UOB Kay Hian Research 2015-07-31: Halcyon Agri Corp - A Valuable Asset Play. Maintain BUY.

A Valuable Asset Play 


  • With the recent heightened volatility of rubber prices and a consolidating rubber sector, we adopt a longer-term approach and re-assess HACL on a replacement cost basis. 
  • Moreover, with the increasing potential for consolidation within the sector, we do not rule out HACL as a possible M&A target. 
  • We remain positive on the group’s business prospects, given the expected benefits of lower financing costs and the strengthening of the US dollar. 
  • Maintain BUY. Target price: S$0.68. 


WHAT’S NEW 


  • In view of rubber price volatility and potential consolidation within the sector, we have reassessed our valuation methodology and decided to adopt a longer term approach in analysing HACL through its asset value and replacement cost. 
  • This allows investors to side step quarterly earning variations and focus on the group’s long-term intrinsic value. 


STOCK IMPACT 


• Extracting value through synergistic acquisitions. 

  • In 2014, HACL extended its upstream operations with the acquisition of JFL Agro which is expected to provide for up to 10% of the group’s raw material needs in Malaysia. 
  • The group is expected to tap its first rubber trees in 2020 once the 16,061 acres of cultivable rubber plantation fully mature. 

• In addition, HACL expanded its midstream processing capabilities with the purchase of Chip Lam Seng, PT Golden Energi and Anson Company. 

  • In total, the 14 natural rubber production facilities in Indonesia and Malaysia have an annual licensed export capacity of 748,000 tonnes. 
  • We think that the downstream purchase of Centro Trade and New Continent Enterprises will allow HACL to leverage on their global network of logistics assets and offices. This facilitates the securing of new customers while deepening relationships with its existing customers such as Cooper Tire & Rubber and Bridgestone. 
  • We approximate that Centro Trade and New Continent Enterprise have a distribution capacity of 390,000 tonnes. 

• A beneficiary of the potential consolidation within the rubber industry. 

  • We expect consolidation to intensify within the rubber industry as it transits from “family-run” firms into corporatised outfits. 
  • The president of the Rubber Trade Association of Singapore, Mr. Tan Koh Young, is of the view that with an increasing need for rubber firms to have a trading platform, global reach, and financing capability, consolidation is inevitable. 
  • Given the capacity and size of HACL, we do not rule out the possibility of it ending up as an M&A target.

• Well-positioned despite rubber price volatility. 

  • Despite market sentiments that rubber prices have bottomed out, it remains volatile. 
  • We note that rubber (Standard Malaysian Rubber 20) prices in Jul 15 were most volatile in the last three years and on the back of such underlying volatility, near-term earnings could potentially be choppy. 
  • Despite the cyclical nature of the rubber sector, HACL has been able to take advantage of the recent down cycle to expand on its capabilities and undertake investments to position its business for the imminent up cycle. 
  • As a result, we note that HACL is well-positioned to benefit from operating leverage and economies of scale once the up cycle of the rubber market begins. 

• Tailwinds in HACL’s favour. 

  • We remain positive on HACL for the following reasons: 
    1. its ability to secure stable financing at lower interest costs, 
    2. it was successfully upgraded to the SGX mainboard, and 
    3. strengthening of US Dollar (US$). 

• Lower finance costs a positive. 

  • Post the US$413m refinancing in Jul 15, we approximate that HACL will reduce financing costs by US$11.2m in 2016. 
  • In addition, compared with the pre-refinancing bridging loans comprising term loans and working capital loans expected to expire in Aug 15, the new facilities ensure funding certainty and allow HACL to fortify its working capital resources and further ramp up production and distribution. 

• HACL is expected to benefit from the strengthening US dollar. 

  • We understand HACL hedges 50-60% of its forex risk and is a net beneficiary of a rising US dollar. 
  • The group is expected to mostly benefit from a weakening Singapore dollar against the US dollar as a 10% weakening of the Singapore dollar is expected to increase profit by US$9.0m. 
  • We note the Singapore dollar is likely to face weakness against the US dollar, given the expected uplift in interest rates in the US. 

• Successful upgrade to SGX Mainboard. 

  • HACL’s upgrade to the Mainboard marks an important milestone as it enhances the corporate status of the group. 
  • We view the upgrade positively as this will reduce liquidity risk, elevate visibility, extend HACL’s investor base and attract a higher level of interest from institutional funds. 


EARNINGS REVISION/RISK 


• No change to our earnings forecasts. 

  • We highlight that with the heightened rubber price volatility, there could be potential downside risks in our earnings estimates. 
  • However, investors should focus on the group’s long-term ability to benefit from consolidating upstream and downstream margins, operating leverage and economies of scale. 
  • We expect earnings to grow at a 5-year CAGR of 28%. 

• Key risks include low gross material profits and execution risks. 



VALUATION/RECOMMENDATION 


• Maintain BUY with target price of S$0.68. 

  • Given the near-term rubber price volatility and potential consolidation within the sector, we decided to value HACL based on the group’s replacement cost. 
  • We factored in a 30% premium for HACL’s production capacity given that no additional Indonesian rubber export licenses have been issued since 2013. 
  • We think this premium is well justified given its scarcity value. Based on our channel checks, we understand that the current premium potential acquirers are willing to pay is in the range of an additional 40-50%. 
  • We note that there is headroom for target price expansion should we adopt a 40-50% premium. 


SHARE PRICE CATALYST 


  • Rebound in rubber prices. 
  • Better margins.


(Bennett Lee, CAIA; Andrew Chow, CFA)

Source: http://research.uobkayhian.com/



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