Etika International Holdings Ltd Petra Foods Limited · page 2 NRA Capital Pte Ltd Etika International Holdings Ltd Earnings Prospects and Valuation We are expecting strong net earnings

Source: Bloomberg

Etika International Holdings Ltd Petra Foods Limited

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Initiation Report

Defensive Basic Food and Beverage play

� Basic Consumer Food and Beverage Company. Etika International Holdings (Etika) focuses largely on the manufacture and/or distribution of basic food & beverage (F&B) products, such as sweetened condensed milk, evaporated milk, frozen meat, bread, etc. The business offers investors a defensive proposition in a climate plagued with uncertainty and weak global economic growth.

� Health-related F&B vision… achieved through acquisitions. Etika has a longer-term vision to diversify into a health-related F&B company focusing largely on the Asia Pacific region. As part of the longer-term vision, over 2006 to 2008, Etika acquired four other businesses, which provided either synergistic or supporting benefits to the Group’s core business in the manufacturing of sweetened condensed milk and evaporated milk. Each business unit is currently managed by industry veterans, many of whom are also shareholders of Etika to ensure alignment of personal interests with the success of Etika.

� Restructuring and expansionary phase. FY9/08 was a year of consolidation for Etika. The Group is in the midst of restructuring and consolidating the various business operations for cost-saving benefits. Also, in the pipeline are plans to expand the capacity of businesses faced with capacity limitations. The full benefits of the capacity expansion are expected to come through in FY9/2010.

� Ongoing access to trade finance for working capital is a key concern. In view of the proposed acquisition and expansion exercises, the balance sheet position has weakened. Group gearing is expected to remain high but at below 2.0x. More importantly, Etika has a high percentage (about 64% of total bank borrowings as at 31 March 2008) of short-term debt as the Group employs trade financing for its operations. In light of tight credit facilities, the key risks is the ongoing availability of trade financing facilities for the Group’s working capital needs.

� Valuation and Recommendations. We are expecting 3-year CAGR of about 60% over FY9/2007 to FY9/2010 in view of full year contributions from new business acquisitions and capacity expansion as well as abating raw material prices. Valuing each business unit separately at the PER multiple of the respective industry peers and applying a steep 60% discount, we arrived at a fair value of S$0.19, implying an undemanding PER of 4.4x (FY9/09). Etika is a fundamentally undervalued and defensive basic F&B company. We recommend a BUY, on the premise of ongoing access to trade financing.

Key Financial Data RMm YE 30 Sep FY06 FY07 FY08F FY09F FY10F Sales 233.2 391.5 588.7 724.6 909.2 Gross Profit 32.6 66.8 117.2 143.3 185.2 Net Profit 4.9 9.1 22.0 26.5 36.9 EPS (RM cents) 2.9 4.4 8.5 10.2 14.2 EPS growth (%) -59.6 55.2 90.4 20.4 39.4 PER (x) 12.1 7.8 4.1 3.4 2.4 DPS (RM cents) 0.95 1.14 1.38 1.38 1.38 Div Yield (%) 2.7 3.3 4.0 4.0 4.0

BUY Current Price S$0.145 20 October 2008 Fair Value S$0.19 Angelia Phua 65-62366-802 [email protected]

Historical Chart

Source : Bloomberg

Stock Statistics

Market Cap S$36.3m 52-HI S$0.16 52-LOW S$0.10 Avg Vol 43,548 Shares Outstanding 250.2m

Free Float 74.2m

Key Indicators

ROE 15.1% ROA 3.8% P/BK 1.1x Gearing 1.7x

Major Shareholders

Tan Family 50.68%

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Etika International Holdings Ltd

Earnings Prospects and Valuation

We are expecting strong net earnings growth, at a 3-year CAGR of 60% over FY9/2007 to FY9/2010. This will stem mainly from the full year impact of capacity expansion at the Dairies, Frozen Foods and Packaging Divisions in FY9/2010, costs savings achieved through the restructuring the operations of each Divisional business, which were previously independently run, as well as easing costs of certain key raw materials.

Under the Dairies division, the need for halal certified dairy products is expected to bring about strong export demand from the West African region, a Muslim nation, where Etika derives about 23% of the Group revenue from. On the domestic front, growth is expected to be underpinned by further penetration into the Malaysian markets and shifting towards the sale of “Dairy Champ” products, which carries higher margin, instead of OEM arrangements.

The wholesale segment of the Frozen Food division is expected to face continuous pressures from price-cutting activities from competitors, resulting in margin squeeze. However, healthy demand from the high-margin Bakery and Butchery segments will mitigate the effects of margin squeeze from the wholesale business. The Bakery segment is expected to see strong growth through OEM arrangements with major international food chains as well as sale to supermarkets. Greater demand for value-added convenience food will also drive growth for the Butchery segment.

The Packaging division will primarily support the growing Dairies division. Further, the completion of new plant in Klang will carry additional production lines, which are expected to enhance capacity by about 15% to meet both internal and external demand growth for tin cans.

