Malaysia Company Focus Bloomberg: GUAN MK Reuters: GNCH.KL DBS Group Research. Equity 19 Aug 2011 BUY RM2.63 KLCI : 1,503.30 Price Target : 12-Month RM 3.60 Reason for Report : Company update Potential Catalyst: Higher cocoa powder prices and better margins DBSV vs Consensus: DBSV is one of the two brokers covering this company; hence no consensus comparison Analyst KOK Chiew Sia +603-2711 2222 chiewsia@hwangdbsvickers.com.my Price Relative 3.30 2.80 2.30 1.80 1.30 0.80 0.30 RM Relative Index 2007 2008 2009 2010 2011 (LHS) Relative KLCI INDEX (RHS) Forecasts and Valuation FY Dec (RM m) 2010A 2011F 2012F 2013F Revenue 1,169 1,508 1,912 2,175 EBITDA 124 172 214 234 Pre-tax Profit 112 153 190 212 Net Profit 100 119 135 150 Net Pft (Pre Ex.) 100 119 135 150 EPS (sen) 31.3 37.2 42.3 46.9 EPS Pre Ex. (sen) 31.3 37.2 42.3 46.9 EPS Gth (%) 601 19 14 11 EPS Gth Pre Ex (%) 601 19 14 11 Diluted EPS (sen) 31.3 31.3 35.6 39.5 Net DPS (sen) 5.7 11.1 12.7 14.1 BV Per Share (sen) 56.8 82.9 112.5 145.3 PE (X) 8.4 7.1 6.2 5.6 FD PE Pre Ex. (X) 8.4 8.2 7.3 6.5 P/Cash Flow (X) 9.1 6.9 7.2 7.2 EV/EBITDA (X) 8.4 6.1 5.0 4.4 Net Div Yield (%) 2.2 4.2 4.8 5.3 P/Book Value (X) 4.6 3.2 2.3 1.8 Net Debt/Equity (X) 1.0 0.7 0.5 0.3 ROAE (%) 69.7 53.2 43.3 36.4 Earnings Rev (%): 0.0 0.0 0.0 Consensus EPS (sen): 37.0 42.0 47.0 Other Broker Recs: B: 1 S: 0 H: 1 ICB Industry : Consumer Goods ICB Sector: Food Producers Principal Business: Manufactures and sells cocoa ingredients; cocoa butter, cake, liquor and powder. Source of all data: Company, DBS Vickers, Bloomberg 447 397 347 297 247 197 147 97 47 Expansion on course Capacity expansion on track to meet growing demand for cocoa ingredients Margins could improve with larger mix of cocoa powder sales and direct sales to end-users Maintain BUY call and RM3.60 TP (+37% upside) Demand intact. Despite a fragile global economy, demand for cocoa ingredients especially cocoa powder from customers in Asia remains intact. Reflecting its confidence, (GC) is ramping up annual production capacity by 60k MT to 200k by 2Q12, which would propel the Group to the top 5 largest cocoa processors in the world. Possible margin expansion. EBITDA margins rose to 13.3% in 1Q11 and 12.9% in 2Q11, from FY10 s 10.9%, mainly due to positive operating leverage and higher selling prices for cocoa powder. Going forward, there is still room for improvement, from: (a) larger mix of cocoa powder sales as GC starts cocoa powder production in 1Q12 in Batam (it makes only cocoa cake now). In 1H11, cocoa powder (from Pasir Gudang) contributed c.24% of total revenue of RM625m; and (b) more direct sales to major global chocolate manufacturers, who are showing increasing interest to buy cocoa ingredients directly from GC (given its growing size) to diversify their supply risks. Maintain Buy rating for this undervalued stock (RM3.60 TP based on 10x FY12F FD EPS). It is trading at 7.4x FY12F FD EPS vs its closest listed peer Petra Food s 13.8x (PETRA SP; Hold). No change to our forecast net profit, which offer 3- year CAGR of 14.5%. Share price downside is also supported by 30% dividend payout (implying 4.8% net yield in FY12F and low foreign shareholdings of <3%). Potential earnings risks are a global economic downturn (which could force customers to defer deliveries as demand falls, like in 2008/09) and disruption to cocoa bean supply. At A Glance Issued Capital (m shrs) 320 Mkt. Cap (RMm/US$m) 844 / 281 Major Shareholders Resources Sdn 52.0 Misi Galakan Sdn Bhd (%) 9.6 LTAT (%) 8.3 Free Float (%) 30.1 Avg. Daily Vol.