SLP is a niche plastic manufacturer for over 1,000 niche plastic packaging products for both local and international markets. Its operations straddle both upstream (e.g. film production) and downstream (e.g. conversion of film to bag). Although its share price has appreciated c.80% in the past one year, we believe it is not too late to join the party, as SLP is backed by: (i) margin improvement (FY15E EBIT margin of 12.8% vs. FY14 EBIT margin of 8.6%) from lower raw material price and better product mix, (ii) net cash position, and (iii) sustainable dividend yield of 3.0%-4.0%. We are initiating coverage on SLP with an OUTPERFORM rating and a target price of RM0.91/share.

Capacity expansion to drive topline. SLP Resources Bhd (SLP) has budgeted a capex of c.RM7.0m-RM8.0m in FY15 to increase its blown film production capacity to 23.4k MT/year from 21.0k MT/year. This is to cater for new orders from the increasing demand of cement paper sack, which is driven by the higher usage for cement on the back of significant contract flows from incoming ETP and 10MP projects. The new capacity will contribute additional revenue of RM5.0m for FY15, assuming net margin of low teens which would translate into a net profit of c.RM0.5m.

Better product mix to boost profit margins. One of the key strategies of SLP is the innovation of niche products to fetch better margins. For instance, a recent development – the MaxInflax product range carries high-teen net margins as compared to BOPP film’s mid-single digit net margins, due to: (i) lesser raw materials used translating into lower raw material costs and, (ii) better pricing as SLP is the sole producer for this range of products currently. We expect the better product mix to drive margin expansion as FY15-FY16 group net margins are expected to improve to 9.6%-10.1%, compared to 7.0% in FY14.

Benefit from low raw material cost and weakening of MYR. From past observations, lower resin prices typically improved the company’s gross margin. The recent c.50% plunge in crude oil price has led to polymer prices retreating by an average of 20-25%. Thus, we are expecting SLP to continue showing margin improvement in the upcoming quarter (1H15 results). Based on our sensitivity analysis, a 5% drop in average resin price would lead to 8.9%-10.1% improvement in SLP’s net profit. Meanwhile, the weakening of MYR against USD is generally favorable for SLP as approximately half of its sales are quoted in USD; a 5% decline in MYR/USD would lead to 3.3%-3.6% improvement in SLP’s bottomline.

Strong balance sheet and sustainable dividend yield. SLP is in a net cash position of RM10.2m as of FY14 which will provide flexibility to the management to continue expanding its current business and ability to pay dividend consistently. Assuming a repeat of 50% payout ratio in FY15-FY16, this implies net dividends of 2.7-2.9 sen, representing yields of 3.4%-3.6% (on par with sector average of 3.1%).

Initiating with OUTPERFORM and TP of RM0.91/share. Our valuation methodology is based on a targeted PER of 13.5x on FY15E EPS of 6.7 sen. Our targeted PER of 13.5x is based on a 35% premium to peer TGUAN’s ascribed PER of 10x due to its stronger margins comparatively (SLP net margin of c.9.6% vs. TGUAN’s c.4.0%). Although the targeted PER is at a premium to the FBMSC index of 10x, we believe it is justifiable given that (i) the sector’s average price-earnings multiple is trading above that of the small cap index, while (ii) SLP has been registering better profit margin and earnings growth visà- vis TGUAN. Additionally, from our regression analysis (average CY15-CY16 PER vs average CY15-CY16 net profit margin), SLP should be traded at a Fwd PER of 13.8x, based on average CY15-CY16 net profit margin of 9.9%. Overall, we expect a potential total return of 18.6% from here (Upside of 15.2% and dividend yield of 3.4%).

Risks to earnings are: (i) single country risk and, (ii) foreign currency risk. 

Source: Kenanga