CFA IRC-Sunway University Team (2013)

hosted by

CFA Malaysia Sunway University

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Sunway University Student Research This report is published for educational purposes only by students competing in the CFA Institute Research Challenge.

QL Resources Bhd

Ticker: ● QLG MK Price: ● RM3.16

Date: 2 November 2012

Recommendation: ● BUY Price Target: ● RM3.86

In RM’ million-FYE March Total Revenue EBITDA Net Income

FY10 1,476 188 107

FY11 1,777 225 125

FY12 1,947 249 131

FY13F 2,131 300 154

FY14F 2,319 333 173

FY15F 2,654 383 204

In RM Earnings per Share Book Value per Share Dividend Yield (%) Return on Equity (%) Return on Assets (%)

0.14 0.71 1.7% 20.6% 10.4%

0.15 0.96 1.1% 16.7% 9.1%

0.16 1.06 1.3% 15.8% 8.3%

0.19 1.22 1.5% 15.9% 8.4%

0.21 1.38 1.5% 15.8% 8.3%

0.25 1.57 1.5% 16.5% 8.9%

Highlights Market Profile 52 Week Price Range(RM) Average Daily Volume Beta Dividend Yield

2.84 -3.40 132,300 0.8 1.44%

Share Outstanding (Shares) Market Capitalization(RM)

832m 2.6bn

Book Value per Share(RM) Debt to Total Capital Return on Equity

1.1 46.8% 15.8%

Major Shareholders(%) CBG Holdings Sdn. Bhd. Farsathy Holdings SD

44.9% 12.9%

Source: Bloomberg

RM

QL's Share Price & KLCI index

3.60 3.40 3.20 3.00 2.80 2.60 2.40 2.20 2.00 Sep 30 2011

Jan 31 2012

QL

Consumer Industry

May 31 2012

Sep 30 2012

KLCI

Source: Company data and team’s estimates

 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, QL’s 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 1700 and sustainable growth. Based on our projections, we estimate a 3-year earnings 1600 CAGR of 14.5% starting from FY12 while FY15 onwards shall see the fruition of 1500 its current expansion plans across all three industry segments.

1400 1300  Tapping the Asian consumption growth story: Apart from its entrenched dominant position in its home country, QL’s increasing geographical exposure in 1200 Southeast Asia, especially Indonesia is highly strategic in our view. QL has been 1100 aggressively expanding its production and manufacturing operations in Indonesia 1000 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.

Source: Company data

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Business Description Fig 1: Main business segments

QL Resources Bhd

Integrated Lifestock Farming (ILF)

Marine Product Manufacturing (MPM)

Palm Oil Activities (POA)

Animal feed

Surimi

Palm plantation

Eggs

Surimi-based products

CPO milling

Broiler

Fishmeal

DOC

Deep sea fishing

Palm biomass

Source: Company data

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 QL’s 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. QL’s 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 QL’s 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 QL’s operations.

Fig 2: GDP Growth Forecast 8%

7.2% 6.7%

7% 6% 5% 4%

3.6%

3.3%

3%

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.

2% 1% 0% 2012 World

2013

Developing Asia

Source: IMF July World Economic Outlook

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

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40 35 30 25 20 15 10 5 0

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.

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

KG

Fig 3: Broiler Meat per Capita Consumption

2 November 2012

Vietnam

Indonesia

Malaysia

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.

Source: indexmundi.com

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 world’s 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. Fig 4: 2012 World Palm Oil Production

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 QL’s 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.

Source: indexmundi.com

3 = Least favourable to QL 1 = Most favourable to QL

Fig 5: Integrated Lifestock Farming Five Forces Model

In 2012, palm oil is estimated to make up about 32.8% of the world’s 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 QL’s 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 chicken’s 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

3 Source: Team Analysis

CFA Institute Research Challenge 2013 Fig 6 Peer PBT

2 November 2012

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.

Fig 7: Marine Product Manufacturing Five Forces Model

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 QL’s 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.

Source: Team Analysis

Fig 8: Palm Oil Activities Five Forces Model

Source: Team Analysis

Fig 9 Growth trend 25%

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 QL’s, 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

RM’m

20%

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.

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). QL’s 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.

15% 10% 5% 0% FY11 FY12 FY13F FY14F FY15F Sales Growth

COS Growth

PBT Growth

Source: Company data and team’s estimate

(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

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that this is a strong indication of the management’s execution ability.

Fig 10: Indonesia Real GDP Growth 8% 7.2% 7% 6.1%

6.5%6.4% 6.1%

6% 5%

4.5%

4% 3%

Source: Indonesia Government Official Data and Forecast

Fig 11: QL Indonesia Plantation Progress Hectares

16000 14000 12000 10000 8000 6000 4000 2000 0

Both poultry and surimi divisions make up almost 90% of the company’s 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 QL’s 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 country’s large sea area as well as untapped seafood resources.

