Period

3Q15/9M15

Actual vs. Expectations

Thong Guan Industries (TGUAN)’s 9M15 core net profit (CNP*) of RM19.7m is within expectations at 79% of consensus (RM24.8m) and slightly above ours at 81% of our RM24.1m forecast.

We think this was largely due to higher-than-expected 9M15 F&B PBT margins of 9.2%, vs. our expected 5.1%, due to better beverage product margins.

Dividends

No dividend was announced, as expected.

Key Results Highlights

YoY, 9M15 CNP declined 10% to RM19.7m on higher effective taxation (+3.1% to 6.2%) which we think is due to higher F&B segment earnings, which does not enjoy tax incentives. Otherwise, pre-tax profit rose 7% to RM25.0m as Plastic segment’s PBT improved 4% to RM22.0m due to margin improvement from the appreciating USD. F&B segment’s PBT also rose 36% to RM3.1m on higher margins by +2.3% to 9.2% for coffee and tea products.

QoQ, 3Q15 CNP jumped 48% to RM8.5m as Plastic segment’s PBT increased 62% on a turnaround in its China operations as well as better industrial product margins, resulting in 2.5% margin growth to 7.1%.

Outlook

We are positive on its 4Q15 prospects as TGUAN is targeting to begin operations on their two new Purewrap production lines in 4Q15, which will increase the Purewrap capacity to 15k MT/year (+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 from FY16 onwards.

Change to Forecasts

We raise our FY15-16E CNP forecasts to RM25.9-29.3m (+7-7%) as we upgrade our F&B segment’s GP margin assumptions to 17% (from 13%) to reflect the margin improvement seen from higher beverage sales.

Rating

Maintain OUTPERFORM We maintain our positive view on TGUAN’s long-term outlook due to its: (i) continued capacity expansion into high-margin product lines, (ii) well-received 6-micron pre-stretch product, especially in South Africa and Australia, and (iii) successful restructuring of their China operations, as indicated from the turnaround in 3Q15.

Valuation

Upgrade our TP to RM2.45 (previously RM2.40) based on updated Target PER of 8.9x (previously 9.2x) as we roll forward our valuation base year to FY16E (from average FY15-16E) for a higher EPS of 27.8 sen.

Our Target PER of 8.9x is derived from the PEG ratio of 0.69x (reflecting a 10% discount to the Tech sector’s PEG ratio of 0.75x) applied to 12.8% FY16E earnings growth (previously 13.6%). We think our 10% PEG discount is fair for Industrial Packagers as compared to 8% applied to Consumer Packagers as Industrial Packagers have thinner margins and slower growth prospects in comparison.

Risks to Our Call

Volatile plastic resin prices

Foreign currencies risk

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

Source: Kenanga Research - 20 Nov 2015