CFA IRC-Sunway University Team (2013)

1

hosted by

CFA Malaysia

Sunway University

1

Sunway University Student Research Consumer Industry This report is published for educational purposes only

by students competing in the CFA Institute Research

Challenge.

Highlights

Fundamentals and valuations indicating a convincing BUY: We have derived a fair value of RM3.86 for QL, which represents an upside of 22% from current level.

With its involvement in resilient consumer businesses, strong earnings growth

prospects well supported by strong financial fundamentals and aggressive

expansions, we believe the current valuations are still relatively undemanding as

the exciting future prospects have yet to be priced in.

Recession-proof food-based business segments underpins resilient earnings: Fundamentally, QL sells defensive products, being basic staple food items such as

eggs, broilers, surimi and oil palm which are less vulnerable to the current market

uncertainties. Despite the outbreak of the avian influenza disease and sub-prime

mortgage crisis in FY09, QL recorded a significant PBT growth of 14.7%, once

again demonstrating its remarkable earnings resilience. Going forward, the

increasing significance of palm oil plantation business would add to the resilience

of core earnings. With the current market uncertainties, QLs well diversified and highly sustainable business model would be, therefore, appealing to investors

seeking for low-beta exposure.

Exciting earnings growth prospects: Since its inception in 1987, QL has never failed to deliver and this is reflected in its continuing revenue growth over the

years. In the recent three years, earnings have grown steadily with a CAGR of

about 11% since FY10. We believe QL is set to enter into a new phase of exciting

and sustainable growth. Based on our projections, we estimate a 3-year earnings

CAGR of 14.5% starting from FY12 while FY15 onwards shall see the fruition of

its current expansion plans across all three industry segments.

Tapping the Asian consumption growth story: Apart from its entrenched dominant position in its home country, QLs increasing geographical exposure in Southeast Asia, especially Indonesia is highly strategic in our view. QL has been

aggressively expanding its production and manufacturing operations in Indonesia

over the years and we are convinced on the rationale of such moves. Export

growth potential to Indonesia is massive as it is the largest economy in Southeast

Asia. Coupled with the strong GDP growth and expanding middle class, these will

be key engines for consumption growth as per capita income rises, which should

bode well for early movers such as QL.

Ticker: QLG MK Recommendation: BUY Price: RM3.16 Price Target: RM3.86

In RM million-FYE March FY10 FY11 FY12 FY13F FY14F FY15F

Total Revenue 1,476 1,777 1,947 2,131 2,319 2,654

EBITDA 188 225 249 300 333 383

Net Income 107 125 131 154 173 204

In RM

Earnings per Share 0.14 0.15 0.16 0.19 0.21 0.25

Book Value per Share 0.71 0.96 1.06 1.22 1.38 1.57

Dividend Yield (%) 1.7%

1.1%

1.3%

1.5%

1.5%

1.5%

Return on Equity (%) 20.6% 16.7% 15.8% 15.9% 15.8% 16.5%

Return on Assets (%) 10.4% 9.1% 8.3% 8.4% 8.3% 8.9%

Market Profile 52 Week Price Range(RM) 2.84 -3.40

Average Daily Volume 132,300

Beta 0.8

Dividend Yield 1.44%

Share Outstanding (Shares) 832m

Market Capitalization(RM) 2.6bn

Book Value per Share(RM) 1.1

Debt to Total Capital 46.8%

Return on Equity 15.8%

Major Shareholders(%)

CBG Holdings Sdn. Bhd. 44.9%

Farsathy Holdings SD 12.9%

QL Resources Bhd

Source: Company data and teams estimates

Date: 2 November 2012

1000

1100

1200

1300

1400

1500

1600

1700

2.00

2.20

2.40

2.60

2.80

3.00

3.20

3.40

3.60

Sep 30

2011

Jan 31

2012

May 31

2012

Sep 30

2012

QL's Share Price & KLCI index

QL KLCI

Source: Company data

Source: Bloomberg

RM

CFA Institute Research Challenge 2013 2 November 2012

2

3.3% 3.6%

6.7% 7.2%

0%

1%

2%

3%

4%

5%

6%

7%

8%

2012 2013

World Developing Asia

Business Description

QL Resources Berhad is a leading Malaysian agricultural based group. Founded in

1987 as a small scale integrated livestock business, it has come a long way to

evolve into one of the Malaysia's largest integrated resource-based food agriculture

companies with a market capitalization of RM2.6bn. Headquartered in KL, QL was

first listed on March 2000 and currently operates in three principal activities,

namely Integrated Livestock Farming, Marine Products Manufacturing and Palm

Oil Activities. Dr Chia Song Kun is the founder as well as the Managing Director

of the company. Currently, Dr Chia holds 46% direct and indirect stake in QL.

Integrated Livestock Farming Activities (ILF)

Organic growth and a series of strategic acquisitions has driven QLs rise to become one of the largest poultry egg producers and animal feed raw materials

distributors in Malaysia. It is also a leading integrated broiler and Day Old Chicks

(DOC) producer in East Malaysia. It currently operates eight commercial farms

across Malaysia, Indonesia and Vietnam.

Marine Products Manufacturing Activities (MPM)

Apart from livestock farming, QL has also diversified into the fisheries sector

through the development of a marine-based manufacturing chain. Starting with

fishmeal and working up to higher-value surimi, it now conducts full upstream &

downstream activities including surimi, surimi-based products manufacturing,

fishmeal and deep sea fishing.

Through the use of innovative technology and quality practices, QL has achieved

industry leadership positions whereby it is currently the largest producer of surimi

in Asia as well as the top fishmeal and surimi-based products manufacturer in

Malaysia. QLs marine products are distributed nationwide and internationally to more than 15 countries through a wide distribution network under both a private

label as well as QLs portfolio brand such as Mushroom, Figo etc.

Palm Oil Activities (POA)

Closely related to its agricultural base, QL has expanded its capabilities in palm oil

from milling to estate ownership and management. It currently owns three

independent Crude Palm Oil (CPO) mills and two palm plantations, including a

1,200 ha mature palm oil estate in Sabah and another 20,000 ha plantation under

development in Eastern Kalimantan, Indonesia.

