• Maintain BUY with higher P/E-based TP of MYR3.10 from MYR2.70, total return of 74%. 2Q19 earnings are likely to beat Street expectations. The group is adding a new gummy line to capture rising demand. Valuations are compelling and undemanding as we believe earnings are set to recover on receding cost pressure, while capacity expansion should drive earnings growth in the medium term. Cocoaland is also a beneficiary of a stronger USD.

• Ending losing streak. Cocoaland could see an end to the eight consecutive quarters of YoY earnings decline with the upcoming 2Q19 results. Sales contribution from beverage will continue to soften, but robust gummy sales should cushion the impact. In addition, we are expecting cost savings from lower raw material costs (sugar and cocoa), while wage costs are estimated to fall by MYR300,000 per month thanks to higher level of automation at its production lines. This, together with a stronger USD/MYR, should propel earnings growth of 22-57% as we expect 2Q19’s net profit to be in the range of MYR7-9m, and be ahead of consensus forecasts.

• Receding cost pressure. YTD price for key raw material, sugar (11% of total raw material costs) has dropped c.6% YoY (Figure 2) vs YTD 2018’s average price. Packaging costs (45% of raw material costs) have been relatively stable, in line with the crude oil price trend. The group’s automation drive has shown results with reduced overtime hours required for production – this was reflected in 1Q19, and we believe it will continue to invest in automation technology moving forward to effectively mitigate any cost spikes arising from potential increases in minimum wage and changes in foreign workers’ levy policies.

• More gummy please. Gummy capacity will increase by 30% to c.12m kg pa starting Apr 2020. We believe the risks in ramping up production are low given overwhelming demand for gummy products. Management expects 30% of the new capacity to be utilised in FY20. The last expansion in FY14 resulted in net profit jumping to MYR33m in FY15 from MYR22m in FY14. We highlight that it took only 2-3 years for the capacity utilisation rate to reach the optimal level. Total capex is estimated at c.MYR42m but this is unlikely to disrupt the dividend payout given strong cash flow generation and a sturdy balance sheet.

• Keep BUY. We raise our FY19-21 net profit forecasts by 6%/5%/3% after imputing lower cost assumptions. Correspondingly, our TP is lifted to MYR3.10 after we roll forward the valuation base year to FY20, based on an unchanged 18x target P/E. The stock is trading at a compelling P/E of 11.6x, which is below the 16-18x range that comparable peers like Power Root (BUY, TP: MYR2.19) and Apollo Food (NEUTRAL, TP: MYR3.84) are trading at. We believe this is unjustified given the positive earnings growth we are forecasting, attractive dividend yield of 5.5%, as well as strong brand equity and growth potential of its gummy products. The stock is also a proxy as a beneficiary of a strong USD (c.60% of sales derived from exports). Key risks include low trading liquidity and delays in the commissioning of new production lines.

Source: RHB Securities Research - 8 Aug 2019