Despite various global and domestic challenges such as: i) the US-China trade war; ii) weakening of the Ringgit; and iii) implementation of Sales and Service Tax (SST) in Malaysia, demand for milk-based products continues to be resilient, supporting Johore Tin’s plans on capacity expansion. Increase our earnings forecasts by 0.7% and 2.0% for FY19 and FY20 respectively. Raise our target price to RM1.16/share based on SOP CY19 EPS valuation. Maintain Buy.

Trade War and Ringgit Weakening

Management guided that 72% of Johore Tin’s sales are currently derived from exports. As such, the company is concerned about the current US-China trade war, which would likely affect currencies of countries outside the US by reducing purchasing power, especially for countries in the Middle East, Africa and South East Asia. However, this could partially be mitigated by higher exports sales to Central America due to the increase in the US dollar’s purchasing power. Note that Central America’s sales account for 9.0% of the group’s sales in FY17. At the same time, Ringgit is expected to weaken in 2H18 and this would likely boost Johore Tin’s export competitiveness.

Having said that, weakening of the Ringgit is expected to increase raw material costs especially given that 100% of milk-based commodities and about 50% of tinplates are imported. We believe imported raw materials account for about 85% of costs of sales. Overall, based on our sensitivity analysis, if average Ringgit rate weakens from MYR4.00/USD to MYR4.05/USD, Johore Tin’s FY18 earnings could reduce by 3.4%, ceteris paribus.

Sales and Service Tax and Minimum Wage

Management guided that both the Tin Manufacturing and F&B segments are exempted from SST. We do not expect material impact on earnings from the change in tax system from G oods and Service Tax (GST) to SST. This is because approximately 72% of the group’s sales are exported, thus exempted from GST in the past. The balance of 28% local sales, where consumers paid GST in the past, is expected to have immaterial impact on the group’s total revenue and earnings.

In the case of minimum wage, the government has recently announced the increase of minimum wage from RM1,000/year to RM1,050/year, effective Jan-2019. Considering 30% out of 600 people of the group’s production labour forces are earning minimum wage, this is expected to increase Johore Tin’s staff costs by less than 1.0%. Currently, staff costs account for 7.0% of the group’s sales.

Subscription of Additional Investment in Able Dairies

Last week, Johore Tin announced that it has subscribed for an additional 43.5mn ordinary shares at an issue price of RM1.00/share in the capital of Able Dairies Sdn. Bhd. (ADSB), bringing total investment to RM45.0mn for a total of 45.0mn ordinary shares. Payments are made through: i) cash of RM16.6mn; and ii) contra of account for owing by ADSB of RM26.9mn, therefore discharging ADSB from its liability in owing Johore Tin. The purpose of this subscription is expected to be used for: i) paid-up capital for the joint-venture in Mexico; ii) investment for a land and building of a new warehouse in Teluk Panglima Garang which is budgeted to cost RM20.5mn; iii) capex to upgrade machineries; and iv) additional working capital.

To recap, ADSB was wholly acquired by Johore Tin back in 2011 at a purchase consideration of RM31.0mn for 1.5mn sale shares as Johore Tin underwent a diversification of business by adding F&B segment into its business model. Since then, the F&B segment has: i) increased production on a consistent basis to current full capacity of 60,000 tonnes/year within the evaporated and condensed milk business (ADSB); ii) acquired Able Food Sdn Bhd in 2013 and expanded the milk powder repackaging business to capacity of 60,000 tonnes/year in FY17 from 1,200 tonnes/year; iii) created a subsidiary of Able Dairies Marketing Sdn Bhd (51% owned by ADSB) in FY17 to enforce wholesale activities for F&B segment; and iv) entered into a joint-venture to create Able Dairies Mexico (40% owned by ADSB) in FY17 to be closer to existing Central American market with possibility of expanding reach to other closer regions.

Progress of JV in Mexico

As mentioned above, the subscription of new ADSB shares will also be used for the paid-up capital of the plant in Mexico. Management guided that the plant is expected to complete by end of FY18 with a total capacity of about 60,000 tonnes/year. We can expect commissioning in 2Q19 after equipment installations and thereon utilisation rate is expected to reach up to 35% to cater to existing customers based in Central America. With continuous focus on growing sales, the plant can expect to reach utilisation rate of up to 50% by end of FY19 as targeted markets are the South American, Central American, the Carribean and African countries.

Plans for Domestic Expansion

Following the subscription of additional investment into ADSB, domestically Johore Tin plans to add three operational lines within the ADSB evaporated milk and condensed milk plant, which will ramp up the installed capacity by 30% to 78,000 tonnes/annually. To do this, the group has allocated CAPEX of RM3.0mn for additional capacity, which is to come on stream by 2Q19. Reason being, the current plant has been operating at full capacity of 60,000 tonnes/year since FY17. Post commissioning of the additional capacity, management guided that the operation is expected to reach full capacity by 3Q19.

Additionally, note that in March 2018, Johore Tin announced that it has awarded a contract through ADSB to construct a unit of one storey factory connected to three storey office building, a unit of guardhouse and waste chamber as well as a unit of electrical substation for a total sum of RM14.0mn. This is expected to complete by end of FY18 therefore allowing Johore Tin to place the additional three line of capacity in the new factory which we believe is on the same road as the current dairies operations in Teluk Panglima Garang.

On top of these, the subscription of additional investment is planned to be used for a land and new warehouse in Teluk Panglima Garang with a budget of RM20.5mn to support its growing capacity expansion activities. Hence considering the above, we have increased our sales assumptions for FY19 and FY20 by 4.4% and 2.5% respectively as we believe that Johore Tin will fill up the new spaces and increase capacity in stages to ensure a healthy cash flow and balance sheet.

Impact

We raise our earnings forecasts by less than 1.0% and 2.0% for FY19 and FY20 respectively after considering additional domestic capacity for sweetened creamer products and increase in our Capex assumptions.

Recommendation

Maintain BUY on JTB with higher SOP-valuation of RM1.16sen/share (previously RM1.15/share) based on 16x F&B earnings and 8x tin manufacturing earnings for CY19.

Source: TA Research - 24 Sept 2018