Further expansion along the value chain has been achieved with the

commercialization of zero-waste renewable energy projects. QL has also developed

a first of its kind integrated biomass boiler technology, whereby palm biomass is

processed by biogas power plants within the palm oil milling complexes. All these

efforts are expected to result in future cost savings in QLs operations.

Industry Overview

Resilient Asia in the unstable global economic outlook

In the latest July World Economic Outlook (Fig 2), the International Monetary

Fund (IMF) painted a gloomy picture of world economy and trade with a forecast

of 3.3% global GDP growth in 2012 and 3.6% in 2013. However, in Developing

Asia which mainly consists of China, India and the ASEAN-5, IMF projected a 6.7%

growth in 2012 before improving to 7.2% in 2013. While the Asian market is

unlikely to be insulated from the economic volatility, it is expected to fare better in

such difficult times.

Although QL is heavily involved in exports, its main markets are within the

Developing Asia countries and Japan which should be less affected by the global

economic headwinds. In addition, its main involvement in staple food industry is

less cyclical and the demand is expected to be more stable regardless of the state of

economy.

Rising eggs and broiler demand

The demand for eggs has been rising over the years since it is considered the

cheapest source of protein. Research suggests that per capita egg consumption in

Malaysia is one of the highest in the world, averaging around 320 eggs per person

per year, 3.2x higher than that of Indonesia and 4.5x of Vietnam. Therefore, as per

QL Resources

Bhd

Integrated Lifestock

Farming (ILF)

Animal feed

Eggs

Broiler

DOC

Marine Product

Manufacturing (MPM)

Surimi

Surimi-based products

Fishmeal

Deep sea fishing

Palm Oil Activities

(POA)

Palm plantation

CPO milling

Palm biomass

Fig 1: Main business segments

Fig 2: GDP Growth Forecast


Source: IMF July World Economic Outlook


3

0

5

10

15

20

25

30

35

40 2

00

1

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

KG

Vietnam Indonesia

Malaysia

3 = Least favourable to QL

1 = Most favourable to QL

Source: indexmundi.com

Source: Team Analysis

capita income rises, egg consumption in these countries is expected to increase

accordingly.

With the Indonesian government targeting to double the chicken and egg

consumption of Indonesians in the coming three years, any related measures shall

provide significant upside on demand for these products considering the population

mass in Indonesia. This is highly positive for QL which has been expanding its

operation in Indonesia aggressively.

The steady animal feed industry in Malaysia

Corn and soybean meal form 80-85% of animal feed by weight. Therefore, they

are the main drivers of feed prices and trading margins. Due to insufficient

domestic production, Malaysia imports more than 90% of its corn requirement

from other countries such as Argentina and the United States.

Animal feed industry in Malaysia contributed a total revenue of RM213.5million in

2010. As a relatively matured market, it is expected to maintain a consistent growth

performance. Given the steady historical growth trend, its revenue is likely to hit

RM291.1million by 2015 representing a CAGR of 6.4% over the next five years.

The demand and supply mechanism of the surimi market

The world demand for surimi currently stands at around 600,000 metric tonnes (mt),

growing at 5% p.a. on average. Japan has been the largest consumer in the worlds surimi market, with an estimated annual consumption of 320,000mt. Meanwhile,

China has emerged as a new growing consumer due to its nationwide popularity in

steamboat products.

Given the demand and supply mechanism, the pricing of the surimi products has

remained stable over the years, and we believe that the rising demand from the

regional countries will continue to hold up the surimi prices.

The supply of surimi products amounted to 315,800mt in the Southeast Asian

region in 2005. QL is the biggest manufacturer in Malaysia, producing about

32,000mt of surimi products per year, and garnering a domestic market share of

50%. Although Indonesia has the largest sea area of almost 1.89 million square

metres in the region thus providing abundant fishery resources to be used as raw

materials for surimi processing, there are only 8 processing plants currently

running in the country. This is a strong indication that the potential of this industry

in Indonesia remains largely untapped, and QLs expansion in setting up processing plants in Indonesia is strategic and should bode well for the future.

Increasing palm oil influence

The global palm oil production had doubled in the past decade with an increase of

2.3 million tons per year over the past 10 years, largely attributed to the economic

boom of China and India during the period. Due to its higher yield, it is thus the

preferred source of vegetable oil for economical purpose.

In 2012, palm oil is estimated to make up about 32.8% of the worlds vegetable oil consumption. The percentage is expected to reach a whopping 38% by 2020 as its

long-term demand continues to rise, supported by growing population and

increasingly developed economies in Asia over the next 10 years.

Competitive Positioning Having three key business divisions, QL has attained its leadership position in two

of the core businesses. The entrenched position is unlikely to be shaken in our view.

The key factors include:

Stringent hygienic, quality and cost control for the poultry division

QL is at the top of the league in the poultry industry. It currently commands

approximately 13% market share of the industry. The fragmented nature of the

poultry industry has contributed to QLs competitive advantage over other industry players. In contrast to other players which mainly have smaller operation scales,

QL differentiates itself with its modern facilities, located in bird-free enclosures

and equipped with high bio-security. Its focus on quality control in terms of

chickens health and production also ensures consistent demand from its customers.

The recent increase in the animal feed prices has hit other industry players hard.

Poultry farmers will have to resort to buying lower quality feed, subsequently

Fig 3: Broiler Meat per Capita

Consumption

Fig 5: Integrated Lifestock Farming

Five Forces Model

Fig 4: 2012 World Palm Oil Production

Source: indexmundi.com


4

Fig 7: Marine Product Manufacturing

Five Forces Model

Fig 8: Palm Oil Activities

Five Forces Model



RMm

Fig 6 Peer PBT

Source: Company data and teams estimate

leading to the fall in egg production and the incurring of a higher cost base.

Ultimately, we believe that it will lead to an erosion of their profitability. However,

being a significant supplier of animal feed itself, with a market share of

approximately 20%, QL has an edge over competitors in cost control.

