• Keep BUY, lower MYR3.11 TP from MYR3.52, 50% upside, c.2% yield. We came away from Guan Chong’s briefing feeling assured on its strategy in weathering the chocolate industry’s near-term challenges – ignited by the historic high cocoa bean price. Forward-selling mechanism, coupled with strong sales channel and multi-national corp clienteles, should continue to support its solid earnings base in the near-term. Contribution from Ivory Coast and the Schokinag operation’s turnaround should provide the upsides.

• Earnings recap. 1H23’s MYR51.9m core earnings (-45%) was a miss, dragged by the huge commodity future losses and additional write-off (prudent measure) on surging cocoa bean prices and higher interest costs. EBITDA yield improved from MYR776/tonne in 1Q23 to MYR800/tonne, but still lower YoY (2Q22: MYR1,212/tonne).

• The historic high cocoa bean prices this year – caused by tight bean supply and the El Nino phenomenon – created uncertainties to the chocolate industry as chocolate makers are adopting a wait-and-see approach for a lower terminal price. Meanwhile, grinders face margin pressure on additional working capital requirements and hedging cost, plus the inability to pass on the surging bean price in the spot market. On a brighter note, global grinding activities continue to downtrend over the past two quarters as some grinders either cannot afford to continue or stopped grinding due to intensive working capital requirements and volatile pricing in the market. These often lead to softening of cocoa bean price in the future. Besides this, most of the crops are well-sold earlier and current high prices may entice more farming activities to improve the supply – helping to bring the price to equilibrium.

• Strategy. Management is in no hurry to sell its forward capacity at a lower ratio while the majority of the customers are also delaying purchases. Effectively managing inventory to a lower quantity is carried out to reduce the carrying costs. Management is of the view that the bean price volatility should subside once supply-demand reaches equilibrium and/or market absorbs the new price level. All the commodities hedging losses booked-in earlier would translate into higher revenue and margin going forward.

• 2H outlook. Butter products are less affected by the high bean price as it was well covered by the lower raw material prices secured earlier. Slower re-pricing of powder ASP may compress the near-term margin, but we expect the Ivory Coast plant to support the 2H bottomline once the exports start to flow and the market stabilises. The Schokinag operations should chalk a record high performance from lower input costs and higher ASPs.

• Forecasts and TP. Our revised TP of MYR3.11 is based on a lower FY24F P/E of 15x (from 17x) at +1SD above mean to account for the overall uncertainties in the industry. Our TP includes 0% ESG premium/discount. We believe the current uncertainties in the chocolate industry provides a good entry level to GUAN’s unique exposure to global consumer footprint at below-mean valuation. Downside risks: Sharp raw material price fluctuations, weakening cocoa demand, and risks on its expansion plans.

Source: RHB Securities Research - 6 Sept 2023