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Sunzen Biotech Berhad (“Sunzen Biotech” or “Company”) Research Report for the six (6) months 31 December 2008 financial period ended This research report is prepared pursuant to Chapter 9, Part K, Rule 9.23 and the Guidance Note 6/2006 of the Listing Requirements of Bursa Malaysia Securities Berhad (“Bursa Securities”) for the MESDAQ Market (“Research Report”) 1. FINANCIAL PERIOD UNDER REVIEW This is Sunzen Biotech’s first Research Report since it was listed on the MESDAQ Market of Bursa Securities on 8 October 2008. SECOND HALF 6 months 6 months ended ended 31 December 31 December 2008 2007 RM’000 RM’000 Revenue Profit before taxation Taxation Net Profit 13,221 418 31 449 - CUMULATIVE Current Year *Preceding To Date Year To Date 31 December 31 December 2008 2007 RM’000 RM’000 26,260 2,157 (187) 1,970 23,141 3,245 (450) 2,795 Note: * Extracted from the Prospectus of Sunzen Biotech dated 12 September 2008 based on the proforma consolidated income statements for the financial year ended (“FYE”) 31 December 2007. Review of performance For the six (6) months financial period ended 31 December 2008, Sunzen Biotech and its subsidiary companies (“Sunzen Biotech Group” or “Group”) recorded revenue of RM13.22 million and profit after tax (“PAT”) of RM0.45 million. There is no comparison for the corresponding period in the preceding year. In terms of the unaudited twelve (12) months ended 31 December 2008, the Sunzen Biotech Group recorded revenue of RM26.26 million representing an increase of approximately 13.48% as compared to the proforma consolidated financial results of the Sunzen Biotech Group for the FYE 31 December 2007. This was mainly attributable to higher domestic sales of feed additive products. Despite the increase in revenue, the Group posted a PAT of RM1.97 million representing a decrease of approximately 29.52% as compared to the proforma consolidated financial results of the Sunzen Biotech Group for the FYE 31 December 2007. This was mainly due to high product costs, a direct result of an increase in raw materials prices experienced by the Group. Further details are explained in Section 9. 2. SUMMARY OF FINANCIAL RESULTS The following is the summary of the proforma consolidated financial results of the Sunzen Biotech Group for the FYE 31 December 2005 to FYE 31 December 2007 and the unaudited results for the twelve (12) months ended 31 December 2008. Sunzen Biotech Berhad (“Sunzen Biotech” or “Company”) Research Report for the six (6) months 31 December 2008 financial Proforma Group FYE 31 December Revenue Profit/(loss) before tax (“PBT”) PBT margin (%) PAT Gross earnings per share (“EPS”) (sen) Net EPS (sen) No. of ordinary shares of RM0.10 assumed in issue (‘000) period ended 2007* RM’000 Unaudited Twelve (12) months ended 31 December 2008 RM’000 27,225 4,514 16.58 4,114 23,141 3,245 14.02 2,795 26,260 2,157 8.21 1,970 2.93 2.13 3.02 2.75 2.17 1.87 1.44 1.32 149,390^ 149,390^ 149,390^ 149,390^ 2005* RM’000 2006* RM’000 26,170 4,373 16.71 3,181 Notes: 3. * The figures of revenue, PBT and PAT were extracted from the Prospectus of Sunzen Biotech dated 12 September 2008. ^ Based on the entire issued and paid-up capital of Sunzen Biotech. INDUSTRY OUTLOOK Overview of the Malaysian Economy The international economic and financial conditions have deteriorated much more significantly in the recent period. The major industrial economies are now experiencing a recession and this has significantly increased the risks to global growth. The contraction in global demand and trade, combined with the reduction in global commodity prices, has affected the export earnings of many of the regional economies, including Malaysia. These contractionary factors have been exacerbated by the protracted turmoil in the international financial markets. The sharper deterioration of the global economy is expected to have a greater impact on the Malaysian economy. The large decline in external demand has already led to a contraction in exports and a moderation in the pace of private investment activity. In addition, these developments have also affected labour market conditions. Under these circumstances, the urgent implementation of policy measures will be key towards ensuring that the Malaysian economy continues to experience positive growth in 2009. In an environment of moderating growth and the significantly lower commodity prices, inflation has continued to decelerate to 4.4 percent in December 2008. This deceleration is expected to continue with the weaker demand conditions and lower imported inflation. Bank Negara Malaysia decided to reduce the Overnight Policy Rate (“OPR”) by 75 basis points to 2.50 percent with immediate effect. The ceiling and floor rates of the corridor for the OPR are correspondingly reduced to 2.75 percent and 2.25 percent respectively. The Statutory Reserve Requirement (“SRR”) is also reduced from 3.5 percent to 2 percent, effective from 1 February 2009. With the heightened downside risks to growth, the magnitude of the reductions in the OPR and the SRR are aimed to be pre-emptive in providing a more supportive monetary environment for the domestic economy. (Source: Monetary Policy Statement 21 January 2009, Bank Negara Malaysia) 2 Sunzen Biotech Berhad (“Sunzen Biotech” or “Company”) Research Report for the six (6) months 31 December 2008 financial period ended Overview of the Biotechnology Industry Biotechnology was