As the Nutrition industry is highly competitive in the Australia and New Zealand (ANZ) markets, new product development is key to mitigate margin pressures from price discount exercise employed by competitors. The division’s continuous focus on its key competence in product development, advertising and promotions will underpin divisional growth. Further extending its geographical reach to Asia, when market conditions are suitable, will provide the next platform of growth.

The Beverage division is a small outfit within Etika and contribution is small at present. The Division is expected to benefit from Etika’s extensive network for growth.


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Table 1 : Peer Comparison

Cur- Share Mkt Cap PE (x) PE (x) PE (x) PE (x)

Code rency Price $ $mil (FY07) (FY08) (FY09) (FY10)

Malaysian-listed comparables for Dairy products

Nestle (Malaysia) Bhd NESZ MK RM 28.25

6,624.6 20.3 20.6 19.1 18.1

Fraser & Neave Holdings FNH MK RM 8.20

2,923.2 16.5 16.5 15.6 14.8

Dutch Lady Milk Industries

DLM MK RM 8.95

572.8 16.6 13.0 11.0 na

Sector Average 17.8 16.7 15.3 16.4 Malaysian-listed comparables for Frozen Foods division

Silver Birds Group SBG MK RM 0.730

229.3 na na na na

Singapore-listed comparables for Frozen Foods division

QAF Limited QAF SP SGD 0.175

78.9 17.5 na na na Singapore Food Industries SFI SP SGD 0.740

382.0 10.7 11.2 10.7 na

Sector Average 14.1 11.2 10.7 na Comparables for Packaging Division

Hindustan Tin Works HTW IN INR 18.900

196.6 2.4 na na na

Johor Tin Bhd JOHO ML MYR 0.510

40.0 na na na na

Can-One Bhd CAN MK MYR 0.765

116.6 9.7 na na na

Kian Joo Can Factory Bhd KJC MK MYR 1.030

457.5 11.2 7.7 7.4 5.4

Sector Average 7.8 7.7 7.4 5.4 Comparables for Nutrition Division Schiff Nutrition Int'l WNI US USD 5.25 143.7 11.2 10.5 10.1 9.2

Reliv' International Inc RELV US USD 4.74 68.8 14.4 21.5 15.8 na

Sector Average 12.8 16.0 12.9 9.2 Comparables for Beverage Division

Fraser & Neave Holdings FNH MK RM 8.20

2,923.2 16.5 16.5 15.6 14.8

Natural Bio Resources NBIO MK RM 0.31

91.5 na 2.7 3.2 na

Spritzer Bhd SPZ MK RM 1.25

61.3 na 7.8 7.1 6.0 Sector Average 16.5 9.0 8.7 10.4 * loss-making in FY07 & no future earnings estimates from Bloomberg

Source : Bloomberg


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We valued each of the five business divisions independently, at the respective PER multiples traded by its sector peers. For the Dairies Division, we apply PER of 15.0x (FY9/09), Frozen Foods Division : PER of 10.0x (FY9/09), Packaging Division : PER of 5.0x (FY9/09), Nutrition Division : PER of 12.0x (FY9/09) and Beverage Division : PER of 8.0x (FY9/09). We arrived at a valuation of S$0.475. But taking into account the large capitalization of the listed peers, illiquidity of the shares, Etika’s relatively high gearing, heavy reliance on trade financing for working capital needs and the current political risks associated with Malaysia, we apply a 60% discount to arrive at a fair value of S$0.19, implying an undemanding PER of 4.4x (FY9/09) for the Group. The company is a fundamentally undervalued and defensive basic F&B play. We recommend a BUY on Etika on the premise that the Group has ongoing access to trade finance for its working capital needs.

Malaysian Economic and Trade Outlook

Malaysia’s current population of 27.73m is growing steadily at an annual rate of about 1.95%. The country has seen an increase in purchasing power (per capita income of RM24,523) and with it, increases in the standard of living.

Growth for exports of processed food from Malaysia recorded an average annual growth of about 19.85% over 2004 to 2006. In particular, the export of Dairy Products has grown at an average annual growth rate of 20.55% over 2004 to 2006. Among the dairy products produced in Malaysia are milk powder, sweetened condensed milk, pasteurized or sterilized liquid milk, ice cream, yoghurt and other fermented milk. These are indications of the increasing acceptance of Malaysia’s food products in overseas market.

Malaysian Food Industry

Halal Food Hub

The global market value for halal food is estimated at about US$547b per year. Malaysia, as a Muslim nation, has the edge and is well positioned to be the hub for the promotion, distribution and production of halal food and non-food products, to capitalize on this growth. As the Malaysian Government is focusing on increasing food production in the country as well as making Malaysia an international halal hub, food-processing companies can leverage on Malaysia’s strength in halal certification and Government’s promotional efforts to capture the halal market overseas.

Currently, the key areas for growth and development in the food processing industry in Malaysia are functional food, convenience food, food ingredients and halal food.


