Hup Seng Industries Bhd
(Aug 11, RM1.25)
Not rated with a fair value of RM1.37. Being the local market leader in the cream cracker segment, Hup Seng Industries (Hup Seng) has recorded three-year net profit compound annual growth rate of 27%, according to its financial year 2014 (FY14) figures.

The group got off to a good start in FY15 by clocking net profit growth of 37.5% on the back of a 10.2% revenue growth which the group attributed to the benign growth in demand for biscuits in both local and overseas markets.

The net profit growth is deemed impressive compared with the average of 12.8% we are forecasting for the food and beverage (F&B) stocks under our coverage while three-year average return of equity (RoE) of 23.4% is close to double of the average RoE of 12.3% we gathered from small- to mid-cap F&B stocks in Malaysia.

We spotted the spike up in sales starting from fourth quarter financial year 2014 (4QFY14), with the revenue in the last six months surging 10.3%.

While we believe the stronger export sales could be partially due to the effect of a weaker ringgit, the local demand has also picked up, which resulted in more production shifts in order to capture the surge in demand.

We think that the group might have indirectly benefited from the plunge in consumer sentiment, which induced consumers to focus more spending on small-ticket staple food products.

Besides, the group is also banking on innovation to drive the demand growth moving forward as it aims to launch new products in 3Q15. 

The group recorded gross margin of 40.6% in 1QFY15, which was an improvement of 2.9 percentage points from 1QFY14.

We believe the margin expansion was achieved on the back of favourable raw material prices as well as better operating efficiencies.

Note that the key raw materials include flour, palm oil and sugar. We understand that the group has undergone internal restructuring exercises that would boost its efficiencies in terms of production, procurement and logistics.

As such, we are projecting further expansion in gross margin to 43% in FY15 and FY16. With that, we project net profit to grow 36.2% and 9.4% in FY15 and FY16 respectively. 

The group is currently adopting a dividend policy of paying out at least 60% of the net profit. 

However, we foresee the higher payout starting FY15, supported by its cash of RM95.2 million or 12 sen per share as of 1QFY15 and strong operating cash flow of RM46.8 million in FY14.

Moreover, we also understand that capital expenditure moving forward will moderate after a total amount of RM8.4 million being incurred in FY14 for its new oven. Thus, we are projecting dividend per share of five sen per share and 5.5 sen per share in FY15 and FY16 respectively, representing a payout ratio of 80%.That would translate into decent dividend yield of 4% and 4.4% respectively. — Kenanga Investment Bank Research, Aug 11

This article first appeared in digitaledge Daily, on August 12, 2015.