Maintain OVERWEIGHT. The sector continued to fare well with the recent 2Q16 results season coming in within our and consensus’ expectations. However, SLP’s share price was bashed down recently post results (-27%) between 12th Aug-16 to 18th Aug-16, while SCGM (Not Rated) also declined (-17%) during the same period as profit taking activities were seen on well performed stocks. Post-channel checks with management, we are confident that both company and industry fundamentals remain intact as SLP is expecting better sales in 2H16 as orders tend to pick up in the second half, while its new factory for downstream production, which will help improve margins going forward will be completed in Oct 2016. This is backed by the fact that USD exchange rate and resin cost have remained largely unchanged. We reiterate our view that the sector will continue to re-rate, driven by strong demand evident from capacity expansions as well as margin growth through higher value products and improved product mix. As we make no changes to earnings or our valuations basis, we upgrade SLP to OUTPERFORM (from MP) as it is commanding 39.0% total returns at current levels to our TP, and maintain our calls and TP for SCIENTX (OP; TP: RM7.57) and TGUAN (MP; TP: RM4.49).

2Q16 results within expectations. Plastic packager’s 2Q16 results came in well within our and consensuses expectations vs. 1Q16 when SCIENTX and TGUAN exceeded expectations. YoY, plastic packager’s earnings were up by 20%-150% mostly on improvements in topline, coupled with better margins as the sales of USD-denominated products increased alongside sales of higher-margin products. Industrial plastic packagers (i.e. SCIENTX and TGUAN) saw margin improvements YoY to 8-9% operating margins, from 3-5% in FY15, on the back of flattish resin cost, while consumer packagers’ (i.e. SLP) operating margins remained strong at16%. All in we made no changes to our earnings forecasts as results were inline, but downgraded our calls for TGUAN and SLP to MARKET PERFORM (from OP) as share prices caught up to our TPs as of their respective results dates on 25th Aug-16 (TGUAN) and 5th Aug-16 (SLP).

SLP and SCGM saw sharp sell-downs in August. We only have full coverage on SLP. However, when SLP was sold down heavily starting 12th Aug-16, we noticed that SCGM (NOT RATED) also suffered the same fate. Both share prices of SLP and SCGM were bashed down with the biggest single-day share price drop on the 17th and 18th Aug-16 (SLP: -10.8% and -11.3%, respectively) and (SCGM: -7.7% and -5.2%). As a result, the bulk of their year-to-date gains have been erased with 20% and -6% YTD gains for SLP and SCGM, respectively, as at 6th Sep-16 vs. 58% and 11% YTD gains before the selldown began on 12th Aug-16 in line with a correction of the FBMSC by 1.2% over the past 1 month in August and 0.3% decline during that same period as profit taking activities were seen on well performed stocks.

…but SLP’s fundamentals remain intact. Channel checks with SLP’s management confirmed our view that fundamentals remain intact. In fact, the group expects sales to be stronger in 2H16, as orders tend to pick up after August based on historical trends, which bode well for earnings, while SLP’s new factory will be completed in Oct 2016. This new factory will add to SLP’s downstream processing capabilities, resulting in higher margin products, while capacity expansion plans are still set for FY18 for an additional14k MT (+58% to its existing capacity of 24k MT p.a.). As such, our earnings estimates already reflect the improved margins in FY16-17E of 15.4-17.8% from the inclusion of downstream machinery, as well as capex allocations of RM15-9m, respectively.

SCGM (Not Rated). SCGM also released its 1Q17 results on 2nd Sep-16, and saw improved net profits (+12.8% YoY) while the group expects earnings growth going forward to be driven by the sale of its food packaging products and plastic cup business, which have been picking up steam as both export and local sales have recorded double-digit growth YoY. Additionally, SCGM is catering for increasing orders in the near term by renting a premises in the interim (by Dec 2016) to house two extruders, while its capacity expansion plans are on track for a new plant by end FY19. While we do not cover SCGM, we believe its long-term outlook remains promising, implying a tentative fair value of RM3.95 (36.8% total returns) based on our CY17E EPS of 19.9sen (from our On Our Radar report dated 6th Apr-16)and an applied PER of 19.9x. We apply a tentative PER of 19.9xon CY17E for SCGM, which is only a slight discount to SLP (21.5x PER on FY17E) as: (i) SLP has a higher exposure to export revenue (c.60%) vs. SCGM (c.44%), and (ii) SLP has slightly better net margins of 16.0% vs. SCGM’s 14.5%. Both these companies are almost on par with most other comparables such as: (i) 3-year CAGR of 20%, (ii) dividend policy (40% dividend policy), (iii) ROE’s (est. 24% 1-year Fwd.), and (iv) balance sheet strength as both are net cash companies.