This is proven when 3 out of the 4 largest egg producer in Malaysia suffered a loss

before tax (Fig 6) in the quarter ended 30 June 2012 due to rising prices of corn and

soybean meal. QL (2nd largest producer), however was able to defy the odds and

increase its segment profit before tax by 23.4% to RM21.1million for the same

period.

High barriers of entry throughout the supply chain for the surimi business

Surimi making process has a high barrier of entry due to its capital intensitivity, the

tedious processes involved as well as the requirement of technology know-how.

With its Japanese processing technology, QL is standing tall in its ability to gain

overseas customer confidence. It is now a regional player and exports to more than

15 countries including Japan, Singapore, South Korea etc. which are the key

consumption countries in Asia that demand the highest seafood quality in view of

their affluence and culture.

On the upstream, QL has also established strong partnerships with the local

fishermen. QL has been offering its financial assistance scheme to the fishermen

since 1987. The company has helped over 700 fishermen in rural villages to build

and modernise their boats and at the same time secure the long-term supply of

marine catch. The scheme, which is similar to microfinance, has provided more

than RM25 million of interest-free advances. Currently, 95% of QLs total fish requirements are supplied by local fishermen, and the remaining 5% is sourced

from its own deep-sea fishing division with a fleet of 23 boats.

A growing integrated palm oil player

QL is an integrated palm oil plantation player. Besides the typical upstream

plantation value chain, QL has also successfully ventured into both mid-stream and

downstream activities which include palm milling, biogas, pelletisation, and

biomass boiler technology. No immediate plans are in place to engage in refinery

activities due to its currently thin margin. In view of the fluctuating nature of CPO

price, such integrated model should enable QL to withstand the volatile operating

environment better. In a declining price trend, QL does not have to sell its Fresh

Fruit Bunch (FFB) at depressed pricing as it can feed them into its own CPO mills.

QL has also gone into renewable energy for cost savings purpose. Its biogas plant

in Tawau currently produces about 1MW of electricity and powers the production

of palm pellet plant. Given that many palm oil plants in Malaysia, including QLs, are located off the power grid, the biogas plant enables QL to self-generate the

power needed to operate the Palm Pellet plant. As for the palm pelletizing plant,

QL believes it is the first company in the world to have developed the

proprietary technology of converting Empty Fruit Bunch (EFB) into small-sized

palm pellets that can be used as feedstock to generate power. Transporting EFB in

its bulky state poses much difficulty and thus the new technology represents a

timely opportunity for QL and functions as an effective solution to alleviate the

impact of high Sabah logistic cost, which is currently estimated at RM 200 per

tonne.

Investment Summary

Fundamentals and valuations indicating a convincing BUY

We have derived a fair value of RM3.86 for QL, which represents an upside of 22%

from current level, using valuation methods of Discounted cash flow (DCF) and

Price earnings ratio (PER). QLs track record speaks for its strong fundamentals. We like QL for three key reasons: (i) Entrenched position in resilient consumer

businesses; (ii) Strategic expansion plans underpin solid earnings growth over the

next three years; (iii) Undemanding current valuations as compared to the premium

valuations commanded by many large cap consumer companies with lower

earnings growth. In our view, the exciting growth prospects have yet to be priced in.

(i) Recession-proof food-based business segments underpin resilient earnings

The current market uncertainties are actually favourable for QL, given its defensive

qualities. QL is well diversified with its highly sustainable business model. The

company has never failed to deliver in terms of earnings in the past. We believe

0%

5%

10%

15%

20%

25%

FY11 FY12 FY13F FY14F FY15F

Sales Growth COS Growth PBT Growth

Fig 9 Growth trend


5

0

2000

4000

6000

8000

10000

12000

14000

16000

Cumulative Planting

Matured area

Fig 11: QL Indonesia Plantation

Progress

6.1%

4.5%

6.1%

6.5% 6.4%

7.2%

3%

4%

5%

6%

7%

8%

Fig 10: Indonesia Real GDP Growth

Source: Indonesia Government Official

Data and Forecast

Source: Company data and

teams estimates

Hectares

that this is a strong indication of the managements execution ability.

Both poultry and surimi divisions make up almost 90% of the companys earnings, underpinning an uninterrupted earnings growth for 25 years. In the recent three

years, earnings grew steadily with a CAGR of about 11% since FY10. The

resilience in earnings is evident particularly in FY09. Despite the outbreak of the

avian influenza disease and sub-prime mortgage crisis, the company still recorded a

PBT growth of 14.7%. Going forward, we believe that the palm oil plantation

business will have a growing significance that should add to the resilience of core

earnings. The stock is, thus, appealing to investors seeking for low-beta exposure.

(ii) Exciting earnings Growth Prospects

QL is set to enter into a new phase of sustainable growth. We estimate a 3-year

earnings CAGR of 14.5% since FY12. FY15 will see the fruition of its current

expansion plans for all three industry segments.

The export market tapping the Asian consumption growth story

QLs increasing geographical exposure to Indonesia is highly strategic in our view. QL has aggressively expanded its operations in Indonesia for years in all three

business segments and the management is likely to continue its focus in Indonesia

as the Malaysian market is relatively matured.

Export growth potential to Indonesia for poultry and marine products is massive.

Indonesia is the largest economy in Southeast Asia. Having a population base of

240 million, the country is endowed with rich natural resources. Economic growth

has been robust in the recent years (Fig 10), with GDP achieving 6.5% in 2011.

Regaining its investment grade rating from Fitch in late 2011 and from Moody in

early 2012, official data puts current year GDP growth at 6.4% for 2012, and is

poised for an increase to 7.2% in 2013. The growing middle class is the key engine

for consumption growth as per capita income rises. This should bode well for early

movers such as QL.

As for the surimi segment, having already exported to 15 countries, there is still a

significant upside in demand potential that is yet to be realised. This is largely

driven by both the economic and population growth within the Asia region. China

will be the key target market for surimi products. The rising popularity of

steamboat products in China will be a significant growth driver for surimi and

surimi-based product. To cater to the demand potential, QL is increasing its

capacity by expanding its surimi processing plant in Indonesia given the countrys large sea area as well as untapped seafood resources.

