Risks at Carotech materialise

Hovid Bhd
(July 2, 17 sen)
Downgrade to sell at 20.5 sen with lower target price of 21 sen (from 28 sen): Hovid announced on Bursa Malaysia on July 1 that its 58%-owned subsidiary Carotech has defaulted on its principal and interest servicing in respect of certain banking facilities from financial institutions.

According to Hovid, it does not have any obligation with regard to the defaulted loans by Carotech. The latter is currently working directly with the financial institutions with assistance from the Corporate Debt Restructuring Committee (CDRC) to construct and implement a Debt Restructuring Plan.

As we had been highlighting in our previous reports, Carotech’s high-net-gearing level exceeding 1.5 times was of grave concern, although the stock trading was at an attractive price-earnings ratio (PER).

Although Hovid does not have any obligation on the defaulted loans by Carotech, we believe the default may trigger a cross default with regard to Hovid’s other lenders. Other than the interest costs, Carotech is also exposed to forex risk given that the bulk of its borrowings is in US dollars.

To recap, between 2006 and 2008, Carotech invested more than RM300 million to increase its capacity from 18,000 tonnes to 120,000 tonnes per annum to cater to increasing demand for phytonutrients and oleochemical products as the time.

However, the significant increase in commodity prices in late 2008, particularly the price of crude palm oil (which is the main material for Carotech’s products), and the subsequent global economic turmoil dampened underlying demand and reduced the Carotech’s ability to generate the cash flow to meet its debt obligations.

As such, we believe the default arose mainly due to over-expansion of capacity, a significant rise in working capital and the company’s inability to clear stocks owing to reduced demand arising from poor economic conditions in Europe and the US, which are its major markets.

With such developments, we have cut our PER valuation from eight times to six times PER on FY11 earnings per share and arrive at a lower target price of 21 sen from 28 sen previously.

Despite the lack of downside on the stock, we have downgraded our recommendation from trading buy to sell, due to the negative sentiment arising from the default and amid uncertainties on the future. — OSK Investment Research, July 2


Written by Financial Daily
This article appeared in The Edge Financial Daily, July 5, 2010.