9MFY22 PATAMI of RM699m (-76% YoY) came in at 89%/91% of our/consensus full-year forecast. We consider the results to be below expectations due to the lower-than-expected margins in 3QFY22. We highlight that the sharp fall in margin in 3QFY22 due to its overseas distribution unit having to sell high-priced inventory at falling market prices could impact the next two quarters. Earnings in subsequent quarters are expected to be impacted by: (i) potential revenue loss from US CBP WRO which accounts for 20% of sales, and (ii) impact from one-off prosperity tax in FY22. This prompted us to downgrade our FY22E/FY23E net profit by 21%/17%. Our TP is reduced from RM0.90 to RM0.75 based on 11x FY23E EPS. Reiterate UP.

Key results’ highlights. QoQ, 3QFY22 revenue fell 22%, no thanks to lower ASP and lower volume sales were exacerbated by imposition of the Withhold Release Order (WRO) by US Customs and Border Protection (USCBP’s) and freezing of orders from the Canadian government. EBITDA margin fell to 9% from 21% in 2QFY22 due to: (i) sales of high-priced inventory at falling market prices which could well mean that certain shipment are sold at a loss, and (ii) lower ASP which fell faster than a corresponding decline in input raw material cost. This brings 3QFY22 PATAMI to RM13m (-73%). A 2nd interim dividend of 3.0 sen was declared in this quarter bringing 9MFY22 to 8.0 sen which came in line with our expectation. YoY, 9MFY22 PATAMI fell 76% dragged down by falling ASP and a higher effective tax rate of 29% vs. 23% in 9MFY21.

Outlook. We highlight that 3QFY22 sharp fall in margins due to overseas distribution units having to sell high-priced inventory at falling market prices could impact earnings over the next two quarters. Going forward, earnings in subsequent quarters are expected to be impacted by: (i) potential revenue loss from US CBP WRO which accounts for 20% of sales, (ii) ASP normalising faster than expected, and (ii) impact from one-off prosperity tax in FY22. We believe performance in subsequent quarters could also be impacted by: (i) logistic challenges caused by the global shipping container shortage of which we understand are unlikely to abate over the next two quarters, and (ii) margin crunch as raw material cost is not adjusting as fast as falling ASP and hence earnings could be lower sequentially. Recall that CBP issued a Withhold Release Order (WRO) against Supermax which has identified 10 of the International Labour Organization’s indicators of forced labour in manufacturing operations during its investigation. The group claimed that it had taken measures to meet the International Labour Organisation (ILO) standards on migrant workers since 2019.Note that the US accounts for approximately 20% of sales. The impact severity on earnings depends on: (i) how fast Supermax can replace loss of sales in the US, and (ii) how long it takes for the group to resolve the issue. Note that it took almost a year for TOPGLOV to be cleared of the ban.

Downgrade FY22E/23E net profit by 21%/17%. We downgrade FY22E net profit by 21% after taking into account reduced EBITDA margin to 31% from 35%. We also downgrade FY23E net profit by 17% after taking into account the following; lower utilization from 68% to 65% and EBITDA margin to 17% from 18%.

Reiterate UP. We cut our TP from RM0.90 to RM0.75 based on unchanged 11x FY23E EPS (at -0.5SD below 5-year pre-COVID forward historical mean). The PER is lower than the mean due to execution risk concerns in its US ambition.

Key risk to our call is stronger-than-expected ASP.

Source: Kenanga Research - 26 May 2022