• MYR0.76 FV on 10.5x FY23F P/E. At its MYR0.75/share IPO price, Seng Fong will raise MYR68m from the public issue of 160.9m shares. These proceeds will mainly be used as working capital, to increase the production hours of its facilities and increase profitability by building a solar and biomass system. Future earnings will be driven by the enlarged capacity to meet the growing demand for tyres, from the expanding vehicle sector.

• Key driver: Demand for block rubber for tyres. It is estimated that 70% of global natural rubber is used for tyre manufacturing. The global production of vehicles is expected increase at a CAGR of 7% over the next five years, which will subsequently drive the demand for block rubber. Despite the diverse options presented by synthetic rubber, it cannot completely replace natural rubber, which has better tensile strength and a low heat build-up, which can sustain greater friction. Therefore, synthetic and natural rubber are used as complementary materials for tyre manufacturing. Seng Fong has an established track record, with >36 years of experience and long relationships with customers. The group also maintains business ties with multiple suppliers, either locally or internationally, to diversify its supply risks.

• IPO proceeds for working capital and cost savings. Management has proposed to allocate 55.6% of the IPO proceeds to repay bank borrowings – the bulk of loans was used to purchase raw material. There are also borrowings for the installation of a solar energy system (costing MYR12.8m), which is expected to be fully commissioned by 2Q22 and result in savings of c.MYR2.6m pa. The group has also allocated MYR6.3m (9.2% of proceeds) for the installation of a biomass system to reduce fuel costs, by replacing the usage of diesel for its dryer system with gas generated from wood chips. This is expected to bring in savings of MYR3.5m each year.

• Earnings estimate. We are projecting a 3-year earnings CAGR of 3.6%, driven by the capacity expansion to meet the increasing demand for vehicle tyres. That said, we believe that the earnings growth will be mitigated by the normalisation of ASPs in the long term from the current elevated levels. We are positive on the group’s dividend policy, with a target payout ratio of at least 50% of earnings. Given the relatively small market cap and lack of track record, we ascribe a 10.5x FY23F P/E, which is at a discount to the FBMSC’s average trading P/E of 12.5x, implying FV of MYR0.76.

• Key risks: The group’s dependence on five major customers, fluctuations in raw material prices, and global supply chain bottlenecks.

Source: RHB Securities Research - 22 Jun 2022