MARC has reaffirmed the short term rating of MM Vitaoils Sdn Bhd’s (MMV) RM70.0 million Murabahah Commercial Papers Programme (MCP) at MARC-2ID. The rating outlook is developing. The rating affirmation reflects the company’s average business risk profile as an edible palm oil products manufacturer, its good geographical diversification, improving cost structure and the anticipation of positive market growth rates over the next few years. Moderating these attributes are its sensitivity to general economic conditions, commodity exposure and competitive market conditions. Rating concerns center on MMV’s rising working capital needs, its small equity base and limited funding flexibility which could constrain MMV’s prospects for revenue growth and put pressure on its liquidity position. Despite improved operating results in recent periods, MMV’s cash conversion cycle remains lengthy and continues to impede its cash flow generation. The developing outlook reflects the current uncertainty regarding the efficacy of recent initiatives taken by MMV to address its major challenges in relation to working capital management.

MMV is mainly involved in the manufacturing of edible palm oil products namely liquid cooking oil, margarine, shortening and vegetable ghee. Its main revenue contributor for FY2006 was shortening products (64.2%), which benefited from strong demand from Eastern Europe and Central Asia, and R&D support and marketing from MPOB. MMV has also benefited from the increased level of consumer acceptance for palm oil arising from trans fatty acid (TFA) mandatory labelling in the US and Europe. In the past three years, MMV has expanded its market reach from 16 to 40 countries, with exports accounting for nearly 98% of its total revenue in fiscal 2006. MMV’s main export markets include Eastern Europe, Asia, Africa, Middle East and Russia although contributions vary from year to year due to changing consumer demand and product offerings.

The proceeds from the MCP were utilised by MMV to upgrade its manufacturing plant with additional filling lines and a higher level of automation. Currently, the plant in Shah Alam has a production capacity of 8,000 MT of edible oil per month. The automation of production lines has helped to reduce manpower requirements; facilitating improvements in control processes and a lower production cost structure. The additional production capacity has enabled MMV to receive more orders, as reflected in the doubling of revenue to nearly RM57.0 million in FY2006. In the previous financial year, the company had focused on higher margin products as a result of tight liquidity and working capital constraints. Operating profit margins were sustained, driven by a combination of the company’s ability to pass through rising raw material prices to its customers along with mitigation measures on cost control which included locking in packaging material prices up to six months ahead.

In tandem with the additional sales, MMV’s working capital needs rose considerably in recent years, contributing to a decline in its operating cash flow position. Whilst MMV’s revenue is mainly derived from selected export markets and settled via Letter of Credit (LC) which minimises credit risk, the longer credit period extended lengthens the company’s cash conversion cycle. MMV has taken steps to address this situation by implementing more stringent collection measures for export-related receivables and increasing the amount of advances payable on secured orders. Based on MMV’s FY2006 audited accounts, financial flexibility appears low given the moderate cash and bank balances of RM12.5 million and limited access to banking facilities. Liquidity risk, however, is mitigated to some extent by the requirement to maintain a stipulated amount in the sinking fund six months prior to the redemption of the MCP facility. Tranche 2 of the MCP remains unutilised, however, any potential drawdown will be subject to the maintenance of the debt to equity covenant of 2.5 times. As at FY2006, MMV’s debt to equity level stood at 2.3 times.

The developing outlook could be revised to negative if MMV fails to restore its cash flow measures in the following months, and its liquidity and financial flexibility erode. Alternatively, the outlook could be revised to stable if MMV exhibits improved and consistent free cash flow along with increased working capital efficiencies.