Investment Highlights

• Household product manufacturers still preferred over can makers: We downgrade our OVERWEIGHT stance to NEUTRAL on the manufacturing sector for the next 12 months but still prefer manufacturers tied to the production of household general products such as V.S. Industry (VSI), ATA IMS (ATA) and Luxchem Corporation (Luxchem). We are negative on can manufacturers such as Kian Joo Can Factory (KJC) due to escalating raw material costs, higher anticipated labour costs and increased competition which are hurting margins.
• Bright prospects for household product manufacturers already factored in: Household product manufacturers such as VSI and ATA would benefit from the rising trend in trading up in the floor-care market, particularly due to their ties with a key customer in the segment. The key customer has robust growth prospects and continuously innovates — planning a slate of new product launches over the next few years, which is anticipated to keep box-build orders growth sturdy. However, we believe that the positive earnings prospects for both companies have been factored in at their respective share prices.
• Companies with general underlying products offer stable outlook: For chemicals manufacturing companies such as Luxchem Corporation and Samchem Holding, the end-applications of their outputs are very diverse (general products) and their diversified, large customer base should mitigate supplier switching concerns and excessive reliance on client’s performance. Notably, we opine that Luxchem will benefit from its exposure to the glove sector amid stricter hygiene standards globally.

• Can makers affected by rising cost pressures: When comparing 9M2018 with 9M2017, the average prices of raw materials such as aluminum, tin plate and paper roll escalated by 12%, 5% and 8% YoY respectively. This has been eating into the margins of local can makers including KJC. Apart from higher raw material costs, the group also faces intensifying competition in its corrugated carton space and looming competition for its tin and aluminum can industries due to upcoming capacities from other regional players. Furthermore, KJC is expected to be impacted by higher labour costs in 2019 as the minimum wage in Malaysia was increased from RM1,000 to RM1,100 monthly while Vietnam’s minimum wage is expected to rise by 5.3% in 2019, especially as its manufacturing businesses and contract packing services are labour-intensive.

• Re-rating catalyst: We may upgrade our sector call from NEUTRAL to OVERWEIGHT if: (i) the MYR appreciates against the USD as companies such as Luxchem and KJC are net beneficiaries of the stronger MYR as a higher proportion of their costs are USD-denominated, and (ii) the manufacturing companies under our coverage secure new jobs of significance.

• Key risks: We may downgrade our stance on the sector from NEUTRAL to UNDERWIEGHT if the following key risks materialize: (i) lukewarm demand in end-products due to weakening economic conditions, (ii) rising costs of labour and shortages of workers, and (iii) significant increase in raw material prices.

• Our top picks for the sector are:

Luxchem Corporation (BUY, FV RM0.74): The group offers a cheaper proxy to the rising glove demand which is underpinned by stricter hygiene standards, and further supported by capacity expansions planned for its Transform Master (TMSB) arm which is tied to the increasing demand in latex and latex-related products. Furthermore, the group offers earnings visibility backed by a large clientele of 1,000 customers and a diverse portfolio of chemical products.

ATA IMS (HOLD, FV RM1.83): The group is expected to register robust earnings growth in 2019 as its four new assembly lines at its Jalan Dewani factory go into full swing. ATA is well prepared for more contract wins with its Jalan Hasil factory and has indicated further expansion plans to increase its production capabilities on the back of growth in indicative orders from its key customer in 2019. However, we believe the positive earnings prospects of the group have been factored in at the current price.

V.S. Industry (HOLD, FV RM1.31): Although prospects in 2HFY19 are expected to dampen due to expectations of declining order flow from a key customer for its Malaysian segment, VSI is currently in serious talks with more than five prospective MNC customers to secure new orders that would fill up the excess capacity. The group also continues to undergo cost rationalization to streamline operations in its China segment in light of uncertainties from the US-China trade war, higher operating costs and intense competition.

Source: AmInvest Research - 20 Dec 2018