• Downgrade to SELL from Neutral, new MYR2.75 TP from MYR2.90, 14% downside. We expect Apollo Food’s 4QFY20 (Apr) earnings at c.MYR1.2- 1.7m – weaker, due to the implementation of the Movement Control Order (MCO). The spike in raw material prices in Jan-Mar could also impact 4QFY20-1QFY21 margins. The weakness in demand may extend beyond the MCO, as it may take time before consumer sentiment fully normalises. The risk-reward profile looks unfavourable to investors at the current level. The stock is trading at 19.6x P/E, above its historical average of 17x.

• Anticipating sluggish demand. We expect demand growth for Apollo’s snack food products to be under pressure. This is in view of the weak consumer sentiment, and anticipation of lower consumer spending on discretionary/non essential items. In addition, the school closures are also negative to sales volume, as schoolchildren are a major customer group. Social distancing initiatives and general cautiousness on venturing out (due to fears over COVID-19 infection) indicate that both modern and general trade volumes will remain subdued. Also, shifting sales to online channels may not work best for the company, given its low ASP. We believe the situation or weakness may persist, as it will take time for consumer sentiment to fully normalise.

• Recent spikes in prices of commodities like wheat, sugar and CPO could drive Apollo’s raw material costs higher, and potentially affect its margin. Given the limited pricing power, we believe it may not be able to pass on the hike in costs to customers. This may cause margin erosion from as early as 4QFY20 onwards. Being a net exporter, the weakening of the MYR vs USD is a positive to the company. This is because it derives more than one-third of its revenue from exports, while over 90% of its raw materials are sourced locally.

• Results preview. We expect 4QFY20 earnings at MYR1.2-1.7m. This would to FY20 earnings of MYR11.5-12m, implying a c.33% YoY decline – 9MFY20 was affected by higher-than-expected raw material prices and operating expenses, while 4QFY20 sales were hit by the COVID-19 pandemic. Weak sentiment and public cautiousness on travel and spending on non-necessities due to the pandemic might extend the impact to 1HFY21.

• We trim FY20-21 earnings by 12% and 5% after cutting sales and margin assumptions to reflect a more conservative view, due to COVID-19. In line with the earnings revision, we pare down FY20-21 DPS forecasts to 13 sen and 14 sen (from 15 sen), implying a c.86% payout ratio (vs the historical average of 98%). Apollo’s net cash position and minimal capex plan should help it sustain the payout ratio. A sharp drop in input costs and new product launches could pose upside risks to our recommendation.

• Downgrade to SELL (from Neutral) with a lower MYR2.75 TP. Our valuation is based on 17x target P/E on FY21F revised earnings. At the current level, the stock looks overvalued – it is trading at 19.6x P/E vs the 5-year mean of 17x. We believe the risk-reward profile, at present, is unfavourable to investors – in view of Apollo’s lack of growth drivers, susceptibility to fluctuations in raw material costs, and the challenging economic environment ahead.

Source: RHB Securities Research - 19 Jun 2020