Teo Seng Capital. Equity Explorer NOT RATED RM1.25. Good long-term prospects. Malaysia Equity Research 17 Mar 2016

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1 SMC Research Equity Explorer Bloomberg: TSCB MK Reuters: TSCP.KL Refer to important disclosures at the end of this report Malaysia Equity Research 17 Mar 2016 NOT RATED RM1.25 KLCI : 1, Return *: 1 Risk: Moderate Potential Target * : 12-Month RM 1.50 (20% upside) Analyst Inani ROZIDIN inanirozidin@alliancedbs.com Price Relative RM Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 (LHS) Relative KLCI INDEX (RHS) Relative Index Forecasts and Valuation FY Dec (RM RMm) 2014A 2015A 2016F 2017F Revenue EBITDA Pre-tax Profit Net Profit Net Pft (Pre Ex.) EPS (sen) EPS Pre Ex. (sen) EPS Gth (%) 108 (16) EPS Gth Pre Ex (%) 108 (16) Diluted EPS (sen) Net DPS (sen) BV Per Share (sen) PE (X) PE Pre Ex. (X) P/Cash Flow (X) EV/EBITDA (X) Net Div Yield (%) P/Book Value (X) Net Debt/Equity (X) ROAE (%) Consensus EPS (sen): Other Broker Recs: B: 2 S: 0 H: 0 ICB Industry : Consumer Goods ICB Sector: Food Producers Principal Business: TSC is one of the largest egg producer in Malaysia with a daily output of 3.3m eggs. Moreover, one-third of its production is exported to Singapore. The group is also involved in the trading of pet food, medicine and other related products. Source of all data: Company, AllianceDBS, Bloomberg Finance L.P Good long-term prospects Aggressive growth strategies; capacity expansion, diversification into other streams and cost-saving initiatives Improved earnings visibility with 2-year CAGR of 18% in FY15-17F RM1.50 TP is pegged to 10x FY16F EPS The Business Modern poultry farmer. (TSC) is one of the largest egg producers in Malaysia with a daily output of 3.3m eggs. Moreover, onethird of its production is exported to Singapore. The group is also involved in the manufacture and marketing of paper egg trays and animal feeds, along with the distribution of animal health products. Aggressive growth strategies. TSC is a vertically-integrated layer farming player with a current market share of 6% in Malaysia and 16% in Singapore. TSC targets to steadily grow its market share to 9.6% in Malaysia and 28% in Singapore by We forecast earnings to grow in line with TSC s targeted expanding market share, supported by 1) expansion in daily production capacity; TSC plans to increase its daily production volume by +700,000 p.a. in Singapore and +1.3m p.a. in Malaysia; both by 2019, 2) vertical and upstream diversification 3) costsaving initiatives, and 4) superior operating margin compared to its peers. Its continued growth is also supported by management s projected annual commercial egg consumption CAGR of 4.2% until Although TSC targets to grow at a faster rate in comparison to total population egg consumption, management believes it will be able to market its targeted growth in capacity due to its relatively small size compared to bigger domestic players. Stable industry outlook. Although there are fluctuations in the demand of eggs and ASP, we believe TSC s outlook is still stable, as eggs are deemed inelastic goods as they are a consumer staple and small-ticket item in household spending. The Stock Fair value of RM1.50. Our fair value is based on 10 x fully-diluted FY16F EPS, which is the industry s average (excluding QL and Lay Hong). We have excluded QL and Lay Hong due to their larger market cap and higher institutional shareholding. The stock is currently trading at 7.5x FY16F PE. Although it is above its historical mean PE, we deem it undemanding given our expectation of a strong 2-year EPS CAGR of 18% FY15-17F. The stock is also trading at PEG of c.0.4x. Strong fundamentals. Aside from its strong EPS CAGR, we also like the company for its positive cashflow despite its aggressive expansion (FY15 free CFPS: 6.32 sen), superior net margins (>10%) and high ROAE (>23%). At A Glance Issued Capital (m shrs) Mkt. Cap (RMm/US$m) 374.7/ 91.7 Major Shareholders (%) Emerging Glory Sdn Bhd 52.1 Koperasi Permodalan Felda 5.0 Free Float (%) 42.9 Avg. Daily Vol. ( 000) Refer to important disclosures at the end of this report ed: CK/ sa: BC

