This article first appeared in The Edge Financial Daily on July 7, 2017 - July 13, 2017

Hup Seng Industries Bhd
(July 6, RM1.21)
Initiate hold with a fair value of RM1.10: Hup Seng Industries Bhd is known primarily for its Hup Seng Cream Crackers, which we estimate form at least 65% of its total revenue. As a whole, its earnings are derived from biscuits, beverages (InComix) and other agent products (Wang Wang rice crackers and Ong Sam Yong Chinese tea, among others). While it is able to charge a premium on its cream crackers given the decades-long history of the product, the group’s more recent offerings and beverage line are still trying to carve out a name in a very competitive market. Consequently, production for crackers is at full capacity given the healthy demand but utilisation for other products such as the oats biscuits introduced two years ago is at a significantly lower rate. The group has built a comfortable cash reserve to prepare for expansion of its production facilities. However, this has been held back for the next two to three years due to the continuing softness of the market.

The group earns nearly a third of its revenue from exports. It has 40 export markets with the top five being Indonesia, Singapore, Myanmar, Thailand and Saudi Arabia. While sales in both export markets and Malaysia were flat in the financial year ended Dec 31, 2016 (FY16) due to poor consumer sentiment, revenue from exports grew faster than the domestic market (at a four-year compound annual growth rate of 7% versus 4% for Malaysia). The group is in early stages of forming a long-term plan to derive more revenue from China. This is targeted to eventually raise export revenue by a fifth from the RM80 million it has chalked up annually in the past two years.

We highlight the main challenges going forward to be the group’s work to expand production of its main product and simultaneously boost sales of its other products to accomplish revenue growth; and its vulnerability to commodity prices, with raw materials such as palm oil and flour taking up 50% of its input costs.

We deem the growth story to be uncompelling at this stage as the group works to fortify its domestic business beyond the foundation of its cream crackers, and holds back from making a genuine move into China to boost stagnant export earnings. We project Hup Seng’s net profit to fall further by 3% year-on-year (y-o-y) to RM48 million in FY17 (from RM49 million in FY16), and then softly rebound 5%/4% y-o-y in FY18/FY19.

We expect margins in FY17 to continue to see pressure from high input costs amid limited room to raise selling prices. — Aminvestment Bank, July 6