This article first appeared in The Edge Financial Daily on September 6, 2019

Power Root Bhd
(Sept 5, RM2.10)
Maintain buy with a higher target price (TP) of RM2.49 from RM2.19: Power Root Bhd, one of our sector top picks, has begun engaging with investors more actively. Its maiden briefing received overwhelming response with 80 to 90 people attending. We believe the Power Root management has instilled more confidence, thanks to the presentation of a well-planned business rationalisation initiative. Hence we think its earnings recovery momentum is sustainable. Despite the strong share price run, we see further upside from valuation rerating and a catch-up to sector average.

In summary, the management will continue the business rationalisation initiative to streamline and optimise the productivity of the company’s operations ranging from inventory management, sales and distribution network, to return on investment-based advertising and promotion (A&P) investment. This, together with favourable commodity prices and forex trend, should propel solid earnings growth moving forward.

Power Root’s share price has approached the historical high level following a stellar year-to-date rally to reflect the significant improvement in financial performance and positive outlook which stemmed from the management’s efforts to lift its efficiency level. We believe the run still has legs, and see further room for valuation rerating. Power Root’s current valuation of 17 times forecast 2020 (2020F) price-earnings ratio (PER) represents a sizeable more than 50% discount vis-à-vis peers, and the valuation could catch up given its relatively higher earnings growth and more attractive dividend yield.

We believe it is unrealistic to compare Power Root with sector giants such as Nestle (Malaysia) Bhd (“neutral”, TP: RM132) and QL Resources Bhd (“neutral”, TP: RM6.68), which trade at more than 40 times PE. The average valuation of 23-24 times PER in the brewery sector could be a good benchmark to look at, given the similarity in business model, which is manufacturing and distributing fast-moving consumer goods, as well as the generous dividend payout. While we are aware of the disparity in terms of market capitalisation, the elusive syariah status could potentially balance the equation. The scarcity premium comes into play, as market continues to pursue defensive syariah-compliant stocks offering earnings visibility and decent dividend yield.

Post-briefing, we raise FY20F-22F (March) core earnings by 3% and 5% to pencil in the higher level of efficiency gains. Our discounted cash flow-derived TP (weighted average capital cost: 7.7%; terminal growth: 2%) also rises to RM2.49 (implying 21.6 times 2020F PER), as we also tweak our risks assumptions to factor in the scarcity premium, and more reassured earnings outlook. Risks to our recommendation include lower-than-expected sales and a sharp rise in input costs. — RHB Research Institute, Sept 5