THREE-A Resources' (3A, RM2.10) longer-term growth prospect remains intact. Earnings expansion in 2010-2012 will be underpinned by increasing capacity and volume demand.

Nevertheless, with 3A's share price having done exceedingly well over the past year, the stock does appear fairly valued, for now. Its shares are currently trading at 31.9 times our 2010 estimated earnings of 6.6 sen per share.

Some margins contraction in 4Q09
The company's latest earnings results for the financial year ended December 2009 were broadly in line with our expectations.

Turnover continued to grow strongly, by 22.3% quarter-on-quarter (q-o-q) to RM55.2 million. This was attributed to robust demand for its ingredient products.

In particular, growth was driven by rising utilisation at the second glucose plant, which was completed in 4Q08. The plant is estimated to be running at about 80% of capacity currently. The availability of glucose feedstock also means that 3A is now running its maltodextrin plant at full capacity.

However, margin in the latest quarter was lower compared with 3Q09. This was due to the rising cost of raw materials, primarily tapioca starch, and the slight lag in adjusting its selling prices. As a result, net profit was slightly lower at RM4.5 million compared with the RM5.9 million in 3Q09.

For the full year, 3A's turnover increased 17% year-on-year (y-o-y) to RM178.6 million while net profit grew a strong 49% to RM18 million on the back of better product mix.

Gradual price hikes on rising raw material costs
We are not overly concerned over 3A's margin contraction in 4Q09. As mentioned above, the drop in profitability was due, primarily, to rising raw material costs and a lag in adjusting the company's selling prices.

Indeed, 3A had been in similar situations before over the past two years, especially with global commodity prices turning increasingly volatile. The company has always managed to pass on the higher costs, after a short time lag. We expect the company to gradually raise selling prices for its products over the coming weeks.

The price for tapioca starch, the company's primary raw material, has risen steadily over the course of 2009. We estimate prices averaged about US$350 (RM1,180) per tonne in 4Q09, compared to about US$260 per tonne in 1Q09. Prices have risen further this year, to about US$400-US$410 per tonne in the first two months of 2010.

Rising raw material prices affect all producers. Thus, the planned selling price increases are not expected to affect 3A's competitiveness. The company's margins should gradually improve as the planned price hikes for its ingredient products are progressively implemented.

Still upbeat on longer-term outlook
3A's longer-term growth prospect remains intact. Growth in 2010-2012 will be underpinned by increasing capacity and volume demand.

The second glucose plant, commissioned in 4Q08, is currently running at above 80% of its 7,000 tonnes per month capacity while the older plant is fully utilised. 3A is in the process of finalising plans to upgrade the second plant to produce up to 18,000 tonnes per month, with a portion of the capacity used as feedstock for its new maltodextrin plant.

Demand for maltodextrin has been very strong. Its existing 1,200 tonnes per month plant is producing at full capacity. The new 2,000 tonnes per month plant is slated for completion in 4Q10. We believe the company has already lined up customers for a good portion of the new plant's output. It is the only local producer and there is still much room for import substitution.

Upside from JV with Wilmar
We have yet to quantify any contribution from 3A's planned joint venture plant(s) with Wilmar International in China.

There is little concrete detail on the proposed venture. More information should be forthcoming over the next few months. But the prospect of expanding into the huge Chinese market with a well-established partner is definitely positive — and would boost 3A's earnings over the longer term.

Wilmar has an extensive network, both upstream and downstream, in the food industry and is a leading distributor of staple food, such as cooking oil, flour, rice and bottled mineral water, in China.

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