Valuation

s. To recap, in our 3Q16 Sector Strategy Report titled ‘Valuation Re-Rating’ (dated 8th Jul-16), we re-rated the plastic sector’s valuations which we believe was overdue as the sector was able to command strong growth rates with a 3-year CAGR of 20- 32% for companies under our coverage, on the back of stable dividends (minimum 30% pay-out ratio) and long-term earnings growth through expansion and product development, resulting in higher margins. We re-based our valuations against DAIBOCI as its valuations have remained sticky at 18.0x average Fwd. PER since CY14 on above-average margins and ROE vs. its peers back then, and despite earnings declines (-13%) in CY14 while other plastic manufacturers had since been playing catch-up in terms of margins and earnings growth. Our applied Fwd. PERs took into account the following factors; (i) margins, (ii) dividend pay-outs, (iii) ROE, (iv) 3-year CAGR, (v) balance sheet strength, (vi) market cap, (vii) export revenue, and (viii) exposure to consumer segment. Based on our analysis and using DAIBOCI (18.0x PER) as a base, we awarded SLP richer valuations of 21.5x FY17E PER (from 15.5x), TGUAN at 14.6x FY17E PER (from 11.0x), and SCIENTX at 17.6x PER on CY17E PER (from 14.0x). We remain confident of our valuations as the stocks’ underlying fundamentals are unshaken while we expect earnings growth to stay resilient in coming quarters as risk to earnings are limited and have been accounted for (please refer to APPENDIX).

The sectors macro-economic fundamentals such as Ringgit and resin cost remain stable. We maintain our in-house FY16-17E estimates of USD/MYR at 4.10 (vs. YTD average of RM4.08). Notably, the Ringgit has been weakening recently against the USD down by 2.6% since Jul-16 (from RM3.99/USD in Jul-16 to RM4.08/USD currently). Although the sector is a beneficiary of a weaker Ringgit to USD, the impact is not overly significant as our sensitivity analysis indicates that a 2% decline to the Ringgit would result in a 1-2% increase to bottomline. Going forward, future earnings growth will be more dependent on margin expansions but a weakening Ringgit bodes well for share price sentiment for the sector. Resin cost had also remained stable over the past one year at current levels of c. USD1,100-1200/MT on ample supply of resin due to excess supply from China in the market. This has resulted in resin prices becoming detached from volatile crude oil prices.

Upgrade SLP to OUTPERFROM (from MP) with unchanged TP of RM3.11. As the sell-down was related to reasons, which are neither company nor industry related, we believe this is an opportune time to accumulate SLP as valuations appear compelling at current levels. We continue to like SLP for its: (i) strong EBIT margins 16% vs. peers’ 8%-9%, (ii) consistent net cash position, (iii) recently announced 40% dividend policy which we provide consistency of returns to shareholders, and (iv) high ROE’s of 24% vs. peers’ 9-21%. At current levels, SLP is commanding total returns of 39.0% to our TP of RM3.11, while investors can look forward to capacity expansion plans (+58% to its existing capacity of 24k MT p.a.) in CY18. As we make no changes to our TP of RM3.11, we upgrade our call to OUTPERFORM (from MARKET PERFORM) as SLP appears extremely attractive at current levels. Our TP is based on an applied PER of 21.5x FY17E EPS of 14.5sen.

Maintain calls and TP for SCIENTX (OP; TP: RM7.57) and TGUAN (MP; TP: RM4.49). We leave our calls and TPs for SCIENTX and TGUAN unchanged. SCIENTX’s earnings going forward will be driven by margin improvements in the consumer segment as consumer packaging capacity is expected to make up c.50% of total capacity post expansion in 2H17, from 38% currently, whilst overall earnings will be bolstered by the property segment which tends to command strong operating margins of 25-30%. Our TP is based on an applied PER of 17.6x PER for manufacturing segment based on Sum-of-Parts (SoP) methodology for CY17, and applied PER of 4.0x for the property segment to CY17 RNAV.

We believe TGUAN will be able to maintain its current margins of c.8-9% as: (i) the Group is selling off machinery for lower margin products such as jumbo rolls (est. <5% gross margins), while (ii) top line growth and better margins products are mostly from Maxstretch stretch film on better pricing due to improved product quality, (iii) PVC food wrap and (iv) organic noodles. Our TP is based on a Target PER of 14.6x on FY17E FD EPS of 30.8 sen. We reiterate our OVERWEIGHT view on the plastic sector which will farewell in coming quarters. The plastics packaging sector will continue to see margin expansions over the next two years as packagers under our coverage continue to up their game through product innovation moving towards selling more niche and higher-margin products for specific customers. This coupled with the fact that macro fundamentals remain intact, i.e. weak Ringgit and low cost environment which we have accounted for in our estimates bode well for sentiment.

Risks to our calls include: (i) slower-than-expected demand for plastic products, especially from importing countries, (ii) higher-thanexpected resin prices, and (iii) a sector de-rating due to weaker valuations from unfavourable macroeconomic situation.

Source: Kenanga Research - 7 Sep 2016