identified as a key technology that could drive and support the nation to evolve into a knowledge-based economy. The biotechnology sector faces a challenging future with increasing global competition. To be competitive, Malaysian biotechnology companies will need to identify and build upon niche products and services in appropriate parts of the global biotechnology value chain. The Ninth Malaysia Plan (“9MP”) will focus on implementing the National Biotechnology Policy (“NBP”) to develop Malaysia’s niches in agriculture biotechnology, healthcare-related biotechnology, industrial biotechnology and bioinformatics. In this regard, the promotion of foreign and domestic investments and close collaboration with foreign entities to access new technology, expertise and markets will be intensified. The BioNexus concept will be employed whereby establishment of biotechnology companies or projects will be targeted near relevant research institutions and industrial bases to form synergistic linkages amongst these entities and hence, expedite the growth of clusters. Vital to the success of implementation of the NBP will be follow through of plans, effective implementation of programmes as well as constant monitoring and evaluation of the outcome and impact. For the 9MP period, the focus will be on implementing the strategic thrusts of the NBP to generate new sources of growth in agriculture, healthcare and industrial biotechnologies as well as bioinformatics. To attract private sector investment in biotechnology, among others, a package of customised incentives including matching grants for R&D will be made available to BioNexusstatus companies. Centres of excellence in biotechnology will be established to provide shared facilities and the necessary technical expertise and R&D support to the emerging industry. (Source: Ninth Malaysia Plan 2006-2010) Overview of the Feed Additive Market The Malaysian feed additive market is expected to experience positive growth over the forecast period due to the increasing demand for non-antibiotic feed additives. The total feed additive market in Malaysia was valued at RM189.1 million in 2006. The antibiotic feed additive market was valued at RM133.3 million in 2006 and is expected to decline at a compound annual growth rate (“CAGR”) of (3.4) percent over the forecast period of 2006 to 2010. Consequently, many large manufacturers are actively incorporating alternatives to antibiotics to their feed additives. The non-antibiotic feed additive market is expected to grow at a CAGR of 13.8 percent from RM55.8 million in 2006 to achieve RM106.8 million in 2010. Organic acids as substitutes to antibiotics for growth promotion are expected to be a major contributor to the growth of this segment. Furthermore, new regulation requiring the mandatory registration of all veterinary products (including feed additives) is expected to further depress the antibiotic feed additive market. (Source: Independent Market Research Report by Frost & Sullivan from Sunzen Biotech’s Prospectus dated 12 September 2008) 4. FUTURE PROSPECTS The Group’s strong commitment towards biotechnology R&D and marketing strategies will ensure sustained growth and continued acceptance of its products in the feed additive market, particularly in the non-antibiotic feed additive segment. The management of Sunzen Biotech Group believe that the Group’s major strength in terms of technical expertise is to vary the Group’s existing products and to formulate new products in accordance to the requirements of the market. The Group has a strong and experienced management team, focusing on continually improving productivity and quality. 3 Sunzen Biotech Berhad (“Sunzen Biotech” or “Company”) Research Report for the six (6) months 31 December 2008 financial period ended Based on the business development strategies, the Directors believe that the Group is well positioned to increase its market share in the feed addictives market in general and non-antibiotic feed addictives segment in particular. (Source: Sunzen Biotech’s Prospectus dated 12 September 2008) However, the current global economic slowdown is likely to impact negatively on the economic growth in Malaysia and hence, presents a challenge to the Group for 2009. The unprecedented sharp increase in raw material prices in the second half of 2008 had significantly affected key product costs and profitability of the Group despite the fact that raw material prices of certain items were subsequently reduced towards the last quarter of 2008. A previously dormant wholly-owned subsidiary of the Group, Sunzen Lifesciences Sdn Bhd (“Sunzen Lifesciences”), will be commencing active operations in early 2009. Sunzen Lifesciences is a Bionexus status company accorded with tax incentives and tax exemption on the import of raw materials. It is hoped that the anticipated further decline of the raw material costs coupled with its subsidiary’s tax incentives would enable the Group to enhance its profitability and performance in the next financial year. 5. BUSINESS DEVELOPMENT PLAN The Sunzen Biotech Group’s business development plan (“BDP”), which is in line with that as disclosed in the Company’s Prospectus dated 12 September 2008 are as follows: Key Development Milestones Product development - Introduction of new innovative products that have a large untapped market potential such as direct fed microbials, immune modulators and plant extracts - Invest approximately 2% to 5% of annual sales on R&D activities Market penetration Commentary Please refer to Section 7 for further information. The Group retained its focus on R&D by signing an official memorandum of understanding with Universiti Putra Malaysia in relation to the collaboration on R&D in November 2008. For the six (6) months financial period ended 31 December 2008, the Group had spent approximately 2.57% of its revenue on R&D activities. - To increase market share and The Group continued to promote secure a dominant position in the the demand for non antibiotic feed feed additive market additives by participating in seminars organised and supported by the relevant authorities such as the Department of Veterinary Services or DVS and also Federation of Livestock Farmers Association Malaysia or FLFAM. 