Cumulative Planting Matured area Source: Company data and team’s estimates

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.

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Fig 12: Event analysis timeline

RM 4 3.5 July 10, QL was recognised by The Edge as a member of the Billion Ringgit Club

3 2.5 2

QL FY 06 revenue exceeds 1 bil

28 July 09, QL exceeds 1 bn market capitalisation

July 11, QL won the prestigious The Edge Billion Ringgit Club

1.5 21st Dec 09, QL was included as one of the component stocks of the FTSE- Bursa Malaysia Mid 70 Index

1 0.5 0 April 06

May 06, Ranked 2nd in top 100 best returns listed companies by the Edge Magazine

April 07

April 08

April 09

Valuation

April 10

April 11

April 12

Source: Bloomberg and company website

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.

FCFE Components Estimate Long-Term 1.80% Growth Rate Equity Value 3,314.2 (RM’m) No. of shares in 832 million Share price 3.98 (RM/share) Source: Team Estimate

Fig 13: CPO Recent 6 months Future Price RM 3200

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 QL’s 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.

3000 Due to its gradual shift to higher margin business, coupled with the higher yield of upstream oil palm plantation, QL’s 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.

2800 2600 2400

CAPEX QL Resources has committed RM200 million to fund the capex requirement for both FY13F and FY14F. We project that QL’s 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.

2200 2000

Source: Bloomberg

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

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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 selldown of CPO.

Cost of Equity Components Risk-Free Rate 3.50% Expected Market 7.74% Return Equity Risk Premium 4.24% Beta 0.80 Cost of Equity 6.89%

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 QL’s FY13-15.

Source: Team Estimate

Fig 14 P/E Band

RM 4 3.5 3 2.5 2 1.5 1 0.5 0 1 10 0

PE 23x PE 19x PE 15x PE 11x PE 7x

111

1 12

1 Source: Bloomberg 2

Weight Price FCFE 50% 3.98 PER 50% 3.73 Target Price (RM/share)

WxP 1.99 1.87 3.86

Fig 15: Earnings growth RM’m 250 200

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, QL’s 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 company’s seasonality factor of 0.21 for 1Q and the preceding year’s 1Q revenue which accounted for 23.4% of total revenue for FY12.

150 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.

100 50 0

Source: Company data and team’s estimates

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. QL’s 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.

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CFA Institute Research Challenge 2013 Fig 16: Revenue breakdown by Segment FY12

Palm Oil 18%

Surimi 23%

Egg 20%

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

DOC 3% Broiler 2%

Animal Feed 33%

Deep Sea Fishing 1%

Fig 17: Revenue Breakdown by Segment FY 15

Palm Oil 17%

Deep Sea Fishing 0%

QL’s 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:

Source: Team’s Estimates

Surimi 24%

2 November 2012

Egg 26% DOC 4% Animal Feed 27%

Broiler 2%

Source: Team’s Estimates

Fig 18: Operating Cash Flow and Net Debt to Equity

Healthy operating cash flow Given QL’s steady food business, the company’s 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 QL’s 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, QL’s net gearing will peak at 58% in FY13, which we think is still manageable and also within the company’s 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, QL’s 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, QL’s 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).

Source: Company data and team’s estimates

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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 QL’s short to medium term development. Halal food products Most of QL’s 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). QL’s 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 QL’s strong management and governance structure.

Investment Risk Sensitivity to a 10% decline in CPO Price FY13F EPS

% Change (2.55%)

FY14F EPS

(1.94%)

FY15F EPS

(2.54%)

Target Share Price

(0.52%)

Source: Team’s Estimates

Weaker Oil Palm Prices The fluctuations in Crude Palm Oil (CPO) prices will have an impact on QL’s 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 QL’s 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 QL’s 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, QL’s modern facilities, located in bird-free enclosures with high bio-security, and focus on quality control in terms of chicken’s 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 company’s financial figures as both warm and cold waters may drive fishes away, leading to a lower fish capture. However, past studies

9

CFA Institute Research Challenge 2013 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%)

Source: Team’s Estimates

2 November 2012

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 QL’s 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 QL’s 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 QL’s 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 QL’s performance. As noted in the Annual Report, a 1.5% weakening in USD against RM would increase QL’s 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) 1.4% 1.6% 1.8% 2% 2.2%

Terminal Growth Rate

10

6.3% 4.18 4.35 4.53 4.74 4.96

6.6% 3.93 4.08 4.24 4.41 4.61

Cost of equity 6.89% 3.71 3.84 3.98 4.14 4.31

7.2% 3.5 3.62 3.75 3.88 4.03

7.5% 3.32 3.42 3.54 3.66 3.32

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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 company’s 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 company’s stock.

