Plastics & Packaging - Still Looking Good, But More Selective

Maintain OVERWEIGHT. Latest quarterly results of stock under our coverage came in within or broadly-within our and consensus estimates, while margins remained fairly stable. The sector continues to be driven by resilient demand, allowing plastic packagers under our coverage to embark on robust capacity expansion over the next 1-2 years, and product innovation, translating to strong earnings growth in FY17, 18 and 19. We like the sector as it is backed by stable macro fundamentals, i.e. low resin cost and weak Ringgit environment, allowing the plastic packagers to flourish on positive market sentiment. However, we have become more selective with our sector picks as share prices have fared well, and we have since downgraded SCIENTX (+24% gains YTD) and SCGM (+25% gains YTD) over the quarter. As such we make no changes to our calls and TPs for now. We have an OUTPERFORM call on SLP (TP: RM3.72) and TGUAN (TP: RM5.40), and MARKET PERFORM call for SCGM (TP: RM4.90), SCIENTX (TP: RM8.15) and TOMYPAK (TP: RM1.00). Our top pick is SLP as it has yet to fully price-in its full earnings potential from capacity expansion.

1Q17 results came in generally within our and consensus estimates, which was the same as 4Q16. YoY, all manufacturers saw better demand, which led to YTD top-line growth of 2-25%, but CNP declined by 10-34% for all packagers (save for SCGM) on higher expenses, financing cost and mostly higher effective tax rates, which is expected to taper off in coming quarters. QoQ, top-line was up for all packagers (2-12%), while bottom-line growth was positive for all packagers by 21-24%, save for SLP (-49%). However, we are expecting significantly stronger quarters ahead for SLP, especially in 2H17 from the roll-out of its healthcare products, which command far better margins than its kitchen bags and MaxInflax products, lower effective tax rates in coming quarters upon capex utilization, while raw materials prices have tapered off after a slight increase in 1Q.

TOMYPAK top gainer YTD at 54%. Plastic packagers under our coverage have done fairly well YTD with TOMYPAK being the top gainer, up 54% on strong 1Q17 results (released on 18th May 17), which we initiated coverage on 9th June 17. SCGM and SCIENTX were also strong performers YTD, inched up 25% and 24%, respectively. We believe this was on the back of decent quarterly results and expectation of strong earnings growth and a stable outlook going forward. As a result of the stellar performance, we have since downgraded our call from OUTPERFORM to MARKET PERFORM. Lastly, SLP (+13% YTD) and TGUAN (-1%) appear to be laggards at current levels as YTD gains have yet to price in the full earnings potential, making them attractive at current levels, warranting OUTPERFORM calls.

Resilient demand for plastic products. We expect demand for plastic products under our coverage to remain resilient as; (i) plastic packagers are continuously aiming to penetrate new markets (i.e. China, United States, Canada and Africa), (ii) their niche products (i.e. FMCG or plastic bags) are client-specific and cater to detailed or stringent requirements (ex: TOMYPAK, SLP), (iii) a large portion of plastic packagers (TGUAN, SLP and SCIENTX) sales are driven by loyal Japanese clienteles who rarely change suppliers, and (iv) SCGM is benefiting from the multi-state ban on polystyrene (replaced by SCGM’s lunch boxes). Evidently, plastic packagers under our coverage saw stable revenue growth in the recent quarterly results (2-12%), driven by both local and export demand.

Earnings growth driven by capacity expansions. We expect capacity growth for; (i) SLP, which is planning a new manufacturing facility to increase capacity by 58% to 38k MT by FY19, and targeting to penetrate the Chinese market, (ii) SCGM, which is renting a 20,000sf facility in Kulai to house two new extrusion machines and another rented factory in Teluk Panglima Garang (first factory in the Klang Valley), increasing capacity by 39% to 49.9k MT/year in FY19, while its longer-term expansion plans include a new plant targeted for completion in end FY19, which will boost production capacity to 67.6k MT/year (+88%), (iii) SCIENTX which continues to ramp up its operations at its Rawang plant (+25% to 60k MT/year) and Ipoh plant (+43% to 24k MT/year) by 2H17, and has also invested in a new plant in the United States due for completion in 2H18, and (iv) TGUAN which is constantly investing in capacity expansion over the longer run, and R&D to improve sales and margins on existing products (i.e. stretch film). We expect the continued expansions to ensure long-term earnings growth beyond FY18 while in the near term, all plastic packagers are continuously striving for margin growth through higher value products from improved product mix. As a result of bullish expansion plans, stable margins and resilient demand for plastic products, we expect strong FY17-18E earnings growth of; (i) 25-25% for SLP, (ii) 44-17% for SCGM, (iii) 7-25% for SCIENTX, (iv) 12-14% for TGUAN, and (v) 25-24% for TOMYPAK.

