Guanchg- broke above its downtrend line

In a recent report in The Edge, Guanchg's MD & CEO, Brandon Tay commented on the company's prospects & the recent rebound in the cocoa prices due to the fear of supply disruption arising from a nationwide strike in Nigeria, the third largest producer of cocoa beans. Cocoa futures for March delivery has risen by 16% from USD2028 per tonne in early January to USD2350 per tonne in the middle of January. From the 10-year chart below, we can't see the increase in cocoa prices.


Chart 1: Cocoa Price Chart for 10 years to February 2012 (Source: Mongabay)

Nevertheless, Tay said that this increased prices should not affect the profit margin of its products as most price changes are passed on to its customers. However, he also said that Guanchg sells forward as far as a year while stocking up more than two months of raw materials requirement.

This is quite interesting comment. In the past, I assumed that its financial outperformance was due the hedging of its raw material requirement (by buying forward) while taking advantage of the rising prices of processed cocoa products (by selling its output at the spot rate). From Tay's latest comment, it seems that Guanchg has changed tack by partially hedging of its raw material requirement (by stocking up more than two months of raw materials requirement??) while protecting itself form the sliding prices of processed cocoa products (by selling forward as far as a year). If this prices of cocoa beans & processed cocoa products are going lower, this strategy will yield financial outperformance.

However, things are not always what it seems nor should you choose to totally hedge your position or buy/sell 100% at spot rates. You can adopt a partial hedge to reduce your risk. This must be what Tay was trying to convey when he said that "this increased prices should not affect the profit margin of its products as most price changes are passed on to its customers". You can't pass the increased cost to your customers if you have sold forward.

Since Guanchg is fairly well-adapted to the vagaries of the commodity market, it should be equally good at taking advantage of the movement in the USD. In the past 6 months, you would have noted that the USD-RM cross rate has reversed upward. If Guanchg is able to position correctly in the forex market, by selling USD spot now as compared to selling it forward in the past, the company could maintain its profit margin.

HDBS has maintained it BUY call on Guanchg at a reduced target price of RM2.80 (here). In December 2011, I took the opposite view & called a SELL or REDUCE as the stock was testing the horizontal support at RM2.00 (here). Since then, Guanchg did not break below the RM2.00 support & had in fact recovered steadily over the past 1 month. Yesterday, it broke above the intermediate downtrend line at RM2.45. At the time I was writing this post, it was trading at RM2.50. If Guanchg can stay above the downtrend line at RM2.45, Guanchg's technical outlook has turned positive or even bullish. This ties in with the message conveyed by Tay on how the company will ride out this price changes in the cocoa market. As such, my earlier call to SELL or REDUCE Guanchg may have to be revised.


Chart 2: Guanchg's daily chart as at February 2, 2012 (Source: Tradesignum)