Viz Branz Ltd - Profitability affected by margin squeeze (OCBC)

Maintain HOLD

Previous Rating: HOLD

Current Price: S$0.26

Fair Value: S$0.27

FY11 net profit down on higher raw material costs. Viz Branz reported a 15.1% decline in its FY11 net profit from S$14.4m to S$12.2m as the result of higher raw material costs experienced during the year. Although its FY11 revenue came in within 0.4% of our FY11 forecast and showed an 8.5% improvement to S$165.7m, a subsequent 15.2% jump in cost of sales dragged its gross profit margins down by four percentage points to 31.7%, causing our bottom line estimates to deviate by 17%. Despite the fall in net profit, management still managed to declare a final dividend of 0.5 Singapore cents to bring the total dividends declared this year to 1.75 Singapore cents a share for a dividend yield of 9.6% (FY10: 3.25 Singapore cents; 12.5%).

Price increases failed to mitigate cost pressures. Viz Branz has about half of its raw materials cost involved in the production of coffee-related products, and it purchases coffee in powder form for its instant coffee product-lines. Although Viz Branz employs a policy of purchasing coffee powder six months in advance, it still experienced a significant but gradual uptick in cost. (As a guide, Robusta coffee prices spiked 48% in FY11 vs. FY10's 9% increase.) During the year, it raised prices by 5% to counter the production cost increases but the bump was insufficient to maintain its gross profit margins. Prices of its other raw materials like sugar and palm oil also showed significant increases (66% and 33% respectively) during the year.

Margin pressures to sustain if raw material costs continue on its uptrend. Assuming a continued uptrend in raw materials, management expects sustained margin pressures and they are planning another 5% price increase to help alleviate the squeeze. While its strong brand recognition allows for smooth implementation of prices increases, management is mindful that drastic price increases will result in market share impact so price increases for FY12 may trail cost increases.

Growth forecasts revised downwards, maintain HOLD. We pare our revenue growth forecast for FY12 to 2% (3.5% previously) to account for an anticipated softer demand going forward, and impose a conservative gross profit margin of 32% to be in line with FY11 (38.5% previously). China will also continue to be its key driver of growth for its instant beverages segment (FY11 revenue +10.5% YoY). We maintain our HOLD rating for Viz Branz with a revised fair value of S$0.27 (S$0.30 previously), which includes a 15% discount to account for its low trading volume.