2 REVENUE DRIVERS Sensitivity to movement m of egg price. Layer farming contributes c.63% of total revenue in FY15 (see Exhibit 1). As such, TSC s earnings are highly exposed to the ASP fluctuations that depend on the supply-demand dynamics of eggs. FY15 net earnings came in at RM41m (-16% y-o-y) due to lower egg ASP and higher raw material costs. Although TSC is subject to ASP fluctuations, we believe that its outlook remains positive, supported by management s forecast of stable growth in egg consumption CAGR of 4.2% until This is in line with TSC s plans to expand its daily egg production to 5m by FY19 (FY15: 3.3m). Egg ASP had a sharp decline in 2Q15 at 26 sen from 1Q15 at 34 sen, as a result of seasonally low demand from the absence of festivities and the commencement of fasting month in June/July and to some extent, the impact of GST on overall consumer sentiment. While egg ASP had rebounded slightly to 29 sen as at end-4q15, it is comparatively lower by 21% y-o-y from 4Q14 at 35 sen. However, management believes this will improve to 30 sen in FY16F due to slight improvement in the consumer sentiment. Furthermore, we believe TSC s outlook to remain stable are a consumer staple and small-ticket item in household spending. See Exhibit 2. Exhibit 1 : Revenue weightage by business segment % 100% 80% 63% 63% 64% 65% 60% 37% 37% 36% 40% 35% 20% 0% FY14 FY15 FY16F FY17F Investment Trading Layer Farming Exhibit 2 : Historical average commercial egg ASP TSC. Given TSC s relationship with LH, it usually gets the first pick of these top breeds for its Day-Old-Chick (DOC) purchases. This helps ensure the quality of TSC s eggs production. Diversification into other segments. Aside from layer farming, TSC is also involved in the trading and distribution of a wide range of imported pet food, medicine and other animal health-related products. This makes up c.37% of total revenue. TSC has a competitive advantage in this segment, as it is the sole agent for Bayer Group to distribute the latter s animal health products in Malaysia, Singapore and Brunei. Additionally, TSC is the sole distributor for Vetpharm Laboratories (S) Pte Ltd s animal antibiotics and supplements in Malaysia. Moreover, TSC has expanded upstream into the manufacturing and marketing of paper egg trays, and the production of animal feed, to complement its layer farming division. Its two paper egg tray machines produce 126,000 egg trays daily or 45m pcs p.a. This is sufficient to meet 90% of its internal requirements and the remaining 10% of its egg tray production is sold to external customers. Cost Structure Economies of scale from LH tie-up. TSC benefits from economies of scale as it purchases its raw materials on a group basis with LH. Collectively, LH purchases c.2m tonnes of raw materials p.a. and management has stated that LH proactively hedges its USDdenominated purchases of its raw materials, namely soybean and corn. Its forward purchase of soybean is now up to six months while corn is at four months. The weakening of the ringgit last year had negatively affected TSC s margins, as majority of its raw materials, namely corn and soybean purchases are contracted in USD. Although net margins in FY14 increased to 13% owing to cost improvement measures, net margins in FY15 dropped to 10% due to the depreciation in ringgit. Moving forward, we expect margins to steadily improve to 11% due to TSC s further cost-management initiatives, which can offset the impact of a weaker ringgit, fluctuating egg ASP and the group s expansion plan. See Exhibit 3. Exhibit 3 : Margin trend % 20% 18% 15% 13% 15% 15% 10% 10% 10% 13% 10% 11% 11% 5% 6% 7% Source: Company 0% FY12 FY13 FY14 FY15 FY16F FY17F Gross Margin Net Margin First pick of top layer breed. According to DVS data, the Hisex Brown is a popular breed in Malaysia in 2013/2014 with a market share of 39%/28%. Leong Hup (LH) is the dominant breeder of Hisex Brown. LH and Nam Family collectively have a 53% stake in Page 2