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Appendix Appendix 1: Income Statement FYE March

FY10 RM'm

FY11 RM'm

FY12 RM'm

FY13F RM'm

FY14F RM'm

FY15F RM'm

Revenue Growth

1,476.4

1,777.1 20.4%

1,946.7 9.5%

2,130.7 9.5%

2,319.4 8.9%

2,654.0 14.4%

(1,233.0)

(1,489.6)

(1,645.2)

(1,788.7)

(1,943.6)

(2,219.3)

Gross Profit -Gross Profit Margin

243.4 16.5%

287.7 16.2%

301.6 15.5%

341.6 16.03%

375.5 16.19%

433.7 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)

11.7

9.3

30.7

25.6

27.8

31.8

EBIT -EBIT Margin

148.5 10.1%

174.8 9.8%

184.9 9.5%

213.3 10.0%

235.9 10.2%

274.0 10.3%

Finance Cost

(13.7)

(18.4)

(22.6)

(25.1)

(26.2)

(27.3)

0.8

1.1

1.7

2.3

2.5

2.7

0.5

3.5

8.4

11.4

13.1

15.2

136.0 9.2%

161.0 9.1%

172.4 8.9%

201.9 9.5%

225.4 9.7%

264.6 10.0%

Income Tax Expense Effective tax rate

(20.9) 15.4%

(27.0) 16.8%

(33.1) 19.2%

(39.4) 19.5%

(43.9) 19.5%

(51.6) 19.5%

Profit for the Year

115.2

134.1

139.4

162.6

181.5

213.1

8.2

9.2

7.8

8.3

9.0

9.6

106.9

124.6

131.4

154.3

172.6

203.5

7.2%

16.5% 7.0%

5.5% 6.8%

17.4% 7.2%

11.9% 7.4%

17.9% 7.7%

197,586 790.3

208,000 832.0

208,000 832.0

208,000 832.0

208,000 832.0

208,000 832.0

13.5

15.0

15.8

18.5

20.7

24.5

Cost of sales

Other income

Finance Income Share of Profits of Equity Accounted Profit Before tax - PBT margin

Non-Controlling Interest Profit Attributable to: Owners of Parent Growth Net margin

Share capital Total no. of shares EPS (cents)

Source: Company data and team’s estimates

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Appendix 2: Balance sheet

Source: Company data and team’s estimates

13

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2 November 2012

Appendix 3: Cash Flow Statement Cash flows from operating activities

FY10

FY11

FY12

FY13F

FY14F

FY15F

RM'm

RM'm

RM'm

RM'm

RM'm

RM'm

136

161

172

202

226

267

Depreciation/Amortisation

39

47

56

75

84

93

Non-cash items Operating profit before changes in working capital Changes in working capital

16

14

(6)

(16)

(38)

(56)

191

221

222

261

272

304

(21)

(64)

(26)

(72)

(36)

(47)

171

158

196

189

236

257

0

0

0

0

0

(14)

(23)

(23)

(31)

(35)

(40)

Profit before tax

Cash generated from operations Dividends from liquid investment

-

Tax paid Interest paid and received Net cash generated from operating activities

(3)

(4)

(6)

(5)

(5)

(4)

154

131

168

153

197

213

Cash flows from investing activities Capital Expenditure

(119)

(245)

(261)

(200)

(200)

(100)

7

3

18

13

14

14

Proceeds from disposal Dividends received Other investments Net cash generated from investing activities Cash flows from financing activities Proceeds

1 (111)

1

2

3

3

4

(12)

(3)

(3)

(3)

(3)

(252)

(244)

(188)

(187)

(86)

32

182

101

120

120

60

Repayment of loan

(11)

(15)

(16)

(21)

(24)

(25)

Dividends paid

(25)

(32)

(39)

(48)

(54)

(65)

3

1

1

2

3

4

(2)

136

47

53

44

(26)

41

15

(29)

18

54

101

61

102

117

88

106

160

102

117

88

106

160

262

Other financing items Net cash generated from financing activities Net increase/(decrease) in cash & cash equivalent Cash & cash equivalent at beginning of year Cash & cash equivalent at end of year

Source: Company data and team’s estimates

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Appendix 4: Key Financial Ratios Margins Gross Profit Margin PAT Margin EBITDA Margin