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Etika Group

Etika, which was established in 1997, is a leading Food and Beverage Group domiciled in Malaysia. The Group is a manufacturer and distributor of sweetened condensed milk and evaporated milk, as well as a repacker and distributor of complementary products such as full cream and instant high-calcium non-fat milk powder, instant coffee powder and tea dust. The dairy products, sold under the “Dairy Champ” brand has grown to become a well regarded name. This operation is housed under the Dairies Division.

Over 2006 to 2008, the Group acquired several on-going businesses, which is housed under four other operating divisions.

Under the Frozen Food Division, the Group houses one of Malaysia’s leading frozen food and premium food wholesale business, servicing the hospitality and consumer-based food industry. Its major clients include 5-star hotels, airlines, cruise ships, hyper/supermarkets, bakeries, butcheries, fast-food-chains, grocery store, food processors and other wholesalers.

The Packaging Division houses a local tin can manufacturing business with production facilities in Malaysia. This division supplies tin cans to food related business as well as non-food business such as aerosol producers.

The Nutrition Division markets branded sports nutrition and weight management food products to athletes and mass consumer markets. The business trades under the “Horleys” brand name as well as other proprietary brands including “Sculp”, “Replace” and “Pro-Fit”.

The Beverage Division is involved in the manufacture of carbonated and non-carbonated canned drinks under the “Polygold” brand.

All five businesses are part of Etika’s longer-term vision to diversify into a health-related food and beverage company in the Asia Pacific region.

The Group was listed on the main board of the Singapore Stock Exchange on 23 December 2004.

Industry veterans run and manage each division. At the holding level, four key personnel namely, Datok Kamal Tan, Executive Director, Mr Mah Weng Chong, Non-Executive Director, Mr Khor Sin Kok, Alternate Director to Mr Mah and Mr Desmond Thong, Chief Financial Officer are collectively responsible for the decision-making process, including expansion plans, resource allocation of the Group. The daily operations of each division are currently managed by the previous owners/employees of the businesses prior to being acquired by Etika. These key management personnel are veterans of their respective industries.


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Dairies Division

Industry Outlook

In Malaysia, sweetened condensed milk and evaporated milk are the preferred choice of dairy products used in tea, coffee, other beverages and local desserts and these products are widely consumed in households, restaurants and mamak stalls. Generally, the demand for sweetened condensed milk and evaporated milk are largely driven by the healthy economic and population growth.

The domestic milk market structure is dominated by a few players in view of relatively high-barriers to entry such as high capital outlay, the need to establish a brand and market share, technical expertise and in-depth industry knowledge. Consequently, there are hardly any new competitors in the industry.

In Malaysia, domestic sales of sweetened condensed full cream milk and sweetened filled milk are price controlled items subject to price ceiling imposed by the Ministry of Domestic Trade.

Market trends of major costs

The raw materials used for the manufacturing of sweetened condensed milk and evaporated milk comprise mainly milk powder, sugar, palm oil, vitamins and packaging material (such as tin cans, labels and cartons). The strong surge in prices of these key raw materials starting late 2005 has largely stabilized towards end 2007.

The market price of skimmed milk powder has retreated from its peak of US$5,300 per mt towards end of 2007 and stabilizing at the current price of below US$3,000 per mt as a result of higher milk output from the USA coupled with weakening worldwide demand. Similarly, prices of other milk solid (such as sweet whey powder) have also declined towards end of 2007 and are expected to stabilize in price.

Crude palm oil has stabilized at RM1,800 per mt price range and is expected to remain firm.

The exception is the price of tin plate, which has risen by about 80% over the past one year starting September 2007 and this upward trend is expected to persist in the short term.

Structure, Growth Prospects and Strategy

Experienced team with technology know-how, industry knowledge and strong management skills. The Dairies Division is well managed by a very experienced team of veterans, who were previously employees of Fraser & Neave, an established listed food and beverage company. The team carries with them decades of industry knowledge, manufacturing and technical know-how of the food and beverage business, in particular, sweetened condensed milk and evaporated milk.


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Second largest market share in Malaysia…. and growing stronger. Etika sells sweetened condensed milk and evaporated milk under the “Dairy Champ” brand name as well as under OEM arrangements. To-date, the Group has about 20% to 25% market share for these products in the domestic market, compared to a market share of about 11% in 2004, but coming second after Fraser and Neave, which has the dominant market share of 55% to 60%.

Based on a population growth of close to 2% per annum in Malaysia, the market growth for the sweetened condensed milk and evaporated milk is estimated to grow by about 5% annually, providing Etika the basic landscape for growth. Beyond that, Etika plans to further gain market share through expansion of product range, enhancing market and distribution efforts to penetrate more areas in Malaysia as well as shifting the sale of products under the current OEM arrangement towards the sale of products under its own “Dairy Champ” brand. With the current OEM arrangements with several large supermarkets such as Carrefour, Giant, Tesco and Jusco, which are affirmation of the quality of “Dairy Champ” products, the shift towards the sale of own brand products is expected to be well-received and further enhance profit margin for the Group.

Export growth is strong as well. On the export front, Etika has been successful in exporting to countries in the West African region, which are Muslim nations. Over the past two years, Etika’s export revenue to the West African region registered strong growth of about 30% annually. To further capitalize on the demand for halal dairy products, Etika plans to penetrate into new markets in the region including Angolia and Nigeria.

