Superlon Holdings Bhd
(Dec 27, RM2.50)
Not rated: We attended Superlon Bhd’s analyst briefing following the release of its results for the first half of the financial year ended Oct 31, 2016 (1HFY17). 1HFY17 revenue grew 8% year-on-year (y-o-y) on higher sales volume underpinned by stronger growth in domestic insulation sales volume despite a significant reduction in average selling prices due to diminishing currency tailwinds. 1HFY17 profit after tax (PAT) rose 28% y-o-y on the back of a firmer margin, despite a higher effective tax rate (+three points) due to lower deferred tax income recognised. The net margin expanded four points y-o-y, supported by predominantly higher efficiencies and economies of scale, while a reduction in raw material prices (synthetic rubber and nitrile butadiene) also boosted margins.

Management guided that the construction of the new warehouse costing RM10.3 million had been completed, barring some exterior works. The new warehouse is expected to be commissioned in 2HFY17, which will free up existing factory space and allow for the installation of more production lines. Superlon also plans to invest approximately RM5 million to replace and upgrade existing machinery, which should uplift efficiencies and cushion margin pressure. All things considered, this should increase Superlon’s production capacity by 30% with better efficiencies and higher margins, while full-year impact is expected in FY18.

With rising production capacity, growing efficiencies and a strong management track record, Superlon is poised to maintain its superior profitability profile with a return on investment of 19%. The effective tax rate is likely to trend lower given tax breaks for capital allowance, which should boost PAT margin in the near term. Superlon remains in a net cash position with cash balance of RM29 million, or 15% of its total market capitalisation. Superlon trades at a trailing 10 times price-earnings ratio (PER) on a cash-adjusted basis, with strong free cash flow generation to sustain dividend payouts.

At the last close, Superlon traded at an implied trailing 10 times PER for its calendar year 2016 earnings per share on a cash-adjusted basis. This trails our rubber product sector average of 21 times, but we are cognisant that this is not a like-to-like comparison given that rubber product companies generally have significantly higher barriers to entry as they manufacture certified health devices (condoms and gloves). Nonetheless, Superlon’s valuation remains appealing at price/earnings to growth of less than one times, with strong earnings growth visibility on capacity expansion and improving efficiency. — Affin Hwang Capital, Dec 27