London Biscuits Bhd
(March 17, RM0.79)
Downgrade to trading sell with a target price of 83 sen. Although the first half of financial year 2015 (1HFY15) net profit of RM8.6 million came in at 51% of our estimate, we consider this to be below expectation.

Generally, the first-half periods are stronger, recording between 62% and  77% of full-year earnings over the last three financial years. Year-on-year (y-o-y) and year-to-date, London Biscuits reported a 7.3% top-line growth to RM177.6 million, but saw a 7.5% decline in net profit on the back of higher advertising and promotion (A&P) costs and interest costs. 

Quarter-on-quarter, the second quarter of FY15 (2QFY15) saw a 2.7% increase in revenue, but core net profit (CNP) fell by 31.1% largely due to significantly higher effective tax rates of 17.2% versus 9.9% in 1QFY15.

Top-line was driven by an increase in production lines, which has allowed the confectionary segment to secure new clients while the order book for all segments remains healthy. Its venture into premium products and potato chips has seen strong demand from the market. In addition, London Biscuits’ top-line is likely to benefit from a stronger greenback as 47% of revenue is derived from export markets, with 50% sales denominated in US dollars.

We note there is an increasing A&P cost trend resulting in some slight compression in 1HFY15 earnings before interest and taxation (Ebit) margins by 0.6 percentage points to 10.6%. However, the more glaring impact arises from taxation. The group has been experiencing lumpy taxation trends where the second-half period’s effective tax rates tend to be much higher than the first-half’s. 

The market may not realise that London Biscuits’ effective tax rates are starting to normalise towards the statutory tax rate of 25% as FY13 and FY14 saw a jump to 20% compared with the lows in FY11 and FY12 of 3.2% and 6.8% respectively. 

As of 1HFY15, the effective tax rate is at 13.2%, which is relatively higher than the 6.1% and 6.2% in 1HFY12 and 1HFY13, respectively. This could be largely due to fewer claims for reinvestment allowances and capital allowances.

The group has done most of its capacity expansion, which would improve operational cash flow. 

However, its net gearing remains relatively higher than other consumer food and beverage (F&B) players which are currently in net cash position. This could be the reason for the relatively lower dividend yield of 1.2% versus our in-house consumer F&B player’s peer average of 3.4%.

We have revised FY15 revenue to grow at 8% y-o-y, considering that 1HFY15 revenue growth was 7.3% y-o-y versus our previous assumption of 12% y-o-y. However, we also increased our effective tax rates to a normalised rate of 25%, previously assuming 18%, and A&P cost assumptions so that Ebit margins of 10% are more reflective of the 1HFY15, and the higher finance cost due to higher shorter term such as hire purchase and loan exposures. 

Thus, our FY15 estimate CNP will be flattish at RM14.4 million. In our last report dated May 15 last year, we applied a forward price-earnings ratio (Fwd PER) of 10 times, which implies a 10% discount to the FBM Small Cap Index (FBM SCAP) Fwd PER of 11 times back then.

The applied 10% discount is due to the relatively smaller market cap and lower dividend payout. However, the market had since taken a beating, causing the FBM SCAP Fwd PER to derate slightly to 10 times. 

Considering its aggressive efforts to de-gear its balance sheet, we opt to maintain our applied Fwd PER at 10 times. — Kenanga IB Research, March 17

This article first appeared in The Edge Financial Daily, on March 18, 2015.