Palm Oil Expansion Earnings from the palm oil plantation segment will kick in more substantially in

FY15. The 16,200ha of palm oil plantation in Eastern Kalimantan, Indonesia is

expected to be fully planted by FY14 (Fig 11). The proportion of contribution from

the higher-margin upstream activities is set to expand as the maturity profile of the

trees increases, and hence driving the earnings. We expect a CAGR of 9.1% over

FY12-15F for palm oil plantation revenue. PBT margin should also expand from

9.8% in FY13F to 14.5% in FY15F, as plantation yields improve. The growth in

margin is also attributed to the reduction in the procurement of FFB from third

parties as it increases the reliance on its own FFB production.


6

2000

2200

2400

2600

2800

3000

3200

Source: Team Estimate

Source: Bloomberg

Fig 12: Event analysis

timeline

Valuation We value QL based on a Discounted Cash Flow (DCF) methodology and

Price/Earnings Ratio (PER), which we think are most appropriate to capture the

potential upside from its regional expansion and maturing upstream palm oil

business, which will only start to contribute meaningfully from FY13F onwards.

Using the figures derived from these two methods, we arrive at our target price of

RM3.86/share, which implies upside of 22% over current levels.

Discounted Cash Flow Model: Free Cash Flow to Equity (FCFE)

We use a two stage FCFE model which takes into consideration time value of

money. Since QL has high growth prospects, FCFE would measure its value in a

longer term perspective, reflecting the free cash flow value of the company while

taking into account for strong future growth.

Three-year Projected Cash Flow Assumptions

EPS is forecasted to grow at CAGR 15.1% from FY13F-FY15F as a result of

increasing sales, improving margins as well as low working capital requirement.

Strong Sales with improving margins

From our projections, we estimate that QLs revenue should grow at a CAGR of 10.9% over FY13-15F. This revenue growth will be mainly driven by the increase

in production capacity for its ILF and MPM division as well as the contributions

from maturing upstream POA. Such growth rate is considered exceptional for a

company of its size and its FY15F revenue of RM 2.7 billion is expected to be

more than double its FY 08 revenue of RM 1.3 billion.

Due to its gradual shift to higher margin business, coupled with the higher yield of

upstream oil palm plantation, QLs gross profit margin would improve from 15.5% in FY12 to 16.3% in FY15F. Professional cost management through its

involvement in animal feed supply also helps QL to keep its cost base under check.

CAPEX

QL Resources has committed RM200 million to fund the capex requirement for

both FY13F and FY14F. We project that QLs capex will be reduced to RM100 million in FY15F where it will consolidate its operations after years of aggressive

expansion. QL has expressed its intention to source 60% of this amount externally

via borrowings while the remaining 40% will be funded internally.

CPO price outlook

The CPO price recently slumped to a three-year low at below RM2,200 per tonne

(Fig 13) due to rising stockpiles and the slowing down of global economic growth,

effectively causing demand to spiral downwards. However, it is noteworthy that

0

0.5

1

1.5

2

2.5

3

3.5

4

April 06 April 07 April 08 April 09 April 10 April 11 April 12

RM

28 July 09, QL exceeds 1

bn market capitalisation

July 10, QL was recognised

by The Edge as a member of

the Billion Ringgit Club

July 11, QL won the

prestigious The Edge

Billion Ringgit Club

FCFE Components

Estimate Long-Term

Growth Rate

1.80%

Equity Value

(RMm) 3,314.2

No. of shares in

million

832

Share price

(RM/share)

3.98

Fig 13: CPO Recent 6 months Future Price

Source: Bloomberg

RM

21st Dec 09, QL was

included as one of the

component stocks of the

FTSE- Bursa Malaysia

Mid 70 Index

May 06, Ranked 2nd in top 100

best returns listed companies by

the Edge Magazine

QL FY 06 revenue

exceeds 1 bil

Source: Bloomberg and company website


7

0

0.5

1

1.5

2

2.5

3

3.5

4

1

0

1

1

1

2

PE 23x

PE 19x

Source: Team Estimate

Source: Bloomberg

0

50

100

150

200

250


11 12 10

palm oil output typically peaks around July to October, and with the revision of

export tax starting from 1 January 2013, the stockpile problem shall ease. We

believe the current situation is oversold as the price differential between palm oil

and soybean oil is near four-year high. The arbitrage opportunity between selling

spot on MDEX and the physical spot market also appears to contribute in the sell-

down of CPO.

With the export tax revision, proposal of expanding its usage as biodiesel as well as

talks of a possible supply mechanism between Indonesia and Malaysia, we believe

the CPO price, while may not experience an immediate significant rebound, shall

remain intact in the intermediate term. Therefore, we assign values of RM2,800,

RM3,000 and RM3,100 for QLs FY13-15.

Cost of equity

The cost of equity is derived using the CAPM model. A risk free rate of 3.5% is

determined from the yield on short term Malaysian Government Securities while

the expected market return of 7.74% is the result of compounded annual growth

rate of FBM KLCI Composite Index (previously known as KLSE) for the past 10

years. Together with the company beta of 0.8 extracted from Bloomberg, a cost of

equity of 6.89% is arrived.

Price/Earnings Ratio (PER)

We obtain a fair value of RM3.73/share using a P/E of 18x. For the past 12 months,

QLs P/E has fallen within the range of 16x to 20x (Fig 14). We have thus arrived at the average of 18x to calculate the estimated share price, which is seemingly

reasonable given that QL is currently trading at a P/E of more than 19x. Based on

the estimated EPS growth of 15.7% from FY12-FY15F, a Price/Earnings Growth

Rate (PEG) of 1.15x is derived, which is in line with the regional average, further

justifying the suitability of the P/E used.

Financial Analysis

Earnings: We estimate an EPS of 18.4sen and 20.7sen for FY13F and 14F, representing an

EPS growth of 16.5% and 12.5% respectively. The growth is mainly driven by the

increase in production capacity for both its ILF and MPM division as well as the

contributions from the maturing upstream POA. Income from the egg production

and palm oil will increase, resulting in lower revenue contribution generated from

lower-margin activities such as animal feed trading. The 1Q FY13 revenue

accounted for 23.2% of our projected FY13 total revenue. This is consistent with

the companys seasonality factor of 0.21 for 1Q and the preceding years 1Q revenue which accounted for 23.4% of total revenue for FY12.

