Investment Highlights

• We maintain BUY call on Power Root with a higher fair value of RM2.67/share (from RM2.41/share previously), pegged to an unchanged FY24F PE of 18x – 0.5 standard deviation below its 7-year average. We made no changes to FY23F earnings but raised FY24F/FY25F by 6%/3% due to more certainty in operating costs coupled with improving efficiency. We make no adjustment to our neutral ESG rating of 3 stars.

• We held a virtual meeting with the management recently. These are the salient points:
  • Despite competitors raising prices in 2021, Power Root only started to its first price hike in January 2022 (average 8%), due to its ability to lock in lower raw material costs. Subsequently, another price hike was carried out in Oct 2022 (average 5%), particularly for Ah Huat and Alicafe brands at wholesale level. The third round of price adjustment in January 2023 was targeted at all channels (average 5% - 10%).
  • For its overseas markets, particularly Middle East (ME), the price hike is lower and slower due to approval needed from the local governments. Hence, the group has increased prices only once on average for these markets. However, the group does not rule out the possibility of another price hike in United Arab Emirates (UAE) as we understand that Power Root remains price competitive in the region against other players.
  • We gather that its main competitors such as Nescafe have increased prices in March 2023 but the group has not jumped onto the bandwagon immediately, given that: 1) it has secured adequate raw materials such as coffee powder and creamer at lower prices to last for the entire year – benefiting FY23F and at least three quarters of FY24F, and 2) more room for price adjustment given its competitive pricing vs. peers.
  • Earnings-wise, we expect net margins to be stable, given that prices of coffee (-17% since September 2022) and creamer (-18% since Nov 2022) have come off. Also, the impact from the sugar tax likely to be muted given that the policy implementation has been delayed and the group has revamped all the sugar content in its products to below the stipulated requirements.
  • In terms of sales recovery, ME has reached 90% of its prepandemic level. Power Root has also resolved its distributorship issue in Saudi Arabia after appointing a new distributor. Sales are only expected to recover in 1QFY24 but sales from other ME countries like Qatar and UAE could help to minimise the shortfall, in our view.
  • Power Root’s growth trajectory will be bolstered by continuous expansion in market reach by launching more new Alicafe brand products, which remain its mainstay for both local and export markets. The group currently has 19 key distributors for the local market and 1 distributor for each export destination. Moreover, we opine that overall profitability could improve due to better operational efficiency by switching over to sales force automation (SFA) software since end of 2022 from a manual system previously, whereby orders are done onsite which is more real-time basis and efficient in reducing lead time, better in monitoring orders, stock availability and certainty of sales on the ground, which were all conveyed verbally by dealers in the past.
  • For operating expenses, the group has fully reflected the minimum wage impact, whereas the hike in electricity prices will cost an additional monthly RM60,000, which is less than 1% of its FY23F net profit. On capex, RM12mil was spent on maintenance and new machinery for 9MFY23. Excluding spending on new machinery, capex could be range-bound at RM6mil–RM7mil for FY24F. As such, assuming prices of raw materials stay at current levels, we do not foresee major cost concerns in FY23F–FY24F.
  • Management guided for a high single-digit growth in the topline for FY24F with a net margin of 12.5% - 13.5%.
• Power Root’s near-to-medium term outlook remains positive as the recovery in domestic and export sales volumes continue to gain momentum. At a compelling FY24F PE of 14x, the stock is trading below its 5-year peak of more than 30x while offering an attractive dividend yield of 6.5%.

Source: AmInvest Research - 28 Mar 2023