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Hup Seng will release its 1Q18 quarterly results this month. We expect 1Q18 profit to come in the range of between RM10mn and RM13mn, or little changed from RM11.5mn achieved in 1Q17. We expect a few factors to play out and influence the 1Q18 results performance, including: i) stable domestic and export sale growth; ii) lower crude palm oil (CPO) price to provide earnings support and buffer against, iii) higher fuel and packaging costs stemming from higher crude oil price.

Refined Palm Oil Costs Expected to be Favourable

Refined palm oil is one of the key raw materials used in Hup Seng’s production. It is usually priced at a 20% to 30% premium to the price of CPO. In our forecast, we have assumed the refined palm oil price to trade at an average RM3,000/tonne, down from the average RM3,300/tonne for FY17, thus providing the earnings support to FY18 earnings. Based on our sensitivity analysis, every 10% decline in CPO price, Hup Seng’s core net earnings are expected to improve by 7.3% ceteris paribus.

For 1Q18, we expect the refined palm oil price to fall in tandem with the CPO price, which has declined by 21.2% YoY in 1Q18. This is expected to provide some buffer against the rise in cost of sales in 1Q18.

Rise in other cost components

However, based on our assumptions that packaging and logistics costs would escalate by as much as 20% in FY18 - in tandem with the rise in crude oil price, we expect it to dilute some of the growth generated by lower refined palm oil price. Note that prices of packaging materials like carton and plastic material prices are correlated with the movement of crude oil price, which is expected to rise to average US$60/b in 2018 from USD50/b last year. Transportation cost would also increase due to higher diesel price.

Besides, staff costs are expected to rise further after the implementation of new policy that employers must bear the cost of levy payment for new foreign workers as well as foreign workers who have renewed their temporary employment visit pass. Based on 240 foreign workers employed by the company, there would be additional RM444,000 staff cost as levy payment for FY18.

Stable Sales Growth

As far as sales are concerned, we expect Hup Seng’s FY18 revenue growth to be driven mainly by higher exports to the Middle East and China markets on the back of: i) higher sales incentives; and ii) promotional sponsorship activities for the distributors. We also expect domestic sales to grow organically by 2.8% in FY18.

We understand from management that the company has no intention to raise product prices in the near future. As such, domestic sales are expected to be stable and revenue growth is expected to be resilient.

Healthy Balance Sheet

The investment merit for Hup Seng share is always about its attractive dividend yield. With a 60% dividend policy, investors can benefit from a compelling divided payment, which yields 4.8% in FY18. Note that Hup Seng is currently in a net cash position without any loans. The healthy balance sheet and low capex requirement would ensure dividend sustainability at average dividend yield of 4.8% over the next three years.

Impact

We raise our earnings forecasts by 1.7% and 3.1% for FY18 and FY19 respectively after imputing the audited FY17 results into our forecasts.

Recommendation

Maintain BUY call on the stock with unchanged target price of RM1.25/share based on DDM valuation (k: 7.6%, g: 2.5%). Risks to our call are i) higher-than-expected refined palm oil costs; ii) lower-than-expected domestic as well as export sales; and iii) higher-than-expected labour costs.

Source: TA Research - 3 May 2018