Investment Merits

• Reaching more wholesale customers with capacity expansions  and new product launches

• Room for ASP adjustments to protect margins from inflationary  pressures

• Replicating the retail model beyond its stronghold Johor market

• Undemanding valuation, trading at <10x FY24F P/E

Company Profile

SDS Group was established in Johor in 1987, and listed on the Bursa  Malaysia ACE market in 2019, before moving to the Main Market in  2023. Through its wholesale division, the company is involved in the  manufacturing and distribution of bakery products to over 10,000  customers under the brand names of ‘Top Baker’ and ‘Daily’s’. The  company also operates 35 retail F&B outlets under the brand name of  ‘S.D.S’ in Johor, Seremban, and Selangor. SDS’ principal markets are  Malaysia and Singapore.

Highlights

Earnings sustainability. Having grown its earnings steadily, with a 3- year CAGR of 60% since its IPO, we expect SDS’ robust earnings  growth to continue – taking into account the sound expansion plans for  both its wholesale and retail businesses. Going forward, we expect  SDS to chart a 3-year earnings CAGR of 40%, as we believe its strong  business fundamentals, experienced management team, and sturdy  balance sheet will help the company weather through the challenging  business environment with elevated inflation levels, rising interest  rates, and an uncertain global economic outlook.

Wholesale division benefitting from rising brand equity. We  believe SDS’ bakery product brands Top Baker and Daily’s have been  gaining encouraging traction, thanks to successful efforts to penetrate  into more markets. To build on the positive momentum, SDS is looking  to further expand its customer base by extending its distribution  network to cover more areas. The company is also aiming to launch  more new products to remain competitive and spur consumer  spending. We also highlight that SDS has the room to adjust selling  prices to protect its profit margins, considering the price gaps between  its products and that of its competitors.

Venturing out of Johor. A popular F&B name in Johor, SDS’ retail  business exposure is relatively limited outside of the southern region  (33 out of 36 outlets are in Johor). This is as the company has been  focusing on capturing the opportunities within the state. That said, SDS  has now set its sights on replicating the model of its retail business by  expanding into other regions, with at least two of the six new stores planned for 2023 to be located outside Johor. The company will have  three formats to choose from – café, bakery, and café-cum-bakery – depending on the location, to ensure its new stores can perform strongly with a minimal gestation period. With such flexibility and an established business model, the company is also looking to set up a franchise network to drive higher market penetration without incurring heavy capex.

Company Report Card

Results highlights. 9MFY23 net profit surged to MYR20m from  MYR4.9m in 9MFY22 on the back of a 51% jump in revenue to  MYR210m. Apart from the low-base effect, the strong performance  was driven by expansions in the wholesale and retail segments, as  well as the economic reopening which boosted consumption.

Healthy net cash position. The company has net cash of MYR24m  or 5.9 sen per share as at 3QFY23. We expect SDS to maintain its  strong balance sheet going forward, given its improving profitability  and solid cash flow generation.

ROE. ROE has risen tremendously over the years, from 6.3% in FY20  to 13% in FY22, and is on track to surpass the 20% mark in FY23. The  encouraging positive trend can be attributed to the improved  profitability on the back of capacity expansions and market  penetration.

Dividend. While it does not have a dividend policy, SDS paid a total  DPS of 0.75 sen in FY22, implying a payout ratio of c.30%. YTD FY23,  the company has declared a DPS of 0.5 sen, and we expect a second  interim dividend to be declared in May 2023.

Management. SDS is helmed by co-founders Tan Kim Seng and Tan  Kim Chai, who have 4-50 years of working experience in the bakery  industry. The next generation of family members are also involved in  the management of the company –Tan Kee Jin, as the Executive  Director, and Tan Kee Meng as the Chief Financial Officer.

Investment Case

Fair value of MYR0.85-0.98. We like the stock for its solid underlying  fundamentals, which should drive sustainable earnings growth amidst  the challenging market environment. By ascribing a P/E range of 13- 15x to projected FY24F earnings, we estimate the fair value to be in  the range of MYR0.85-0.98. The valuation is in line with the FY24F  P/E multiple of 15x commanded by the Bursa Malaysia Consumer  Index.

Key risks include competition that is more intense than expected, a  sharp rise in input costs, and a delay in expansion plans.

Source: RHB Securities Research - 16 May 2023