This article first appeared in The Edge Malaysia Weekly on November 8, 2021 - November 14, 2021

HUP Seng Industries Bhd’s Cap Ping Pong is synonymous with cream crackers that bring back memories for many — the flaky, crisp cracker that tastes great with a piping-hot cup of local black coffee or chocolate malt.

Therefore, the recent results of a study on prepackaged biscuits available in Hong Kong by the Hong Kong Consumer Council (HKCC) would have come as unwelcome news. The independent statutory authority reported that the beloved Hup Seng cream crackers were among 60 samples tested that contained strains of cancer-inducing contaminants such as glycidol and acrylamide.

Not surprisingly, Hup Seng’s share price crumbled, falling 7% over a span of five trading days, from 94 sen on Oct 18 to 87.5 sen on Oct 25.

Yet another blow was to follow as the managing director of the biscuit manufacturer, Kuo Choo Song, 89, passed away during the period.

Going by its share price, which has regained most of its lost ground as it closed at 91 sen on Nov 2, valuing the company at RM720.02 million, things appear to have mostly settled down.

As for the issues with HKCC, the Malaysian Ministry of Health (MoH) came to the defence of Hup Seng as well as several other local biscuit manufacturers implicated in the report.

On Oct 27, Director-General of Health Tan Sri Dr Noor Hisham Abdullah said the average level of acrylamide content in biscuits and crackers in the local market is below the benchmark set by European Commission Regulations.

He added that the Food Safety and Quality Division (BKKM) under MoH conducts risk assessment on acrylamide and glycidol in food and it has been shown that both substances are a low health risk in the consumption of biscuits.

Hup Seng itself reiterated in a statement that its cream crackers manufactured and marketed locally are fit for human consumption and in compliance with local regulations, quality standards and food safety standards.

Nearly 74.5% of Hup Seng sales are derived locally, with the remaining 25.5% coming from export markets, according to its 2020 annual report.

Notably, Hong Kong is not listed as one of its main export markets, which are Myanmar, Singapore, Thailand, Indonesia and Saudi Arabia.

Even though Hup Seng has been around for more than six decades, there are concerns that the HKCC report could damage the reputation of the biscuit maker.

In a report dated Oct 25, TA Securities pointed out that the HKCC findings are expected to create short-term negative news flow for Hup Seng, but not to the point of materially derailing the growth projection of the group.

The research house pointed to the example of PepsiCo Inc’s operating segment Frito-Lays, which produces chips and has continued to grow in revenue despite a previous report by HKCC that said crispy snacks in the Hong Kong market contain carcinogenic contaminants.

While the report by HKCC could be just a storm in a teacup, the bigger concern ought to be Hup Seng’s lacklustre performance in recent times.

The company may have been plagued by similar issues faced by any other manufacturer since the outbreak of Covid-19, but it is worth noting that its net profits have been on a decline since hitting a peak of RM72.9 million in FY2015.

Even though revenue continues to grow — albeit at an uneven trajectory — earnings are on the decline. The growth rate of its revenue between FY2015 and FY2019 fluctuated between a 4.9% year-on-year expansion and a 0.4% y-o-y contraction.

Net profit slipped from RM72.9 million in FY2015 to RM38.93 million by FY2019.

In the latest financial year (FY2020), it recorded revenue of RM327.32 million while net profit inched up to RM40.38 million. Management has highlighted the stresses on its earnings, given the soaring prices of commodities in 2020.

In a report dated Aug 12, Hong Leong Investment Bank (HLIB) Research observed that palm oil constituted about 40% of the group’s raw material costs.

Palm oil prices have continued to rise throughout the year and it does not bode well for the biscuit manufacturer that prices are expected to stay elevated until at least the first quarter of 2022.

The group appears to be worse hit this year, as its cumulative six month net profit amounted to RM13.45 million while revenue stood at RM149.24 million. If annualised, net profit and revenue would amount to RM26.9 million and RM298.48 million respectively, making up only slightly over half of FY2020 net profit and 90% of revenue.

In its second quarter ended June 30, 2021, announcement, the group said it had been affected by compliance with the mandatory 60% workforce control measures in line with standard operating procedures (SOPs) for manufacturers since May 2021, which affected its revenue.

“While demand for Hup Seng’s product is still intact, performance was affected because of constraints of a 60% workforce since May 2021,” it said.

Its net profit, on the other hand, has been affected by lower sales as well as an increase in certain raw and packaging materials for the first half of the year.

HLIB projects earnings will remain subdued for the rest of the year, owing to high commodity prices.

“While we like Hup Seng for its net cash position of 6.6 sen per share, we expect tepid sales and steeper commodity prices to impede near-term profitability. The lower dividend may also cause some share price weakness, as Hup Seng has traditionally been viewed as a stable dividend-paying stock,” said the research house.

So far, the dividend proposed for FY20201 amounts to 1.5 sen per share compared with the two sen it usually doles out by the first half of the year. The trailing 12-month dividend yield stands at 6.08%.

HLIB, which has a “sell” call on the stock, has pencilled in a dividend payout of 4.5 sen per share in FY2021, 1.5 sen lower than the usual six sen it has declared in the past.

TA Securities reckons that at the 87 sen level and below, Hup Seng’s shares would become more attractive to long-term dividend-seeking investors.

As at 2QFY2021, the company had net cash of RM58 million, adds TA Securities, which has projected a dividend distribution of five sen and six sen per share in FY2022 and FY2023 respectively.

TA Securities also has a “sell” call on the stock.

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