4 Sunzen Biotech Berhad (“Sunzen Biotech” or “Company”) Research Report for the six (6) months 31 December 2008 6. financial period ended Key Development Milestones Market development - To increase the Group’s pace of geographical development, tapping of its regional network, improving the existing plant to a good manufacturing practice (“GMP”) compliant plant and to increase the Group’s capacity to meet the expected demand of its products Commentary The Group is targeting to set up the sales offices in Indonesia and Philippines by the middle of year 2009. In addition, the upgrading of its manufacturing plant to GMP status should be completed by the middle of year 2009. Human resource policy As part of efforts to improve the technical competency of employees, the Group had arranged for field veterinarians to attend seminars on their relevant area of expertise. The Group will continue to have more technical training for its employees in the near future. - To ensure continuous business success by improving technical knowledge of its employees via training and other avenues FINANCIAL IMPACT OF THE PROGRESS OF THE BDP The progress of the business development plan has no significant financial impact on the Sunzen Biotech Group for the six (6) months financial period ended 31 December 2008. The Board of Directors of Sunzen Biotech (“Board”) is of the view that the BDP is being carried out as planned but is also aware of the costs and energy involved to implement the BDP. However, the plans undertaken by the Group, upon completion, are expected to contribute positively towards the earnings of the Group in future years. 7. R&D The Sunzen Biotech Group believes that R&D is the most important activity in its business as it is the bedrock of its mission, creates sustainable earnings growth and secures its long-term business success. The Group also conducts research through collaborations with universities and government agencies. The Group’s R&D and product strategies focus on developing animal health products that are progressive and have a large untapped market potential. Thus, Sunzen Biotech Group is concentrating the majority of its R&D efforts on non-antibiotic feed additives to capitalise on the growing demand for non-antibiotic growth promoters that are safe for humans, animals and the environment following the anticipated withdrawal of antibiotics by producers and governments in the near future. 5 Sunzen Biotech Berhad (“Sunzen Biotech” or “Company”) Research Report for the six (6) months 31 December 2008 financial period ended The Group’s R&D activities are as follows, as disclosed in the Company’s Prospectus: Product types Direct fed microbials (“DFM”) Description DFM are live naturallyoccuring microorganisms which are fed to animals to improve its health and growth by altering the microbial balance in the intestine. Planned timeline for completion (Months) 24 Immune Immune modulators are modulators immunologically active compounds that affect the working of the immune system, thus enhancing resistance to disease. 12 Planned expenditure Status of (RM’000) implementation 1,810 Currently, the Group is researching into new products for species of poultry, cattle and swine that will improve the health, growth rate and feed efficiency of the livestock. DFMs are currently in the technical and regulatory development stage and are expected to be launched in year 2010. 1,000 At present, the Group is looking into products that will stimulate immunity, improve piglet and calf growth and survival rate for cattle and swine. The Group is also looking at new products that will stimulate immunity and improve survival of dayold chicks for poultry. Immune modulators are currently in the commercial development stage and are expected to be launched in year 2009. Plant extracts Plant extracts, or phytochemicals, are nonnutritional biochemicals produced by plants that contain protective and disease-preventing compounds. 36 1,960 At present, the Group is researching into plant extract products for poultry, swine and cattle. Plant extracts are currently in the candidate progression and technical and regulatory development stages and are expected to be launched in year 2010 and 2011. 6 Sunzen Biotech Berhad (“Sunzen Biotech” or “Company”) Research Report for the six (6) months 31 December 2008 financial period ended The Board is of the view that the R&D expenditure and future allocation of R&D has not resulted in any material financial impact on the Group. For the six (6)-months financial period ended 31 December 2008, the total unaudited R&D expenses incurred are approximately RM339,718, representing approximately 2.57% of the Group’s total revenue. On an overall basis, the new products arising from the completion of the above product types are expected to enhance the Group’s competitive advantage via the offering of a wider and more innovative product range to its customers. Effectively, it is hoped that this will provide positive contribution to the financial performance of the Group in the future. 