This article first appeared in The Edge Financial Daily on December 12, 2019

Superlon Holdings Bhd
(Dec 11, 98.5 sen)
Upgrade to buy with a higher target price (TP) of RM1.17: We came back from Superlon Holdings Bhd’s investor briefing feeling more positive about its outlook. For the first half ended Oct 31, 2019 (1HFY20), the company posted a gross profit (GP) margin of about 27%, six percentage points lower than a year ago mainly due to higher sales to low margin markets and lower efficiency in the Vietnam factory as well as higher raw material costs. On the other hand, the higher GP margin product from a new customer has only started to pick up and we estimate that the orders make up about 10% of its year-to-date volume. Looking ahead, we expect this customer to contribute about 20% of its total volume, which should improve its overall GP margin in the coming quarters.

Meanwhile, Superlon management updated that the utilisation rate at its Vietnam plant has ramped up to about 50% as of the second quarter of FY20 (2QFY20), compared with 30% in 4QFY19 when the plant was completed. We believe the plant is on track to break even operationally and that could help ease its profit margin going forward. This is sooner than expected as the management had previously targeted utilisation rate to reach about 50% by April 2020. Looking past the break-even point, we expect further improvement in profit margin due to the tax break in Vietnam, which may kick in in the coming quarters considering operational momentum that is well on track.

While India remains a large market for Superlon, contributing about 20% to its sales, margins remain thin due to market competition. On top of maintaining market share and volume there, Superlon is also trying to get into other new markets in South America and selling more to countries that can provide better margins to mitigate the low margin sales from India and fluctuation in raw material costs.

We maintain our earnings forecast for FY20/FY21 and roll over our valuation to peg our TP at FY21 earnings per share of 8.97 sen. Our price-to-earnings ratio of 13 times is unchanged. Looking past 1HFY19, we expect operational and financial improvement at Superlon to enhance its profitability in FY21F. Another catalyst is lower raw material cost that prolongs. Since end-October, certain main raw material cost has eased by 25-30%. Dividend yield is expected at 4.1%. — MIDF Research, Dec 11