Etika also exports to the Asean countries, particularly, Singapore and Indonesia, which share similar culture and food as Malaysia. In Singapore, Etika distributes “Dairy Champ” products via Yeo Hiap Seng, which is an established food and beverage company with a wide distribution network. To-date, sales have been well-received, exceeding Group expectations. In Indonesia, the locals have strong preferences for sweet products, offering strong growth potential for the Group. Etika plans to have a manufacturing presence in Indonesia in the future to take advantage of the lower costs of operations.

Capacity expansion by 30% to capitalize on domestic and export growth. To capitalize on the growth potential, Etika is planning to expand the current plant capacity at the existing factory, which is running at a high utilization rate for both sweetened condensed milk and evaporated milk, by about 30%. The expanded capacity is expected to be fully operational by end of FY9/2009 and full contributions are expected in FY9/2010.


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Risks

Significant increase in raw material prices. The costs of raw materials used for the manufacturing of sweetened condensed milk and evaporated milk such as milk powder, sugar, palm oil, vitamins and packaging material (such as tin cans, labels and cartons) have seen strong surge in prices since late 2005 till end 2007. These costs hike have eroded gross profit margin (GPM). Although the strong branding of “Dairy Champ” has enabled Etika to raise the selling prices of its products without impacting the continuous demand for the products, there is a six- to nine-month lag period between an increase in raw material price and raising the selling price of Etika’s dairy products. This lag is partly due to market competition. Also, about 90% of the sweetened condensed milk and evaporated milk manufactured by Etika are in the creamer segment, which is not a price controlled item in Malaysia. However, the price of creamer in the domestic market is guided by price controlled items, such as sweetened condensed full cream milk and sweetened filled milk, and are subject to price ceiling imposed by the Ministry of Domestic Trade in Malaysia. This further accounted for the lag period.

Failure to meet health standards resulting in loss of consumer confidence. The recent food scandal over milk powder in the PRC containing melamine content has brought about questions on the quality and safety standards of milk and dairy products. Etika has confirmed that the milk ingredients used for the production of milk products are sourced from New Zealand, Australia, United States of America and Europe. More specifically, none of the milk ingredients used in the production of sweetened condensed milk and evaporated milk is contaminated with melamine.

Inability to retain experienced and competent management personnel. The success in relation to the Dairies business depends largely on the continuous efforts of the existing management team. In particular, Mr Mah Weng Chong, Managing Director (MD) of Dairies Division, Mr Khor Sin Kok, Executive Director (ED) of Dairies Division and Mr Ronnie Kwong, Director of Sales and Marketing of Dairies Division, are veterans of the dairy food industry having spent about 34 years, 12 years and 34 years respectively, in the Malaysian dairy division of Fraser & Neave, a listed company in the SGX-ST. In addition, all three veterans have been with Etika for about 11 years each. To ensure alignment of personal interests and the success of Etika, Mr Mah, Mr Khor and Mr Kwong have an equity holding of 5.29%, 4.98% and 4.72% respectively in Etika.

Frozen Food Division

Industry Outlook

Worldwide beef prices have been on the increase due to higher demand from PRC, Japan and Russia. This is further compounded by bad weather conditions in producing countries as well as rising feed costs. The delay in approving more Australian and New Zealand beef plants by the Malaysian government for halal slaughtering further aggravated the supply issue and hence prices.

The prices of imported dairy products such as butter, cheese and cream, have also increased by over 45% over six months from September 2007 till March 2008 but have since stabilized though sales have been dampened.


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Other imported Fast Moving Consumer Goods (FMCG) products (such as oats, muesli, frankfurters, etc) have also increased in prices and with further price increase expected in the short term.

Structure, Growth Prospects and Strategy

Industry veterans running the show. The Frozen Food Division houses a leading frozen food and premium food wholesale business, Pok Brothers Sdn Bhd (PB), which Etika acquired in 2006 from the Pok family, at a fair PER of about 9x (FY2006) of sustainable net profit after tax of RM2.5m annually. The previous owners, the Pok brothers, have many decades of experience in the business and are currently running the daily operations of the Division.

This division imports and distributes food products, both in raw and processed form, to the hospitality and consumer-base food industry, with major clients including 5-star hotels, airlines, cruise ships, hyper/supermarkets, bakeries, butcheries, fast-food chains, grocery stores, food processors and other wholesalers. The business also holds the official appointment to import and distribute goods on behalf of internationally known restaurant chains in Malaysia, such as TGIF, Subway, Tony Roma’s, Carl’s Junior, etc. Some of the Division’s major customers include Tesco Stores (M) Sdn Bhd, Dairyfarm Giant Retail Sdn Bhd and Sunway Resort Hotel Sdn Bhd.

The division is also involved in the manufacturing of value-added frozen food products such as cold-cuts and sausages, smoked salmon, etc, which is sold under the “Gourmessa” home-grown brand as well as frozen bakery/confectionery products.

