This article first appeared in The Edge Financial Daily on December 10, 2019

Luxchem Corp Bhd
(Dec 9, 48 sen)
Maintain buy with an unchanged target price (TP) of 59 sen: Recall that Luxchem Corp Bhd is building a new warehouse on a piece of reclaimed land in Pulau Indah with a capital expenditure (capex) of RM17 million allocated — entirely internally funded. On completion, the warehouse will have a floor space of 130,000 square feet. The project has reached 20% completion, with earthworks almost completed, while piling has hit 50% completion. Upon completion, the new warehouse is expected to generate cost savings in terms of reduced rental payments. Luxchem’s manufacturing arm Transform Master Sdn Bhd’s (TMSB) plant expansion to 18,000 tonnes per annum (tpa) from 13,800 tpa currently is on track for completion by year’s end. TMSB was acquired in 2016. During this period, its manufacturing capacity stood at 9,600 tpa.

We forecast financial year 2019 (FY19F) profit after tax and minority interest (Patami) growth at 2.5% on better profit before tax (PBT) margins for its manufacturing segment (18%), offsetting its trading segment’s weak margins (FY19:4%). For the cumulative nine months of 2019, Luxchem’s trading segment realised a PBT margin of 3.9%, which is near the low end of its last five-year range of between 3.5% and 5.2% due to keener competition. Moving into FY20, we are expecting this segment to record a better margin of 4.4%. This is premised on expectations that the domestic glove sector will continue to see an annual organic growth of between 5% and 8% and that the sector’s financial performance will improve in FY20 after a relatively uneven performance in FY19 — this should alleviate the pricing pressure for its suppliers, including Luxchem.

We reiterate a “buy” call with an unchanged TP of 59 sen based on an unchanged 13 times price-earnings ratio (PER) on earnings per share (EPS) of 4.5 sen. Despite the competitive nature of its business, we still like Luxchem for its relatively stable bottom line, strong operating cash flow, low capex intensity, net cash balance sheet, and healthy and sustainable return-on-equity. This reflects the management’s conservative style, adopting measured expansion plans.

With Luxchem currently trading at 10.6 times PER of FY20F EPS, vis-à-vis its five-year +1 standard deviation of 11.6 times and FBM Small Cap Index’s current forward PER of 16.8 times, we believe the stock has the potential to rebound — sweetened by a 4% yield. Moving into FY20, margins for its trading segment are expected to normalise, hence anchoring our forecasts for a modest Patami growth of 3.8%. — RHB Research Institute, Dec 9