INVESTMENT HIGHLIGHTS

• Earnings to be negatively impacted in the short-to-medium term with potential losses projected for FY19 and FY20

• The liberalisation of the sugar industry by the government amid a period of sugar glut is a key factor

• This led to an influx of foreign refined sugar products with cheaper pricing in the domestic market

• Gestation period for its foray into the downstream segment to diversify its product portfolio

• Earnings revised downward to take into account expected fall in ASP of refined sugars and declining sales volume

• Maintaining our SELL recommendation with a revised TP of RM1.07

Oversupply of sugars. The persistent sugar glut in the market as depicted in Figure 1 is a result of raw sugar production remaining in overdrive mode since 2016, particularly from neighbouring countries such as Thailand and India. On the domestic sugar landscape, MSM’s sales were beleaguered by an influx of additional 80-100k mt of imported sugar from additional approved permits (AP) issued in late 2018 to plug a shortage issue. Consequently, we view that the domestic market would continue to be awashed with greater supply of imported sugar predicated on the recent issuance of AP to eight F&B manufacturers in Sarawak state by the government with possibly Sabah state to be eligible next. To note that, MSM ships about 8-10k mt to Sabah and Sarawak on a monthly basis. Thus, we believe that the glut would lead to heightened competition at both the domestic and export market segment, causing sales volume continues to be on downtrend (Figure 4). Furthermore, continued smuggling of refined sugar from Thailand adding to the supply in the domestic market and recently implemented soda tax could partially dampens the demand from domestic industrial sales.

Downward pricing pressure to be intensified. The expected surplus would likely continue to add downward pressure on pricing of both raw (Figure 2) and refined sugars. Thailand and India in particular, are expected to have higher productions of 14.1m mt and 32.5m mt respectively in 2019. This would have a negative impact for MSM in terms of its pricing power amid a liberalisation exercise in the domestic market, as Thai and India sugar imports have the pricing advantage over local refinery. For example, the largest sugar refinery in Thailand could sell its sugar for about RM1,700/mt compared against MSM’s ASP of RM2,200-RM2,400/mt. As a result, this could intensify the sugar price war and pressure MSM to lower further its ASP of refined sugars(Figure 3). In addition, the reduced ceiling price of retail sugar at RM2.85/kg set by the government is the lowest average price among the Asean countries (Table 1), adding downward pressure on the profit margin for MSM amid a declining ASP of its refined sugar products across all segments. Moving forward, we do not expect a significant recovery in the ASP of MSM’s refined sugar products.

Cost structure expected to be challenging. Due to the weak prospects of sales volume, we view that this could result in MSM production volume to decline and its refineries to run at a lower utilisation rate, resulting in higher refining costs going forward. The lower utilisation rate of the MSM Johor refinery at about 30.0% (Table 2), coupled with increasing energy costs due to upward revision of gas tariff would keep the refining cost at the current high level (i.e. RM350-400/mt). As such, we are of the view that the management’s target for the refining cost to be at less than RM300/mt would be a stretch goal given a potential liberalisation of gas price by 2020 and lacklustre production operation. In addition, the volatility of forex such as the weakening ringgit against USD would result in higher raw sugar. The other operating costs such as the higher depreciation and interest due to increased borrowing mainly resulted from its Johor refinery also continue to weigh on the MSM’s profitability moving forward. Should the cost of raw material increase gradually, MSM’s profit margin would then be further compressed if it is unable to increase its ASP of refined sugars at similar rate or quantum.

Downstream segment in gestation. MSM is making its first foray into the downstream segment to produce higher margin sugar-based related products as part of its product portfolio and income stream diversification plan. With a solid ready demand of 3.0-4.0m mt for sugar premix products worldwide, MSM plans to develop and export sugar premix products (e.g. cocoa, milk and others) to the Asian market, primarily into the China market. In fact, it has shipped two products, namely sugar premix and liquid sugar, in sample-size quantity to China and counterparties have validated the proof of concepts and have expressed their interests to have more orders. However, the plan is still in its initial stages and with target commercialisation by 2021. Investments into the downstream equipment and refinery would be made in its Johor refinery and but so far MSM has yet to provide a substantive investment plan. While this development is seen to be positive for MSM in the long term, we opine that the earnings visibility is yet to be clear at the current gestation period.

Earnings estimate revised downwards. We are now expecting the group to be in loss-making position in FY19 and FY20 before returning to being profitable in FY21 in view of the current escalated competition in the domestic market from the liberalisation of sugar industry and oversupply of sugars which might persist into FY20. Thus, we are lowering our assumptions for both ASP of refined sugars and sales volumes.

Target Price. We are deriving a new target price of RM1.07 (previously RM1.19) by pegging the forecasted FY20 book value per share of RM2.14 to its two-year low historical price-to-book ratio of 0.5x. To also note that we are changing our valuation method to price-to-book (previously price-to-earnings) to reflect for the negative earnings trajectory in the next two years.

Maintain SELL. The prolonged oversupply of refined sugar in the domestic market where MSM derives circa 90.0% of its sales revenue presents a challenging outlook for the group. This is reflected by the declining sales revenue due to the continuous downtrend in its ASP of refined sugars and dwindling sales volume as shown in Figure 3 and 4. The situation is further exacerbated by the recently issued AP by the government to eight F&B manufacturers in Sarawak, allowing it to import foreign sugars for up to 60.0% of their required usages. Consequently, we opine that MSM would be lowering its ASP of refined sugars to remain competitive in the domestic market. Coupled with expected higher refining costs, we are more likely to observe a further deterioriation in its profit margin. Should there be further liberalisation (i.e. AP issuance) to other states, we believe MSM’s earnings trajectory would be in dire straits. Meanwhile, the implementation of sugar tax on soft drinks and juices with a 40 sen tax per litre on 1st July 2019 might be additional dampening factor for MSM. All in, we are maintaining our SELL recommendation on the stock.

Source: MIDF Research - 4 Jul 2019