8. TOP TEN (10) SHAREHOLDERS The details of the top ten (10) shareholders of the Company (i.e. the securities account holders having the largest number of securities in the Company) based on the Record of Depositors as at 20 February 2009 are as follows: No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 9. Name Tan Kim Sing Kok Poe Chu Fong Chan Seng Teo Kim Lai Heng Teik Teow Tan Choon Shong Tan Sok Ing Ha Chan Kuan Cheong Yit Cheng HLG Nominee (Tempatan) Sdn Bhd Pledged Securities Account for Kok Poe Chu No of Sunzen Biotech Shares held 41,046,510 16,905,895 15,636,860 13,636,860 7,818,430 7,818,430 4,009,090 3,909,090 3,909,090 3,086,615 % 27.48 11.32 10.47 9.13 5.23 5.23 2.68 2.62 2.62 2.07 ACHIEVEMENT OF PROFIT FORECAST Save for the profit forecast stated in the Prospectus, the Group did not issue any profit forecast or profit guarantee in any public document during the current financial year. The comparison between the actual and forecast profit is as follows: Revenue Consolidated PBT Taxation Consolidated PAT Actual (Unaudited) Current Year To Date 31 December 2008 RM’000 Forecast Current Year To Date 31 December 2008 RM’000 26,260 28,703 (2,443) (8.51) 2,157 (187) 1,970 4,510 (512) 3,998 (2,353) 325 (2,028) (52.17) 63.48 (50.73) Variance RM’000 % The unaudited consolidated PAT for the financial year ended 31 December 2008 was RM1.970 million. The Company had in its Prospectus dated 12 September 2008 forecasted a consolidated PAT of RM3.998 million. Therefore, the unaudited PAT results for the Group represent a deviation of RM2.028 million, or 50.73% from the forecast PAT. 7 Sunzen Biotech Berhad (“Sunzen Biotech” or “Company”) Research Report for the six (6) months 31 December 2008 financial period ended The Group recorded revenue was 8.51% lower than forecasted due to the general slow down in the economic environment, as well as indirect consequences of the rise in overall livestock production costs. Livestock production costs have been on the rise in tandem with the increase in crude oil price, primarily due to the increase in prices of raw materials and distribution products such as soybean and corn. The cost of feed, which constitutes a large portion of the cost of production for feedmillers and livestock farmers, has also risen, adding on to the high production costs. As the feed additive market is dependent on the livestock industry, the increase in the cost of feed has the effect of declining the sales demand of the Group’s products, since the feedmillers and farmers would be more reluctant to spend more in using feed additives for their livestock. The Group recorded PBT 52.17% lower than forecasted mainly due to the unprecedented sharp jump in raw material prices which had caused key product costs for the Group to be very much higher, a result of which had eroded the profitability of the Group. The increase of the raw material prices were initially fuelled by the surge in global fuel price in the second quarter of 2008, which caused production costs to be much higher. A major factor in the rise of production costs has been the upsurge in the price of phosphoric acid by 203% in the third quarter of 2008. Phosphoric acid is one of the raw materials used by the Group in large amounts for the production of Orgacids. This had caused a major impact on the Group’s overall production costs, as Orgacids accounted for about 25% of the Group’s total revenue. The Group had decided against increasing the selling price of its products in order to maintain the competitiveness of its products in comparison with its competitors, in light of the current economic environment. Additionally, the Olympic Games that was held in China in August 2008 had triggered the shortage of raw materials in the local market due to the delayed delivery of supplies from China. Hence, the prices of raw materials remained high for the large part of the second half of 2008, before gradually declining towards the end of 2008. However, there was a tax deduction of RM0.325 million in line with the reduction of the PBT recorded. Hence, the Group recorded PAT 50.73% lower than forecasted mainly due to the abovementioned reasons for the deviation of PBT and the reduction in tax. 10. STATUS OF UTILISATION OF PROCEEDS As at 31 December 2008, the status of the utilisation of proceeds raised from the Company’s Public Issue are as follows: Purpose R&D Overseas expansion Working capital Estimated listing expenses Total Proposed utilisation RM’000 4,770 1,000 430 1,800 8,000 Intended timeframe for utilisation from the listing date (Months) 36 48 24 3 Actual utilisation RM’000 235 12 221 1,980 Deviation RM’000 (180) % (10.00) Explanation N1 2,448 Note: N1 The excess amount of listing expenses was mainly due to the additional costs incurred as a result of revision to the Public Issue Shares issued, which had caused the delay in the issuance of the Prospectus and the listing of Sunzen Biotech. The deviation of 10% will be adjusted accordingly to Sunzen Biotech’s working capital requirements. This announcement is dated 24 February 2009. 8