Penetrating into upmarket food-segment. The acquisition of PB brings Etika a step closer to the long-term vision of a healthy-related Food & Beverage Group. The strong recognition of the Frozen Food business within the industry provides Etika with a wider spectrum of food products, a wider distribution network and a larger customer base. The diversity will enable Etika to spread market risks and broaden the Group’s business within the food industry.

Major restructuring to address capacity constraint. The entry into value-added frozen food and bakery products has proven to be a success. Although the margins are attractive, revenue contributions to Group from this business segment is still small, at less than 5% in view of capacity constraints at the current production premise at Shah Alam, where the warehousing facilities comprising cold rooms and dry stores for the core business are also located.

Plans are in place to relocate the bakery segment to a new plant-cum-warehouse in Klang, which will house the new bakery facilities and expand the bakery capacity by about 150% by end FY9/09. The current warehousing-cum-production facility at Shah Alam will also undergo restructuring to further enhance the cold room and dry room capacities by about 30% and 20% respectively, but more importantly, expand the production capacity of the butchery segment, where capacity constraint prevails currently. The restructuring at the existing warehousing-cum-production facility is expected to complete by end FY9/09.


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Capacity constraints are also felt in Penang, where Etika also owns a small cold room warehousing facility. Plans are also in place to build a new cold room warehouse in Penang, which is estimated to costs about RM4.0m, to enhance the warehousing capacity by about 100%. The completion of the new facility is expected by end FY9/09.

The full-year impact of the production and warehousing expansion at the various segments of the Frozen Foods Division will come through by FY9/2010.

Risks

Inability to retain experienced and competent management personnel. The success in relation to the Frozen Food business depends largely on the continuous efforts of the existing management team of Pok Brothers. In particular, Lawrence Pok, MD, has been instrumental in building up the business having spent about four decades in the business. We understand that the MD’s “contractual” ties with the Group will end by February 2009 with the payment of the final dividend instalment. However, the Pok family collectively has an equity stake of 7.01% in Etika. This will, help to align the interest of the Pok family and the success of Etika.

Increase in prices of supplies will raise costs of purchases and adversely affect profit margins. Most of the supplies from the Frozen Food divisions are sourced internationally and the prices of these supplies may fluctuate according to demand and supply conditions. Any unusual shortage in supply, surge in demand or adverse currency movements may lead to increase in the price of the supplies. There will be risks of margin pressure if all the price increase cannot be passed to consumers.

Increase in market competition may result in lower selling prices, reduced profit margins and erosion of market share. The frozen foods and wholesale business is highly competitive and barriers to entry are low. The strengthening US Dollar versus Ringgit, the increasing prices of most major imports coupled with higher shipping and transportation costs have resulted in competitors resorting to constant price under-cutting and increased advertising and promotion in the FMCG business via trade marketing and price-off short-term activities. In order to protect its market share, Pok Brothers may need to adopt aggressive pricing policies, which will result in margin squeeze.

Product deterioration may result in loss of revenue and compensation payments. A large proportion of revenue from the Frozen Food division is derived from import and wholesale of generic products where PBs has to assume the inventory risks. (This is in contrasts to the proprietary business where PB holds the official distributorship to import and distribute supplies for international restaurant chains and do not assume the inventory risks.) Any delivery delays or malfunctioning of the freezer facilities or poor handling may result in revenue loss or compensation to customers.


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Packaging Division

Industry Outlook

One of the key raw materials for tin can manufacturing is tin plates. The global economic and construction boom has resulted in sharp escalation of commodity prices over the past two-and-a-half years. In particular, prices of tin plate have escalated by 80% over a one-year period from September 2007 to about US$1,800 per metric tonne (mt). In view of higher input costs of raw material, tight worldwide supply and higher freight costs, prices of tin plates are not expected to taper off in the short term.

Company Structure, Strategy and Growth Prospects

Industry veterans running daily operations. This division houses the operations of General Packaging Sdn Bhd (GP), a local tin can manufacturing business with production facilities in Malaysia. The daily operations are run and managed by Mr Yong Weng Chye, Chief Executive Officer (CEO) and Ms Cindy Chan, General Manager (GM), who are industry veterans and were the previous controlling shareholders of the packaging business. The division supplies tin cans to both food and non-food companies and also exports its tin cans to Singapore, Philippines and Australia.

Etika invested an initial 65.04% stake in GP in April 2007 and further raised the stake to 99.04% in January 2008.

Vertical integration. As one of Etika’s key businesses is in the manufacture of sweetened condensed milk and evaporated milk, which is packaged using tin cans, the acquisition into a tin can manufacturer will reduce the Group’s reliance on external suppliers of tin cans. More importantly, it enables the Group to control the costs of packaging, which is one of the key costs components of the Dairies division. Currently, the Dairies division contributes about 60% to the Packaging division’s revenue.

Expansion plans will bring about Group costs savings and meet internal and external demand needs. With a large percentage of the capacity dedicated to the tin can demands of the growing Dairies division, the capacity available for external demand is limited. This is evident from the revenue breakdown which shows that about 35% and 5% of the divisional revenue are derived from third-party food-related customers and customers in the aerosol business respectively.