3 Cost-management initiatives. TSC has carried out several initiatives to improve its cost structure. This includes the replacement of liquefied petroleum gas with natural gas in its egg tray production to reduce its energy costs by 75% or RM2m p.a. Moreover, TSC plans to construct five biogas facilities at its farms to convert raw chicken manure to electricity. The electricity generated will also be used to dry its paper egg trays. The first plant is targeted to be operational from mid-fy16 and once in operation, TSC may save up to RM2m p.a. on its electricity expenses. These cost management initiatives is expected to help stabilize net margins at 11% and mitigate the increase in costs from the capacity expansion. Capex for expansion plan. TSC is allocating c.rm183m capex for its expansion plan over that covers building two layer farms and renovating its existing farms. The group targets to achieve a daily egg production of 5m by end-2019 (see Exhibit 4). Moreover, the group is also allocating RM6.7m p.a. to the construction of five biogas plant-ups. Aside from the expansion plans, the group has a small capex amount of c.rm20m earmarked for the maintenance of farms and machineries. Exhibit 4 : Targeted daily production Growth Prospects Aggressive earnings growth. We forecast TSC s earnings to grow at a 2-year CAGR of 20% over FY15-FY17F (see Exhibit 5), supported by 1) expansion in production capacity; TSC plans to increase its daily production volume by +700,000 p.a. in Singapore and +1.3m p.a. in Malaysia; both by 2019 from the current production volume of c.990,000 in Singapore and c.2.3m in Malaysia, 2) vertical diversification, 3) cost- saving initiatives, and 4) superior operating margin compared to its peers. (See Exhibit 6). Its continued growth is also supported by management s projected commercial egg consumption CAGR of 4.2% in Malaysia and 6% in Singapore until 2019, amid population CAGR of 1.2%. Although TSC targets to grow at a faster rate than industry demand growth, management believes it will be able to market its targeted growth in capacity due to its relatively small size compared to bigger domestic players. Based on TSC s current Malaysian market share of 6.2% at 3.3m daily production volume, total daily production in Malaysia is estimated at 53.2m. At projected 4.2% demand growth per annum, absolute demand is expected to increase by 2.2m eggs per day. By 2019, absolute demand is expected to grow by 8.8m per day as compared to current demand. At projected capacity expansion of 2m eggs per day by 2019, TSC is implied to target capturing 23% share of incremental demand over 4 years. Besides topline growth, we expect margins to improve slightly despite the low expected blended ASP at 30 sen, compared to 31 sen in FY14, due to softer commodity prices (soybean and corn) and the addition of biogas plants to lower operating costs. Exhibit 5: Earnings trend Source: Company RM'm Key Operating Assets Farms and production capacity. TSC operates 25 farms in total, and these are categorised into brooding, pullet and layer farms (two brooding, seven pullets and 16 layers). Purchased DOCs are placed in brooding farms for five weeks. The chicks are then moved to a