We believe Hup Seng’s share price is currently undervalued therefore upgrading our call from Hold to Buy with higher target price of RM1.19/share based on DDM valuation. Our valuation basis includes: i) Hup Seng’s shares are currently trading at discount to its three-year historical trailing PER of 20.6x and PBV of 5.6x; and iii) dividend yield is attractive at more than 5.0%.

Overview of Share Price

YTD, Hup Seng’s share price has declined by 8.3% to RM1.01 from RM1.09/share. It fell as much as 10.6% YoY from RM1.15/share. In the middle of the year, the share price recovered up to RM1.18/share after GE14 before falling.

We attribute the fall in share price to its poor results performance where sales and profit grew slower-than-expected at 3.8% and 4.0% respectively for 9M18, despite 2018 being an eventful and auspicious year for consumers due to higher cash allocations for B40 income group as well as tax break period during Jun – Aug 2018.

Share Price is Currently Undervalued

We believe that Hup Seng’s share price is currently undervalued, trading i) at a trailing PER of 18.8x, which is more than 1 standard deviation below the threeyear mean PER 20.6x; and ii) at a trailing PBV of 4.8x, which is more than 1 standard deviation below the three year mean PBV 5.6x. The last time Hup Seng was trading at current level, it was in 2015 when Goods and Services Tax (GST) was implemented by the previous government.

Hence, we believe that the market has fully priced in those risk factors which include i) soft sales following high costs of living domestically; ii) possible increase in average sales prices following change in tax format to Sales and Services Tax (SST) from GST; and iii) projected higher costs of flour and carton packaging. In fact, we believe that the market has overplayed the risk factors and could possibly miss out on i) sugar price in Malaysia that is currently at an all-time low; and ii) Hup Seng’s ability to maintain 60% dividend policy.

Attractive Dividend Yield

Hup Seng has a dividend policy of 60%. However, the company has been making an average dividend payout of 97% over the past three years. We believe the group is able to maintain the dividend policy considering i) net cash position; and ii) high free cash flow yield of 9.0% based on FY18 projected earnings. Assuming that Hup Seng continues to payout dividend at an average of 95% at 5.0 to 5.5 sen/share between FY18 to FY20, the dividend yield is expected to be in the range between 5.0% and 5.5%. We deem this as attractive as this is in line with the projected dividend yield offered by its peers.

Outlook

We believe that FY19 earnings to be driven by Ringgit weakening. Based on our sensitivity analysis, if Ringgit weakens from MYR4.05/USD to MYR4.15/USD, Hup Seng’s earnings are expected to increase by 2.0% and 2.1% for FY19 and FY20 respectively ceteris paribus, considering 30% of its sales come from exports. Moreover, the global sugar price is currently at an all-time low. Hence, local price of coarse granulated sugar to reduce to RM2.85/kg from RM2.95/kg for retailers and therefore some food manufacturers is expected to reduce the costs of sales. However, these may be offset by higher costs of carton packaging as well as flour due to increasing demands for consumable goods.

Impact

We make no change to our earnings forecasts.

Recommendation

Upgrade our call from Hold to Buy with higher target price of RM1.19/share based on DDM valuation. Reduce our discount rate from 8.1% to 7.8% after adjusting our beta accordingly and maintain our terminal growth rate of 2.5%.

Source: TA Research - 14 Dec 2018