To address the issue of space and capacity constraint, which will stifle the growth of the division, expansion plans are on the cards. Etika plans to relocate the existing manufacturing facilities in Petaling Jaya, which is running at a high utilization rate, to a new plant-cum-warehouse in Klang, which will reside next to the new and extended manufacturing plant for the Dairies Division. The relocation will bring about smoother operational flow and savings in transportation costs, which will further boost Group GPM. In addition, the new plant will also carry additional production lines, which is expected to enhance capacity by about 15%, to meet both internal and external demand growth for tin cans. More specifically, one of the new lines will be dedicated to the production of tin cans for packaging aerosol, which carries higher GPM.


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Risks

Rising prices of tin plates. Tin plate is the key raw material used in the manufacturing of tin can, constituting about 60% of total raw material costs. Over the past one year, the price of tin plates has risen by about 80% but a substantial portion of the raw material price increase has been passed on to customers. Going forward, the risk is that the Packaging division will not be able to pass future price increases of raw materials, in particular tin plates, to customers. Management, however, has indicated that they are confident of passing on future price increases of raw materials to customers.

Inability to retain experienced and competent management personnel. The success in relation to the Packaging Division depends largely on the continuous efforts of the existing management team. In particular, Mr Yong of GP has extensive knowledge in the food and packaging business in Malaysia, Thailand, Singapore, Hong Kong and the PRC markets through his involvement with the Lam Soon Group. To ensure management continuity, Etika has structured the payment of 50% of the consideration for GP via the issue of new shares of Etika. Currently, Mr Yong has an equity stake of 3.96% in Eitka. This will help to align the interest of Mr Yong and the success of Etika.

Nutrition Division

Industry Outlook

Dairy based proteins are a significant ingredient in a large percentage of sports nutrition and weight management food products. The surge in demand in emerging economies has coincided with an international shortage of supply, driving prices higher towards end of 2007. Even though world prices of milk powder has since softened from its high, certain ingredients used for sports nutrition and weight management food products remained in tight supply.

Company Structure, Strategy and Growth Prospects

Managing Director who reconfigured the Group is still running the operations. The nutrition division markets branded sports nutrition and weight management food products to athletes and mass consumer markets, under the “Horleys” brand name. The business, Naturalac Nutrition Ltd (NNL), which was acquired in January 2007 from the Fonterra Group, a company listed on the New Zealand Exchange and is one of the world’s largest dairy product companies, is a small operation relative to Fonterra Group’s core operations. Mr Richard Rowntree, Managing Director (MD) of NNL, who was part of the team that reconfigured and moved NNL to a strong financial footing, is currently part of Etika’s senior management team involved in the daily operations of NNL.


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Lean Business Model helps speed up new product development and reduces resource needs. NNL adopts a lean business model, focusing on its key competence in product development, advertising and promotions as well as customer service. (Presently, NNL has one exclusive distributor in New Zealand and four sales territory owners in Australia). The focus on product development will shorten the time taken for product development from concept to market, providing the business an edge over its competitors as well as stand-out in this niche market. Further, as the processing and production of products are outsourced to third party manufacturers, the need for substantial resources, both financial and non-financial are reduced, lowering the operational risk of the business.

Achieve further synergy and extend geographical reach. The acquisition of the nutrition business will further widen Etika’s offering of food products in the market. Further synergy will also be achieved through integration of marketing, warehousing and distribution facilities. As the Nutrition division operates in a niche market, which offers products that are of higher margins albeit lower volumes, the Nutrition business will help lift GPM of the Group. The Horleys brand name is well-known and established in the ANZ markets, where the Nutrition division derives about 90% of total revenue from. This business will also serve as a platform for the other business divisions of Etika to access a new geographical market and enhance recognition in ANZ, through co-branding and brand promotions.

Product launches and other markets. New product launches will continue to underpin growth in this niche business. The launch of new product lines has been on or ahead of schedule with the re-launch of the entire elite range planned for the later part of 2008. The introduction of products from the Nutrition division into South East Asia, where Etika has or is actively building up a brand name and distribution network, will further lift growth. Currently, the Division has one non-exclusive distributor in Malaysia. Going forward, the Group plans to move into other Asian markets, including, Singapore, Hong Kong, Thailand, PRC, Indonesia and the Philippines as well as North Asian countries. However, the progress on this front has been slow in view of brand loyalty and consumer preferences.

Risks

Intense competition from industry players. NNL operates in a competitive industry in its key markets in ANZ. Its key competitors include Nutralife, Musashi, Max’s and EAS and some of these competitors may have access to more technical and financial resources which enable them to reach faster to consumer demands. Further, in a competitive market, price discounts or non-price competitive measures may be employed by competitors to gain market share.

Limited knowledge in business. One key concern is the limited knowledge the current senior management of Etika has in the nutrition business, which may affect their ability to manage the operations profitably and in a timely manner.