pullet farm until they reach 16 weeks old. When the layers reach 17 weeks old, they are moved to their laying units where they will remain until they reach 85 weeks old when the spent hens are then sold. The existing capacity of the layer farms are 4.2m birds, laying approximately 3.3m eggs daily. Currently, eight of its layer farms are accredited and granted export licences by the Agri-Food and Veterinary Authority of Singapore (AVA) FY14 FY15 FY16F FY17F Exhibit 6: Peer Margins Comparison FY15 Gross Ma rgin Net Profit Ope ra ting Ma rgin Ne t Ma rgin QL Resources 17% 9% 7% Lay Hong 11% 5% 2% Teo Seng 32% 13% 10% Huat Lai 18% 5% 3% CAB Cakaran 8% 4% 2% LTKM 29% 23% 23% Source: Bloomberg Finance L.P., AllianceDBS Page 3

4 Leading layer farmer. TSC is the third largest egg producer in Malaysia, with a daily egg production of 3.3m and market share of c.6.2% in Malaysia. In the mid to long term, TSC targets to increase its daily egg supply domestically by +1.3m eggs p.a. and is aiming to grow its market share by 3.4ppts to 9.6%. Growing the export e segment. TSC is among the top Malaysian egg exporters to Singapore with a market share of c.16%. The group currently exports about c.30% of its total egg production, which is a large increase compared to only 10% of total egg production three years ago. In the mid to long term, TSC targets to increase its daily egg supply to Singapore by +700,000 eggs p.a. and is aiming to grow its market share by 12ppts to 28%. Penetration into niche segment. TSC is also focusing on expanding its animal health product segment which contributes c.13% of total revenue in FY15. Management targets a 2-year revenue CAGR of 15% from FY15-FY17F. Aside from being the sole distributor for Bayer Group and Vetpharm Laboratories (S) Pte Ltd, TSC also distributes other high-quality and branded products such as Elanco, Innovad and O. Corporation (Korea). Management and Strategy Strong regional back-up. TSC has a strong management track record and parentage, backed by regional poultry giant LH. It is 52.1% owned by LH and Nam family, who are still actively managing the business since the group was established in TSC s revenue and net profit have grown from RM168m/RM15m in FY10 to RM413m/RM41m in FY15. This represents a 5-year CAGR of 20%/22% in revenue/earnings from FY10 to FY15. As part of LH, TSC has the first pick of the top layer breeds, which ensures the quality of its eggs. It also enjoys bulk discounts for its raw materials, as these are purchased by LH at the group level. Two-pronged growth strategy. Management has adopted a dualengine growth strategy that focuses on growing the layer farming capacity and the investment trading segment regionally. TSC plans to expand its market share in Malaysia and Singapore from the existing 16%/6% to 28%/9.6% by Additionally, TSC also plans to grow its investment trading segment, namely animal health products, at the same pace as its layer farming segment. Monetising ing waste with fertilisers ers. TSC plans to recycle its waste and maximise its profit, as chicken manure production is expected to increase in tandem with the growing farm capacity. The group has developed organic pure fertiliser which it sells to farmers. Management has forecast the revenue contribution from this area to reach approximately RM9m by FY2019 (FY15-17F CAGR of 3.6%). Page 4