Gross Profit Margin Based on our forecast, gross profit margin is expected to trend up from 15.5% in

FY12 to 16.3% in FY15F, due to the gradual shift to higher-margin businesses. For

the poultry division, focus will be concentrated on egg broilers and DOC which

traditionally have a better yield. In comparison to the largest egg producer in

Malaysia, Huat Lai Resources Bhd, QL has been able to achieve a higher PBT

margin (8.23%) than the former (6.14%) due to professional cost management. We

believe QL, being a supplier of animal feeds itself, enjoys a relatively lower cost

base and has the ability to pass on any cost hikes to its customers.

Furthermore, in view of the recent slew of measures introduced by Malaysian and

Indonesian government, we expect palm oil prices to stabilise over the intermediate

term. QLs margin in the palm oil segment is, therefore, expected to increase as its upstream plantation matures, driving margin expansion.

Margins well controlled via efficient cost management and strategic

investments

While there may be concerns among investors that the recent Midwest drought in

the US would push up feed cost for animals as corn and soybean prices soar,

impact on QL is mitigated given its engagement in feed raw material trading

business. This natural hedge would help to partially offset the higher cost arising

from the import of the raw materials from the US. Historically, QL has also been

able to pass on the cost increase to the customers, allowing the trading margins to

be kept intact.

Cost of Equity Components

Risk-Free Rate 3.50%

Expected Market

Return

7.74%

Equity Risk Premium 4.24%

Beta 0.80

Cost of Equity 6.89%

Weight Price W x P

FCFE 50% 3.98 1.99

PER 50% 3.73 1.87

Target Price (RM/share) 3.86

Fig 14 P/E Band RM

PE 15x

PE 11x

PE 7x

Fig 15: Earnings growth

RMm


8

Egg

20% DOC

3%

Broiler

2%

Animal

Feed

33%

Deep Sea

Fishing

1%

Surimi

23%

Palm Oil

18%

Egg

26%

DOC

4%

Broiler

2%

Animal

Feed

27% Deep

Sea

Fishing

0%

Surimi

24%

Palm

Oil

17%

Fig 16: Revenue breakdown by

Segment FY12

Fig 17: Revenue Breakdown by

Segment FY 15

Fig 18: Operating Cash Flow and Net

Debt to Equity

Source: Teams Estimates



RMm

QL currently owns a 40.51% stake in Boilermech Holdings Bhd. Given

Boilermechs expertise in agricultural biomass power and heat generation, QL could leverage on the technology to extract higher output yield, and therefore

generate better profit margins.

QLs 24.17% equity stake in Lay Hong also offers a synergistic benefit. Given that Lay Hong is also in the poultry business, QL has turned a competitor into a

strategic partner. Both companies will be able to collaborate in various areas to

improve operation efficiency and supply chain networks. Moving forward, the

management of QL has not ruled out the possibility of acquiring other suitable

industry players if such opportunities were to arise. We believe any acquisition

(provided at the right price), will help QL to further strengthen its market position

in the poultry business by reducing market rivalry.

Cash flow:

Healthy operating cash flow

Given QLs steady food business, the companys cash flow generation profile has been rather steady, delivering positive operating cash flow every year since FY00.

The low working capital requirement has also contributed to the strong cash flow

position. Despite some slight fluctuations in certain years, its cash flow has grown

by a healthy 9.5% CAGR from 2008-2012, which allows the company to fund its

continuing CAPEX commitment. Thus far, QL has also never encountered any

issues in raising finance and we do not foresee any changes to this.

Stable cash cycle and dividend policy

We expect that QLs cash cycle should remain between 44 and 50 days over FY13F-FY15F. The management has also committed itself to a 25-30% dividend

payout policy, which is in line with its historical payout. With the anticipated

increase in operating cash flow and the absence of any difficulties in the raising of

funds, we forecast a DPS of 27.81sen and 28.88sen for FY13 and 14, representing

a dividend payout rate of 27.8%. Retained earnings will be better utilised for future

expansion.

Balance sheet and financing:

Manageable gearing level despite aggressive expansion plans

In our view, QLs net gearing will peak at 58% in FY13, which we think is still manageable and also within the companys comfortable zone. This can be confirmed by its strong Altman Z-Score (Appendix 7). The higher gearing is

mainly attributed to the aggressive expansion plans put in place by the management

in scaling up its operations, especially in Indonesia.

The RM200m investments set aside for FY13 and FY14 include ramping up the

egg and day-old-chicks production, as well as expanding the production capacity in

the marine operations in Indonesia. As a result, the capacity is estimated to increase

by 10,000mt each year from FY13-FY15, representing a growth of 31.6% from its

existing capacity. More funds will also be allocated to the palm oil activities in

Kalimantan, Indonesia for the planting exercise which shall be completed by FY14.

Over a longer term, we believe that QL will continue with its regional expansion in

Indonesia and Vietnam where the growing population in these emerging markets

represents a new growth area especially for food consumption. QL has rightly

positioned its foothold in the region.

With a fairly healthy interest cover of between 9 times to 10 times, QLs fundamentals are strong enough to generate enough cash flow to finance its interest

expense. Supported by strong financial performance, its interest cover should

further improve to 11.7 times by FY15 despite some increase in borrowings.

Beyond FY14, QLs gearing is expected to normalise as CAPEX commitment declines. Cash flow from main businesses will pick up and therefore debt will be

pared down over the next 2-3 years (Fig 18).

Figure: Increase/Decrease in C& CE Figure: Increase/Decrease in C& CE


9


Additional positive factors

Budget 2013

From the recent budget announcement, the consumer sector as a whole is

expected to benefit from the estimated RM 7-8 billion distribution to the general

public in forms of aids and incentives. The cash handouts, bonuses for civil

servants and reduction in taxes should increase the public disposal income and

continues to underpin consumer demand and spending. While not a direct

beneficiary of any specific measures, we view the budget is in overall favourable

for QLs short to medium term development.