FY10 16.49% 7.79% 12.74%

FY11 16.18% 7.53% 12.67%

FY12 15.49% 7.15% 12.79%

FY13F 16.05% 7.58% 14.06%

FY14F 16.20% 7.80% 14.37%

FY15F 16.38% 8.10% 14.43%

Growth Sales Growth COS Growth PBT Growth Net Profit Growth

5.61% 2.96% 23.77% 19.04%

27.12% 20.81% 18.23% 16.27%

39.26% 10.45% 7.14% 4.01%

52.42% 8.72% 17.40% 16.11%

65.92% 8.66% 11.90% 11.90%

89.85% 14.18% 18.06% 18.92%

0.03 0.14 0.71 1.68% 7.84%

0.04 0.15 0.96 1.14% 4.83%

0.04 0.16 1.06 1.31% 4.86%

0.05 0.18 1.22 1.51% 5.41%

0.06 0.21 1.38 1.46% 5.20%

0.07 0.25 1.57 1.51% 5.41%

41.36 27.00 38.92

41.95 30.99 41.66

40.31 30.35 33.99

41.21 29.44 38.19

41.21 29.44 38.19

41.21 29.44 38.19

1.55 0.52

1.47 0.53

1.29 0.44

1.42 0.50

1.43 0.58

1.71 0.78

20.60% 10.40% 18.31%

16.74% 9.09% 16.60%

15.81% 8.33% 15.60%

15.91% 8.39% 15.42%

15.76% 8.30% 15.29%

16.49% 8.94% 15.83%

Investors Ratios Dividend per Share (RM) Earnings per Share (RM) Net Asset per Share (RM) Dividend Yield (%) Earnings Yield (%)

Activity (days) Receivables Payables Inventory Liquidity Ratio (times) Current Ratio Quick Ratio Profitablity Ratio Return on Equity Return on Assets Return on Capital Employed

Source: Company data and team’s estimates

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Appendix 5: Peer Comparison 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: Bloomberg and team’s estimates

Appendix 6: DuPont Analysis Profit Margin (%) Asset Turnover (times) Equity Multiplier (times) ROE (%)

FY10 7.79% 1.3348

FY11 7.53% 1.2070

FY12 7.15% 1.1652

FY13F 7.58% 1.1065

FY14F 7.80% 1.0652

FY15F 8.10% 1.1034

1.9802

1.8420

1.8984

1.8963

1.8978

1.8443

20.60%

16.74%

15.81%

15.91%

15.76%

16.49%

Source: Company data and team’s estimates

Appendix 7: Altman Z-Score Analysis Working capital/Total Assets Retained earnings/Total Assets EBIT/Total Assets Market Value of Equity/Total Liabilities Sales/Total Assets Z-Score

Weight 1.2 1.4 3.3 0.6 1.0

FY10 0.144 0.286 0.135 2.490 1.335 3.8

FY11 0.123 0.280 0.121 3.832 1.207 4.4

FY12 0.076 0.304 0.116 3.421 1.165 4.1

FY13F 0.102 0.321 0.117 3.115 1.107 3.9

FY14F 0.107 0.341 0.115 3.207 1.065 4.0

FY15F 0.170 0.370 0.121 3.450 1.103 4.3

Source: Company data and team’s estimates

Altman Z-Score Interpretation Scale: Z-Score > 3.0 2.7-2.99 1.8-2.7 < 1.8

Interpretation Company is considered ‘Safe’ based on financial figures This zone is an area where one should ‘Exercise Caution’ Good chance of the company going bankrupt within 2 years of operations from the date of financial figures given Probability of financial catastrophe is very high Source: Grahaminvestor.com

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Appendix 8: Worldwide Distribution of Muslim Population

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Appendix 9: QL’s Operating Bases

City HQ Kuala Lumpur Integrated Livestock Farming Kulim Nilai Rawang Kuching Kota Kinabalu Tawau Cianjur Tay Ninh Province Marine Product Manufacturing Hutan Melintang Endau Johor Bahru Tuaran Surabaya Palm Oil Activities Tawau East Kalimantan Source: Company data

18

Country Peninsular Malaysia Peninsular Malaysia Peninsular Malaysia Peninsular Malaysia East Malaysia East Malaysia East Malaysia Indonesia Vietnam Peninsular Malaysia Peninsular Malaysia Peninsular Malaysia East Malaysia Indonesia East Malaysia Indonesia

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2 November 2012

Appendix 10: QL’s Group Structure

Source: Company data

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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

Leaching and refining

Mixing and forming

Export

White meat fish

Automatic deboning

Quick freezing

Storage in cold room Source: Company data

21

Dehead and gutting

Deheading

X-ray detection

Packing

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2 November 2012

Appendix 13: Weather conditions Figure 8: Probability of Southern Oscillation Event

Note: Rolling 3-month probability, SON 2012 = September/October/November 2012 Source: International Research Institute for Climate and Society

Southern Oscillation Index

Source: Australia Bureau of Meteorology

Sustained values of the SOI above +8 may indicate a La Niña event, while sustained negative values below −8 may indicate an El Niño event. Values of between about +8 and −8 generally indicate neutral conditions. 22