QL Resources -- Solid Like A Rock

Investment Highlight

- We initiate coverage on QL Resources with a BUY call and target price of RM3.70. QL Resources is the best laggard defensive play among the consumer counters as the share price has only appreciated 3.25% ytd. We value QL Resources at 17.5x FY14 PER which is at its mid-cycle 3-year average PE. Our target price renders 16.4% upside to the last closing price of RM3.18.

- Niche business model with three resources-based core segments. The Group’s business model is mainly capitalising on the natural resources of South East Asia by operating three resources-based business segments, which are marine products manufacturing business, integrated livestock farming business, and palm oil plantations. We reckon that the Group’s business model is hardly to be replicated by new entrants given the extensive capital requirement of the business and the intellectual know-how in operating marine products manufacturing business and livestock farming business.

- Strong earnings momentum. It is a tremendous pride of the Group for its uninterrupted profit track record of having delivered earnings growth over the past 12 years thanks to its recession-proof business nature of producing staple food-based products and sound management. The earnings growth of the Group remains intact despite economic downturn. In addition, we are impressed with the Group’s FY08/09 earnings growth in face of bird flu pandemic that was ought to poise strong threat to its livestock farming business. We witnessed the Group has weathered both the systematic and business associated risks reasonably well.

- M&A as expansion mode. Besides organic expansion, the Group does not rule out the possibility of expanding its integrated livestock farming business via acquiring small industry players. The Group acquired 23.39% stake in rival company Lay Hong back in August 2010. With the recent hiking of soy meal price that could put some livestock operators under pressure, we reckon that the Group may turn the headwinds into tailwinds by resuming its acquisition trail on smaller players and hence further strengthen its position as a market leader.

- Future growth further spurred by venturing into palm oil plantations. The Group has sowed the seeds for future earning growth by venturing into palm oil plantations in Sabah and Kalimantan. The Group is currently having approximately 5,000 ha of matured palm oil planted area and matured area is expected to reach 9,000 ha in FY15. We believe the upcoming matured palm oil areas to become one of the catalysts for the Group’s earnings. We expect the Group’s earnings margin to be widen in future in tandem with the widening of palm oil plantation segment’s PBT margin on the back of CPO mills process more fresh fruit bunches (FFB) from its own production.

- Regional expansion poised to deliver steady growth. The Group has not rest on its laurels and is expanding its core business regionally. The Group has set up poultry farms in Vietnam and Indonesia. Similarly, the Group has replicated its marine business model in Indonesia by setting up fishery plant for Surimi and fishmeal manufacturing in Surabaya, Indonesia. We understand that the Group is in the midst of expanding its fishery plant capacity and ramping up its egg production capacity in Vietnam and Indonesia. We are positive on its regional expansion as it enables the Group to tape the fast-growing Indonesian and Vietnam markets.

- Muted impact of hiking feedstock prices. The recent drought in US has sent the corn and soybean prices spiralling higher, leaving farmers grappling with higher feed costs. However, the Group is also engaged in animal feed raw material trading activities and has given the Group a competitive edge in cost control for its integrated livestock farming business. Furthermore, we understand from management that the Group has no issue in passing on the higher cost to customers within the time lag of one to two months. We reckon the segment’s margin would be compressed, as the Group is to absorb the additional cost during the pass on period. In a nutshell, we do not expect it to take toll on the Group’s bottom line on the back of its diverse operations to balance out the negative performance of the livestock segment.

- We deem QL Resources to be the cup of tea for investors who seek shelter in defensive consumer stocks with its relatively recession-proof line of business in face of the current uncertain economic outlook. Potential re-rating catalysts from its regional expansion and potential M&A in local poultry industry which would propel the Group’s future earnings growth.


Principal Activities

Marine Products Manufacturing Activities (MPM)
Marine Products Manufacturing consists of upstream and downstream activities including surimi, surimi-based products manufacturing, fishmeal, and deep-sea fishing. Trough the use of innovative technology and quality practices, the Group has achieved industry leadership positions including being the largest surimi producer in Asia, leading producer of surimi-based products in Malaysia, and the largest fishmeal manufacturer in Malaysia.