Halal food products

Most of QLs food products (poultry, broilers, surimi etc.) have obtained the halal certification and with this, there is great growth potential from the sizeable and growing Muslim population in the global halal market (Appendix 8).

The Muslim population is expected to reach 1.9bn by 2020 while the Halal

Industry Development Corporation estimate current global halal market at more

than US$800 billion (RM2.42 trillion). QLs main market of Southeast Asia is home to about 250 million Muslim consumers and with the right leverage, it may

discover more untapped potential in its food products.

The management and governance structure

While most family businesses are often associated with the practice of nepotism,

QL appears to have a strong governance structure in place to deal with these

inherent issues effectively, thus leading to its success today. Voted one of the

Highest Profit Growth Company by the EDGE in 2011 and with an average Return On Equity (ROE) of 28.2% for the last 5 years, it appears that shareholders

wealth has been maximized and this can be replicated in the future. The award of

The Edge Billion Ringgit Club Company of the Year in 2011 is a further testimony

and recognition of QLs strong management and governance structure.

Investment Risk

Weaker Oil Palm Prices

The fluctuations in Crude Palm Oil (CPO) prices will have an impact on QLs earnings given its exposure to the segment. However, it should be noted that the

impact will be limited as the segment currently makes up only a small proportion

of QLs business activities, and is only expected to contribute 9.73% to its consolidated PBT of FY13.

CPO prices have weakened in the recent months. The rising stockpiles and

lacklustre demand growth amidst slowing global economy are likely to exert

downward pressure on CPO prices over the short term. Since hitting its 3-year low

of RM2,200 per tonne, the CPO prices have since rebounded to a level of

RM2,500-2,600 per tonne. With the downward revision of export tax starting from

1 January 2013 and talks of possible supply mechanism collaboration between

Malaysia and Indonesia, the long-term fundamentals and outlook for CPO remain

intact in our view. Underlying demand will continue to be underpinned by

population and economic growth in the region.

Outbreak of Avian Influenza Virus

Given QLs poultry business represent more than 50% of its business activities, we think any outbreak of influenza virus will pose the biggest risk. Outbreak of

diseases could result in a 45-60% drop in the demand for day old chicks and feed

inputs as seen in Indonesia in 2004, as reported by CASERED. According to WHO,

the total number of human influenza A(H5N1) cases in Indonesia to date is 191

with 159 fatalities, 8 of which occurred in 2012. However, QLs modern facilities, located in bird-free enclosures with high bio-security, and focus on quality control

in terms of chickens health and production, should be able to help to control any spread of diseases.

Fluctuating Weather and Climate

We do not discount the possibility that fishing grounds in Malaysia may decline in

FY13-15 due to unforeseen circumstances and adverse changes in the weather

conditions such as the La Nina and El Nino phenomenon. With the marine segment

being the second largest segment in QL resources, this may have an impact to a

certain extent on the companys financial figures as both warm and cold waters may drive fishes away, leading to a lower fish capture. However, past studies

Sensitivity to a 10%

decline in CPO Price % Change

FY13F EPS (2.55%)

FY14F EPS (1.94%)

FY15F EPS (2.54%)

Target Share Price (0.52%)

Source: Team Estimates


10


have indicated that countries in the west pacific such as Malaysia, Thailand and

Indonesia were relatively unaffected by the last El Nino in 1998. The recent

climate indicators have also signalled low possibilities of adverse La Nina or El

Nino conditions. (Appendix 13) Therefore, we think that the probability of this

risk arising is considerably remote.

Limited impact from cut in diesel subsidy

The changes in diesel price are unlikely to disrupt QLs cost management. As part of the ongoing subsidy reform in Malaysia, diesel subsidies were cut with effect

from 2011 to RM1.80/litre. This would result in an increase in procurement cost.

However, we note that the subsidy cuts only affect C2 deep-sea fishing trawlers,

where the impact will be limited to QLs deep-sea fishing operations, as the segment only accounts for merely 1-2% of total revenue. The surimi fishing

operations, where the fishes are of lower value and can be caught closer to shore,

would remain unaffected. Given also the industry supply constraints, any price hike

can be passed on easily to the consumers.

Regulatory and economical risk in Indonesia

Nationalist policies and inconsistent regulations have recently spook investors in

the banking and mining industry. The cut of benchmark rates by 100 basis points in

late 2011 and early 2012 by the Indonesia central bank was also seen as an

overreaction to the economic environment and has spark inflationary pressure in

early months of 2012. However, we note that QLs operations in Indonesia are largely food products and are not heavily regulated. The benchmark rate has also

been held at 5.75% for eight consecutive months. We draw comfort from the recent

policy statement by Bank Indonesia Governor Darmin Nasution to keep the policy

rate consistent with low and manageable inflationary pressure. We believe that a

rate cut is unlikely until 2014 as the economy is growing well thus the economic environment for QL in Indonesia should be kept stable.

Foreign Exchange Risk

QL mainly imports its animal feed for the livestock division from the US market

and exports its marine products to Japan. The main exposure to foreign currency

risk for QL is, therefore, the US dollar whereas exposure to other currencies is

relatively insignificant. In our view, outlook for the US dollar is still mixed,

considering that the Federal Reserve System could hold its low interest rate until

mid 2015 while the US economy has somewhat recovered but still lacks the

necessary momentum. In any case, we believe that the exposure should not have a

material effect on QLs performance. As noted in the Annual Report, a 1.5% weakening in USD against RM would increase QLs profit by RM51,000 and equity by RM118,000. An equal but opposite effect would occur if RM weakens

against USD.

Valuation risk

Our FCFE derived target price assumes a 6.89% cost of equity and 1.8% terminal

growth rate. A sensitivity analysis of the target price to these two variables

suggests a valuation range of RM3.54-4.53, which in any case shall still represent a

significant upside from the current level. With the additional assurance from the

PER method, we note that the sensitivity is nominal and thus the final valuation

derived is fair.

