• Keep BUY with a new MYR2.70 TP from MYR3.10, c.47% expected total return. 4Q19 earnings are expected to be seasonally stronger in view of the festive holidays. However, 1Q20 sales are likely to be affected by the COVID- 19 outbreak, given Cocoaland’s presence in China, Singapore, and Hong Kong. The quantum of the impact cannot yet be quantified. Notwithstanding, we believe growth prospects and fundamentals will remain intact beyond the virus outbreak concerns, riding on the robust demand for gummy products.

• Stronger 4Q19, but 1Q20 likely weaker. We estimate 4Q19 earnings to be MYR11-12m, (+22% YoY, +68% QoQ), bolstered by higher sales on seasonality and favourable raw material costs. However, we think the COVID- 19 virus impacting Asia will pose a downside risk to 1Q20 earnings. China, Hong Kong, and Singapore collectively contribute c.28% of Cocoaland’s total sales. The quantum of the impact should depend on the duration of the outbreak.

• Missed opportunity due to a delay at the new plant. Cocoaland’s plan to expand capacity has been delayed, as construction of its new factory is taking longer than expected. The plant is now scheduled to run in April/May vs initial expectations of March/April. Hence, the group will not be able to capitalise on the surge in demand during the Aidil Fitri celebrations at end May. Recall that the group was planning to increase its gummy production capacity by 30% to c.12m kg pa, with total capex estimated at c.MYR42m.

• Costs remain stable. Packaging costs (45% of raw material costs) have stayed low, in tandem with resin price movement (Figure 3). The slight increase in sugar prices recently should have minimal impact to earnings, as it only makes up c.10% of raw material costs. The impact from the higher minimum is estimated at MYR720,000 pa, but Cocoaland is actively upgrading its automation processes to mitigate the impact.

• Key risks and forecasts. We trim our FY20F-21F earnings by 3% after imputing a more conservative sales assumption. This is to reflect the virus outbreak and delays in the commissioning of its new plant. Key risks to our call and earnings forecasts: A sharp rise in raw material costs, stronger MYR/USD, and further delays in the commissioning of new production lines.

• We maintain our call with a new TP, which is based on a lower target P/E of 16x from 18x. We opt to be more conservative with our valuation, as we observe the delivery of steady earnings growth (9M19: +13%) has failed to excite the market or lift trading volumes. Additionally, sentiment on the stock could further be dampened, given the potential earnings downside from the COVID-19 outbreak and expansion plan delays. Notwithstanding, we believe its growth prospects and fundamentals will remain intact beyond the viral outbreak concerns. The stock is trading at a compelling 11x P/E, which is below the 16-18x valuation range of comparable peers like Power Root (PWRT MK, BUY, TP: MYR2.80) and Apollo Food (APOF MK, NEUTRAL, TP: MYR3.40). It also offers a decent 5.3% yield.

Source: RHB Securities Research - 14 Feb 2020