We recently visited Scientex Berhad (SCIENTX)’s manufacturing plant in Rawang, Selangor to get an update on their consumer packaging expansion progress. All-in-all, while we expect to see long-term earnings growth from SCIENTX due to its current consumer packaging capacity upgrades, valuations appear stretched at this point. Thus, we reiterate UNDERPERFORM on SCIENTX with an unchanged TP of RM6.91 based on Sum-of-Parts.

Rawang facility for PE and BOPP film productions. We recently visited SCIENTX’s manufacturing plant in Rawang, Selangor. The Rawang facility is one of SCIENTX’s four consumer packaging facilities, with PE film capacity of 48.0k metric tons (MT)/year and BOPP film capacity of 6.0k MT/yr. The other three facilities are in: (i) Ipoh (recently acquired from Mondi Group) with PE film capacity of 14.4k MT/yr, (ii) Melaka (in progress), with CPP film capacity of 12k MT/yr, and (iii) Pulau Indah (in progress) with BOPP film capacity of 54k MT/yr.

New expansions on track. We gather that the Melaka and Pulau Indah plants’ construction works are progressing as scheduled. The Melaka plant which is focused on CPP film production has completed factory construction and is targeted to begin operations in end-2015. Meanwhile, the new Pulau Indah plant, which is adjacent to SCIENTX’s existing stretch film plant, is 70% constructed and should begin operations in mid- 2016. SCIENTX also intends to expand its existing Rawang plant by adding 1.2k MT/yr of PE film capacity in mid-2016. The new expansions would double total consumer packaging capacity to 152.4k MT/yr, which we expect to result in FY16-17E plastic segment revenue growths of 21- 22% to RM1.6-RM2.0b.

Resin prices trending downwards. As noted in our recent 4Q15 Strategy update (published 6-Oct-15), we expect resin costs for plastic manufacturers to decline due to excess market supply as China has been increasing its resin production capacity to support local demand. We estimate the current resin prices to be USD1,100-1,200/MT, compared to >USD1,300/MT in 1Q15, and we expect the lower cost environment to persist well into 2016 due to ample supply of crude oil. The lower resin cost and expansion into consumer packaging should contribute to FY16- 17E GP margin improvements to 11-12% from 9% currently.

However, valuations are stretched. Although the on-going expansion and declining raw material cost bode well for SCIENTX’s FY16-17E earnings growth at 16-15%, we think the market has already reflected the growth in its share price. Its recent closing price of RM7.66 is only 2% below its all-time high of RM7.80. The current share price implies a PER of 9.5x which reflects +1.2SD above mean valuation (7.3x). In comparison, consumer packager SLP is currently trading at +1.8SD or 15.8x PER while industrial packager TGUAN is trading at +0.8SD or 8.2x PER. Besides being an industrial packaging player, 54% of its FY15 earnings was derived from its Property segment, which is currently trading at a sector valuation of mean to +0.5SD (for small-caps). Hence, we think SCIENTX’s valuation should be closer to TGUAN’s +0.8SD than SLP’s +1.8SD. At +1.0SD, SCIENTX’s implied share price is RM7.04 (close to our TP of RM6.91), leading us to conclude that SCIENTX’s share price is overvalued at this juncture.

Reiterate UNDERPERFORM on SCIENTX with TP of RM6.91. Our target price is based on Sum-of-Parts with Manufacturing segment PER pegged to 13.0x. The Manufacturing segment PER at 13.0x is derived from a 9% discount to Tech sector PEG of 0.75x. We think the 9% discount is fair as we take the average between the discount applied to industrial (8%) and consumer (10%) packaging players. As mentioned above, despite a positive earnings growth outlook, we believe that valuations are stretched at this juncture and hence reiterate UNDERPERFORM on SCIENTX. However, we would consider upgrading its earnings should new capacity utilisation kick in more rapidly than expected, or if resin cost decline further, leading to better-than-expected margins. 

Source: Kenanga Research - 3 Nov 2015