Surimi (fish paste) is a paste made from white-fleshed fish that has been pulverized. Surimi is a useful ingredient for producing various kinds of processed foods. Surimi is being frozen and used to produce surimi-based products such as imitation crabmeat and fish ball. The Group exports frozen surimi paste and manufactures surimi-based products such as fishball and imitation crabmeat. The marine products are also distributed nationwide and internationally through distribution network both under private label and QL portfolio brands (Mushroom, Figo, Ocean Ria).

The Group has five fishery plants in Malaysia which are located at Hutan Melintang, Endau, Johor Bahru, and Tuaran in Malaysia, and in Surabaya in Indonesia.

Integrated Livestock Farming Activities (ILF)
The Group is one of the Malaysia leading operator in animal feed raw materials and poultry farming driven by organic growth and a series of strategic acquisitions. The Group is the leading poultry egg producers in Malaysia. Besides, the Group is also the leading integrated broiler and breeder producer in East Malaysia and replicates its success story in Indonesia. The Group is also a leading local distributor of corn and soyabean meal for commercial animal feed products.

Palm Oil Activities (POA)
The Group has two independent Crude Palm Oil (CPO) mills servicing small and medium sized estates in the Tawau and Kunak regions of Sabah, East Malaysia. The Group has its first CPO mill in Eastern Kalimantan, Indonesia which was commissioned in April 2012. The Group owns a 1,200 hectares palm oil estate in Sabah and 15,000 hectares plantation under development in Eastern Kalimantan, Indonesia. The Group has also developed a first of its kind integrated biomass solution, whereby palm biomass is
processed by biogas power plants within palm oil milling complexes.


Investment Merit

Three resources-based core business segments. The Group’s business model is mainly capitalising on the natural resources of South East Asia by operating three resources-based business segments, which are marine products manufacturing business, integrated livestock farming business, and palm oil plantations. We reckon the Group’s business model is hardly to be replicated by new entrants given the extensive capital requirement of the business and the intellectual know-how in operating marine products manufacturing business and integrated livestock farming business. We believe the high barrier of entry has given the Group’s a competitive edge in the industry and expect the Group to continue enjoy its leadership status in these two business segments.

Solid like a rock. It is a tremendous pride of the Group for its uninterrupted profit track record of having delivered earnings growth over the past 12 years thanks to its defensive business nature and sound management. The Group’s business nature of producing staple food-based products enables it to remain a bright spot amid external headwinds. The earnings growth of the Group remained intact despite crisis of SARS epidemic and economic downturn. In addition, we are impressed on the Group’s FY08/09 earnings growth in face of bird flu pandemic that was ought to poise strong threat to its livestock farming business. The Group’s livestock farming division raked in 16% and 54.5% growth for FY09 revenue and profit before tax respectively. Besides, we reckon that the burgeoning demand for the Group’s marine products during bird flu pandemic had further spurred the revenue growth of the Group. We witnessed the Group has weathered both the systematic and business associated risks reasonably well.

Venturing into palm oil plantations. The Group has sowed the seeds for future earning growth by venturing into palm oil plantations in Sabah and Kalimantan. The Group is currently having approximately 5,000 ha of matured palm oil planted area and matured area is expected to reach 9,000 ha in FY15. We believe the upcoming matured palm oil area to become the catalyst for the Group’s earnings growth. We expect the Group’s earnings margin to be widen in future in tandem with the widening of palm oil plantation segment’s PBT margin on the back of CPO mills to process more fresh fruit bunches (FFB) from own production.

Regional expansion poised to deliver steady growth. The Group has not rest on its laurels and is expanding its core business regionally. The Group has set up poultry farms in Vietnam and Indonesia. Similarly, the Group has replicated its marine business model in Indonesia by setting up fishery plant for Surimi and fishmeal manufacturing in Surabaya, Indonesia. We understand the Group is in the midst of expanding its fishery plant capacity and ramping up its egg production capacity in Vietnam and Indonesia.

