We maintain NEUTRAL on the sector as we believe it is fairly valued, having fully priced in positive re-rating catalysts, while share prices are already reflective of our FY17E earnings. Latest 4Q15 results were all above expectations mainly on better margins from favourable exchange rates. However, growth factors like near-term capacity and margin expansion are already priced in, for now. Nevertheless, resin price trends should remain stable for the time being. We are comfortable with our resin price assumptions of USD1,150-1,200/MT, but we have also lowered our USD exchange rate assumptions to RM4.10 (from RM4.21) closer to current levels and in line with our in house estimates. This lowers our earnings for TGUAN and SLP marginally, by <2% in FY16-17E, and their TPs to RM3.33 (from RM3.40) and RM2.24 (from RM2.26), respectively. Longer-term prospects remain positive on continued capacity expansion and potential benefits from TPPA. Maintain OUTPERFORM on TGUAN (TP: RM3.33) and MARKET PERFORM on SCIENTX (TP: RM13.25) and SLP (TP: RM2.24).

4Q15 results above expectations. Generally, 4Q15 results were above expectations, mainly due to better-than-expected net margins from: (i) stronger contribution from premium products, (ii) increased export sales as the USD to Ringgit was the strongest in 4QCY15, as well as (iii) higher property sales recognition for SCIENTX as property development provides higher margins. This was a slight improvement from 3Q15 when only SCIENTX and TGUAN were above expectations. Resin cost remained stable during the quarter. We raised our earnings estimate for SCIENTX (30%-23% in FY16-17E) and TGUAN (12% in FY16E) to be more reflective of margin expansions, and we rolled forward our valuations for SLP and TGUAN to FY17, and SCIENTX to CY17. Long-term earnings growth through expansion. To recap, we noted that packagers SLP and SCIENTX are still planning to grow capacity beyond current levels, with SLP planning a new manufacturing facility to fully materialise by FY18, while SCIENTX intends to double the capacity at its newly acquired Ipoh plants, which have already begun contributing to earnings in its most-recent quarter (2Q16, announced on 22nd March 2016). We expect the continued expansions to ensure long-term earnings growth beyond FY18E. Note that we have already priced in these plans for companies, which have finalised details such as timeline and production capacity.

Low resin cost priced in, but may decrease further if supply continues to increase. To recap, resin cost has been on the decline, from c.USD1,300MT in 1HCY15 to USD1,050-1,200MT in 1QCY16. Recall that one of the key determinants of lower resin price is the supply and demand dynamics of resin, which have seen a supply glut in 2HCY15 as China has increased its resin production capacity to support its local demand. All in, we have accounted for lower resin prices for all plastic packagers under our coverage as we are now assuming USD1,150-1,200/MT in our estimates.

Resin prices stable against crude oil prices. Resin prices remain strongly correlated with crude oil prices over the long run with an average correlation of 90%. However, despite the sharp crude oil price correction since mid-2014 by 75%, we noted that resin prices corrected only by 35%. This was likely due to cost of resins production providing a floor price. On the other hand, the recent crude oil price rally from its bottom of USD28/MT to c.USD40/MT (+43%) resulted in resin prices rising by only 13% to c.USD1,200/MT, well below its 3-year peak of c.USD1,700/MT. We expect the trend of current low resin prices to continue, with resin price movement being more stable than crude oil prices, likely due to the high supply situation as noted above. 

Source: Kenanga Research - 6 Apr 2016