We maintain our OVERWEIGHT view on the sector. The latest 2Q15 results season was within expectation and we now anticipate a stronger 3Q15 on better margins as the sector continues to benefit from: (i) the weaker Ringgit as sales are denominated in USD, (ii) depressed oil prices, and (iii) global resin oversupply resulting in cheaper raw material cost. SLP is the main beneficiary, but SCIENTX and TGUAN may take a slight hit despite higher revenue due to higher interest costs on their USD-denominated debts. Valuation-wise, we have derived new targeted PERs by discounting the sector to small-mid cap Tech stocks (Fwd. PEG of 0.75x) which are also USD-denominated export beneficiaries. SLP’s lower PEG discount (8%) to an unchanged 15.6x PER signifies its premium to industrial packagers (10% discount) for SCIENTX (13.0x PER on FY16E EPS) and TGUAN (9.2x PER on average FY15-16E EPS). As such, we increase our TP for SCIENTX and lower our TP for TGUAN while keeping SLP’s TP unchanged. Our Calls are SCIENTX (UP; TP: RM6.91), SLP (OP; TP: RM1.87), TGUAN (OP; TP: RM2.40).

2Q15 results review. For our stocks coverage, the 2Q15 results were all within expectations. SCIENTX came in below consensus forecast due to lower-thanexpected margin expansion but met ours on higher-than-expected property sales in the quarter. This is an improvement from 1Q15 whereby TGUAN came in below our estimates due to weak export demand and lower ASPs. Consumer packager SLP’s earnings jumped 116% YoY and 44% QoQ as margins rose on lower resin cost and increased focus on high-margin products. Meanwhile, Industrial Packager SCIENTX saw decent YoY growth (+10%) on better property sales, while TGUAN’s YoY earnings declined 32% on softer sales volume to Japan. Earnings-wise, we upped SCIENTX’s FY15-16E earnings forecasts by 6-5% to reflect higher manufacturing margins from its push into Consumer Packaging products, while SLP and TGUAN’s earnings forecasts remain unchanged.

 Improving revenue stream from a stronger USD. Plastic manufacturers stand to benefit from a strengthening USD due to their high percentage of USD-denominated exports (56%-78%). As it is, the USD continues to strengthen against Ringgit, and is already 26% higher YTD at USDMYR4.40 as of 30-Sep. 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: 25%, TGUAN: 76%) compared to SLP, which is in a net cash position.

Long-term growth from new capacity plans. Additionally, plastic packagers such as SLP and SCIENTX are in an expansion phase. SLP is in the planning stages of establishing a new RM25.0m manufacturing facility in Kulim, which will increase its total capacity to 38.0k metric tons (MT)/year (+58%) in 2-3 years (from 24.0k MT/year by end-FY15E). This could easily contribute an additional RM60-100m to revenue in FY18E (which we will impute into our estimates once the final details are announced) depending on the product mix at the new facility, and we expect SLP to remain in a net cash position post the expansion assuming a 30:70 debt-equity ratio. Meanwhile, SCIENTX’s recent acquisition of Mondi Ipoh for RM58.0m increases its Consumer packaging capacity by 14.4k MT/year (+24%) with tentative plans to add at least 20.0k MT/year of capacity at an investment of RM25-30m which we estimate could generate at least RM150m in revenue from FY17E. Like SLP, we will impute the potential earnings contribution once more details are available.

Resin cost to decline going forward due to excess resin supply in the market. Besides lower oil prices and USD exchange rates, the primary determinant of lower resin price is the supply and demand dynamics of resin. In recent months, we understand that China has increased its resin production capacity to support its local demand, causing excess resin supply outside China, which has been flooding the market, and driving down resin prices. We estimate that resin cost has fallen closer to USD1,050MT/month in 3Q15, from >USD1,300MT/month in 1Q15 and we expect this lower cost environment to persist well into 2016. Furthermore, we believe any sharp increase in oil prices is unlikely for now as OPEC member countries have no plans to trim output, while shale producers have been weathering the situation better than expected. We have accounted for lower resin prices for all plastic packagers under our coverage, although margins could continue to surprise on the upside should the resin oversupply situation worsen.

