This article first appeared in The Edge Malaysia Weekly on January 28, 2019 - February 3, 2019

HUP Seng Industries Bhd, a household name for quality biscuits, is counting on exports to drive growth amid soft consumer spending at home.

“The group will focus on expanding its export market, especially in Asia, Southeast Asia and the Middle East,” executive director Kerk Chian Tung tells The Edge in an email response.

Kerk’s remarks are consistent with the group’s direction over the last few years.

In the financial year ended Dec 31, 2016 (FY2016), management had targeted export sales growth of RM10 million in four years. Hup Seng increased export sales to RM86.5 million in FY2017; from RM80 million in FY2016, or 65% of its four-year target, within a year.

Management says in its FY2017 annual report that it envisages export sales to pass the RM100 million mark by FY2020.

The contribution of exports to the group’s revenue averaged 28% from FY2015 to FY2017. It is worth noting that close to 60% of Hup Seng’s total export revenue comes from its top five markets — Thailand, Saudi Arabia, Indonesia, Singapore and Myanmar.

In FY2017, export revenue from Saudi Arabia soared 41% from a year earlier. Notable growth was also seen in China, which became Hup Seng’s sixth largest market in 2017, from 10th in 2016.

Kerk tells The Edge that while the China market is still in its infancy, with a contribution of only 2.6% to the group’s total revenue, management is targeting at least 20% growth.

“The China market needs time to develop. It is just beginning and sales are expected to improve gradually. This year, we are targeting at least 20% growth. We will focus on crackers and sandwich by supporting listing fees and campaigns,” she says.

She adds that the competition in China is intense and the group will focus on the development of new flavours and new packaging designs to attract sales.

“The best-selling products are cream crackers and sugar crackers,” she says.

Weaker ringgit a boon for company

Nonetheless, Hup Seng’s exports are sensitive to foreign exchange movements. Export market growth for FY2018 appears to have hit a roadblock due to the strength of the ringgit last year. During the first nine months ended September (9MFY2018), Hup Seng’s export market saw a year-on-year decline of 3%. The ringgit averaged 3.99 against the US dollar during the period under review, or 8.3% stronger than its average of 4.35 for 9MFY2017.

With the ringgit weakening towards the second half of last year, Kerk notes that this could be beneficial to Hup Seng moving into FY2019.

TA Securities analyst Damia Othman — who has a “hold” call on Hup Seng and a 12-month target price of RM1.19 — agrees that a weaker ringgit would be a boon for the company.

According to Damia’s sensitivity test, if the ringgit weakens from 4.05 to 4.15 against the greenback, group earnings are expected to increase by 2% and 2.1% for FY2019 and FY2020 respectively, all other things being equal, considering 30% of its sales come from exports.

As the time of writing, the ringgit was trading at 4.137 against the US dollar, 0.1% weaker in less than a month from its closing of 4.1335.

Damia believes that Hup Seng’s earnings for FY2019 will see a boost due to the softer local currency.

Regular dividend and attractive yield

Damia says Hup Seng is a good investment amid the volatility in the global equities markets.

Hup Seng weathered the fierce selldown of mid and small-cap stocks last year better than other counters. Its share price dropped 16.8% from its peak of RM1.13 in mid-May to a low of 94.5 sen in late December, while other stocks dropped 50% or more.

“If you look at Hup Seng’s valuation, it is at a good entry level for investors who want to avoid the uncertainties of the equities markets or someone who wants to invest in the long term.

“The dividend yield is also at a decent level of 5% to 5.5% and it has a strong track record of delivering. It offers consistent earnings, a strong balance sheet with zero borrowings and a positive cash flow,” Damia says.

At its closing price of 99.5 sen last Thursday, Hup Seng’s dividend yield amounted to 6.1% and it had net cash of 11.4 sen per share with zero borrowings.

According to Damia, the stock appears to be undervalued, with a trailing price-earnings ratio of 18.8 times, which is more than one standard deviation below its three-year average PER of 20.6 times. Aside from PER, Hup Seng is trading at a trailing price-to-book value of 4.8 times, which is also more than one standard deviation below its three-year average P/B of 5.6 times.

“The last time Hup Seng was trading at the current level was in 2015, when the Goods and Services Tax was implemented,” she says.

On the group’s dividend payout ratio, Kerk says Hup Seng has been rewarding shareholders consistently over the past few years.

“The group has been paying a dividend per share of six sen since 2015, which is equivalent to a dividend payout ratio of more than 95%,” she says.

Challenging home market

One of the biggest challenges Hup Seng faces this year is the local market, where retail consumption is expected to be dampened by the rising cost of living and uncertain global and domestic economic prospects.

“The operating environment over the next six months could see decelerating domestic growth, uncertain global demand and investment activities as well as a lack of positive catalysts. Faced with uncertain global and domestic economic prospects, consumers are once again being more prudent in their spending, leading to weaker sentiment on retail consumption this year,” Kerk says.

In order to sustain its performance, she says the group will focus on improving its financial performance by innovating its product portfolio, reducing costs, improving efficiency, broadening the distributor network to safeguard revenue and addressing the needs of consumers.

A local fund manager tells The Edge that the group has not increased its product selling prices since 2011, and with the rising cost of doing business — on raw material cost pressure and other operational costs — it is likely that Hup Seng will embark on some price adjustments.

“We are seeing some price increases in the industry as most players have absorbed the higher costs in the last few years. But with the cost of doing business expected to rise with raw material costs such as flour, packaging, higher electricity tariffs on the increase in the imbalance cost pass-through surcharge by Tenaga Nasional, as well as more volatile petrol prices, we should see the industry begin to increase some prices,” he says.

TA Securities’ Damia agrees and says that price increases are likely to be selective, but should protect its margins.

It is worth noting that gross margins have been on a decline amid rising cost pressures. During 9MFY2018, gross profit margin was 36.2%, lower than the average of 39% over the last five years. Price increases could help to mitigate the margin erosion.

For the longer term, Kerk says that its newly acquired RM12.1 million production line, which is expected to be commercially operational in January next year, could increase capacity and replace the existing production line.

“The new line, with modern technology, could improve the cost of production, such as reducing fuel cost, improve quality and hygiene and reduce waste. It is also safer and more environment-friendly,” she says.

The existing production line has a capacity of about 40,000 tonnes per year, and the utilisation rate for the coming financial year is expected to be more than 90%.
 

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