• Maintain BUY with unchanged TP of MYR3.10 TP, 71% expected total return. Cocoaland’s 2Q19 earnings were within our expectations, with net profit of MYR8.6m. Receding cost pressure has lifted earnings despite softer sales from the beverage segment. The group is expanding its gummy production capacity to capture rising demand. Valuations are compelling as we believe earnings are set to recover, while capacity expansion should drive growth in the medium term.

• Positive results. Cocoaland’s 2Q19 results were within our expectations but slightly above consensus, with earnings of MYR8.6m (+50% YoY, +2.2% QoQ). 1H19 earnings of MYR17m (+19% YoY) accounted for 49% and 53% of our and consensus full-year forecasts. As expected, lower raw material (sugar and cocoa) and labour costs led to margin expansion and better earnings during the quarter. No dividend was declared.

• Lower raw material costs. The decline in YTD sugar price of c.6% vs 2018’s average price (Figure 3) has aided in easing cost pressure, helping to lift margins. Packaging costs were relatively stable, in line with the crude oil price trend. The group’s initiative to reduce overtime hours required for production through automation is also bearing fruit. We believe the group will continue to invest in automation initiatives moving forward, in order to reduce dependence on labour – especially given potential increases in the minimum wage and changes in foreign workers’ levy policies. Notably, Cocoaland’s GP margin improved by 5.6ppts in 2Q19 vs 2Q18.

• Resilient gummy demand. Robust gummy sales helped to cushion the impact of lower sales contribution from its beverage segment. Accordingly, the group plans to increase capacity by 30% to c.12m kg pa starting Apr 2020. We believe the risks in ramping up production capacity are low, given overwhelming demand for gummy products. Management expects 30% of the new capacity to be utilised in FY20.

• Key risks and forecasts. Sharp rises in raw material costs, weaker consumer sentiment and delays in the commissioning of new production lines could pose downside risks to our call and earnings forecasts. Stronger MYR/USD would also impact earnings negatively. No change in forecasts.

• Maintain BUY with unchanged TP of MYR3.10, based on target P/E of 18x (unchanged) FY20F earnings. The stock trades at a compelling P/E of 11.8x, which is below the 16-18x range that comparable peers like Power Root (BUY, TP: MYR2.19) and Apollo Food (NEUTRAL, TP: MYR3.65) command. We believe this is unjustified given the expected steady earnings growth, attractive 5.5% FY20F dividend yield, as well as strong brand equity and growth potential of its gummy products. The stock is also a beneficiary of a strong USD (c.60% of sales derived from exports).

Source: RHB Securities Research - 28 Aug 2019