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Coping with a happy problem
Emmanuel Samarathisa 
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Stock markets and commodities may have taken a beating last year but one commodity, cocoa, bucked the trend. It witnessed a surge in demand due to dry weather hurting production in some of the top producing countries such as Ivory Coast.

This has left cocoa processors such as Guan Chong Bhd (GCB) with a “happy problem” – they can’t cope with demand. Not surprisingly, GCB’s share price has surged from just RM2.05 on Jan 30 last year to RM3.22 currently.

GCB chief executive officer Brandon Tay Hoe Lian tells FocusM: “So we are facing a good problem right now and everything seems too good to be true. The last quarter and this quarter have been a blessing to us. This year, all we need to do is catch up with delivery because last year we had difficulties fulfilling everything.”

As the world’s fourth-largest cocoa processor, Johor-based GCB posted robust financials for the third quarter ended Sept 30, 2018, registering a 47.7% jump in net profit to RM43.87 mil from RM29.7 mil in the previous corresponding . Quarterly revenue also ticked up 10.3% to RM598 mil from RM542.86 mil on the back of higher cocoa sales volume, increased bean grinding and lower input costs.

 

Being chased by customers

Demand, according to Tay, has been ramping up over the last quarter and despite 2019 only being a few weeks’ in, “people are already looking towards the first and second halves of 2020 in terms of orders,” says Tay. “Customers are already chasing me for more since last year. This is a good thing, to have this privilege of being chased by your customers.”

GCB grinds and processes cocoa beans into butter and solids. The latter is available in powder or “cake” form. Both butter and solids have seen steady demand, says Tay. “In terms of solids, normally we sell six months ahead but now we are selling nine months ahead and we are almost 90% sold already. For butter, we are looking at sales for the first half of next year.”

The sustained appetite for cocoa butter and solids have boosted GCB’s confidence this year, says Tay. “So far we feel good. Since everything is driven by sales, my total output is going to be almost done, the only focus now is delivery.”

The only way forward, since Tay has his sales down pat, is expansion. “We are hungry to move forward,” he says without giving specifics. “But this has been keeping us busy,” he adds as GCB, despite being the fourth largest in the world, is “still rather small in relation to global potential. But we are looking to double our manufacturing capacity going forward.”

Expansion has been a dominant theme for GCB since it decided to augment production last year after a few years of curtailing output. Among the measures the group undertook was a RM70 mil investment in a facility in Pasir Gudang, Johor, owned by GCB Cocoa Malaysia Sdn Bhd. GCB Cocoa was known as Koko Budi Sdn Bhd until GCB acquired the company, which was its rival, in June 2017 for RM17 mil. “This year, we should reach 235,000 MT of processed cocoa and we are confident of meeting the target,” he says.

 

Going global

But Tay hints that the expansion will not be done on local shores. “I am not busy with Malaysia right now and we are looking at outside the country.” This evolution, according to Tay, will see GCB set up operations in “major cocoa bean producing nations, thus giving us direct access to key cocoa bean sources and better quality control.”

Another reason for the growth drive is to “improve sales in key chocolate consuming markets in Europe” he adds. European Union members are the largest consumers of cocoa but just like other commodities markets, cocoa has its fair share of protectionist policies that come in the form of export and import tariffs.

“Exporting our products to Europe will incur us an estimated 4.5.-8.9% in tax, so naturally we don’t benefit. It’s not competitive to be there,” says Tay. “But we need to find newer ways to enter the market.” This global expansion is one of such “ways” and the GCB team has been busy to meet this goal, he adds. “We intend to grow from an Asian-based company to a global cocoa player.”

But size does matter for cocoa processors. “In our line, you need to be sizeable. All our competitors are getting bigger and bigger. So if you don’t double up, you will be left behind,” says Tay.

The timing seems right for GCB. “Conditions appear good in East Africa and Asia. Demand is said to be improving as offers from the new harvest start to increase,” Jack Scoville, senior softs analyst at Chicago’s Price Futures Group, wrote in a Dec 31, 2018, note. Bloomberg, in a Jan 15 survey, also found that cocoa grinding in Europe and North America have kept processing profits at high rates.

Rising demand has also been seen in Asia, including Malaysia where grinding shot up 23% year-on-year in the fourth quarter to 72,451 tonnes, according to the Malaysian Cocoa Board while the cocoa futures traded in London jumped 28% last year against the backdrop of stronger demand. Prices are still below the five-year average, making processing these beans a lucrative venture and stronger demand in 2019 is expected to continue, according to Goldman Sachs Group Inc.

But there might be headwinds. “Firstly, the US interest rate hike as the group’s loans were most denominated in US dollars, which means higher interest cost will affect profit margins. Secondly, growing global grinding capacity that may outpace demand growth, which might lead to another round of oversupply risk,” says a KL-based softs analyst.

The last time the market witnessed an oversupply of cocoa beans was in 2014. GCB suffered low margins as a result of the oversupply, posting a net loss of RM17.56 mil in the financial year ended Dec 31, 2014.