( 000) 225 In Singapore, this research report or research analyses may only be distributed to Institutional Investors, Expert Investors or Accredited Investors as defined in the Securities and Futures Act, Chapter 289 of Singapore. Recipients of this report, received from DBS Vickers Research (Singapore) Pte Ltd ( DBSVR ), are to contact DBSVR at +65 6398 7954 in respect of any matters arising from or in connection with this report. www.dbsvickers.com Refer to important disclosures at the end of this report ed: SGC / sa: WMT
Highlights Post-result update. GC held an analyst briefing early this week to provide an update on its operations in 2Q11. During the quarter, it processed 32.1k MT of cocoa beans (up 21.6% qoq), comprising 19.1k in Pasir Gudang and 13k in Batam, into cocoa butter and cocoa solid (powder and cake). This takes 1H11 cocoa bean output to 58.5k MT (versus 39.3k MT in 1H10). In terms of revenue mix, cocoa butter contributed 41% and cocoa solid 56%, and the balance cocoa liquor. The larger cocoa solid contribution was due to better cocoa cake sales (31.5% share vs 24% in 1Q11), lifted mainly by its Batam plant (which produces only cocoa cake currently). Cocoa powder revenue mix was stable at 24% in 2Q11. EBITDA margin was stable qoq at 12.9% in 2Q11 (vs 1Q11: 13.3%, 2Q10: 10.3%), on the back of positive operating leverage and higher average selling prices for cocoa powder. Demand outlook remains positive. Despite the prevailing fragile global economy, we understand GC has not seen any visible slowdown in demand for cocoa ingredients. The Group s expanded capacity is fully absorbed by existing orders for this year. As GC continues to sell 6-9 months forward, it has sold 30-40% of next year s capacity year-todate. By geographical region, almost all its cocoa butter is sold to the US and Europe, while sales of cocoa cake/powder products are scattered across the world, with growing exposure in Asia. This has lent confidence to management to proceed with its expansion plan. GC will be spending RM60-70m (bringing total investment cost to c.rm150m) to add 60k MT in production capacity in Batam, raising its annual capacity there to 120k MT by 2Q12. mainly due to GC s decision to move its stocks faster (at the expense of lower margins) in response to the deteriorating economic condition; and (c) net profit fell by half to RM6.8m in FY08 from RM14.2m the previous year. Our sensitivity analysis shows that each 1% drop in cocoa beans sales volume would reduce our FY12F net profit by 1.1%. Potential margin improvement. This could come from two sources: (a) Larger sales mix of cocoa powder. GC plans to produce cocoa powder in Batam starting 1Q12. The plant, which now only produces cocoa cake, will be installed with additional facilities (including drop stations, silo, alkali solutions system, Anco cookers, blender and mills) in end-2011/early-2012 to grind cocoa powder. This downstream venture into higher value-added products a natural progression in cocoa production will boost contribution from cocoa powder. In 1H11, cocoa powder (from its Pasir Gudang plant in Malaysia) accounted for 24% of Group revenue of RM625m (vs butter: 44%; cake: 28%; and