• Still BUY, with new MYR3.30 TP from MYR2.70, 29% upside and c.2% yield. We remain bullish on Guan Chong’s anticipated robust performance in FY24F, driven by margin expansion (higher ratio and revenue). There is still substantial upside to the share price as we think the market has underestimated sustainable earnings potential from its newfound pricing power, bolstered by limited capacity and resilient demand despite prolonged elevated cocoa bean prices. These unprecedented conditions have provided a fertile ground for GUAN to gain market share and extend its reach.

• Dispelling misconceptions. Contrary to unsubstantiated thesis in the market, we believe GUAN stands to benefit from more than just a one-off advantage stemming from securing low raw material costs early in the current environment of elevated bean prices. Rather, the most important profitability metrics of a grinder rely on the combined ratio (which is a key driver in the ASP and revenue) among others. In normal circumstances, both the butter and solids ratios tend to balance off each other in an uptrending and downtrending cocoa bean price environment, leading to a rather neutral impact on profitability.

• Seizing opportunities in a seller's market. However, as both ratios are at a historic high given the supply shortage (in both bean and grinding) and sustained demand, GUAN has benefitted since Jan 2024. These should substantially expand grinding margins and fuel robust earnings potential in 2H24F and FY25F, supported by forward selling mechanisms. Bean deficit in the 2023-2024 season, affected by adverse weather, pod disease, and swollen shoot virus, coupled with shortage at chocolate makers shifted the dynamics to a seller’s market and it should remain in the current mid-crop season (April-September) where beans are hard to come by.

• Proactive strategic hedging. GUAN’s proactive hedging strategy aims to safeguard margins in the forward selling mechanisms. Grinders would typically (note: depends on how the book is being managed) be in a long bean position and will dip into the futures/forward/options market to hedge and cover the position, which resulted in the company’s huge marked-to-market loss in FY23 (should translate into higher revenue in the future) due to the surge of bean prices. Given the great volatility in the bean prices and extensive margin costs, management has strategically shifted a substantial amount of its cover to options (both call and put), which should result in manageable marked-to-market loss (if not gain) in 1Q24F.

• Forecasts and risks. Our revised forecasts incorporate stronger margin and higher bean prices as well as adjusted gearing assumptions, resulting in a 22- 6% earnings revision for FY24F-26F. Our new TP is now at MYR3.30 (includes a 0% ESG premium/discount) from MYR2.70, pegged to an unchanged 15x FY24F P/E (5-year mean), and on par with the Consumer Product Index. Risks: Sharp bean price fluctuations, counterparty risk, weakening cocoa demand, gearing and risks on expansion plans.

Source: RHB Research - 22 Apr 2024