Expect margin improvements from 3Q15 onwards. All in, a stronger topline has allowed for stronger margins in 2Q15, while we expect 3Q15 to be the strongest quarter yet in terms of earnings as USD has strengthened QoQ (by 11% from 2Q15 to 3Q15) while oil prices have fallen 19% QoQ to USD51/MT in 3Q15, hitting fresh 6-year’s low. We are currently expecting FY15-16E net margins of 14.1-15.4% for SLP, 3.3-3.5% for TGUAN and 8.0-7.6% for SCIENTX.

SLP our TOP PICK for 4Q15. SLP is still in an expansionary mode, while current macroeconomic conditions appear to work in its favour. All in, we like SLP for: (i) strong sales demand with more orders from Japan by 4Q15 which we have already accounted for in our forecasts, (ii) being a beneficiary of a strengthening USD rate as all exports are USD denominated (57% of revenue as at 1H15 vs. 46% in FY14), (iii) low raw material (resin) cost, allowing for stronger margins, (iv) lower tax rates from additional incentives, (v) lower trading volume, (vi) full year contributions in FY16 from capacity expansions, which materialised in Aug-15, and (vii) downstream services, which will help improve net margins to 14.1-15.4% in FY15-16E (from 11.3 -13.6%). As a result, we have recently (in our report dated 25th Sept 2015) increased our FY15-16E earnings by 14-6% to RM24.3-29.8m, and based TP on FY16E EPS of 12.0 sen (from 11.3 sen), on a targeted Fwd PER of 15.6x @ +1.5SD levels. Updating valuation basis. We believe a growth-based valuation method is more appropriate for this fast-growing sector. Thus, we have derived our target PER by discounting the sector to small-mid cap Tech stocks’ (which are USD/export beneficiaries) Fwd. PEG of 0.75x. SLP’s lower PEG discount (8%) signifies its premium to industrial packagers (10% discount for SCIENTX and TGUAN) because SLP : (i) is a beneficiary of a strengthening USD, (ii) is a strong export-driven company, (iii) commands strong NP growth prospect of 100.0-22.5% in FY15-16E, vs. industrial packagers’ -2.4%-13.2%, and (iv) enjoys better margins of 14.1-15.4% in FY15-16E, vs. industrial packagers’ 3.5%-4.5%. Consumer Packaging applied PER is now updated to 15.6x (0.69x PEG), while Industrial Packaging’s new applied PER is 9.2x (0.68x PEG).

Revised TPs for SCIENTX and TGUAN. Post-adjustment, we maintain 15.6x PER on FY16E EPS to Consumer Packager SLP with no change to TP (RM1.87) and 9.2x PER on average FY15-16E EPS to Industrial Packager TGUAN for a lower TP of RM2.40 (from RM2.70). For blended packager SCIENTX, we apply the average PEG discount (9%) translating to 13.0x PER (previously 14.0x) on manufacturing segment earnings, leading to higher SoP-based TP of RM6.91 (from RM6.68), which TP implies 8.4x CY16E PER, or close to +1.0SD valuation).

Risks to our calls include: (i) USD reversing against the Ringgit, compressing sales growth, (ii) slower-than-expected demand for plastic products, and (iii) higher-than-expected resin prices, compressing margins.

Maintain OVERWEIGHT on Plastics sector because: (i) the sector is a beneficiary of stronger USD and robust export demand, (ii) growing production capacity serves as a potential earnings catalyst, (iii) the stable cost outlook ensures sustainable margins going forward. We reiterate our OUTPERFORM call on SLP (TP: RM1.87) and TGUAN (New TP: RM2.40; Old TP: RM2.70), and maintain our UNDERPERFORM call for SCIENTX (New TP: RM6.91; Old TP: RM6.68). 

Source: Kenanga Research - 6 Oct 2015