5 Key Assumptions FY Dec 2012A 2013A 2014A 2015A 2016F 2017F Number of Livestock (m) Daily Production (m) Estimated Blended ASP (RM) Segmental Breakdown FY Dec 2012A 2013A 2014A 2015A 2016F 2017F Revenues (RMm) Poultry Farming Investment Trading Others Total Operating profit (RMm) Poultry Farming Investment Trading (0.2) Others Total Operating profit Margins Poultry Farming Investment Trading (0.3) Others N/A N/A N/A N/A Total Sensitivity Analysis Daily Production +/- 1% Blended ASP +/- 1% FY16 Operating Profit +/- 0.8% Operating Profit +/- 0.8% Income Statement (RMm) FY Dec 2012A 2013A 2014A 2015A 2016F 2017F Revenue Cost of Goods Sold (179) (226) (231) (280) (318) (366) Gross Profit Other Opng (Exp)/Inc (60.2) (70.9) (80.5) (77.6) (81.8) (93.6) Operating Profit Other Non Opg (Exp)/Inc Associates & JV Inc Net Interest (Exp)/Inc (3.2) (4.0) (3.6) (4.5) (6.2) (6.2) Exceptional Gain/(Loss) Pre-tax Profit Tax (7.4) (6.6) (17.6) (9.6) (11.7) (13.7) Minority Interest (0.2) (0.1) Preference Dividend Net Profit Net Profit before Except EBITDA Growth Revenue Gth (%) EBITDA Gth (%) (15.9) Opg Profit Gth (%) (4.4) (21.1) Net Profit Gth (Pre-ex) (%) (21.9) (15.7) Margins & Ratio Gross Margins (%) Opg Profit Margin (%) Net Profit Margin (%) ROAE (%) ROA (%) ROCE (%) Div Payout Ratio (%) Net Interest Cover (x) Margins Trend 20.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 2013A 2014A 2015A 2016F 2017F Operating Margin % Net Income Margin % Net margins expected to remain resilient at c.11% Page 5

6 Quarterly / Interim Income Statement (RMm) FY Dec 3Q2014 4Q2014 1Q2015 2Q Q2015 4Q2015 Revenue Cost of Goods Sold (86.6) (86.6) (88.1) (83.5) (92.8) (100) Gross Profit Other Oper. (Exp)/Inc Operating Profit Other Non Opg (Exp)/Inc Associates & JV Inc Net Interest (Exp)/Inc (0.9) (0.9) (0.9) (1.0) (1.3) (1.3) Exceptional Gain/(Loss) Pre-tax Profit Tax (4.1) (4.1) (6.2) (1.5) (0.1) (1.7) Minority Interest (0.1) Net Profit Net profit bef Except EBITDA Revenue Trend Q2013 4Q2013 1Q2014 2Q2014 Revenue 3Q2014 4Q2014 1Q2015 2Q2015 3Q2015 Revenue Growth % (QoQ) 4Q % 15% 10% 5% 0% -5% -10% -15% -20% -25% Growth Revenue Gth (%) (19.5) EBITDA Gth (%) (53.6) 28.7 (33.4) Opg Profit Gth (%) (60.6) 37.1 (45.1) Net Profit Gth (%) (2.7) (58.4) 64.7 (64.4) Margins Gross Margins (%) Opg Profit Margins (%) Net Profit Margins (%) Net margins affected by lower egg ASP Balance Sheet (RMm) FY Dec 2012A 2013A 2014A 2015A 2016F 2017F Asset Breakdown (2015) Net Fixed Assets Invts in Associates & JVs Other LT Assets Cash & ST Invts Inventory Debtors Other Current Assets Total Assets ST Debt Creditor Other Current Liab LT Debt Other LT Liabilities Shareholder s Equity Minority Interests 0.17 (0.1) Total Cap. & Liab Non-Cash Wkg. Capital Net Cash/(Debt) (45.1) (50.0) (38.1) (85.5) (86.7) (60.5) Debtors Turn (avg days) Creditors Turn (avg days) Inventory Turn (avg days) Asset Turnover (x) Current Ratio (x) Quick Ratio (x) Net Debt/Equity (X) Net Debt/Equity ex MI (X) Capex to Debt (%) Page 6

7 Cash Flow Statement (RMm) FY Dec 2012A 2013A 2014A 2015A 2016F 2017F Pre-Tax Profit Dep. & Amort Tax Paid (7.4) (6.6) (17.6) (9.6) (11.7) (13.7) Assoc. & JV Inc/(loss) Chg in Wkg.Cap. (6.4) 0.09 (4.2) (4.2) 2.52 (10.6) Other Operating CF Net Operating CF Capital Exp.(net) (16.3) (17.5) (23.2) (31.7) (56.4) (26.0) Other Invts.(net) Invts in Assoc. & JV (24.1) Div from Assoc & JV Other Investing CF Net Investing CF (15.7) (15.5) (22.1) (55.0) (56.4) (26.0) Div Paid (3.5) (5.0) (20.0) (10.5) (15.0) (17.6) Chg in Gross Debt (8.0) Capital Issues Other Financing CF (7.5) (5.0) (8.9) (38.1) Net Financing CF (5.1) (4.0) (36.9) 9.28 (15.0) (17.6) Currency Adjustments (0.2) Chg in Cash (0.8) 14.5 (2.9) 4.41 (1.2) 27.2 Opg CFPS (sen) Free CFPS (sen) Capital Expenditure RM A 2014A 2015A 2016F 2017F Capital Expenditure (-) Valuations Fair value of RM1.50. Our fair value is based on 10x fully-diluted FY16F EPS, which is the industry s average (excluding QL and Lay Hong). We have excluded QL and Lay Hong due to their larger market cap and higher institutional shareholding. The stock is currently trading at 7.5x FY16F PE. Although it is above its historical mean PE, we deem it undemanding given our expectation of a