Kawan Food- North America outperforms

Price: RM0.79
Target Price: RM1.05
Recommendation: BUY

· Kawan Food’s (KFB) 1HFY09 net profit of RM6.5m came in above expectations constituting 63% of our FY09 estimate of RM10.3m and 60% of consensus forecast of RM10.8m. Strong sales growth in all markets, particularly North America, coupled with moderating raw material costs caused the earnings outperformance. The economic slowdown appears to have benefited KFB as consumers in developed countries opt to dine in.

· Appreciation of the US dollar and strong demand from export markets, particularly US and Canada, drove 1HFY09 revenue up by 31% YoY. Operating profit margin improved by 7% due to lower input costs (for key raw materials flour, sugar, margarine), resulting in operating profit close to doubling to RM8.9m. Net profit rose by a more modest 76% however due to higher tax rate. The 10% increase in effective tax rate came from lower reinvestment allowances as KFB concentrates its expansion in China rather than Malaysia.

· Lower raw material costs and improvements in operating efficiency were largely responsible for the 22% QoQ increase in 2QFY09 net profit of RM3.5m. Revenue rose by 8% due to moderate double-digit sales growth in Europe, North America and Asia offsetting the lower domestic sales.

· Disposal of entire 24% stake by Kilat Kaca Sdn Bhd. We gather that KFB’s substantial Bumiputera shareholders and owners of Kilat Kaca, Datuk Ibrahim Ahmad and Tan Sri Mohd Ibrahim Mohd Zain, have sold their stake to an existing OEM customer of KFB’s based in the UK.

· Nantong, China plant on schedule to begin commercial operations in 3QFY09 manufacturing flatbreads for KFB’s export sales. KFB has spent c.RM50m on the factory, and expects the plant to breakeven by end-FY10 at the earliest.

· Revising FY09 net profit estimate upwards by 12% to RM11.5m to factor in a 16% increase in revenue (+4% from previous estimates) sustained by strong demand from developed countries. Anticipate improvement in FY09 pretax profit margin from lower commodity prices.

· Upgrading to BUY recommendation with new target price of RM1.05, based on rolling-over to FY10 earnings. By utilising a 10x PER (at 25% discount to industry average in view of KFB’s lower market cap) to FY10 EPS of 10.4 sen, we arrive at our target price of RM1.05 and potential 33% upside. The stock is currently trading at an undemanding 7.5x FY10 PER.