We maintain OVERWEIGHT on the Plastics sector. Overall 1Q15 results were within expectations, but TGUAN came in below due to weaker export demand. The sector has become a darling for investors under the current challenging times as it benefits from: (i) weaker Ringgit and stronger USD as sales are denominated in USD, and (ii) depressed oil prices resulting in cheaper raw material cost. SLP stands to benefit the most but SCIENTX and TGUAN may take a hit despite higher revenues due to higher interest costs on their USD-denominated debt. With the positive earnings outlook driven by solid earnings growth and strengthening USD, we also believe that the Consumer Packaging segment deserves to trade on par with the small-mid cap Technology sector stocks (applied PE average of 15.5x) as it is also export driven and largely a strong USD play. We have applied a Fwd PER of 15.5x for Consumer packager SLP on upgraded earnings, and 12.0x and 11.0x for the less aggressive growth Industrial packagers SCIENTX and TGUAN, respectively, thus resulting in our TP’s increasing by 4.1%-38.3%. Our Calls with TPs are SCIENTX (UP; TP: RM6.09), SLP (OP; TP: RM1.76), TGUAN (OP; TP: RM2.70).

1Q15 results review. 1Q15 results were within our expectations for SLP and SCIENTX. TGUAN came in below expectations due to weaker exports demand and lower ASP but this is still a turnaround from the last quarter due to stronger sales from high-margin products. Consumer packager, SLP saw better earnings which were up QoQ (+12%) and YoY (+76%) on low raw material cost and better sales mix which doubled its net margins (10.7%). Industrial packager, SCIENTX saw modest YoY earnings growth (+5%), while TGUAN’s YoY earnings declined (-40%) on weaker margins due to declining volume and forex losses. As a result, we have lowered our TGUAN’s earnings forecast by 18%-12% in FY15-FY16 on lower utilisation from a softening export market.

Export play on strengthening USD. A strengthening USD is generally positive for plastic manufacturers as a high portion from their exports is denominated in USD. Although the current USD level is likely to moderate, the consensus average indicates USD will be 14% higher YoY at USDMYR3.73. This bodes well for plastics sector revenue due to its high percentage of USDdenominated exports sector-wide. As of our cut-off date, the USDMYR exchange rate stood at RM3.76. Among the packagers under our coverage, SLP is the biggest beneficiary as its export sales are denominated in USD, while SCIENTX and TGUAN could take a hit despite higher revenue as both companies have net gearing of 0.4x and 0.1x in FY14, respectively, with a high proportion of USD denominated debt (SCIENTX: 61%, TGUAN: 76%) compared to SLP which is in a net cash position.

Resin cost outlook: stable. Year-to-date (YTD) average resin prices at c.USD1,400/MT is close to our resin price assumption, and we think that full-year costs are likely to remain stable in line with crude oil price trends. We expect resin prices to stay range bound in the near term, while a sharp hike in oil prices is extremely unlikely because OPEC has vowed not to cut crude oil output in its recent meeting (5th June 2015). Although like crude oil, resin costs have recovered slightly from Jan-15 (USD1,300/MT) to about USD1,500/MT, note that YTD average resin price at c.USD1,400/MT is 18% lower against FY14 average of USD1,700/MT. Our current assumption for companies under our coverage implies net margin at about 11%-13% for consumer packaging and about 3-6% for industrial packaging.

