Period

1Q15

Actual vs. Expectations

Thong Guan Industries (TGUAN)’s 1Q15 core net profit (CNP*) of RM5.3m came in below expectations at 16% of consensus (RM32m) and 18% of our forecast (RM29m).

This was mainly due to lower-than-expected revenue as demand weakened in its export markets, particularly in Japan. Also, average selling prices declined in tandem with lower raw material costs.

Dividends

No dividend was announced, as expected.

Key Results Highlights

YoY, 1Q15 CNP dropped 40% as its main Plastic Products (Plastic) segment’s PBT fell 73% on lower revenue (-10% to RM149.8m) and sharply lower margins (1.6% vs. 5.4% previously). We gathered that the revenue decline was due to softer sales in Japan after its VAT was increased to 8% (from 5%) in Apr-14. The resulting lower volume compressed Plastic segment’s margins, worsened by higher realised forex losses (RM3.4m vs. none previously). However, F&B segment’s PBT jumped 3.5x to RM1.3m despite flattish revenue (-4% to RM10.9m) as TGUAN recorded stronger margins (12% from 3%) on sales of more profitable tea products.

QoQ, 1Q15 CNP improved 32% as the Plastic segment recorded a turnaround from its LBT of RM4.2m in 4Q14 as the company saw higher contribution from its stretch film business, which commands a better margin of 6% compared to other products with margins of 4-5%. The F&B segment also recorded positive PBT against 4Q14’s LBT (RM0.3m) due to reasons outlined above.

Outlook

We think 2Q15 performance should improve as TGUAN has previously stocked up on its raw materials and hence should see better margins as crude oil prices gradually rise.

TGUAN is targeting to add two new Purewrap production lines in 4Q15, which will increase the Purewrap capacity to 15k MT/yr (+25%). We also note that the company is expanding their sales team to improve current utilisation (60-70%). This should result in stronger earnings contribution in FY16.

Change to Forecasts

We reduce our FY15-16E earnings forecasts to RM24.1m- RM27.4m (-18% and -12%) as we trim our utilisation expectations to 60-72% from 60-75% to account for softening demand in export markets.

Rating

Maintain OUTPERFORM Despite lowering our earnings, we are still positive on TGUAN’s long-term outlook due to: (i) continued capacity expansion, (ii) its well-received 6-micron pre-stretch product, especially in South Africa and Australia, and (iii) planned restructuring of their China plant to reduce operating cost.

Valuation

TP reduced to RM2.45 (from RM2.80) post-earnings revision as we partly roll forward to average FY15-16E EPS of 25.0 sen (previously 28.0 sen). Our valuation is based on 10x Fwd. PER implying a 10% discount to its closest peer Scientex (which we ascribe an 11x PER for its Manufacturing segment). We believe the discount is justified given TGUAN’s smaller market cap and relatively illiquid trading volume.

Risks to Our Call

Volatile plastic resin prices

Foreign currency risk

Lower-than-expected contribution from its China-based subsidiaries.

Source: Kenanga Research - 28 May 2015