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Posted Date: October 6, 2020 MARC has assigned a preliminary rating of AA-IS with a stable outlook to Guan Chong Berhad’s (GCB) proposed Sukuk Wakalah Programme of up to RM800.0 million. The proposed rating incorporates GCB’s strong market position in the midstream cocoa industry, established operational track record and healthy debt coverage metrics. The rating is constrained by the group’s inherent exposure to fluctuations in cocoa commodity prices, its high customer concentration risk as well as risks associated with executing its expansion into the European market through Africa. Initial proceeds of the sukuk amounting up to RM300.0 million will mainly be used to fund GCB’s expansionary programmes. GCB commenced cocoa grinding operations in 1990 in Pasir Gudang with an annual grinding capacity of 6,000 metric tonnes (MT). The group’s grinding capacity has since increased to 250,000 MT as at end-December 2019 through a combination of organic and acquisitive expansion. GCB is currently the largest cocoa grinder in Asia and fourth-largest in the world by capacity. It produces cocoa butter, cocoa cake, cocoa powder and cocoa liquor, which are the grinding products of cocoa beans and are key ingredients used by industrial and retail chocolate manufacturers. The group’s plant utilisation rate has been strong at an average of 86% over the past five years. In 2018, 50,000 MT in grinding capacity was added through the acquisition of a new facility in Pasir Gudang which was subsequently upgraded. Due to growth in demand, the group’s combined utilisation achieved full capacity in 2019. To meet the increasing demand and at the same time expand into the European market, the group is building a grinding facility with an annual grinding capacity of 60,000 MT in Ivory Coast, the largest cocoa-producing country. This will provide logistical advantage in terms of being able to deliver its products directly to Asia and Europe. Scheduled to be completed in 2H2021, the investment would cost about €50 million to €60 million. As at end-June 2020, GCB has incurred €17.6 million for the facility with the remainder expected to be funded through internal funds and borrowings. GCB has also acquired a downstream industrial chocolate manufacturer, SCHOKINAG-Schokolade-Industrie GmbH (Schokinag), in January 2020 for €30 million. The acquisition would reduce its reliance on global cocoa traders through which it has been selling its products. Schokinag, with existing clients from over 90 years of operations, will absorb 40%-50% of GCB’s incoming Ivory Coast capacity. The group is exposed to fluctuations in cocoa bean prices which make up about 86% of the cost of goods sold. However, the group’s earnings are largely hedged by forward contract agreements which ensure a fixed margin over market-quoted cocoa bean prices. This arrangement is evidenced by the average selling price of cocoa butter which has moved in line with cocoa bean prices over the last five years. Cocoa butter typically makes up 70% of GCB’s total revenue. GCB’s major clients comprise large midstream cocoa product traders and confectionery producers such as Barry Callebaut AG. While geographically diversified, the group’s client concentration is relatively high as its top five clients made up about 57% of total revenue in 2019. Partly mitigating client concentration risk is the long relationship GCB has maintained with its top five clients, extending beyond 10 years. Additionally, the group’s proven track record alleviates concerns on customers switching suppliers. GCB has exhibited steady financial performance since its listing in 2005 with revenue growing at a compounded annual growth rate (CAGR) of 15% to RM2.94 billion in 2019. In 1H2020, revenue grew by about 30% y-o-y, attributed to the consolidation of Schokinag. Operating profit before interest, tax, depreciation and amortisation (OPITBDA) interest cover stood strong at 14.32x in 1H2020. Leverage position improved to 0.63x in 1H2020 from 2.20x in 2015. The improvement was largely attributed to the group paring down term loans incurred to fund an expansion in 2012 coupled with growth in internally generated funds. Going forward, additional funding for the ongoing Ivory Coast expansion, coupled with the associated working capital requirements, would increase the group’s leverage position to 0.81x.