Business Description
Superlon was set up in 1992 and listed on Bursa in 2007. The company acquired its first factory in 1996 and bought its second factory in 2004. The first factory sits on a 2.9-acre parcel with a built-up of of 60,000 sq ft while the second factory sits on a 3-acre parcel with a built-up of 66,000 sq ft. Both factories are located at Tempat Sungei Jaty in Klang. In 2012, the company ceased operations of its then loss-making steel pipe division. In 2016, it started to build its new warehouse near its current factory as its production reached a bottleneck. The 70,000 sq ft warehouse is expected to be completed by the end of 2016.
Superlon manufactures synthetic rubber insulators mainly for heating,ventilation and air-conditioning (HVAC) and refrigeration, which are important components of high-rise buildings and industrial usage. The company specialises in the usage of nitrile-butadiene rubber (NBR) to produce sheets and tubes for thermal insulation.
Superlon exports to more than 50 countries globally. The diversification of its markets provides a cushion for any softening in one particular region. It sells to distributors, sales agents, project managers in these countries under its own brand.
Top markets are Asia and Malaysia, making up ~88% of its yearly turnover for the past three years. Due to the higher sales growth from other Asian countries, the percentage contribution from Malaysia to its annual sales appeared to be on a down trend.
however, sales in Malaysia ranged steadily from RM19.6m to RM20.4m for the past three years. We reckon that there is still room for Superlon to increase its grip in strategic markets. It can also further expand its footprint in the future as its bigger peers export to more than 100 countries
Competitive Advantages
1. Market dominance in synthetic rubber insulation Superlon is a market leader in Malaysia with an estimated market share of 50% to 60%. It also exports to more than 50 countries and is ranked top five in the world in terms of market presence
2. Strong local production capability . efficiency, modification of machine, wastage, sales increase =cost efficient
3. Niche market specific: focused on insulation only. Can price premium over customer since no many choice of supplier from customers.
4. Higher average selling price (customized/specific product price premium) ASP is determined by the product type and specifications as well as supply and demand. The company thrives on R&D to produce higher value products such as acoustic products
5. Higher volume (wide distribution network), Achieved through higher demand from existing and new customers. Boosted by the increasing number of construction projects
Growth Driver
New warehouse to boost capacity by 30%. The construction of its new warehouse is on track and that will further optimise the production layout of its plant. We are expecting increased production capacity by 30% in FY18. We expect Superlon’s core EBIT margin to improve further due to layout optimisation that will lead to better work processes. the new warehouse is expected to shorten lead time and response time to its clients thus, improving sales. The RM12m project is funded through a combination of internally-generated fund and bank loan but the management has yet to drawdown its approved loan. Full-year earnings impact from the new facility is expected in FY18.
Well positioned to capitalise on high growth markets. Asia is a high growth market for Superlon, with India and Vietnam contributing the most.
Management is positive on the growth from these two countries as well as other Southeast Asian countries. The economic growth, which spurs development in these two countries, will provide sales opportunities for Superlon. The company has a geographical advantage as due to its close proximity to these high growth markets. It can price its products competitively as it save on logistics cost to transport its products, which can be bulky, to the sales destinations.
Dynamic sales strategies to meet demands from different markets. Superlon continues to expand into new markets including some countries in the African continent. It targets to enter two new countries every year. Sales to Africa surged by 91% from RM1.86m in FY15 to RM3.56m in FY16. America, which contributes ~5% to Superlon’s annual income, saw a jump in sales by 27% from RM3.43m in FY15 to RM4.34m in FY16. management’s proactive marketing strategy in penetrating new markets albeit with a focus on the high-growth region. It also adopts sales strategies that meet specific market needs. It will be hard to replicate the export experience and the network Superlon has built in more than two decades.
Business Risk
Hike in raw material prices.
Raw material makes up ~70% of Superlon’s cost. The main material used is NBR, which is made up of acrylonitrile and butadiene. Price trends of these two materials are positively correlated to crude oil prices. However, we do not expect a sharp hike in crude oil prices as our house forecast for Brent crude averages at USD50 per barrel in 2017. Premised on this assumption, we do not expect escalating costs due to high raw material prices. We expect FY17F costs to be similar to FY16 due to the improved formulation, less wastage as a result of efficiencies and improved economies of scale as a result of higher production capacity.
Weakening of USD. A weaker USD
may translate into a normalised profit margin for Superlon as it is a net beneficiary of a strong USD. On the flipside, the lower sales will be offset by lower input cost as ~70% of its raw materials are imported. Note that that even when USD/MYR rate was trading between 3.00 and 3.40, Superlon was able to record core EBIT margins of 8% to 16%. We expect USD/MYR exchange rate to average at 4.10 in 2017.
Emergence of a better and cheaper thermal insulator.
A new product that can replace NBR as a preferred thermal insulator could risk the demand for Superlon’s products. That said, NBR has been used as a thermal insulator for a long period of time and was proven to be a reliable and long-lasting material so it will take time for the new product to prove itself.
Financial Analysis
The fluctuation in profit margins is contributed mainly from raw material prices (i.e. NBR, copper). Major adjustments in profit were made to exclude foreign exchange gains. Recent rise in revenue mainly contributed by appreciation of USD against RM Large gap between cash ratio and current ratio is contributed from trade receivables and inventories.
Slow movement in inventories prior to FY2012 (presumably due to poor performance in steel fabrication business) further enlarge the gap. After that, we can see the management efficiency in managing of its capital causes the ROE increases rapidly. Going forward, due to its competitive position, we anticipate it will take more market share in the global and locally.
Valuations & Recommendations
The business is a major player in Malaysia market (>50%) market share. The target customers in developing countries will continues rising its demand toward insulations.
With the company has strong balance sheet with net cash position and they positioned in niche market with economy of scale, we rate a recommendation of BUY below RM 2.40 for longer term