Target price (RM) Cost of equity

6.3% 6.6% 6.89% 7.2% 7.5%

Terminal

Growth

Rate

1.4% 4.18 3.93 3.71 3.5 3.32

1.6% 4.35 4.08 3.84 3.62 3.42

1.8% 4.53 4.24 3.98 3.75 3.54

2% 4.74 4.41 4.14 3.88 3.66

2.2% 4.96 4.61 4.31 4.03 3.32

Sensitivity to a 10%

decline in Marine

Production Volume

% Change

FY13F EPS (2.99%)

FY14F EPS (2.30%)

FY15F EPS (3.59%)

Target Share Price (0.78%)


11

Disclosures:

Ownership and material conflicts of interest:

The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company.

The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or

publication of this report.

Receipt of compensation:

Compensation of the author(s) of this report is not based on investment banking revenue.

Position as a officer or director:

The author(s), or a member of their household, does [not] serves as an officer, director or advisory board member of the subject company.

Market making:

The author(s) does [not] act as a market maker in the subject companys securities.

Disclaimer:

The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable,

but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to

be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a

solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA

Malaysia, CFA Institute or the CFA Institute Research Challenge with regard to this companys stock.


12

Appendix

Appendix 1: Income Statement

FYE March FY10 FY11 FY12 FY13F FY14F FY15F

RM'm RM'm RM'm RM'm RM'm RM'm

Revenue

1,476.4

1,777.1

1,946.7

2,130.7

2,319.4

2,654.0

Growth

20.4% 9.5% 9.5% 8.9% 14.4%

Cost of sales

(1,233.0)

(1,489.6)

(1,645.2)

(1,788.7)

(1,943.6)

(2,219.3)

Gross Profit

243.4

287.7

301.6

341.6

375.5

433.7

-Gross Profit Margin 16.5% 16.2% 15.5% 16.03% 16.19% 16.34%

Administrative expenses

(71.7)

(83.9)

(105.9)

(106.7)

(116.1)

(132.9)

Distribution cost

(23.4)

(25.7)

(28.0)

(31.8)

(34.6)

(39.6)

Other expenses

(11.5)

(12.5)

(13.4)

(15.4)

(16.7)

(19.1)

Other income

11.7

9.3

30.7

25.6

27.8

31.8

EBIT

148.5

174.8

184.9

213.3

235.9

274.0

-EBIT Margin 10.1% 9.8% 9.5% 10.0% 10.2% 10.3%

Finance Cost

(13.7)

(18.4)

(22.6)

(25.1)

(26.2)

(27.3)

Finance Income

0.8

1.1

1.7

2.3

2.5

2.7

Share of Profits of Equity

Accounted

0.5

3.5

8.4

11.4

13.1

15.2

Profit Before tax

136.0

161.0

172.4

201.9

225.4

264.6

- PBT margin 9.2% 9.1% 8.9% 9.5% 9.7% 10.0%

Income Tax Expense

(20.9)

(27.0)

(33.1)

(39.4)

(43.9)

(51.6)

Effective tax rate 15.4% 16.8% 19.2% 19.5% 19.5% 19.5%

Profit for the Year

115.2

134.1

139.4

162.6

181.5

213.1

Non-Controlling Interest

8.2

9.2

7.8

8.3

9.0

9.6

Profit Attributable to:

Owners of Parent

106.9

124.6

131.4

154.3

172.6

203.5

Growth

16.5% 5.5% 17.4% 11.9% 17.9%

Net margin 7.2% 7.0% 6.8% 7.2% 7.4% 7.7%

Share capital

197,586

208,000

208,000

208,000

208,000

208,000

Total no. of shares 790.3 832.0 832.0 832.0 832.0 832.0

EPS (cents)

13.5

15.0

15.8

18.5

20.7

24.5



13

Appendix 2: Balance sheet



14

Appendix 3: Cash Flow Statement

FY10 FY11 FY12 FY13F FY14F FY15F

Cash flows from operating activities RM'm RM'm RM'm RM'm RM'm RM'm

Profit before tax 136 161 172 202 226 267

Depreciation/Amortisation 39 47 56 75 84 93

Non-cash items 16 14 (6) (16) (38) (56)

Operating profit before changes in

working capital 191 221 222 261 272 304

Changes in working capital (21) (64) (26) (72) (36) (47)

Cash generated from operations 171 158 196 189 236 257

Dividends from liquid investment - 0 0 0 0 0

Tax paid (14) (23) (23) (31) (35) (40)

Interest paid and received (3) (4) (6) (5) (5) (4)

Net cash generated from operating

activities 154 131 168 153 197 213

Cash flows from investing activities

Capital Expenditure (119) (245) (261) (200) (200) (100)

Proceeds from disposal 7 3 18 13 14 14

Dividends received 1 1 2 3 3 4

Other investments - (12) (3) (3) (3) (3)

Net cash generated from investing

activities (111) (252) (244) (188) (187) (86)

Cash flows from financing activities

Proceeds 32 182 101 120 120 60

Repayment of loan (11) (15) (16) (21) (24) (25)

Dividends paid (25) (32) (39) (48) (54) (65)

Other financing items 3 1 1 2 3 4

Net cash generated from financing

activities (2) 136 47 53 44 (26)

Net increase/(decrease) in cash & cash

equivalent 41 15 (29) 18 54 101

Cash & cash equivalent at beginning of

year 61 102 117 88 106 160

Cash & cash equivalent at end of year 102 117 88 106 160 262



15

Appendix 4: Key Financial Ratios

Margins


Gross Profit Margin

16.49% 16.18% 15.49% 16.05% 16.20% 16.38%

PAT Margin

7.79% 7.53% 7.15% 7.58% 7.80% 8.10%

EBITDA Margin

12.74% 12.67% 12.79% 14.06% 14.37% 14.43%

Growth Sales Growth

5.61% 27.12% 39.26% 52.42% 65.92% 89.85%

COS Growth

2.96% 20.81% 10.45% 8.72% 8.66% 14.18%

PBT Growth

23.77% 18.23% 7.14% 17.40% 11.90% 18.06%

Net Profit Growth

19.04% 16.27% 4.01% 16.11% 11.90% 18.92%

Investors Ratios Dividend per Share (RM) 0.03 0.04 0.04 0.05 0.06 0.07

Earnings per Share (RM) 0.14 0.15 0.16 0.18 0.21 0.25

Net Asset per Share (RM) 0.71 0.96 1.06 1.22 1.38 1.57

Dividend Yield (%)

