Investment Highlights

• Prefer household products manufacturers over can makers in 2018. We have an OVERWEIGHT stance on the manufacturing sector over the next 12 months. We prefer manufacturers that are tied to household/general products (V.S. Industry and Luxchem). On the other hand, we are cautious on can manufacturers (Kian Joo Can Factory) due to rising raw material costs.

• Prospects are bright for household product manufacturers. In household product manufacturing, we are seeing a rising trend of trading up in the floor-care market. This would benefit V.S. Industry (BUY, FV: RM3.30) due to its ties with a renowned customer in the segment. The said customer has unveiled plans to invest heavily in research and development to support a slate of new product launches over the next few years. This will keep order flow strong for V.S. Industry (VSI). In addition, the group's customers are recently making waves in fast-growing markets, including China and South Korea.

• Companies with general base products offer stable outlook. For chemicals manufacturing companies such as Luxchem Corporation (BUY, FV: RM0.92) and Samchem Holdings (UNRATED), the end-applications of their outputs are very diverse (general products). Hence, the companies offer relatively stable revenue growth. Notably, rising intermediate inputs in the construction industry and mounting glove demand due to stricter hygiene standards bode well for Luxchem Corporation (Luxchem).
• Can makers affected by rising raw material costs. From 2016 to 2017, costs of tinplates and aluminium foils have on average increased by more than 15%, while the cost of paper rolls spiked by over 20%. This has been eating into the margins of our local can makers, including Kian Joo Can Factory (Kian Joo). Apart from rising material costs, the segment's manufacturers are also facing intensifying competition in the tin and aluminium can industries due to upcoming capacities from other regional players.
• USD/MYR not favourable, but impact is minimal. Our USD/MYR assumptions are 4.30 for 2017 and 4.12 for 2018, a projected depreciation of circa 4%. Based on our sensitivity analysis, every 1% depreciation (appreciation) in the USD/MYR will decrease (increase) VSI, Luxchem and Kian Joo's net profits by 1-5%. Note that the expected USD depreciation has already been accounted for in our earnings forecasts.

• Upside to our call. Our OVERWEIGHT stance can be reinforced if: 1) there is a change in the USD outlook for the better; 2) the manufacturing companies under our coverage secure new jobs of significance; and/or 3) share prices of the companies correct by 15-20%.

• Key risks. 1) Lukewarm demand for end products owing to weak economic conditions; 2) rising costs of labour and shortages of workers; and 3) significant increase in raw material prices. If such risks materialise, we may downgrade our stance on the sector from OVERWEIGHT to NEUTRAL.

• Our top picks for the sector are:

V.S. Industry (BUY, FV: RM3.30). The company is expected to register robust earnings growth in 2018 as its seven assembly lines go into full swing. The company is well prepared for more contract wins with its upcoming factory, which will be able to accommodate up to 12 additional assembly lines. The group is currently working on procuring new jobs for an American lifestyle product and a Swiss hygiene system. If awarded, we estimate that the contracts could add over RM1bil to VSI's FY19F revenue.

Luxchem Corporation (BUY, FV: RM0.92). A cheaper proxy to rising glove demand, which is underpinned by stricter hygiene standards. The group's expansion of chemical manufacturing capacity by >30% is expected to take revenue to a new level in 2018 and improve profit margins due to better product mix. The company offers good earnings visibility with a large clientele (~1,000 customers) and diverse portfolio of chemical products.

Source: AmInvest Research - 22 Dec 2017