But after that blip, the company not only posted a comeback but also a year-on-year profit increase to RM22.76 mil, RM42.58 mil, and RM91.05 mil for the financial years 2015, 2016 and 2017 respectively. One of the success factors has been a continual investment in production facilities, a feat that only few could pull off as it is capital heavy.

“Our extensive experience allows us to have the foresight in potential headwinds,” says Tay. “In recent experience, we set up our plant in Batam as it is a freeport to facilitate tax-free movement of beans and machinery.”

Indeed, the sheer nature of cocoa processing which requires heavy upfront capital has either deterred many from venturing into the market or have led others to either consolidate or wind up operations.

GCB started as a humble family business in the 1980s, engaged principally in the trading of cocoa beans, when Malaysia was among the top three cocoa producing nations in the world with more than 200,000 MT of cocoa beans harvested annually. During this stage, GCB started a small processing plant in Parit Jawa, which was close to cocoa plantations. The company grew and in 1991, it moved its operations to Pasir Gudang to be closer to one of the major ports in Malaysia and take advantage of the export market.

One of its major breakthroughs came in the early 2000s when GCB expanded its global reach by acquiring a 49% stake in Carlyle Cocoa Co in Delaware, US, through its wholly-owned subsidiary GCB America Inc. This helped provide GCB direct access to the US market.

As demand for processed cocoa began to rise, GCB more than doubled its annual grinding capacity to 200,000 tonnes from 80,000 in 2011-2012. That was when it set up shop in Batam as most of its cocoa beans come from Indonesia. The expansion came after the Indonesian government decided to slap an export tax on locally grown cocoa beans in April 2010.

Today, GCB is a mainstay of the billion-ringgit club on Bursa Malaysia with a market capitalisation of RM1.55 bil and has footprints in various parts of the region. Aside from operations in Batam and the US, it also has trading subsidiaries in Singapore and Indonesia.

 

Driven by demand

Tay also shrugged off concerns over its loans, noting that these would not depress the group’s plans as the borrowings are short term. “We think that last year’s profit and this year’s profit should allow us to justify the expansion,” says Tay, who also shrugged off concerns over the tense US-China trade war, the “no-deal hard Brexit” where the UK will make a clean break from the EU, and the anti-palm oil lobby in Europe, which has been a bane to the Malaysian government.

Some of these externalities, especially the trade war and Brexit, have led research houses such as Maybank IB Research to remain wary. “We expect portfolio capital flows to remain volatile,” it said in a Jan 23 note.

The good news for GCB is that its share price has been moving upwards. This is in “anticipation of better results yoy,” says the analyst. “But, do note that most of the positive catalysts have been priced in by now, leaving little upside in the near term. Moving forward, GCB’s share price should mainly be driven by demand growth for chocolate products.”

 

‘Recession-proof’

Regardless of how the future pans out for the markets, Tay is confident that GCB will be able to weather any storm as the cocoa industry has been known to be “recession-proof.” Demand from multinational giants such as Nestle and Hershey’s, which GCB counts among its long-term customers, has been stable and increasing, he says. “Thus cocoa is considered to be a safer commodity compared to others because cocoa ingredients are industrial food products that are used in a wide range of foodstuff globally. Thus there is global demand resilience even during a crisis. People may switch to lower-grade chocolates, but they will still eat chocolates during both bad times and good times, making it recession-proof.”

 

Sticking to core business

One thing’s for sure, GCB is not looking to diversify, notes Tay. “We are keen to expand our core business of cocoa processing. Instead of diversifying to different industries, we are looking towards expanding group capacity.” This time round Tay, who joined GCB in 1993, will be banking on his experience in leading the company during both good and bad times to navigate newer markets.

“During the tough times, we actually cracked our heads, thinking whether we should expand or not. That was during the 2014 oversupply. We had to let go some of our downstream operations and just focus on grinding. So far we’ve made the right moves and we learned our lessons,” he says.

What’s changed since then, among others, is a more experienced team that has been with the company since the early stages. According to Tay, his “elite team” is ready to go into the next phase and some are already overseas working towards making GCB’s goal a reality.

“We know the industry inside out and are able to manage all aspects of the group such as keeping production costs low, using advanced machinery and managing raw material procurement and currency hedging,” he says, adding that another ace in GCB’s bag is its long-term relationship with its suppliers as well as its rolodex of multinational customers such as Mars, Hershey’s and Nestle.

Indeed, the cocoa industry is highly competitive as key cocoa producers boast large financial and production resources and many of them are vertically integrated from cocoa bean trading up to chocolate manufacturing. Customer satisfaction is of paramount importance.

But, ultimately, Tay believes GCB’s love for cocoa will see the group move to greater heights through thick and thin. “We are passionate about the chocolate industry in Malaysia. Chocolate is our lifeblood so that’s why we are devoting our entire lives to this industry,” he says. FocusM



This article first appeared in Focus Malaysia Issue 319.