February 9, 2018

Although U Market’s losses exacerbated this quarter, management cited that it reduced the subsidiary’s trading transactions, which have higher risks of losses. Neo Group also has plans to turn the business around by consolidating the operations to its headquarters office and leasing cold-rooms at lower rental rates. Given management’s track record of turning around its food manufacturing arm (Thong Siek Group), we believe U Market would follow a similar trajectory and deliver profits by FY19F (Mar). In fact, we think there could be potential upside to our FY19F estimates, should the group be able to tap into its other subsidiaries’ distribution networks to sell U Market’s products.

We do not like Neo Group’s net current liability position and its high net gearing ratio of 1.6x. We think this is very risky especially in this rising interest rate environment. The group has an interest cost of about 3-3.5%. Given the huge amount of borrowings, the interest payment easily represents 50% of our FY18F PATMI. While Neo Group could improve its current ratio by refinancing some of its shorter term debt with longer term borrowings, we think the group still needs at least 2-3 years of spectacular results to bring down its net gearing ratio to a more reasonable level.  Some options the group could explore would include placement of its shares or listing of some of the new entities it had previously acquired. Given that the founder-cum-CEO, Mr Neo Kah Kiat, and his wife collectively own about 75% of Neo Group, we think the group could place out a maximum of 50% more shares in order for the couple to maintain a controlling stake. Alternatively, the group could also list some of its businesses to unlock value and recycle its capital. In particular, we note that the food manufacturing arm (Thong Siek Group) has grown pretty strongly and now contributes 32% of 9MFY18 revenue. It owns the DoDo fishball brand, which is the industry leader of Singapore’s surimi products. As the group continues to ramp up its profitability, we think this is one of the possible entity that it could list in the future. Maintain NEUTRAL and TP SGD0.64 by RHB. Share price closed at S$0.675