strong 2-year EPS CAGR of 18% FY15-17F. The stock is also trading at PEG of c.0.4x. TSC declared dividend of RM10.5m in FY15, implying a payout of 26% with yield of 3%.Management has guided that it plans to keep its dividend policy at 25%-30% payout. Risk Assessment: Moderate Category Risk Rating Wgt Wgtd Score 1 (Low) - 3 (High) Earnings 2 40% 0.8 Financials 1 20% 0.2 Shareholdings 1 40% 0.4 Overall 1.4 Expect steady earnings growth and strong balance sheet. Its sales volatility is low, given the defensive nature of food products. The main source of earnings volatility stems from the volatile ASP of eggs. Its balance sheet is expected to remain strong with positive cashflow, despite its aggressive expansion plans (FY15 free CFPS: 6.32 sen). Management s interest aligned with shareholders. Most key executives in TSC are paid less than RM50,000 annually, with the exception of some directors who were paid RM500,000 in FY14. LH and Nam family (key management and founders) collectively own a 52.1% stake in TSC through Emerging Glory Sdn Bhd. As such, management s interest seems to be aligned with the shareholders, in our view. Page 7

8 Exhibit 7: Forward PE Band (x) Exhibit 8: PB Band (x) (x) sd: 12.8x (x) sd: 3.29x sd: 9.6x Avg: 6.4x sd: 2.47x Avg: 1.65x sd: 3.2x sd: 0.82x 0.0 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Sources: AllianceDBS, Bloomberg Finance L.P 0.0 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Sources: AllianceDBS, Bloomberg Finance L.P Exhibit 9: Peer comparison (as at 16 Mar 2016) EPS (FD) Growth (YoY) P/E (FD) Price/ BVPS Dividend Yield ROE Call Target Price (LC) Current Price (LC) Mkt Cap (MYR m) CY2015 CY2016 CY2015 CY2016 CY2015 CY2016 CY2015 CY2016 CY2015 CY2016 QL Resources HOLD , % 9% 27.1x 24.8x 3.5x 3.2x 1.1% 1.2% 14% 14% Lay Hong % N/A 16.9x 24.3x 3.0x N/A N/A N/A 13% N/A % 19% 10.0x 8.4x 1.9x 1.7x 3% 4% 23% 24% Huat Lai Resources % N/A 9.1x 8.9x 1.1x N/A N/A N/A 21% N/A CAB Cakaran Corp % 124% 14.9x 15.2x 0.8x 1.3x N/A N/A 10% 10% LTKM % N/A 5.7x 5.9x 0.9x N/A N/A N/A 19% N/A PWF Consolidated % N/A 13.5x 14.2x 0.4x N/A N/A N/A 4% N/A Total / weighted avg 7, % 12% 23.4x 22.2x 3.1x 2.6x 1.0% 1.1% 14% 12% Without QL & Lay Hong Sources: AllianceDBS, Bloomberg Finance L.P 1, % 31% 10.3x 9.9x 1.2x 1.1x 0.9% 1.2% 18% 9% Page 8

9 DISCLOSURE Stock rating definitions STRONG BUY - > 20% total return over the next 3 months, with identifiable share price catalysts within this time frame BUY - > 15% total return over the next 12 months for small caps, >10% for large caps HOLD - -10% to +15% total return over the next 12 months for small caps, -10% to +10% for large caps FULLY VALUED - negative total return > -10% over the next 12 months SELL - negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame Commonly used abbreviations Adex = advertising expenditure EPS = earnings per share PBT = profit before tax bn = billion EV = enterprise value P/B = price / book ratio BV = book value FCF = free cash flow P/E = price / earnings ratio CF = cash flow FV = fair value PEG = P/E ratio to growth ratio CAGR = compounded annual growth rate FY = financial year q-o-q = quarter-on-quarter Capex = capital expenditure m = million RM = Ringgit CY = calendar year M-o-m = month-on-month ROA = return on assets Div yld = dividend yield NAV = net assets value ROE = return on equity DCF = discounted cash flow NM = not meaningful TP = target price DDM = dividend discount model NTA = net tangible assets trn = trillion DPS = dividend per share NR = not rated WACC = weighted average cost of capital EBIT = earnings before interest & tax p.a. = per annum y-o-y = year-on-year EBITDA = EBIT before depreciation and amortisation PAT = profit after tax YTD = year-to-date Page 9

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