liquor: 4%). Demand for higher-priced cocoa powder is also more resilient (than cocoa butter), underpinned by wider applications for flavourings and coatings in the food and beverage industry. The selling price of cocoa powder is currently about US$5,500/mt (37% higher than 2010 average of US$4,000; 10% higher than US$5,000 in May11). Figure 1: Powder price and Butter ratio are moving in opposite directions US$/MT 6,000 Ratio (x) 3.00 Global economic recession risk. The possibility of the world economy slipping into a double-dip recession remains relatively remote at this juncture, but as a major global exporter of cocoa ingredients, GC will inevitably be affected by an abrupt disruption to economic activity. This could lead to lower demand for its products as its customers may be forced to delay deliveries and/or cancel orders. Like during the financial crisis in 2008/2009, when GC saw its: (a) sales volume plunge to 59.9k MT in FY09 (from 71.7k in FY08) as some customers delayed shipments to FY10; (b) EBITDA margin squeezed to 3.7% in 2008 (from 6.5% in 2007) 5,000 4,000 3,000 2,000 1,000-2005 2006 2007 2008 2009 2010 2011F 2012F 2013F Cocoa powder/cake (LHS) Butter Ratio (RHS) Source: Company, DBS Vickers 2.50 2.00 1.50 1.00 0.50 - Page 2
(b) Growing direct sales to end users. Traditionally, GC sells its cocoa ingredients to major chocolate manufacturers like MARS, Hershey s, Lotte, Cocoaland, London Biscuit, and Apollo, mostly through international traders. But as GC grows (to be among the top 5 largest in the world based on projected annual capacity of 200k MT by 2Q12), we gather a few key customers are negotiating to source directly from GC going forward. This is a positive development, as direct orders from big players will provide clearer demand visibility and possibly better margins. We have assumed 165.5k MT output for FY12F (c.95% of effective grinding capacity at 175k MT). Our EBITDA margin assumptions are 11.4% for FY11F, 11.2% for FY12F and 10.8% for FY13F (versus FY10: 10.6%). Tax implications. After exhausting its final RM115m export tax incentive allowance at end 2Q11 which had resulted in low effective tax rates of 10.3% in FY10 and 11.5% in 1H11 GC could see higher tax expenses ahead. We assumed effective tax rates of 19% for FY11F and 25% for each of FY12F and FY13F. For more efficient tax planning, GC s Singaporeincorporated fully-owned subsidiary GCB Cocoa Singapore Pte Ltd, which enjoys 10% corporate tax rate for five years under the Global Trader Programme will be its main procurement and sales/trading centre to support its plants in Malaysia and Indonesia. This could lower the Group s effective tax rates going forward. Valuation Maintain Buy. We are retaining our FY11-13F net profits, which imply 3-year CAGR of 14.5% to RM150.2m in FY13F. Its current PE valuation is undemanding at 7.4x FY12F FD EPS vs Petra Food s 13.8x (PETRA SP, Hold, S$1.74 TP). Our target price also remains at RM3.60 (based on fair valuation of 10x FY12F FD EPS). We like GC as an emerging global manufacturer of cocoa ingredients with attractive valuation and steady earnings growth potential. Figure 2: Peer valuation Company FYE Price Mkt Cap PE Div Yield (%) CAGR Net gearing ROE FY10-12F (%) (%) (local) (US$m) FY10A FY11F FY12F FY13F FY11F FY12F Archer-Daniels-Midland Jun 28.33 18,071 9.4 8.7 8.3 7.5 2.2 2.3 6.2 54.8 13.1 