Tuesday, 25 April 2017

Eating Chocolate is easy, but understanding the making of a Chocolate is an Art

According to my previous article in GCB, I believe now you will be anticipating eagerly to know my thoughts and perspective into Guan Chong Berhad (GCB - 5102).

Here, I will share with you 2 of my views into GCB from different angles.

On the first angle, I will definitely need to highlight the massive 40% drop of cocoa prices in the international market, and it's subsequent effect for the next 2 to 3 years.

Let's go to some basic of economics - The Law of Supply and Demand.

If you do not really know what is supply and demand, I will try to explain to you in the simplest manner I can using my own layman words. Basically, consumer creates demand, and manufacturer creates supply.

For a consumer point of view, when a subject item is cheaper, it will create more demand. For example, a chocolate bar selling at RM 25 might probably get 100 buyers, but if the same chocolate bar is now selling at RM 10, then there will be 700 buyers willing to buy it. So, when an item get more expensive, the demand become lesser ; vice versa, an item get cheaper, more demand. So, I assume you already understand the terminology of "demand" now.

Now, we will look into the "supply" of the chocolate, since we are talking about chocolate now. For a chocolate manufacturer point of view, if the chocolate is going to be sold at RM 25, then they will be willing to manufacture 900 pieces, but if the chocolate is to be sold at RM 10 (baseline price), then the manufacturer will be willing to manufacture 100 pieces only.

Let's say at the baseline price of RM 10, the cost is RM 9 and the profit is RM 1. Now since the raw material price - Cocoa, had dropped to almost 50%, the input production cost become lower now.

Let's assume the cost is RM 4, and the manufacturer continue to take RM 1 profit, so the new baseline price is RM 5 now.

As you can see in the chart, there will be a new Supply Curve S2 formed due to the lower production cost. And without sacrificing the manufacturer own profit (Maintain at RM 1), now the manufacturer is able to sell at a cheaper price (due to cheaper raw material cost), hence pulling more demand from consumer as the price of chocolate bars drop. This will see a new equilibrium at point E2, where buyer increase from 400 to 500.

Based on this simple analysis, I can tell you that Chocolate demand will pick up again, and it will definitely going to last for more than 1 year if there is no supply disruption. When that happen, GCB will be having a busier year grinding more cocoa which will translate to more revenue, and more profits.

Now, after looking at the macro economic scale, I will bring you to see the immediate relationship between the prices of cocoa and the share price movement of GCB.

As you can see from above, I had done a same period comparison from year 2011 to the current 2017. The price movement of the cocoa and share price movement of GCB definitely have an inverse relationship, whereby when cocoa price increase, GCB share price will drop, and when cocoa price decreases, GCB share price will increase.

This inverse relationship is of course by no means of luck. If you would understand the law of demand and supply, you would understand that when chocolate bars are cheap, then there will be more consumer demands. When raw material become cheaper, chocolate bar manufacturer will increase their production and sell cheaper chocolate bars. The increase in production from the chocolate manufacturer will then increase the buying of cocoa powder, which means, GCB will need to buy more raw cocoa and grind them into cocoa powder, and sell them to the chocolate manufacturer.

That is a simple 2 different angle of view I had presented to you on my analysis towards GCB.

If that is enough, then go and do your own due diligence and study.

Still have doubts? Alright

Now, I will give you one more information before you decide to invest into GCB.

I know that you might be wondering why the 4th Quarter FYE 2016 result is so poor. As you can see from the statement obtain from Bursa filling, the 4th Quarter took in a lot of impairment from forex and commodity futures contracts. These 2 item alone had taken RM 50 million off from the profits, which can contribute to 10 cents of EPS (Share outstanding only 480 million)

Since the MYR had already rock bottom, and could be poising for recovery due to foreign fund flowing back into emerging market, this is a good time again for GCB, ready to ride high on 2017 with a clean sheet after full impairment done.

So, I had gave you a 3 point shot. But, the ball will be on your hand, to take the shot, or to call it off. But again, make your own study until you are convince, don't rush into it.

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