by Kenanga Research:
We downgrade the sector to NEUTRAL as we believe it is fairly valued after the sector’s stellar 98% run-up (average) in share prices in 2015. 3Q15 results were all within expectations, and 4Q15 is likely to deliver as well. However, growth factors like shortterm capacity and margin expansion are already priced in, and we are comfortable with our exchange rate and resin price assumptions. The recent Budget announcement held few surprises as well. Long-term prospects remain positive on continued capacity expansion and potential benefits from TPPA. We downgrade TGUAN to MARKET PERFORM post-rally, on a limited upside prospect despite upgraded its TP (to RM3.07 from RM2.45) based on 11.0x Fwd. PER as we switch over our valuation basis to a 30% discount vs. Consumer Packagers. With the impressive sector-wide performance, we think most positives are priced in and thus downgrade our sector call to NEUTRAL. However, we may consider upgrading the sector should the resin oversupply issue drive down resin costs further. Maintain MARKET PERFORM on SCIENTX (TP: RM9.49) and SLP (TP: RM1.87).
3Q15 results review. 3Q15 results were largely within consensus for the three stocks under our coverage. SCIENTX and TGUAN exceeded our expectations on margin expansion from new lines, and higher-margin beverage products, respectively. This improved over 2Q15 where SLP and TGUAN were within consensus, but SCIENTX was below consensus (within ours) as margin expansion had yet to kick in. Plastic packagers overall saw margin improvement on lower resin cost, stronger USD-denominated sales and new higher-margin products. TGUAN and SCIENTX’s earnings were raised 7-9% to reflect margin expansion. Meanwhile, we downgraded SLP to MP after its share price doubled YTD to hit our TP (RM1.87). Other calls were maintained.
Stellar stock price performance in 2015. The Plastics and Packaging sector performed extremely well over 2015, doubling in 2015 on average. The top performer was SLP – our Top Pick for the last two quarters – which saw an impressive 219% gain in its share price, from RM0.59 to RM1.88 as of our cut-off date. Note that TGUAN, also rallied strongly in 4Q15, posting 60% gains as investors jumped onto this laggard play after the company reported solid 3Q15 results.
Comfortable with our USD exchange rate assumptions, for now. Plastic manufacturers stand to benefit from a strengthening USD due to their high percentage of USD-denominated exports (56%-78%). The USD/MYR exchange rate currently stands at RM4.29 (+23% gain YTD), while we have forecasted FY15-16 USD/MYR exchange rates at RM4.21. We are comfortable with our assumptions for now as it is only slightly lower than current levels, and we prefer to remain conservative on our earnings outlook. Among the packagers under our coverage, SLP is the biggest beneficiary as its export sales are denominated in USD, while SCIENTX and TGUAN could take a hit despite higher revenue as both companies have net gearing of 0.4x and 0.1x in FY14, respectively, with a high proportion of USD-denominated debt (SCIENTX: 25%, TGUAN: 76%) compared to SLP which is in a net cash position
Long-term earnings growth through expansion. In our previous strategy report published 6-Oct-15, we noted that packagers SLP and SCIENTX are both planning to grow capacity, with SLP planning a new manufacturing facility while SCIENTX intends to double the capacity at its newly acquired Ipoh plants, which have already begun contributing to earnings in its most recent quarter. We expect the continued expansion plans to ensure long-term earnings growth beyond FY18E. Note that we will only price this into our estimates once final details on the expansion such as timeline and production capacity are available.
Low resin cost priced in, but may decrease further if supply continues to increase. To recap, resin cost has been on the decline, from >USD1,300MT in 1Q15 to USD1,100MT in 4Q15. Recall that one of the key determinants of lower resin price is the supply and demand dynamics of resin, which have seen a supply glut in 2HCY15 as China has increased its resin production capacity to support its local demand. All in, we have accounted for lower resin prices for all plastic packagers under our coverage, although margins could continue to surprise on the upside should the resin oversupply situation worsen due to China’s economic slowdown.
Budget 2016 measure mostly neutral to the sector. Budget 2016 announced two measures related to plastic packagers, namely: (i) increased minimum wage from RM900 to RM1,000 per month effective 1 July 2016, and (ii) Special Reinvestment Allowance extends the tax incentive for capital expenditure from 2016-2018, allowing 60% of capex to offset 70-100% of statutory income. We are neutral on the increase in minimum wage for plastics and packaging companies as most workers are already earning wages close to RM1,000/month at present, while incremental impact to 6MCY16 earnings, if any, should be minimal at <5 9-22="" account="" allowance.="" allowance="" also="" as="" between="" companies="" effective="" exemptions="" existing="" expectations="" extension="" for="" including="" is="" of="" p="" plastics="" range="" rates="" reinvestment="" special="" tax="" the="" to="" within="">
TPPA a longer term positive. A recent Pricewaterhouse Coopers (PWC) study highlighted that the US currently has antidumping duties of 104% on Plastic Retail Carrier Bags which comprise about one-third of Malaysia’s production of downstream plastics. Hence, reduction/removal of the duty will benefit plastic players, including SLP and BP Plastics. They also pointed out that resin costs could also decline, because 37% of raw material comes from TPPA member countries (i.e. Singapore, Japan & US). Thus, we are optimistic that the TPPA will have a long-term positive impact on the Plastics and Packaging sector.
Downgrading TGUAN to MARKET PERFORM. We upgrade TGUAN’s TP to RM3.07 (from RM2.45) based on an upgraded Fwd. PER of 11.0x (from 9.0x) as we switch over our valuation basis to a 30% discount to Consumer Packaging PER (15.6x). Our discount incorporates Industrial Packager TGUAN’s lower net margins (5% vs. SLP’s 15%) and lower FY16E earnings growth outlook (13% vs SLP’s 23%). Despite upgrading our TP, total return post-rally is 7.7% (upside: 4.8%, dividend yield 2.9%) which warrants a downgrade to MARKET PERFORM (from OUTPERFORM).
Calling it a day, for now. While the sector has been the darling of investors throughout CY2015, we believe that most positives have already been priced in, i.e. weakening Ringgit and low resin prices. Although we expect 4Q15 to be a strong quarter due to the favourable macro conditions, we have well accounted for this in our estimates previously and believe share prices have already priced this in. As such, we downgrade the Plastics sector to NEUTRAL (from OVERWEIGHT) as the sector has well priced in most positives. However, we will continue to monitor the low resin cost as a result of excess supply in the market, which could lead more margin expansions in the near-term and potentially warrant an upgrade. We reiterate our MARKET PERFORM call on SLP (TP: RM1.87) and SCIENTX (RM9.49), while TGUAN is downgraded to MARKET PERFORM despite its upgraded TP to RM3.07.
Risks to our calls include:
(i) USD reversing against the Ringgit, compressing sales growth,
(ii) slower-than-expected demand for plastic products, and
(iii) lower-than-expected resin prices, compressing margins.
Source: Kenanga Reseach - 7 Jan 2016