Resin cost stable at c. USD1,100-1,200/MT, remains detached from crude oil prices. Resin cost has remained fairly stable over 2016-17 and is close to current levels of c. USD1,100-1,200/MT due to the ample supply of resin from China, which is flooding the market. This has resulted in resin prices becoming detached from rising crude oil prices. Going forward, we expect costs to remain stable with a downside bias on excess supply, which will offset rising crude oil prices, especially given the reduced correlation between crude oil and resin prices.

Ringgit stabilising against the greenback. A weakening Ringgit had boded well for share price sentiment in the past. However, going forward, we expect future earnings growth to be more dependent on capacity expansions. Our sensitivity analysis suggests that a 2% decline in the Ringgit results in c.1-4% increase to earnings, implying that the impact is not overly significant. We are comfortable and maintain our USD/MYR assumption at 4.25 in CY17, which is close to current levels of 4.29.

Valuations. To recap, we had previously re-based the plastic sector’s valuations (refer to our 3Q16 Sector Strategy Report titled ‘Valuation Re-Rating’ dated 8 July 2016) against DAIBOCI as its valuations have remained sticky at 18.0x average Fwd. PER since CY14 on above-average margins and ROE vs. its peers back then, and despite earnings decline (-13%) in CY14 while other plastic manufacturers had since been playing catch-up in terms of ROE, margins and earnings growth. Based on our analysis with DAIBOCI (18.0x Fwd average PER) as a base, we gave SLP a valuation of 21.5x FY18E PER, SCGM at 19.9x CY18E PER, TGUAN at 14.6x FY18E PER, SCIENTX at 17.6x on FY18E PER, and have recently initiated coverage on TOMYPAK with 19.2x FY18 PER which is based on a slight premium to its direct comparable, DAIBOCI, due to better core net margins, earnings growth, slightly better dividend yields, and lower net gearing of 0.06x, but below SLP (21.5x Fwd. PER) and SCGM (19.9x Fwd. PER) as they fared better than TOMYPAK in terms of margins, earnings growth and ROEs. Thus, we make no changes to our valuations for now.

Maintain OVERWEIGHT on positive earnings growth and favourable macro fundamentals. We maintain OVERWEIGHT on the sector as it continues to be driven by resilient demand, allowing plastic packagers under our coverage to embark on robust capacity expansion over the next 1-2 years, and product innovation, translating to strong double-digit earnings growth in CY17-18. We continue to like the plastic and packaging sector for its stable macro fundamentals, i.e. weak Ringgit environment and low resin cost which we have accounted for in our estimates, allowing the sector to thrive on positive market sentiment. However, we have become more selective with our sector picks as share prices have fared well, and we have since downgraded SCIENTX (+24% YTD gains) and SCGM (+25% YTD gains) over the quarter. Our top pick is SLP as it has yet to fully price in its full earnings potential on capacity expansions. All in, we maintain our call and TP for SLP (OP; TP: RM3.72, FD Ex-All TP of RM3.10), TGUAN (OP; TP: RM5.40), SCIENTX (MP; TP: RM8.15), SCGM (MP; TP: RM4.90) and TOMYPAK (MP: TP:RM1.00) . At current levels, Plastics Packagers under our coverage are commanding attractive total returns of 5-53% (save for SCIENTX at -1%).

SLP our Top Pick. We like SLP (OP; TP: RM3.72, FD Ex-All TP of RM3.10) for its strong earnings growth potential of 25% each in FY17-18 driven by increased sales to from tapping into new markets such as China, and maintaining strong sales with existing clients in Japan. We expect core net margins expansion to 19.5% in FY17-18 (from 17.3% in FY16) on the full-year effect upon commissioning of downstream machinery (i.e. printing machines) in end FY16 which will enable higher margins from value add/niche services, and on sales of higher margin products (i.e. healthcare products and MaxInflax). The Group’s capacity expansion plans (+58% to 38k MT/year) by CY19 are on track, driven by strong demand from existing clients. Lastly, SLP is a strong net cash company with a 40% dividend policy, confirming that the company is committed towards shareholders’ returns and it is commanding attractive total returns of 53% at current levels, and decent dividend yields of 2.2-2.8% in FY17-18.

Risks to our calls include: (i) slower-than-expected demand for plastic products, especially from importing countries, (ii) higher-than-expected resin prices, and (iii) a sector de-rating due to weaker valuations from unfavourable macroeconomic situation.

Source: Kenanga Research - 5 Jul 2017