This article first appeared in The Edge Financial Daily on June 7, 2018 - June 13, 2018

Power Root Bhd
(June 6, RM1.69)
Maintain market perform with an unchanged target price (TP) of RM1.50: In its financial year ended March 31, 2018 (FY18), the group underwent a sizeable kitchen-sinking exercise.

This includes impairing RM2.3 million from its leased land in the United Arab Emirates with the relocation of a prospective plant construction to Bahrain where operating costs are more favourable in addition to support from local authorities.

Inventories of up to RM2.8 million were impaired owing to buy-backs from unsold stock by Middle East and North African (Mena) distributors due to overly aggressive sales expectations.

A net adjustment to FY18 receivables of RM1.1 million includes rationalising client portfolios which are unprofitable to the group. We also account for bonus provisions of up to RM4 million arising from a one-time compensation scheme in FY18.

Domestically, tighter sales procedures were established with hopes to ensure margins are kept at sustainable levels. While this may undermine top-line prospects in the short term, new product developments in an attempt to penetrate new markets (that is, tea offerings, “Kopi O”) could translate positively with the right marketing strategy.

Self-audits on operating procedures identified areas for improvement would be progressively rectified. This could include minimising overtime expenses and production wastages as well as streamlining procurement and stock management.

An extension of the group’s warehouse to be completed by the second half of 2018 could facilitate better inventory controls.

Investments towards an automated batching line could prepare the group ahead of an increase in minimum wage.

Export-wise, management remains optimistic about its sales potential as its brands are able to sustain growth in spite of a perceived contraction in market size. Better volumes may be slightly offset by a stronger ringgit environment.

In FY18, exports accounted for 49% of total revenue. At this moment, plans to commence the construction of the Mena plant in Bahrain may not be hastened as producing domestically still remains cost-efficient in the near term.

Post visit, we feel reassured of management’s efforts to support its bottom line. Zero-rating of the goods and services tax in June 2018 and reintroduction of the sales and service tax in September 2018 may distort local sales trends as distributors withhold orders to purchase stock at levels most beneficial to them.

Nonetheless, we believe this would normalise during the rest of the year. Better costs are also expected to be reflected as hedged commodities (particularly coffee) could see an around 15% improvement against the prior year.

FY19 could be seen as the gestation year to incorporate the above-mentioned points in anticipation for a significantly well-rooted FY20. As we believe these have been fairly accounted for in our assumptions, we leave our estimates unchanged for now.

Our TP is derived from an unchanged 15 times FY19 price-earnings ratio which is currently in line with the stock’s -1SD over its three-year mean.

At present, dividend yields for FY18 and FY19 of 6.5% and 7.2% could appear attractive to yield-seeking investors. In addition, the proposed bonus issue and free warrants issuance are expected to improve liquidity and market participation in the near future.

Risks to our call include lower-than-expected domestic and export sales, prolonged exposure to high commodity prices, and lower-than-expected dividend payments. — Kenanga Research, June 6