Barry Callebaut AG Aug 752.50 4,898 15.5 14.2 13.2 11.8 2.0 2.2 8.0 66.8 19.3 Petra Foods Ltd Dec 1.80 910 20.5 15.1 13.8 11.1 2.6 2.8 21.9 172.5 15.1 Dec 2.63 335 9.9 8.4 7.4 6.7 4.2 4.8 15.5 104.0 54.2 Average ex GC 12.7 11.8 10.1 Source: Bloomberg, DBS Vickers Figure 3: Peer comparison Company Revenue (US$m) Pretax margin (%) Net profit (US$m) FY10A FY11F FY12F FY13F FY10A FY11F FY12F FY13F FY10A FY11F FY12F FY13F Archer-Daniels-Midland 61,682 84,661 86,295 92,468 4.2 3.4 3.5 3.6 1,919 2,083 2,165 2,408 Barry Callebaut AG 6,564 6,691 6,662 7,145 5.5 6.0 6.4 6.9 317 346 370 416 Petra Foods Ltd 1,566 1,836 2,016 2,094 3.7 4.3 4.3 5.3 44 60 66 82 392 506 641 729 9.5 10.1 10.0 9.8 34 40 45 50 Source: Bloomberg, DBS Vickers Page 3
Key Assumptions Cocoa bean price 2,616.5 3,089.8 3,357.1 3,524.9 3,701.2 Production capacity 75,000.0 80,000.0 130,000.0 175,000.0 200,000.0 Sales tonnage 59,851.0 79,243.0 118,100.0 149,695.0 164,380.0 Butter price 4,780.2 6,571.7 5,539.2 5,594.6 5,650.5 Powder price 2,161.2 3,887.1 4,237.0 4,618.3 4,987.8 Sensitivity Analysis 2012 Production +/- 1% Net Profit +/- 1.1% Segmental Breakdown Revenues (RM m) Cocoa Butter 375 628 713 874 960 Cocoa Cake/ Powder 242 499 754 997 1,171 Others 26 42 41 42 44 Total 643 1,169 1,508 1,912 2,175 Income Statement (RM m) Revenue 643 1,169 1,508 1,912 2,175 Cost of Goods Sold (608) (1,052) (1,343) (1,704) (1,942) Gross Profit 35 117 165 208 233 Other Opng (Exp)/Inc (9) 0 (7) (12) (16) Operating Profit 27 117 158 196 217 Other Non Opg (Exp)/Inc 0 0 0 0 0 Associates & JV Inc 0 0 0 0 0 Net Interest (Exp)/Inc (6) (5) (5) (6) (4) Exceptional Gain/(Loss) 0 0 0 0 0 Pre-tax Profit 21 112 153 190 212 Tax (6) (11) (29) (48) (53) Minority Interest (1) 0 (5) (7) (9) Preference Dividend 0 0 0 0 0 Net Profit 14 100 119 135 150 Net Profit before Except. 14 100 119 135 150 EBITDA 34 124 172 214 234 Growth Revenue Gth (%) (7.4) 81.8 29.0 26.8 13.7 EBITDA Gth (%) 33.4 264.6 38.2 24.5 9.7 Opg Profit Gth (%) 45.8 339.8 35.7 23.9 10.6 Net Profit Gth (%) 110.5 601.1 18.9 13.8 11.0 Margins & Ratio Gross Margins (%) 5.5 10.0 10.9 10.9 10.7 Opg Profit Margin (%) 4.1 10.0 10.5 10.3 10.0 Net Profit Margin (%) 2.2 8.6 7.9 7.1 6.9 ROAE (%) 14.1 69.7 53.2 43.3 36.4 ROA (%) 3.8 22.7 21.0 18.2 17.2 ROCE (%) 5.9 27.7 28.0 26.2 25.0 Div Payout Ratio (%) 46.3 18.3 30.0 30.0 30.0 Net Interest Cover (x) 4.6 23.2 30.0 34.8 48.5 Source: Company, DBS Vickers Margins Trend 12.0% 11.0% 10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% Cocoa Cake/Powder sales contribution is expected to exceed Cocoa Butter s, as we expect Powder ASP to trend up. 2009A 2010A 2011F 2012F 2013F Operating Margin % Net Income Margin % Margins are expected to be resilient, benefiting from higher ASP and economies of scale. Page 4
Quarterly / Interim Income Statement (RM m) FY Dec 2Q2010 3Q2010 4Q2010 1Q2011 2Q2011 Revenue 271 297 332 290 335 Cost of Goods Sold 0 0 0 0 0 Gross Profit 0 0 0 0 0 Other Oper. (Exp)/Inc (244) (268) (299) (255) (293) Operating Profit 26 28 33 35 41 Other Non Opg (Exp)/Inc 0 0 0 0 0 Associates & JV Inc 0 0 0 0 0 Net Interest (Exp)/Inc (1) (1) (1) (1) (1) Exceptional Gain/(Loss) 0 0 0 0 0 Pre-tax Profit 25 27 32 34 40 Tax (6) (9) 11 (4) (5) Minority Interest 0 0 0 0 (1) Net Profit 20 18 43 30 34 Net profit bef Except. 20 18 43 30 34 EBITDA 26 28 33 42 45 Growth Revenue Gth (%) 0.7 9.5 12.1 (12.7) 15.4 EBITDA Gth (%) (8.3) 7.1 18.5 26.0 7.5 Opg Profit Gth (%) (8.3) 7.1 18.5 4.7 18.3 Net Profit Gth (%) (1.1) (8.4) 140.1 (29.9) 14.5 Margins Gross Margins (%) 100.0 100.0 100.0 100.0 100.0 Opg Profit Margins (%) 9.7 9.5 10.0 12.1 12.4 Net Profit Margins (%) 7.2 6.0 12.9 10.4 10.3 Source: Company, DBS Vickers Revenue Trend 400 350 300 250 200 150 100 50 0 1Q2009 2Q2009 3Q2009 4Q2009 1Q2010 2Q2010 3Q2010 4Q2010 1Q2011 2Q2011 Revenue Revenue Growth % (QoQ) 40% 30% 20% 10% 0% -10% -20% Page 5