Consumer packaging segment should trade on par with mid cap Tech stocks. With the positive earnings outlook due to solid core earnings growth bolstered by a strengthening USD, we believe the Consumer Packaging segment deserves to be re-rated on par with the small-mid cap Technology sector stocks (applied PE average of 15.5x). We selected the Technology sector as the benchmark because we think the Consumer Packaging segment is benefitting from very similar factors, such as high growth based on strong consumer demand and riding on the export play given their largely USD-denominated earnings. For the Industrial Packaging segment, we apply a lower 12.0x and 11.0x on SCIENTX and TGUAN, respectively, as earnings upside on a weaker ringgit could be partly offset by higher borrowing cost. (Refer to Table 1 for details). Consumer packager SLP’s expected earnings growth are stronger at 75.8%-31.1% for FY15-16E vs. small mid-cap technology sector average of 62.1%-22.7%, However, the higher growth rates for SLP is because it is coming from a low base in FY14, and FY15-16E would be fuelled by capacity expansion set to kick in in July-15, alongside favourable macroeconomic conditions. As a result, we believe the Consumer Packagers deserves to trade on par with the Technology sector while we peg industrial packagers to a 20% discount to the Technology sector due to their weaker growth rates, lower margins and higher forex cost. Interestingly, based on plastic packaging peers in Japan, we observe a weighted average PER of 19.3x representing a 4% premium against market PE (TOPIX) of 18.5x. This is not the case in the Malaysian market as the overall packaging segment trades at 12x PER vs. the FBMKLCI’s PER of 16x. One can attribute this to the market capitalisation size of the Malaysian packaging players. However, if these players continue to expand and gain market share, we reckon that valuations will continue to re-rate.

Expecting better earnings for SLP. SLP is still on expansionary mode, while current macroeconomic conditions appear to work in SLP’s favour. As a result, we increase FY15-16E earnings by 10%-17% to RM21.4m-RM28.0m on: (i) stronger sales demand with increased orders from Japan, which is expected to kick in end-3Q15 to 4Q15 onwards, (ii) higher USD rate of USDMYR 3.65- 3.60 (from USDMYR 3.53) for FY15-FY16Ewhich will benefit all SLP’s exports which are on a rising trend, (1Q15 exports increased to 57% of total sales vs. 46% in FY14), (iii) stable low raw material (resin) cost due to lower oil prices, allowing for stronger margins, and (iv) expecting full-year contributions in FY16E from capacity expansions which kicked in in July-15, and downstream services which will help improve net margins to 11.3%-13.6% in FY15-16E (from 10.8% -12.0%). The bump in earnings growth should allow SLP to trade on par with Technology sector’s PE of 15.5x, and above industrial packagers (SCIENTX and TGUAN) as it is a beneficiary of a strengthening USD (similar to the Tech Sector), and also as a strong exportdriven company. SLP enjoys better margins of 11.3%-13.6% in FY15-16E vs. industrial packagers at 3.5%-4.5%, and commands strong NP growth prospect of 75.8%-31.1% in FY15-16E vs. its Industrial packaging peers of -4.7%-12.9%. We are also rolling forward fully to FY16E on a revised EPS of 11.3 sen (from FY15-16E EPS of 8.8 sen), on a slightly higher targeted Fwd PER of 15.5x (from 14.5x) (refer to Table 2). This results in a 38.3% increase in our TP to RM1.76.

Maintain UNDERPERFORM on SCIENTX. While we are overall positive on the Plastics and Packaging sector, we reiterate our UNDERPERFORM call on SCIENTX (TP: RM6.09) as we expect the property market to be challenging in 2015, especially in Johor, where 93% of its landbank is located. Going forward, we think the property segment’s sales trend could slacken due to tighter lending policies and poor market sentiment. Near-term manufacturing margins are also likely to be compressed from 5.8% in FY14 to 5.0% in FY15E, until the company’s substantial capacity expansion is completed by mid-2016. With the soft near-term outlook on both its operating sectors, we maintain our UNDERPERFORM call even after upgrading our SoP-based TP to RM6.09 (from RM5.79) on a higher manufacturing segment applied PE of 12x (from 11x) as we switch over our valuation basis to a 20% discount on the Technology sector, in line with the Plastics sector’s valuation. We think the discount is justified by SCIENTX’s lower earnings growth potential, lower margins and higher borrowing cost risk on its USD-denominated debt.

Maintain OVERWEIGHT on Plastics sector because: (i) the sector is a positive beneficiary of stronger USD and robust export demand, (ii) growing production capacity serves as a potential earnings catalyst, (iii) the stable cost outlook should ensure sustainable margins going forward. We reiterate our OUTPERFORM call on SLP (New TP: RM1.76; Old TP: RM1.27) and TGUAN (New TP: RM2.70; Old TP: RM2.45), and maintain our UNDERPERFORM call on SCIENTX (New TP: RM6.09; Old TP: RM5.79). 

Source: Kenanga Research - 2 Jul 2015