Scientex Berhad: A growing glowing story Part 2

“Investing is ultimately a function of two things- A good story and a judgement call that the story is not in the price.”

I wrote an article on Scientex on 21^st July 2014 on “A growing and glowing story: Scientex Berhad” outlining its investment thesis in the link below.

http://klse.i3investor.com/blogs/kcchongnz/56316.jsp

Investment thesis of Scientex

The article above described the high quality growth story of Scientex. Its revenue and earnings have been growing at a compounded annual growth rate of 17.3% and 32% respectively for a long period of 10 years until the financial year ended 31^st July 2013. Its expected high growth in the near future is unabated. Scientex’s revenue has surpassed the RM1 b mark to RM1.23b and net income over RM100m mark to RM112.5m for the year ended July 2013.

The excellent quality of its growth is reflected from the abundant cash flows from operations which are consistently way above its net income. Despite its heavy capital expenses to fund its growth, it has positive free cash flow every year.

The high return on equity (ROE), last year was 17.5%, provided surplus funds from its ordinary business to be invested to improve business operations without the shareholders having to invest more capital. It did borrow quite substantially last year to fund its acquisition of Great Wall Plastic and Seacera Polymer which yield great return from those investments. 

Scientex has become one of the world’s leading industrial packaging manufacturers and market leader with various products such as stretch film, laminated bags, bulk bags, corrugated carton boxes etc. It is now the third largest stretch film manufacturer in the world and the largest in Asia with about 33% market share.

Most importantly, when I wrote the article 2 months ago, the good growth story of Scientex wasn’t reflected in the price yet. At RM5.74 then, it provided a comfortable price-to-earnings ratio of less than 12 and earnings yield (Ebit/EV) of 9.4%. This is a very reasonable price for such a high quality growth company.

Since then its share price has risen from RM5.74 to the close of RM7.09 on 26^th September 2014. The gain is 24% within the two months period. What went right for Scientex?

Financial performance for year ended July 2014

Scientex announced its annual results ended 31^st July 2014 two days ago. Its revenue and net profit increased by 30% and 35% to RM1.59 billion and RM151.5 million respectively from a year ago and achieving new highs, driven both by its packaging arm and property development division. Earnings per share is 67 sen.

ROE improved to 20% from 17.5% last year. The increased ROE was driven from all the right places by improved net profit margin to 9.5% from 9.2%, and improved asset turnover to 1.14 compared to 0.96 the previous year, while financial leverage was reduced to 1.9 from 2.0 last year. The balance sheet remains healthy with total debts less than half of equity, and current ratio at unity.

Scientex expects revenue from its consumer packaging business to quadruple to RM1b in three years following its strategic partnership with Futamura Chemical Co., Ltd of Japan which would see it expanding its operations. Going forward, the packaging business will slowly overtake its property development business.

Valuations

At RM7.09, the PE ratio for Scientex is 10.8 and enterprise value 10.4 times its earnings before interest and tax. It is an attractive investment opportunity for a high growth company.

In the previous article, I have used a discount free cash flow analysis and obtained an intrinsic value of RM8.50 per share. Incidentally this value is not far off from that given by RHB at RM8.64 in its latest report on 25^th September 2014 which uses a PE ratio of 15 times forward earnings.

Conclusion

Scientex’s share price has appreciated substantially in a short period of time. Its latest financial results ended 31^st July 2014 show that it deserves it. Will its share price spike further upwards in the immediate future? Well it is, I would say, probable, especially if the catalyst I mentioned in the last article materialized. I don’t see why it wouldn’t happen when it has a retained earnings 6 times its share capital.

K C Chong (25^th September 2014)