1.68% 1.14% 1.31% 1.51% 1.46% 1.51%

Earnings Yield (%)

7.84% 4.83% 4.86% 5.41% 5.20% 5.41%

Activity (days) Receivables

41.36 41.95 40.31 41.21 41.21 41.21

Payables

27.00 30.99 30.35 29.44 29.44 29.44

Inventory

38.92 41.66 33.99 38.19 38.19 38.19

Liquidity Ratio (times) Current Ratio

1.55 1.47 1.29 1.42 1.43 1.71

Quick Ratio

0.52 0.53 0.44 0.50 0.58 0.78

Profitablity Ratio Return on Equity

20.60% 16.74% 15.81% 15.91% 15.76% 16.49%

Return on Assets

10.40% 9.09% 8.33% 8.39% 8.30% 8.94%

Return on Capital Employed 18.31% 16.60% 15.60% 15.42% 15.29% 15.83%



16

Appendix 5: Peer Comparison

Appendix 6: DuPont Analysis


Profit Margin (%) 7.79% 7.53% 7.15% 7.58% 7.80% 8.10%

Asset Turnover (times) 1.3348 1.2070 1.1652 1.1065 1.0652 1.1034

Equity Multiplier

(times) 1.9802 1.8420 1.8984 1.8963 1.8978 1.8443

ROE (%) 20.60% 16.74% 15.81% 15.91% 15.76% 16.49%

Appendix 7: Altman Z-Score Analysis

Weight FY10 FY11 FY12 FY13F FY14F FY15F

Working capital/Total Assets 1.2 0.144 0.123 0.076 0.102 0.107 0.170

Retained earnings/Total Assets 1.4 0.286 0.280 0.304 0.321 0.341 0.370

EBIT/Total Assets 3.3 0.135 0.121 0.116 0.117 0.115 0.121

Market Value of Equity/Total Liabilities 0.6 2.490 3.832 3.421 3.115 3.207 3.450

Sales/Total Assets 1.0 1.335 1.207 1.165 1.107 1.065 1.103

Z-Score 3.8 4.4 4.1 3.9 4.0 4.3

Altman Z-Score Interpretation Scale:

Z-Score Interpretation

> 3.0 Company is considered Safe based on financial figures

2.7-2.99 This zone is an area where one should Exercise Caution

1.8-2.7 Good chance of the company going bankrupt within 2 years of operations from the date

of financial figures given

< 1.8 Probability of financial catastrophe is very high

Companies

Market

Cap (RM)

Share

Price

PE

FY12 (x)

PE

FY13(x)

EPS

FY12

EPS

FY13

FY13 EPS

growth

ROE (%)

FY12

DY (%)

FY13

BAT 18,359.58 64.30 23.2 22.6 2.79 2.86 2.7% 173.3 4.22%

JIT 1,780.00 6.80 14.2 13.8 0.48 0.49 2.9% 30.5 4.51%

Carlsberg 3,992.69 12.96 21.6 19.6 0.60 0.66 10.2% 28.6 4.98%

Guinness 4,996.70 16.54 22.3 21.0 0.74 0.79 6.3% 59.0 4.53%

AEON 4,506.84 12.84 21.7 19.8 0.60 0.66 9.9% 14.7 1.24%

Parkson 5,228.85 4.78 12.3 10.3 0.39 0.47 19.8% 16.1 3.67%

NESTLE 16,339.96 69.68 32.7 30.6 2.13 2.28 6.7% 75.4 3.38%

F&N 7,186.09 19.78 37.5 26.0 0.53 0.76 44.4% 14.4 3.77%

Dutch Lady 3,200.00 50.00 28.3 26.8 1.77 1.87 5.6% 43.1 2.62%

QL Resources 2,604.17 3.17 20.2 18.0 0.18 0.21 16.7% 15.8 1.51%



Source: Grahaminvestor.com

Source: Bloomberg and teams estimates


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Appendix 8: Worldwide Distribution of Muslim Population


18

Appendix 9: QLs Operating Bases

City Country

HQ

Kuala Lumpur Peninsular Malaysia

Integrated Livestock Farming

Kulim Peninsular Malaysia

Nilai Peninsular Malaysia

Rawang Peninsular Malaysia

Kuching East Malaysia

Kota Kinabalu East Malaysia

Tawau East Malaysia

Cianjur Indonesia

Tay Ninh Province Vietnam

Marine Product Manufacturing

Hutan Melintang Peninsular Malaysia

Endau Peninsular Malaysia

Johor Bahru Peninsular Malaysia

Tuaran East Malaysia

Surabaya Indonesia

Palm Oil Activities

Tawau East Malaysia

East Kalimantan Indonesia



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Appendix 10: QLs Group Structure



20

Appendix 11: Surimi

What is surimi?

Surimi is a fish-based food product that has been pulverized to a thick paste that has the property of a

dense and rubbery food item when cooked. It is typically made from white-fleshed fish (such as

Pollock or hake). Surimi is a common food product in many Asian cultures and is often used to

mimic the texture and colour of the meat of lobster, crab and other shellfish. The most common

surimi product in the Western market is imitation crab and mock crab in America, and as seafood

sticks, crab sticks, fish sticks or seafood extender in Commonwealth nations.

Fig 7: Imitation crab meat Fig 6: Imitation shrimp

Source: Wikipedia


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Appendix 12: Surimi making process

Fish landing at jetty White meat fish Dehead and gutting

Deheading Automatic deboning Leaching and refining

Mixing and forming Quick freezing

X-ray detection

Export Storage in cold room

Packing



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Appendix 13: Weather conditions

Figure 8: Probability of Southern Oscillation Event

Sustained values of the SOI above +8 may indicate a La Nia event, while sustained negative

values below 8 may indicate an El Nio event. Values of between about +8 and 8 generally indicate neutral conditions.

Source: International Research Institute for Climate and Society

Note: Rolling 3-month probability, SON 2012 = September/October/November 2012

Southern Oscillation Index

Source: Australia Bureau of Meteorology

CFA IRC-Sunway University Team (2013)

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