We are initiating coverage on Scientex Berhad (Scientex) with an OUTPERFORM rating and a Target Price of RM6.28 based on SOP valuation after assuming a 35% discount to its property RNAV and 10.2x FY14E PER on its manufacturing segment. We believe that this packaging cum property play has further upside potential despite its share price almost doubling over the past year. Through its acquisition of GW Plastic’s manufacturing segment and its on-going expansion plants, Scientex will be the world's top 3 largest stretch film manufacturer, in addition to becoming Southeast Asia's largest blown film manufacturer. The growing popularity of stretch films in emerging markets is still in its infancy, potentially offering the group far greater growth. Manufacturing margins are expected to expand via greater economies of scale, merger-related efficiency and a more diversified earnings profile. As for its property segment, Scientex has a pipeline GDV of RM4.8b which provides up to 10 years visibility. Scientex stands to benefit from the Iskandar Malaysia story, given that 90% of the Group's remaining landbanks are concentrated within prime locations in Pasir Gudang, Kulai, Skudai and Senai. Most of these are geared towards the affordable housing market, which has thus far enjoyed strong take-up rates of 80-90%. We are estimating FY14-15E net profits of RM155.0m (+40.5%) – RM182.8m (+17.9%) and dividend yields of 4.3%-5.1%.

A more diversified earnings mix. As a result of the acquisition of GW Plastic's business segment, not only has Scientex gained an instant boost to its stretch film capacity, its also provided the Group its maiden foray into a distinct, rapidly expanding consumer packaging market. Coupled with further expansion this year, Scientex would be able to bring its annual stretch film capacity to 194k MT and blown film capacity to 51k MT, which is far ahead of its local competitors. This would also give Scientex a more diversified earnings mix where the stretch film would account for (42%), followed by the property segment (24%), Consumer packaging (17%) PP strapping bands (5%) and other polymer products (12%).

Combined synergies. With the expanded capacities, we believe that Scientex would: (i) gain the cost advantage via economies of scale, (ii) open up opportunities in new markets and gain a greater share of the market, as well as to (iii) establish a niche with a broader range of products via thin film. More importantly, the new capacities would allow the group to alleviate the immediate bottlenecks, particularly in the consumer packaging segment. This would allow the Group to utilise the excess capacity in its downstream printing and lamination segments, which would translate to better margins as it delves deeper into the value chain. Overall, we anticipate a 75-24bps improvement to manufacturing segment gross margins for FY14-FY15E.

Huge GDV pipeline with cheap landbanks. Scientex has a total pipeline GDV of RM4.8b based on the existing 1,025 acres of landbank - 90% of which are located in prime locations in Johor, which has seen 20%-100% surge in YoY property sales. Furthermore, Scientex's remaining landbanks are undervalued at an average cost of RM6 psf against the current valuations of "greenfield" landbanks of RM8-10 psf. This would allow Scientex to reap higher margins vs its peers with gross margins reaching as much as 55% for its current project in Skudai (Note that the property development segment gross margins has expanded from 34% in FY09 to 47% in FY13).

Potential to spin off property segment. While the manufacturing segment had contributed 75% of Group revenue in FY13, it only accounted for 44% of EBITDA. We reckon that this disparity had been a dampener on the stocks's historical valuation. We see a possibility that Scientex could spin off its property segment, which would unlock value for shareholders and our analysis reveals they can raise up to RM349m – RM488m cash if so. This is bearing in mind that the property division by itself is in a strong financial standing, with promising projects in the Iskandar region and supported by a sizeable RNAV/share of RM6.19.

Initiate coverage with OUTPERFORM and TP of RM6.28 based on blended SOP valuation. This assumes that: (i) The property development division is valued using the RNAV-DCF (10% WACC) and by applying a 35% discount, which is more aggressive than its peers - Crescendo’s 30% discount to the RNAV value of RM5.72. (ii) Valuing the manufacturing segment using 10.2x FY14 PER, which is in line with the average PER for packaging and can manufacturers, (iii) Holding company discount of 10%. Including a decent dividend yield of 4.3%, our TP provides a total return of 18.5%. 

Source: Kenanga