Fundamentals Remain Intact

While 3QFY18 results came in below expectations due to the property segment, we remain optimistic on Scientex’s prospects underpinned by: a) maiden contribution from KHPI, b) rising manufacturing utilisation rate amid improved consumer packaging performance, and c) normalised property segment performance post general election. Maintain BUY with a higher target price of RM8.60, to reflect improved visibility for the consumer packaging division.

WHAT’S NEW

• Manufacturing utilisation rate expected to improve to 70% in FY19. As its manufacturing division’s utilisation rate is expected to improve from 55% in FY17 to approximately 65% in FY18, management guided that this could further improve to around 70% in FY19 even after taking into account Klang Hock Plastic Industries’ (KHPI) contribution starting 4QFY18. This is primarily attributed to the expected higher utilisation from its consumer packaging. Note that utilisation rates of stretch film and custom film (excluding biaxially-oriented polypropylene (BOPP)) stood at approximately 85% and 70% respectively as of end-Apr 18.
• BOPP plant has started to break even. Positively, after some delays from its original plan to breakeven by end-FY17, we gather that the new BOPP plant has begun to breakeven at end-FY18 with utilisation rate at >50%. Essentially, the delay was due to Scientex’s change of strategy to focus on higher-margin orders and forgo some of the high volume and penetrative pricing orders. Recall that the BOPP plant saw its 60,000MT capacity fully installed after the second line came on board in Dec 16, with one-third of production supplied to Futamura Japan (which owns a stake in Scientex), one-third to the domestic market, and the balance to the rest of Southeast Asia.
• Completion of acquisition of Johor lands. Scientex’s wholly-owned subsidiary, Amber Land Berhad, has fully acquired the freehold lands in Pulai, Johor Bahru, measuring 335.6 acres for RM284.2m cash funded by internal funds and bank borrowings. We deem the purchase price of RM19psf to be attractive (asking price for agricultural land in Pulai is around RM30psf). The purchase raises Scientex’s landbank to approximately 3,000 acres with estimated GDV above RM16b, sufficient to sustain its property development activities over the next 10-15 years. Going by Scientex’s execution record, we expect the company to launch the first phase of the development within 6-12 months, and the development should mostly comprise affordable homes priced below RM500,000.
• Property sales to recover in FY19. 3QFY18 results came in below expectations on weaker-than-expected contribution from the property segment amid lower progress billings and longer-than-expected property approval process prior to the general election. Nevertheless, we are expecting property segment performance to improve slightly in 4QFY18 and normalise in FY19, supported by approximately RM500m of unbilled sales. Scientex is targeting to launch more than RM1b worth in GDV of new projects in both FY18 and FY19.

• Growing consumer packaging segment. Scientex has increased its polyethylene (PE) capacity by more than three-fold in three years after completing: a) the installation of additional production lines at its plants in Rawang worth RM21m at end-16, and b) capacity expansion of 24,000 MT p.a. (worth RM50m) at its Ipoh plant (Scientex Great Wall Ipoh). Consequently, annual PE output has increased from 60,000MT to 84,000MT p.a.. Separately, management also intends to install a third BOPP line in the new plant in FY18/19, which should raise capacity to approximately 100,000MT p.a..

• Penetrative pricing effect in the manufacturing segment should ease gradually. FY17 operating margin of the manufacturing segment dipped 1.8ppt yoy to 6.0%, primarily attributed to the penetrative pricing strategy adopted by management to gain market share amid capacity expansion especially in the consumer packaging segment. That said, we believe margin compression should ease as reflected in the latest 3QFY18 manufacturing margin, which has improved 1.9ppt yoy. Our forecast incorporates a 1.1ppt improvement in FY18 gross margin.
• New stretch film plant in US has begun operations with minimal losses. The US$25m new stretch film plant in Arizona, US, which has a current capacity of 30,000MT p.a., promises synergistic benefits from Scientex’s efficient manufacturing operations, savings in logistics costs, and low feedstock costs via ample supply of shale gas-based resin. The plant has commenced operations in Apr 18 and is expected to contribute positively in FY19. The plant has the floor space to expand production capacity to as much as 80,000MT p.a. in the likely case of a demand pick-up.

EARNINGS REVISION/RISK

• No change to earnings forecasts.

VALUATION/RECOMMENDATION

• Maintain BUY with higher SOTP-based target price of RM8.60 (previously RM8.20), as we raise our 2019F manufacturing PE to 15x from 14x to be in line with other consumer packaging players post better earnings visibility from its consumer packaging segment. Our target price implies 11.1x 2019F PE. We continue to believe Scientex’s long-term prospects are promising, attributed to greater economies of scale at its manufacturing segment post several acquisitions as well as a growing landbank to support the property segment.

Source: UOB Kay Hian Research - 18 Jul 2018