Cocoa powder prices a drag on Guan Chong’s earnings

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AN increase in the global consumption of chocolate has yet to have a positive impact on Guan Chong Bhd’s earnings. In fact, the company’s financials in recent times have exhibited a shrinking net profit, which is surprising, considering that the company is one of the largest cocoa ingredient producers in the region.

The dwindling profit in the past year was attributed to lower average selling prices (ASP) of cocoa powder and stiff competition among international players, among others.    

The challenging environment has been aggravated by a massive inventory writedown brought about by lower ASP for cocoa powder. As at June 30, Guan Chong had written down RM21.54 million in inventories.

Due to the challenging environment, the company’s margin in the financial year ended Dec 31, 2013, contracted to a mere 0.25% as net profit slumped to RM3.41 million — a far cry from a margin of 8.19% in the year before, which saw the company chalk up a net profit of RM118.98 million.

However, there has been a slight improvement in the first six months ended June 30 with margin improving to 0.57% and net profit to RM5.13 million.

So, what happened at Guan Chong?

The company’s cocoa grinding process produces two main substances — cocoa butter, which is used to create the “melt in the mouth” effect in chocolates, and cocoa powder, which is used in cakes, cookies and ice cream, among others.

Depending on the bean type, the extraction  process produces 45% cocoa powder and 35% cocoa butter.

Last year, Guan Chong experienced a build-up in cocoa powder inventory caused by increased grinding capacity that was meant to cater for the demand for cocoa butter.

While cocoa butter prices soared, the oversupply of cocoa powder caused its prices to slump. Recent reports reveal that cocoa powder ratios are quoted at 0.6 times raw bean prices while cocoa butter ratios are 2.4 times raw bean prices.

Cocoa futures for delivery in December 2014 hit a peak of US$3,371 per tonne on Sept 24, up from US$2,283 on Jan 1, 2013. The price dipped to US$3,038 last Thursday, but it was still a gain of 33.07% from Jan 1, 2013, which does not augur well for processors such as Guan Chong.

An industry executive says, “If processors earn good margins from (cocoa) butter and are able to cover the cost of powder, they can afford low powder prices … I don’t expect powder prices to increase any time soon.”

In Guan Chong’s 2013 annual report, it says the increase in revenue for cocoa butter could not offset the decline in revenue for cocoa solids — powder and cake.

SJ Securities analyst Tou Hui Ling, the only one covering the counter, says demand for cocoa powder has recovered somewhat since early this year as the global economy, particularly the eurozone, showed signs of recovery.

“I would not say it is a situation of oversupply (for cocoa powder). It was in oversupply in 2013, causing an inventory build-up. However, cocoa grinders have since cut down production volume and the equilibrium has been restored somewhat,” she says.

Tou forecasts Guan Chong clearing its inventory by the end of this year, although cocoa powder can be stored for up to two years.

Market experts, however, opine that for Guan Chong and even the global industry, the prospects for cocoa powder are not bright.

They see Guan Chong facing a lot of competition from bigger players like Barry Callebaut in Indonesia and Cargill, which recently commissioned a new plant in Indonesia that will compete head-on with Guan Chong’s cocoa-processing facilities there that grind about 120,000 tonnes a year.

“This may change the operating environment next year. If Indonesia increases its export tax on cocoa beans, the situation may affect the cocoa powder prices,” says an executive familiar with the industry.

Indonesia is the world’s third largest cocoa bean producer and it imposes a 10% tax on the beans. Reports in August this year indicate that the government has left the export tax unchanged at 10%.

While the outlook for cocoa powder prices seems lacklustre and uncertain, perhaps Guan Chong could reap better profits from its industrial chocolate factory that was commissioned a year ago.

A year ago, the company moved downstream into manufacturing industrial chocolate that can be sold to bakeries and confectioneries. Managing director Brandon Tay was reported as saying that the business was more stable and provided higher margins compared with the cocoa ingredient segment.

“We cannot remain just an ingredient supplier,” Tay was quoted as saying during the opening ceremony of the industrial chocolate plant in January. But this division has yet to contribute significantly to the group’s earnings.

Guan Chong’s executives were not available for comment.

The company’s shares hit a two-year low of RM1.17 on Aug 28 and ended trading last Thursday at RM1.20.

SJ Securities has a target price of RM1.80, which is at a 50% premium to Guan Chong’s close last Thursday, and an “overweight” call on the counter.  

This article first appeared in The Edge Malaysia Weekly, on October 13 - 19, 2014.