KEY INVESTMENT HIGHLIGHTS

• Higher margin product contributing

• Vietnam operations breaking even

• Competition continues in India, expanding footprint elsewhere

• Upgrade to BUY (previously NEUTRAL) with a revised TP of RM1.17 (previously RM0.97)

Higher margin product contributing. We came back from Superlon’s investor briefing feeling more positive of its outlook. For 1HFY20, GP margin recorded ~27%, which is 6ppt lower than a year ago mainly due to higher sales to low margin markets and lower efficiency in the Vietnam factory as well as higher raw material costs. On the other hand, the higher GP margin product from a new customer has only started to pick up and we estimate that the orders making up about 10% of its ytd volume. Looking ahead, we expect this customer to contribute ~20% of its total volume, which should improve its overall GP margin in the coming quarters.

Vietnam operations breaking even. Meanwhile, management updated that the utilisation rate at its Vietnam plant has ramped up to about 50% as of 2QFY20, compared to 30% in 4QFY19 when the plant was completed. We believe that the plant is on track to break even operationally and that could help ease its profit margin going forward. This happens sooner-than-expected as management had previously targeted utilisation rate to reach ~50% by April 2020. Looking past the break-even point, we expect further improvement in profit margin due to the tax break in Vietnam, which may kick in the coming quarters considering operational momentum that is well on-track.

Competition continues in India, increasing footprint elsewhere.

While India remains a large market for Superlon, contributing about 20% to its sales, margins remain thin due to the competition in the market. On top of maintaining market share and volume there, Superlon is also trying to get into other new markets in South America and selling more to countries that can provide better margin to mitigate the low margin sales from India and fluctuation in raw material costs.

Upgrade to BUY (previously NEUTRAL) with a revised TP of RM1.17 (previously RM0.97). We maintain our earnings forecast for FY20E/FY21F and roll over our valuation to peg our TP to FY21F EPS of 8.97 sen. Our PER of 13.0x is unchanged. Looking past 1HFY19, we expect operational and financial improvement at Superlon to enhance its profitability in FY21F. Another catalyst is lower raw material cost that prolongs. Since end-October, certain main raw material cost has eased by 25%-30%. Dividend yield is expected at 4.1%.

Source: MIDF Research - 11 Dec 2019