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Failure to retain services of key personnel. Currently, Mr Rowntree, MD of NNL, who was part of the team that reconfigured and moved NNL to a strong financial footing, is currently part of Etika’s senior management team involved in the daily operations of NNL. However, Mr Rowntree is an employee of Etika and does not have any equity stake in the Group. The continued success is highly dependent on the ability to retain the service of Mr Rowntree and other personnel who are instrumental to the success of NNL.

Dependency on major manufacturers. NNL’s products are subcontracted out to external manufacturers (OEM manufacturers) including Nice & Natural and Sutton. Manufacturers, who produce a substantial portion of NNL’s sales, may also hold certain proprietary manufacturing knowledge or recipe for NNL’s product ranges and there is no certainty that these proprietary knowledge will stay with NNL.

Inability to pass higher raw material costs fully to consumers. As a result of higher raw material costs, NNL has passed on a portion of raw material price increases to end consumers through several selling price revisions towards end of 2007. The response has not been positive as there has been negative impact on sale volume. In view of that, NNL is now forced to absorb some costs increases to maintain market share in both of its core markets in ANZ. Accordingly, GPM from the Division is expected to come under pressure.

Beverage Division

Structure, Strategy and Growth Prospects

Contributions immaterial; previous GM at the helm of the business. The Beverage Division is involved in the manufacturing of carbonated and non-carbonated canned drinks under the brand name of “Polygold”, an established brand in East Malaysia. The business is a relatively small outfit within the Group and contribution is immaterial at present. Acquired in July 2007, the previous GM of the operations who worked under the previous East Malaysian owners, is currently running the operations.

Tap on distribution network of Dairies Division for growth. This Division provides Etika with a new product offering to consumers whilst tapping on Etika’s existing urban and rural distribution network in Malaysia under the Dairies division to gain market penetration.

However, as the historical focus was in East Malaysia, strong marketing and advertising efforts had to be put in place by Etika to strengthen the brand name in West Malaysia.


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Financial Performance

FY9/2007

Etika achieved 85.9% increase in profits after tax to RM9.1m on the back of a 67.9% increase in revenue to RM391.5m due to improvement in sales from all business divisions.

Dairies division, which accounted for 66.7% of Group revenue was the main contributor, grew by 46.1% to RM261.3m over FY9/06. The growth came from stronger sales of “Dairy Champ” in Malaysia as well as increase in export sales to Africa and the ASEAN countries, namely Indonesia, Singapore and Philippines.

The Frozen Food division, which contributed about 24.2% to Group revenue, registered about 74.4% increase in revenue growth to RM94.8m over FY9/06 due to the 12-month financial contributions in FY9/07, compared to 8 months in FY9/06 as the acquisition of the Pok Brothers frozen foods and wholesale business was only completed in January 2006.

The balance of the Group revenue was contributed by the Packaging, Nutrition and Beverage divisions.

Cost of Sales increased by 62.0% to RM324.7m, at a lower growth rate than revenue growth, resulting in 310-bps improvement in GPM to 17.1% in FY9/07, compared to 14.0% in FY9/06. The improvement in GPM was due to higher selling prices and process improvement which resulted in lower production costs in the Dairies division. The Group also benefitted from cheaper imports from strong Ringgit versus US dollar in the Frozen Foods division. Lastly, higher margins from the newly acquired businesses during FY9/08 further lifted GPM. In FY9/07, gross profit soared 104.6% to RM66.8m.

Total operating expenses soared 138.6% to RM48.1m. This was largely due to increase in administrative as well as marketing and distribution expenses, which increased by 95.4% and 142.7% to RM22.8m and RM22.3m respectively as a result of full year costs impact from the Frozen Foods division as well as from the newly acquired businesses in the Nutrition and Packaging divisions. As a result, operating profit margin improved only by 80bps to 5.3% in FY9/07 over 4.5% in FY9/06.

Finance costs also soared 120.2% to RM6.7m in FY9/07 due to higher working capital requirements from the Dairies division, 12-month financial impact of the Frozen Food Division as well financing requirements for the acquisition of new businesses under the Nutrition and Packaging divisions.

The effective tax rate is lowered by 520 bps to 28.1% in FY9/07, from 33.3% in FY9/06, due to the presence of negative goodwill. This further lifted the bottomline growth.

In FY9/07, Group gearing increased to 1.7x from 1.4x in FY9/06 due to loans requirements for the purchase of additional land adjacent to the existing plant in Klang as well as trade financing requirements to meet higher working capital needs of higher sales volume from the Dairies division.


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Etika recorded a negative cashflow from operation due to higher working capital requirement (in particular, higher raw material costs, inventory and trade receivables) as a result of growing business volume in the Dairies division. Apart from the Dairies division, all the other business divisions contributed positively to Group operating cashflow.

