Recovery in sight but sugar tax a key risk
? We are positive on PWRT in the near term given price hikes in Jan 22 and pent-up demand, which should bode well for 2HFY22.
? However, the reformularisation of its pre-mixed beverages to lower the sugar content following the sugar tax effective 1 Apr 22 may pose demand risk.
? Reiterate Hold, with a higher TP of RM1.40 (20x CY23 P/E).
Price increases in Jan 22 to offset the rising input and labour costs
We are positive on Power Root Berhad (PWRT) as management disclosed that it has raised average selling prices (ASP) by c.9-10% for its products in Malaysia (60% of 1HFY22 sales) and c.5% for other regions. We believe this could partially offset the rising raw material prices (i.e. coffee, sugar and creamer) and logistics costs, which we estimate could lift COGS by c.10-15%. Additionally, we gather that the group has locked in coffee prices at a favourable rate until Oct 22, which should help to alleviate some cost pressure. Prices remain unchanged for the Middle East market given the subdued recovery prospects owing to unfavourable policies. Wages have risen due to the labour shortage (up to 80%) but are still manageable (account for less than 15% of COGS).
Pent-up demand upon the reopening of economic activities
We gather that PWRT’s plants are now running at full workforce capacity and utilisation rates have almost returned to pre-pandemic levels (>90%) in order to catch up with production delays and fulfil backlog orders as well as pent-up demand upon the reopening of economic activities on 11 Oct 21. The group is also seeing strong replenishments from its customers in 2HFY22 on the back of the year-end festive season and Chinese New Year. We believe customers are front-loading purchases ahead of the price hikes. We understand that the rise in domestic sales (1HFY3/22: +19.4% yoy) was fueled by the expanding convenience and fixed-price shops (e.g. Mr Dollar, 99speedmart, Eco-Shop), which will continue to be one of its main sales growth drivers, in our view.
Measures undertaken to avoid sugar tax but demand at risk
In response to the excise duty (RM0.47 per 100g on pre-mixed beverages with sugar content of more than 33.3g per 100g) effective 1 Apr 22, the group has reformularised up to 95% of its pre-mixed beverages (c.75% of sales) to lower the sugar content to pre-tax levels instead of raising prices, which will be rolled out in Mar 22. However, we expect the slight change in taste to put demand at risk, particularly after the front-loading of purchases. Therefore, we cut our earnings for FY23-24F by 14-17%.
Reiterate Hold with a higher TP of RM1.40 as we roll over to CY23F
We retain our Hold call with a higher TP of RM1.40 (20x CY23F P/E, 5-year mean P/E). The stock is trading at a stretched valuation of 19x CY23F P/E but we believe that valuations will be supported by: i) solid dividend yields (3.3-5.2% for FY22-24F), ii) strong balance sheet (net cash of RM94.0m (RM0.22 per share) as at end-2QFY22), and iii) strong instant coffee market share in the domestic and Middle East markets.