• BUY and MYR5.10 TP, 77% upside with c.3% yield. The sharp selldown on Guan Chong is overdone. We reiterate our BUY thesis, and try to shed some light on investors’ doubts that may have dampened its share price performance. GUAN has delivered robust YoY earnings growth (+3x) in 1H24 (which exceeded FY23 YoY growth), and is set to book record earnings this year. Management has guided for a higher combined ratio into 2H24, and an even better ratio into 1H25 (~50% forward sales covered), underpinned by robust demand and the shortage of beans and grinding on offer.

• 2Q24 operating statistics. Sales and production tonnage fell by 11.4% and 8% QoQ due port congestion issues and a high base, while its overall plant utilisation rate was at 96%. This metric dropped to 82% for its Ivory Coast factory due to power outages in 2Q, upon which GUAN switched to using an alternative power generator, albeit at higher costs. Management clarified that the lower quality of cocoa beans also affected the yield. These factors, coupled with lower hedging gains, affected its overall margins in 2Q24. 2Q24 core earnings surged by 138% YoY but contracted 27.2% QoQ to MYR67m, bringing 1H earnings to a record high of MYR159m.

• Port congestion issue. We note that the minor operational hiccups stemming from port congestion have alleviated since this month. An estimated of 6-7k tonnage (2% of annual capacity) of production was affected, leading to an estimated earnings impact of MYR7m-14m across two quarters.

• Gearing and hedging. Net gearing deteriorated to 1.71x (1Q24: 1.53x) on higher working capital needs amid elevated bean prices and additional bean inventory required to cushion against any potential delay from port congestion. However, we expect gearing to improve in 4Q, on stronger cash conversion from the record high revenue coupled with cash flow freed up from the previous hedging position covering the forward buying of beans in an environment of more stabilised prices. GUAN’s hedging position remains favourable, with various instruments employed including long options.

• A US Federal Fund Rate cut would boost GUAN’s gearing and earnings, given the high interest expenses (1H24: MYR121m, +108% YoY) and as 80% of its borrowings are denominated in USD, GBP and EUR. A stronger MYR would have a minimal negative impact on translation to reporting currency overall, given the natural hedge postions from its bean cost and borrowings.

• The EU Deforestation Regulation (EUDR) on sustainable sourcing practices and traceability measures that is expected to be implemented by 1 Jan 2025 would benefit GUAN, given its presence in the Ivory Coast and access to EUDR-compliant beans, giving it a certain advantage over competitors.

• Our forecasts and MYR5.10 TP are unchanged. Our TP reflects an unchanged 15x P/E (5-year mean) – on par with the Consumer Product Index – and includes a 0% ESG premium/discount. Key downside risks: Sharp raw material price fluctuations, weakening cocoa demand, a softening USD/MYR rate, and counterparty risks.

Source: RHB Research - 28 Aug 2024