July 17, 2008

Food Player in Demand

By James S

IT STARTED WITH ENERGY, especially crude oil prices and then later, other hard and even soft commodities followed suit. In the last year or so, food has been the latest addition on the growing list of items hit by soaring prices. Yes, inflation is rearing its head globally and consumers now just have to pay higher for their foods or risk cutting down on their consumption.

With basic food products heavily subsidised, and the economy still growing strongly, especially in Asia, food consumption decline is not seen as much a major concern. In fact, with food prices rising, some investors are now looking at food players that are likely to benefit from this trend.

Locally, analysts have long touted QL Resources Bhd (QL) as the player that should ride on its own growth momentum, and the rising food price trend. The company is not a household name, but this has not stopped it from being one of the fastest growth companies on Bursa Malaysia.

In fact, since its listing in 2000, the company's net profit has grown by a compounded annual growth rate (CAGR) of 27%, although on a lower base initially. Analysts say that while its future growth rates are likely to moderate to around 15% yearly, this is still considered much better than other companies on the local bourse, especially given its defensive food business in the current volatile market.

Food-based businesses

QL's business activities are broadly categorised under three main divisions: marine-based manufacturing, crude palm oil milling, and integrated livestock farming. Marine-based activities and integrated livestock farming are the main contributors to the group's pre-tax profit (around 40% and 50%, respectively, for the financial year ended March, 2008), followed by crude palm oil milling (10%).

According to a previous investment report on the company by Standard & Poor's (S&P), QL was founded in 1987 as a small-scale marine-based products trader. Over the years thereafter, the company's marine products trading activity moved upstream to include manufacturing - surimi (fish paste), surimi-based products and fishmeal - and even deep sea fishing. The group later also diversified into crude palm oil milling and integrated livestock farming.

QL operates predominantly in Malaysia, but has the distinction of being the biggest producer of surimi in Asia, no small feat today for a Malaysian company founded originally in a small district in Perak.

QL's founders are Chia Song Kun (who remains the company's managing director) and his brothers, all of whom are still active in the company's management today.

QL is 61% held by CBG Holdings Sdn Bhd (47%) and Farsathy Holdings Sdn Bhd (14%) - both family vehicles of the Chia family. The founders listed QL on the Second Board of Bursa Malaysia in March 2000 before it was promoted to the Main Board in January 2002.

Fish-based products a hit

According to S&P, QL is an integrated fish marine products manufacturer and operates in both the sector's upstream and downstream activities. Its products include fishmeal (high protein fish-based animal feedstuff); surimi (frozen raw fish paste); surimi- based products (fishballs, fishcakes, crabclaws); and other fish- based products (dried snacks).

QL even has its own small fleet of deep-sea fishing vessels with 19 trawlers now in operation. However, its fish supply is mainly sourced from other local and foreign fishermen.

According to a recent report by foreign research house, CLSA Research, surimi is now an international commodity of sorts. Prices of surimi products are believed to have doubled over the past one year as food prices rose worldwide. QL obtains an average of 13%- 16% pretax margin from its marine products division.

The company's marine products processing plants, located in the major fishing towns of Hutan Melintang (Perak), Endau (Johor) and Kota Kinabalu (Sabah), have a total capacity of around 82,000 tonnes a year. The company is the largest surimi producer in Asia, exporting half of its products to major markets like Japan, South Korea, Singapore and Taiwan.

According to S&P, QL is also the largest fishmeal producer in Malaysia with an estimated 30% market share. Its products are marketed under the brand names of `Double Shark' and `Double Dolphin' for fishmeal and `Mushroom' and "`Top 1' for surimi-based products.

Acording to S&P, QL has an edge in the business by virtue of its size and market share. The local surimi and surimi-based products industry is fragmented with many small players, who supply mainly to the domestic market.

On the global front, S&P believes that QL has a competitive edge because of its emphasis on quality control. This has enabled QL to penetrate the export market, especially in developed countries, as it meets the prescribed food safety and hygiene standards.

With over 20 years' experience in the business, the company is also said to have established a good network with the fishing community in the country, ensuring it an uninterrupted supply of fresh fish.

Profitable livestock business

QL is also involved in poultry livestock farming and animal feed distribution. The company has five layer farms (of which three are in East Malaysia) and produces about two million eggs daily for local consumption and for export to neighbouring countries, like Indonesia and Philippines. Under the Ninth Malaysia Plan (9MP), the livestock industry has been allocated about RM530 million.

