSM might probably lose out market share. On another note, during Budget 2019, an excise duty of 40 sen per litre on sweetened beverages will be implemented from 1 April 2019. This would potentially lessen the demand for sugar domestically. Meanwhile, we expect the average selling price for sugar to be lower as the Government set the ceiling price for granulated sugar and refined granulated sugar to be reduced by 10 sen per kg effective September 1 to RM2.85 per kg and RM2.95 per kg respectively. We opine that all these government interventions might be a drag to MSM’s sales revenue and volume.

Earnings estimate reduced for FY19. FY19 core earnings has been cut by -50.0% to RM50.5m in regard to the current tightening domestic competition and government intervention amid a downtrend of the demand growth for sugar. We have lowered our assumption of sales volume and average selling price (ASP) for each segment.

Target Price. Subsequent to our earnings adjustment, we lower our target price to RM2.19 (previously RM3.03). Valuation is based on unchanged Forward PE of 21x to FY20 EPS forecast. The 21x forward PE valuation is based on a 2-year historical average.

Maintain NEUTRAL. For FY19, we view that MSM would be facing some headwinds especially from the domestic market as policies emerge are not in the favour of the company where domestic segment accounted for 52% of the company’s sales revenue. The new sugar refinery in Johor Bahru might provide MSM economies of scale and ramp up production, however, the current demand condition is not that promising. On the flip side, production seem to began tapering in sugar-producing countries such as Brazil, EU and Thailand which will probably give rise to a deficit in 2H19. While this might provide an export opportunity for MSM to expand its businesses, the downside would be the increase in cost of sales (as raw sugar price increases) and lower ceiling price in the local market. All in, we are maintaining our NEUTRAL recommendation on the stock.

Source: MIDF Research - 21 Feb 2019