This article first appeared in The Edge Financial Daily on August 9, 2019

Cocoaland Holdings Bhd
(Aug 8, RM1.95)
Maintain buy with a higher target price (TP) of RM3.10 (previously RM2.70): We maintain “buy” with a higher price-to-earnings (P/E)-based TP of RM3.10 from RM2.70, with a total return of 74%. Second quarter of financial year 2019 (2QFY19) earnings are likely to beat street expectations. Cocoaland Holdings Bhd is adding a new gummy line to capture rising demand. Valuations are compelling and undemanding as we believe earnings are set to recover on receding cost pressure; capacity expansion should drive earnings growth in the medium term. The group also benefits from a stronger US dollar.

Cocoaland could see an end to the eight consecutive quarters of year-on-year (y-o-y) earnings declines with the upcoming 2QFY19 results. Sales contributions from beverages will continue to soften, but robust gummy sales should cushion the impact. We expect cost savings from lower raw material costs (sugar and cocoa), while wage costs are estimated to fall by RM300,000 per month, thanks to a higher level of automation at its production lines. This, together with a stronger US dollar-ringgit exchange rate, should propel earnings growth of 22% to 57% as we expect its 2QFY19 net profit to be RM7 million to RM9 million.

The year-to-date (YTD) price of sugar, a key raw material (11% of total raw material costs), has dropped about 6% y-o-y versus the YTD 2018 average price. Packaging cost (45% of raw material costs) has been relatively stable in line with the crude oil price trend. The group’s automation drive has shown results with reduced overtime hours required for production, which was reflected in 1QFY19, and we believe it will continue to invest in automation technology to mitigate effectively any cost spikes arising from potential increases in minimum wage and changes in foreign workers’ levy policies.

The group’s gummy capacity will increase by 30% to about 12 million kg per annum from April 2020. We believe the risks involved in ramping up production are low on gummy product demand. The management expects 30% of the new capacity to be utilised in FY20. The last expansion in FY14 resulted in net profit rising to RM33 million for FY15 from RM22 million for FY14. It took only two to three years for the capacity utilisation rate to reach the optimal level. Total capital expenditure is estimated at about RM42 million but this is unlikely to disrupt the dividend payout given the strong cash flow generation and sturdy balance sheet.

We raise our FY19 to FY21 net profit forecasts by 6%/5%/3% respectively after imputing in lower cost assumptions. Our TP is lifted to RM3.10 after we rolled forward the valuation base year to FY20, based on an unchanged 18 times target P/E. The stock is trading at a compelling P/E of 11.6 times. We believe this is unjustified given the positive earnings growth we are forecasting, attractive dividend yield of 5.5%, as well as strong brand equity and growth potential of its gummy products. — RHB Research Institute, Aug 8