3A: More details needed on potential JV

Written by InsiderAsia
Tuesday, 20 October 2009 16:12


FOOD ingredient products manufacturer, Three-A Resources (3A, RM1.58) has hogged more than its fair share of the limelight over the past few weeks. Its share price has risen by more than five-fold in the year to date, most of its gains coming in the past month, on the back of high trading volumes.

The primarily catalyst was news that Singapore-listed Wilmar International Ltd will invest in the company via a private placement of 61.6 million shares. The shares were priced at 75 sen per share, which will raise RM46.2 million cash proceeds for 3A. Upon completion, Wilmar will hold a 16.67% equity stake in the company.

More importantly, the placement exercise is widely seen as the precursor to a closer business partnership in the future. 3A has suggested the possibility of the two companies setting up manufacturing facilities for food ingredient products in neighbouring countries, such as China.

Private placement a precursor to future JV?
Wilmar is one of the world's largest refiners and traders for crude palm oil. It is also a leading distributor of staple food, such as cooking oil, flour, rice and bottled mineral water, in China. Its extensive network, both upstream and downstream, is expected to work just as well for food ingredient products.

3A is already the leading ingredient products manufacturer in Malaysia. Its main products include caramel colour, glucose and maltose syrup as well as owning our country's only maltodextrin plant. Business has been growing at a rapid pace. The company's sales expanded at a compounded rate of 30% per annum between 2003-2008. Plans for the next few years will further underpin growth, forecast to be in the double-digit range annually.

Success in the overseas markets is another acknowledgement of the company's product quality. Its ingredient products are sold to countries such as Korea, Taiwan, Singapore, Australia and the Philippines. Exports currently account for about one-third of the company's sales. In short, 3A has established a good reputation and track record after being in the business for more than three decades. Partnership with Wilmar will help 3A penetrate the world's most populous market more effectively and significantly expand its business operations beyond the local shore.

Devil is in the details
Nonetheless, discussions on any overseas joint ventures are believed to be in very preliminary stages. It is certainly too early to quantify future earnings stream. While Wilmar will undoubtedly give 3A a leg up in the Chinese market, we expect it will take time to convince manufacturers of end consumer products — such as soya sauce, confectionery and dairy products manufacturers — to switch from their existing supply source. Customers will require assurances on consistency of quality, production and delivery. For instance, new plants often encounter teething problems.
In other words, the process is not as simple as getting products on the shelves. In this sense, the steep rise in 3A's share price may have been a little premature.

Good longer-term growth prospects
To be sure, 3A's earnings are set to expand going forward. Its new 7,000-tonne per month glucose plant, completed in the fourth quarter of 2008 (4Q08), is registering rising utilisation. The 1,200-tonne per month maltodextrin plant is almost running at full capacity, thanks to the availability of glucose feedstock.

It is planning for a second maltodextrin plant with up to 2,000 tonnes per month capacity. If all goes to plan, the new plant will be operational by 4Q2010. Additional feedstock requirement for the new maltodextrin plant was already taken into account when 3A was building its glucose plant last year. The glucose plant can easily be upgraded to produce up to 12,000 tonnes per month with the incurrence of just a small additional capex.

3A's net profit is forecast to grow by 34% to RM16.2 million this year and a further 25% to RM20.2 million in 2010. That translates into earnings per share of 4.4 sen and 5.5 sen for 2009-2010 (after adjusting for the additional shares issued).

But valuations-rich pending further information
However, following the strong price rally, the stock is now trading at a relatively rich price-to-earnings (P/E) of 36 times and 28.9 times our estimated earnings for the two years.

Our forecast has not taken into account earnings from any future partnership ventures with Wilmar, which may or may not materialise. Hence, pending more concrete details, we are inclined to downgrade our recommendation from buy to hold, at least for now.