• Stay BUY, new MYR5.10 TP from MYR4.70, 17% upside with c.2% yield. Guan Chong’s stellar 1Q24 earnings (+2.9x YoY) is in line with its sanguine earnings growth outlook for 2H24 – due to newfound pricing power, as highlighted in its positive post-results briefing session. We remain bullish and see upside risks to our estimates during this super-cycle, bolstered by the historic high combined ratio on sustained cocoa demand coupled with limited grinding and bean-on-offer. Medium-term catalysts include production growth in both its Ivory Coast (tax-free) and UK plants.

• Forward selling well-covered. Management hinted that production is operating at full capacity, with this year’s capacity well-covered with only some solids still available to meet short-term demand. For FY25, c.20% of butter capacity has been sold, and GUAN aims to secure more forward sales at the current elevated ratio. Meanwhile, demand for industrial chocolate in Germany has temporarily slowed, with sales tonnage down 11% YoY – due to smaller local chocolate manufacturers adjusting to the higher selling prices. Management’s primary focus is to: i) Ensure a steady supply of beans, given the tight crop situation, and ii) proactively manage cash flow due to the high working capital requirements amid elevated bean prices.

• The historic high combined ratio (butter ratio: >3x, powder ratio: >0.7x) is anticipated to remain for at least the next 3-6 months, due to ongoing supply disruptions, until the main crop season resumes in 4Q24. This elevated combined ratio is expected to result in stronger earnings 6-9 months later, due the forward selling mechanism. Furthermore, there is an upside risk that the butter ratio may stay elevated structurally, even if the supply of beans improves (favourable weather) and prices normalise. This is due to the new normal of the operating environment of a persistent shortage of grinding and bean-on-offer, additional hedging and holding costs, and the heightened risk premium that grinders have to undertake.

• Capacity-led growth. GUAN has added 5,000 tonnes in capacity at its Ivory Coast plant. It is also looking to increase capacity by 20,000 tonnes more in Asia, with additional pressers installed by 2H24. In the UK, additional industrial chocolate capacity of 6,000 tonnes will be installed in 2H24, bringing the total capacity to 22,000 tonnes, alongside liquor and butter- melting facilities. Total capex planned for these extra facilities are estimated to be at c.MYR120m.

• Forecasts. Following the upbeat sales outlook at a favourable ASP, we lift FY24-25F earnings by 8.5% and 4.5%, leading to a higher TP of MYR5.10 (from MYR4.70), pegged to an unchanged 15x FY24F P/E (5-year mean), and on par with the Consumer Product Index. Our TP includes a 0% ESG premium/discount, as GUAN’s ESG score is on par with the country median. Key downside risks include sharp raw material price fluctuations, weakening cocoa demand, a softening USD/MYR rate and counterparty risks.

Source: RHB Research - 29 May 2024