Source : FY2007 Annual Report

Source : FY2007 Annual Report


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Summary Financial Forecast YE 30 September 2006A 2007A 2008F 2009F 2010F Profit & Loss

Revenue (RMm)

233.2

391.5

588.7

724.6

909.2

Gross Profit (RMm)

32.7

66.8

117.2

143.3

185.2

Net profit (RMm)

4.9

9.1

22.0

26.5

36.9 Margins Gross margin (%) 14.0% 17.1% 19.9% 19.8% 20.4% Net margin (%) 2.1% 2.3% 3.7% 3.7% 4.1% Per share

Basic EPS (RM cts)

2.9

4.4

8.5

10.2

14.2

Op Cashflow (RM cts)

4.2

(7.0)

1.2

6.8

6.6

Net asset value (RM cts)

28.5

29.8

36.1

45.0

57.9 Common metrics PER (x) 12.1 7.8 4.1 3.4 2.4 P/OCF (x) 8.2 nm nm 5.1 5.2 P/NAV (x) 1.2 1.2 1.0 0.8 0.6 Free Cashflow

FCF* (RMm)

4.9

(17.8)

0.3

10.7

8.4

FCF/share (RM cts)

2.8

(8.6)

0.1

4.1

3.2

FCF Yield (%)

46.7 nm

2.0

67.6

53.3 * FCF takes into account capex needed to maintain current business capacity and operations


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Profit & Loss YE 30 September (RMm)

2006A 2007A 2008F 2009F 2010F

Revenue

233.2

391.5

588.7

724.6

909.2

Cost of Sales

(200.5)

(324.7)

(471.4)

(581.3)

(724.0)

Gross Profit

32.7

66.8

117.2

143.3

185.2

Operating Income

0.4

2.1

2.5

2.5

2.8

Administrative expenses

(11.7)

(22.8)

(32.5)

(40.1)

(50.3)

Marketing & distribution exp.

(9.2)

(22.3)

(40.3)

(49.6)

(65.4)

Other operating expenses

(1.6)

(4.7)

(7.1)

(8.7)

(10.9)

Accreditation of negative goodwill -

1.7 - - -

Operating Profit

10.5

20.8

39.8

47.5

61.4

Net interest

(3.0)

(6.7)

(10.8)

(12.3)

(12.1) Exceptional Items - - - - - Profits from Associated Co. - - - - -

Pre-tax Profit

7.5

14.1

29.0

35.2

49.3

Income tax

(2.5)

(4.0)

(6.2)

(8.6)

(12.3)

Minority Interests

(0.1)

(1.0)

(0.8)

(0.1)

(0.1)

Net Profit

4.9

9.1

22.0

26.5

36.9


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Balance Sheet YE 30 September (RMm)

2006A 2007A 2008F 2009F 2010F

Cash & Fixed Deposit

2.5

12.4

28.7

30.6

17.4

Trade Receivables

66.8

96.1

108.1

134.3

170.2

Inventory

29.5

57.2

84.0

104.6

131.5

Other current assets -

4.5

11.3

11.3

10.1

Current Assets

98.9

170.2

232.0

280.8

329.3

Property, Plant and Equipment

82.5

98.4

98.9

118.5

119.9

Others

4.9

23.3

21.4

21.4

20.9

Non-current Assets

87.4

121.7

120.3

139.9

140.9

Bank Borrowings

37.1

70.5

92.2

115.3

115.3

Bank OD

7.2

5.4

14.4

14.4

14.4

Trade Payable

49.5

61.5

64.6

80.4

101.2

Others

1.0

1.7

10.4

10.8

11.3

Current Liabilities

94.9

139.1

181.6

220.9

242.2

Bank Borrowings

26.5

60.8

60.8

66.9

63.6

Others

14.2

14.3

15.1

15.1

13.2

Non-current Liabilities

40.7

75.1

76.0

82.0

76.8

Shareholder's Equity

50.7

77.6

94.8

117.8

151.2


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Cash Flow YE 30 September (RMm)

2006A 2007A 2008F 2009F 2010F Cash flow from Operating activities

Pre-tax profits

7.5

14.1

29.0

35.2

49.3

Adjustments

6.9

14.8

21.3

23.8

23.8

Operating cash flow before working capital

14.4

28.9

50.3

59.0

73.1

Changes in working capital

(6.9)

(40.3)

(42.0)

(32.6)

(43.6)

Tax paid & others

(0.3)

(2.5)

(5.3)

(8.6)

(12.3)

Net cash generated from operations

7.2

(14.0)

3.0

17.7

17.2 Cash flow from investing activities

Acquisition of subsi., net of cash

(21.5)

(21.8)

(6.7) - -

Property, plant & equipment

(19.5)

(12.5)

(12.3)

(28.0)

(10.0)

Others

(0.4)

1.4

4.9

0.6

0.6

Net cash from investing activities

(41.3)

(32.9)

(14.1)

(27.4)

(9.4) Cash flow from financing activities

Loans

29.4

52.0

30.8

29.1

(3.3)

Others

(6.8)

6.5

(12.6)

(17.2)

(17.0)

Net cash from financing activities

22.7

58.5

18.1

11.9

(20.3)

Net change in cash

(11.4)

11.6

7.0

2.3

(12.5)

Cash balance at beginning of year

5.8

(5.1)

7.0

14.3

16.2

Other adjustments

1.0

0.5

0.3

(0.4)

(0.7)

Cash balance at end of year (net of OD)

(4.7)

7.0

14.3

16.2

3.0


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