Investment Highlights

• We initiate coverage on SLP Resources Holdings Bhd (SLP) with a BUY recommendation and a target price of RM1.55. We like SLP for its: i.) premium margins compared to the average plastic packaging manufacturers, ii.) increasing production capacity at an estimated average growth of 9.8% Y.o.Y from 2018 to 2020, iii.) healthy growth trajectory expected for the global plastic packaging industry to US$202.0 bln by 2022, iv.) solid balance sheet with a healthy net cash position of RM60.4 mln, and v.) strong R&D team which has contributed to SLP’s competitive advantage with innovative products like SLP’s premium brand Maxinflax.

• The niche plastic packaging maker’s long-term revenue growth will be underpinned by higher turnover from the sale of garbage bags, increased production volume from its newly added blown film lines and the stronger U.S. Dollar.

• FY19 net profit and revenue is expected to hit record highs of RM30.7 mln and RM227.4 mln at a five-year CAGR of 20.4% and 5.4% respectively. Bottomline margins are foreseen to expand 13.0% -14.0%, up from 10.7% in 2018, lifted by higher sales volume, lower raw materials prices and the appreciation of the Greenback. The group also adopts a 40.0% dividend policy, paid bi-annually which translates to a conservative dividend yield of 3.1% - 3.4%.

• We arrive at our target price by ascribing a target PER of 16.0x to its forecast 2019 EPS of 9.7 sen. The assigned PER is notably higher than its closest peer Thong Guan Industries Bhd which is justifiable due to SLP’s stronger growth prospects and superior double-digit margins. At the target price of RM1.55, SLP is trading at a prospective PER of 11.7x, which is below the industry average PER of 20.7x, implying a potential upside of 37.1%.

Recommendation

We view SLP as a defensive-play against the rising uncertainties in the global equity market backdrop that is saddled by heightened geopolitical conflicts, rising interest rates and inflation, as well as worries over a slower global growth outlook. In our view, SLP is less susceptible to the volatile market movements, driven by the relatively resilient demand from the plastic packaging industry, which is a consumer-driven segment. Although earnings have been pressured by inflated material costs and weaker U.S. Dollars previously, we are seeing gradual improvements, driven by better product mix and the recovery of the Greenback.

The group has ramped up its capacity with an additional blown film extrusion line, which is expected to serve existing orders as well as incremental orders from China for back sheet films. Further capacity expansion is also in the pipeline, pending the construction of the second extrusion line in 4Q2019. Consequently, we foresee production capacity exceeding 30.0 metric tonnes by 2020. The higher production volume will support SLP’s continuous revenue and earnings growth, in-tandem with improved utilisation rates and ongoing cost management initiatives although unexpected input costs spikes could potentially limit margin growth.

A leading consulting and market research services firm in the U.S. has indicated that the global flexible packaging segment is expected to grow at a CAGR of 6.7% over 2017- 2022 to US$202.0 bln, spurred by growing population, increasing preference for convenient packaging and rising demand for flexible plastic packaging from the F&B and pharmaceutical industry. The sustained sector growth will also be positive for SLP as it will ensure steady demand for its products.

SLP has been in a net cash position over the last three years, underpinned by its positive operating cash flows, strong bottomline margins and minimal borrowings, in the absence of significant expansion in the past few years.

As a niche plastic packaging manufacturer, SLP is able to command above average margins compared to other pure play plastic packaging makers due to its premium thingauge packaging products. The group also prides itself for its technical know-hows (i.e. product formulation) that has enabled the group to produce in higher quality products which consumes less input materials and thus, reduces cost price.

In addition to its proven track record, the group’s longstanding relationship with leading retail brands will also ensure earnings continuity.

Despite adopting a formal dividend policy of 40.0% of net profit, SLP has been consistently paying out more than 50.0% of its earnings, which translates to a dividend yield of about 3.1%.

Investment Risk

Risks to our recommendation include the volatility in the global resin prices which would increase production costs and compress margins. Resin prices generally move in-tandem with feedstock prices - crude oil prices, in addition to the market’s supplydemand dynamics. However, the group is expected to pass-through higher raw materials costs on selected lower-priced products, while absorbing the additional costs for higher-priced products.

Meanwhile, labour issues like manpower shortages or unexpected rise in minimum wages remain as a key concern which could result in production delays and additional costs. The newly formed government has announced the phasing out of rehiring programme for illegal workers by end-June, which coupled with implementation of foreign levy beginning January 2018, could potentially be headwinds that will hamper production flow. Meanwhile, minimum wages will be increased to RM1,050 per month (2018: RM1,000) from January 2019. We think that the wage increase is insignificant as the market is already paying above the minimum required rate currently.

The group is also exposed to foreign exchange fluctuation risk although net forex exposure in U.S. Dollars is capped to about 5.0% as raw material costs and is largely offset by export sales denominated in the same currency (approximately 60.0% of total export revenue).

Rising environmental awareness could also hinder the demand growth for plastic packaging. On that note, the European Union is planning to make all plastic packaging across Europe recyclable or reusable by 2030, in a bid to tackle rising plastic wastes. Meanwhile, U.K. retailers have also pledged to cut plastic packaging amid talks of potentially higher environmental costs related to waste disposal imposed by the government. That being said, the degree of impact arising from the fight against plastic waste remains controllable at the current juncture, mainly due to headwinds like i.) poor enforcement, ii.) lack of cheaper alternatives, and iii.) rising demand for plastic products.

Source: Mplus Research - 18 Sept 2018