We are positive on its regional expansion as it enables the Group to tape the fast-growing Indonesian and Vietnam market. We expect the egg consumption and in these two countries to rise in tandem with their rising income per capita. We believe the Group’s ambitious regional expansion would spur the earnings growth in future.

Muted impact of hiking feedstock prices. The recent drought in US has sent the corn and soybean prices spiralling higher, leaving farmers grappling with higher feed costs. However, the Group is engaged in animal feed raw material trading activities and had given the Group a competitive edge in term of cost control for its integrated livestock farming business. Meanwhile, we understand from management that the Group has no issue in passing on the higher cost to customers within the time lag of one to two months. We reckon the segment’s margin would be compressed, as the Group is to absorb the additional cost during the pass on period. In a nutshell, we do not expect it to take toll on the Group’s bottom line on the back of its diverse operations to balance out the negative performance of the livestock segment.

M&A as expansion mode. Besides organic expansion, the Group does not rule out the possibility of expanding its integrated livestock farming business via acquiring small industry players. The Group acquired 23.39% stake in rival company Lay Hong back in August 2010. With the recent hiking of soy meal price that could put some livestock operators under pressure, we reckon that the Group may turn the headwinds to tailwinds by resuming its acquisition trail on smaller players and further strengthen its
position as market leader.


Financial Highlights

Uninterrupted profit track record. The Group has recorded uninterrupted earnings growth for the past 10 years. The Group has recorded a 10-year CAGR revenue growth of 13.2% and a 10-year CAGR net profit growth of 22%. Moving forward, we expect the Group’s earnings continue to gain momentum on the back of its expansion plan and expect the Group’s net profit to grow at commendable 3-year CAGR of 13.4%.

Integrated livestock farming (ILF) segment is the largest revenue and profit before tax contributor. The Group’s ILF segment contributed 57.5% of the Group’s revenue in FY2012. Similarly, the ILF segment contributed bulk of the profit before tax (PBT) in FY2012, accounted 56.8% of the Group’s PBT. Moving forward, we expect the segment’s revenue to grow at 3-year CAGR of 8.25% backed by its increasing fishery plant capacity in Vietnam and Indonesia.

Marine products manufacturing (MPM) segment commands highest margin. The Group’s MPM segment contributed 24.3% and 35.6% to the Group’s FY2012 revenue and profit before tax (PBT) respectively. The MPM segment renders highest margin, which is 13% amongst the three segments. We expect the Group’s MPM segment to continue support the Group’s earnings growth underpinned by its expansion of MPM business in Indonesia.

Higher earnings contribution from Palm oil activities (POA) segment. POA segment contributed 7.6% of the Group’s profit before tax (PBT) in FY2012. With the Group’s increasing matured palm oil area, we expect POA segment PBT contribution to reach 16.6% in FY2015. Besides, we believe the PBT margin of POA segment to expand as the Group’s palm oil mill to process more of own fresh fruit bunches
instead of sourcing FFB from third parties.


Valuation & Recommendation

We initiate coverage on QL Resources with a BUY call and target price of RM3.70. We value QL Resources at 17.5x FY14 PER which is at its mid-cycle 3 year average PE. Our target price renders 16.4% upside to the last closing price of RM3.18.

QL Resources is the best laggard defensive play among the consumer counters as the share price has only appreciated 3.25% ytd. We deem QL Resources to be the cup of tea for investors who sought shelter in defensive consumer stocks in face of the current uncertain economic outlook. We reckon its regional expansion and potential M&A in local poultry industry would provide ample scope for the Group’s s earnings growth. Besides, we believe QL Resources could provide promising capital gain for investors as its success is being built on three profitable and recession-proof lines of business.


Risk

Hiking of corn and soymeal prices. Higher corn and soymeal prices would increase cost of production of the Group’s integrated livestock farming business. Although the Group is confident in passing through the higher cost to customers within the time frame of one to two months, the Group is ought to absorb the additional cost during the period and the integrated livestock farming segment’s profit margin may be narrowed.

Lower CPO prices. The Group’s earning is exposed to the fluctuation of CPO prices. Slump in CPO prices would take a toll on the earnings of the Group’s palm oil activities segment.

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