Balance Sheet (RM m) Net Fixed Assets 103 145 202 254 252 Invts in Associates & JVs 0 0 0 0 0 Other LT Assets 9 8 8 8 8 Cash & ST Invts 10 12 21 19 22 Inventory 230 155 251 319 362 Debtors 59 149 177 225 272 Other Current Assets 0 2 2 2 2 Total Assets 411 471 662 827 918 ST Debt 208 192 202 212 162 Other Current Liab 62 63 156 210 236 LT Debt 20 13 13 13 13 Other LT Liabilities 13 16 16 16 16 Shareholder s Equity 105 182 265 360 465 Minority Interests 2 5 9 17 26 Total Cap. & Liab. 411 471 662 827 918 Asset Breakdown (2011) Inventory - 38.6% Debtors - 27.2% Net Fixed Assets - 31.0% Associates'/J Vs 0.0% Bank, Cas and Liqui Assets - 3.2% Non-Cash Wkg. Capital 227 243 274 336 400 Net Cash/(Debt) (218) (194) (194) (206) (154) Debtors Turn (avg days) 37.9 32.5 39.5 38.4 41.7 Creditors Turn (avg days) 28.2 20.8 28.6 37.0 38.8 Inventory Turn (avg days) 112.2 67.3 55.8 61.7 64.6 Asset Turnover (x) 1.7 2.6 2.7 2.6 2.5 Current Ratio (x) 1.1 1.2 1.3 1.3 1.7 Quick Ratio (x) 0.3 0.6 0.6 0.6 0.7 Net Debt/Equity (X) 2.0 1.0 0.7 0.5 0.3 Net Debt/Equity ex MI (X) 2.1 1.1 0.7 0.6 0.3 Capex to Debt (%) 1.8 25.0 32.5 31.1 8.6 Z-Score (X) NA NA NA NA NA Typically high net gearing due to large working capital needs. We expect this to improve with better operating cash flow. Cash Flow Statement (RM m) Pre-Tax Profit 21 112 153 190 212 Dep. & Amort. 8 8 13 18 18 Tax Paid (4) (6) (11) (29) (48) Assoc. & JV Inc/(loss) 0 0 0 0 0 Chg in Wkg.Cap. (52) (19) (32) (62) (64) Other Operating CF 6 (2) 0 0 0 Net Operating CF (22) 93 123 117 118 Capital Exp.(net) (4) (51) (70) (70) (15) Other Invts.(net) 0 0 0 0 0 Invts in Assoc. & JV 0 0 0 0 0 Div from Assoc & JV 0 0 0 0 0 Other Investing CF 0 2 (35) (23) (10) Net Investing CF (4) (49) (105) (93) (25) Div Paid (7) (19) (18) (36) (41) Chg in Gross Debt 40 (23) 10 10 (50) Capital Issues 0 0 0 0 0 Other Financing CF (1) 0 0 0 0 Net Financing CF 32 (42) (8) (26) (91) Currency Adjustments 0 0 0 0 0 Chg in Cash 6 2 9 (2) 2 Opg CFPS (sen) 9.4 34.9 48.4 55.8 57.0 Free CFPS (sen) (8.1) 13.0 16.5 14.6 32.2 Capital Expenditure 80 70 60 50 40 30 20 10 0 2009A 2010A 2011F 2012F 2013F Capital Expenditure (-) High capex is related to construction of Batam plant. Source: Company, DBS Vickers Page 6
DBSV recommendations are based an Absolute Total Return* Rating system, defined as follows: 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 i.e. > -10% over the next 12 months) SELL (negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame) Share price appreciation + dividends DBS Vickers Research is available on the following electronic platforms: DBS Vickers (www.dbsvresearch.com); Thomson (www.thomson.com/financial); Factset (www.factset.com); Reuters (www.rbr.reuters.com); Capital IQ (www.capitaliq.com) and Bloomberg (DBSR GO). For access, please contact your DBSV salesperson. 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