According to CLSA Research, with the outbreak of diseases such as the avian flu, governments now are imposing stricter rules on farming and placing greater emphasis on safe food products. The research house believes that QL is well positioned to capitalise on rising demand with its modern farming facilities. The company also has plans to replicate its current livestock business in Vietnam, a promising frontier of growth. QL is believed to have an 18% domestic market share of the poultry business.

Distribution of animal feed is also a main profit contributor for this division. QL distributes animal feed raw material such as corn and soya bean meal throughout Malaysia. These are imported from countries like the US, Argentina and India and QL makes a trading margin from the distribution, where higher import prices are passed on directly to consumers.

Oil palm division booster

QL operates a 3,000ha oil palm plantation in Sabah, supplying fresh fruit bunches (FFB) to its mills in Sabah.

The company has also entered into a 75:25 joint venture to cultivate another 20,000ha of plantation land in Kalimantan, Indonesia, expected to be fully planted within the next five years.

CLSA Research notes that with the current high crude palm oil (CPO) prices, both the company's CPO milling as well as plantation cultivation will see a boost in earnings, especially with the Indonesian contribution in the next few years. However, in the short term, there will be no spike in earnings yet from this division.

Bonus issue and share buyback may spur more liquidity

QL Resources recently had a bonus issue on the basis of one bonus share for every two existing shares held. Local research house, AmResearch is positive on this, saying that it is part of the management's plan to improve the trading liquidity of the company shares. This is the fourth bonus issue for the company since its listing in 2000.

Meanwhile, the company has also announced a share buyback scheme, although the research house does not expect the management to be actually really active in buying back the company shares under normal circumstances. Any buyback is apparently more to mitigate extreme and unusual volatility in the company share price, especially given the recent post-election sell-down on the local bourse.

Impressive track record

Analysts generally have a favourable view of QL, not least because of its steady profit track record since 2000 (see Chart 1). In recent years, CLSA Research notes that QL's earnings per share actually grew by a CAGR of 35% from FY03-FY07, although the growth rate is likely to moderate to 10%-15% in the next few years.

Looking ahead into FY08 and beyond, CLSA Research expects QL to benefit from a number of factors such as its recent acquisition of poultry units and marine product manufacturers; new deep sea fishing vessels; its oil palm development in Indonesia; and also the new livestock farming venture in Vietnam (see table below).

Some risky factors to consider

Still, there are some concerns on the company's marine division, especially given the recent rise in petrol and diesel prices, which are likely to see an increase in fish prices. Analysts say that diesel accounts for around 70% of fishing costs as the nets being pulled by trawlers are actually very heavy.

However, QL's management is apparently confident that increases in fish prices could easily be passed on to consumers as fish-based products are still in demand, especially in its export markets. However, some erosion of margin is likely for the company's domestic market, where local consumption is likely to take a hit with the higher cost of living.

According to CLSA Research, fish supplies are also affected by weather and seasonality effects, the low season being from January to March, while the October to December period is the high season for supplies. Supplies can swing 20%-30% in these periods. While QL always maintains buffer inventories, extended period of short supplies may affect its production, especially given recent cases where fishermen are refusing to go out to sea due to the high fuel cost for their fishing boats.

The local fishing industry and fish product manufacturers also received bad publicity recently when it was reported that seafood products from Malaysia face a possible ban in the European Union (EU), which is proposing measures to suspend their import on the grounds that they do not meet EU health standards.

However, the mitigating factor is that QL's exports to the EU only account for less than 1% of its revenue at present, says AmResearch. Still, sentiment on the stock may be affected if the government does not quickly try to get the proposed measure reversed.

For its poultry business, the biggest risk is probably the outbreak of diseases such as the avian flu, which could affect the consumption of chicken meat and eggs. As for its oil palm industry, the risk is obviously of a new down-cycle in CPO prices after the current up-cycle.


QL has a competitive edge in its businesses by virtue of it being the largest surimi manufacturer in Asia, as well as a leading poultry and animal feed player in Malaysia. The company is touted as a play on rising food consumption and rising demand for palm oil as a food/energy source.

Analysts are generally positive on the company's outlook with the consensus assigning a fair value target price of RM3.59 on the stock, which is trading around RM2.77 at the time of writing, implying a further upside of around 30%.

However, investors will have to bear in mind that the company's share price has risen substantially in the past couple of years, though on healthy fundamentals. The challenge for the management, going forward, is to sustain the company's growth momentum, which will no doubt be more difficult, given the larger earnings base of the company. The accelerated growth phase of QL is probably over, but the company is still seen to be able to deliver a 10%-15% growth rate in the next few years.

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