PWROOT's 1HFY25 results disappointed on higher-than- expected operating costs, particularly labour costs, although pressure somewhat eased QoQ. Its 1HFY25 net profit fell 38% due to rising labour costs and higher forex loss. We expect local sales to remain relatively flat due to pricing adjustments, partly offset by the upcoming civil servant salary hike, while overseas markets continue to face challenges from geopolitical uncertainties. We cut our FY25-26F net profit by 8-7%, respectively. We fine-tune up our TP by 2% to RM1.30 (from RM1.28) as we roll forward our valuation base year to FY26F (from calendarised CY25F). Reiterate MARKET PERFORM.

PWROOT's 1HFY25 net profit of RM15.8m came in below expectations at only 42% and 37% of our full-year forecast and the full-year consensus estimate, respectively, though revenue was within expectations. The key variance against our forecast came largely from higher-than-expected operating expenses, particularly labour costs. It declared an interim dividend of 2.0 sen in 2QFY25 (consistent with 2QFY24), implying a dividend payout ratio of 109%.

YoY, its 1HFY25 turnover dropped 1% as weaker export sales (-13%) were partially offset by improved local sales (+7%). We believe the increase in local sales could be partially attributed to the effective price hike for Alicafé products implemented a few quarters ago. However, its net profit plunged 38% due to rising labour costs (+15% YoY) and a forex loss of RM2.7m (1HFY24: RM2.1m gain).

QoQ, its 2QFY25 top line declined by 3% mainly due to lower sales in the overseas market (-17%). The weaker export performance was likely due to hefty sugar taxes in the UAE, KSA, and Oman, which doubled Alicafé prices and halved sales volumes. Local sales, however, provided some relief with a 6% growth. In spite of lower revenue, its bottom line grew 16% largely driven by reduced advertising and promotion costs, as well as lower variable labour expenses, leading to strong improvement in margins, particularly in the domestic market.

Outlook. We expect local sales to remain flattish as PWROOT's pricing strategy adjustments narrows the discount of its products against those of competitors. However, this may be partially offset by the upcoming salary increase for civil servants effective Dec 2024, which could help restore some consumer spending power. On the other hand, we are still cautious on the overseas market which is expected to face persistent challenges due to geopolitical instabilities, impacting global retail demand and causing supply chain disruptions, especially in Middle East markets. Fluctuations in commodity prices and foreign exchange rates are likely to continue putting pressure on costs.

Forecasts. We cut our FY25-26F net profit by 8-7%, respectively, to account for higher labour costs. We expect minimal impact from the upcoming increase in local sugar tax under Budget 2025, as 88% of the group's SKUs in Malaysia are already below the sugar tax threshold (as of FY24) due to ongoing product reformulation efforts.

Valuations. We adjust our TP upward by 2% to RM1.30 (from RM1.28), based on FY26F EPS (previously blended CY25 EPS) with an unchanged targeted PER of 15x. This remains at a discount to the average historical forward PER of 22x for food and beverage industry players, reflecting PWROOT's less extensive product range vs. its peers. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 4).

Investment case. We like PWROOT for: (i) its leading position as one of the largest coffee manufacturers in Malaysia, and (ii) its strategic marketing initiatives to promote brand awareness for products such as Alicafé, Per'l and Ah Huat. However, its seemingly eroding foothold in its key export market, i.e. the Middle East, coupled with elevated key commodity prices particularly for coffee may pose challenges to its margins. Reiterate MARKET PERFORM.

Risks to our call include: (i) consumer spending being impacted by high inflation, (ii) MYR's weakness resulting in higher costs for imported raw materials, and (iii) significant rise in food commodity prices.

Source: Kenanga Research - 22 Nov 2024