This article first appeared in The Edge Financial Daily on March 13, 2020

Guan Chong Bhd 
(March 12, RM2.18)
Reiterate buy with a target price of RM3.45: Guan Chong Bhd has completed the Schokinag Holding GmbH acquisition in January while its Ivory Coast plant’s progress remains on track. Half of this facility’s capacity should be taken up by Schokinag, which ought to be sufficient for it to break even. On Covid-19, the group has minimal presence in China or Europe. 

Schokinag is in the bag and should contribute to Guan Chong’s bottom line from February onwards. Its contribution at 2020 profit-before-tax level is estimated at €5 million, while Germany’s statutory tax rate, including the municipal trade tax rate, is about 30%. Meanwhile, Fuji Oil Asia has exercised the call option to acquire Guan Chong’s remaining 27.75% stake in Fuji Oil Global Chocolate for RM32 million — generating an expected first quarter of 2020 ended Dec 31 (1Q20) disposal gain of RM25 million. 

We gather that cocoa bean prices have normalised to about RM2,500 per tonne from 4Q19’s high of about RM2,700 per tonne. Having an inverse relationship, cocoa butter ratio should improve and ought to reduce the risk of potential margin compression in the future if a sudden bean price decline occurs. The normalisation of such prices should also provide margin stability for cocoa solid products, as steep movements in the terminal price may affect Guan Chong due to time lags in passing through costs.

Some big chocolate makers have said that they cannot afford to switch their cocoa bean sources away from the Ivory Coast or Ghana at short notice. This implies a certain degree of inelasticity on demand that, in turn, should sustain grinders’ profitability. In the longer term, any bean price premium should lead to cocoa bean oversupply and the market will reach a new equilibrium .

We increase our effective tax rate assumption after Guan Chong fully utilised its investment tax allowance. However, the increase in tax expenses should be offset by Schokinag’s contributions. All in, there are no changes to our forecasts. Key risks to our call include cocoa bean price volatility and prolonged uncertainty over the living income differential issue.

Guan Chong’s new ventures into the Ivory Coast and Europe should be future earnings drivers. Schokinag’s ability to offtake 50% of the Ivory Coast’s plant supply ought to reduce the latter’s underutilisation risk and be enough for the facility to break even. Demand for cocoa-based products should remain stable, while the group’s strong and wide customer base is likely to help minimise external shocks. — RHB Research Institute, March 12