Initiating coverage on SCGM Berhad (SGCM) with OUTPERFORM call and TP of RM3.81. We like SGCM for the following factors; (i) above-average core margins (14- 15%) driven by high-margin innovations, (ii) market leader position with international quality certifications, (iii) strong FY17-18E earnings growth (15-30%) on upgrading and expansion, (iv) polystyrene ban opening up new F&B container markets, and (v) a beneficiary of stronger USD.

Market leader with strong growth prospect. As the largest listed local manufacturer of thermo-form packaging in Malaysia, SCGM is set to expand its market share in the F&B, electronic, medical and other sectors with its solid expansion pipeline and new product innovations. We expect FY17-18E revenue to rise 20-22% to RM159.5-195.0m as new expansions come online while the food container market opens up on state-wide polystyrene ban. Meanwhile, we forecast strong earnings growth of 15-30% to RM23.2-30.1m on upgrades to high-speed equipment and product innovations in the F&B sector.

Solid core margins at 14-15%, compared to the sector average of 12-13%. We expect margins to continue improving, driven by better utilization at high-margin product lines such as F&B lunch boxes and disposal cups, as well as upcoming upgrades to high-speed manufacturing equipment and stable resin costs thanks to its locally based supply chain.

Boosting capacity by 2.5x. We expect SGCM to see continued topline growth of 20-22% in FY17-18E as it continues on its expansion track. The company intends to increase its FY17E capacity by 44% by renting a factory to house its new machines, while its new plant is targeted for completion in FY19, which will boost production capacity by 2.5x to 62.6m metric tons/year (MT/year).

Opening up new markets. Locally, polystyrene ban in multiple states will shift demand to alternative packaging products, especially food trays and lunch boxes. We understand that unlike SCGM, most existing food container manufacturers are involved in polystyrene food container manufacturing and very few have extrusion production capabilities. Hence, we expect SCGM to strongly benefit from these trends, with its wide product range, capacity expansion plans, and use of resins with biodegradable features.

Beneficiary of stronger USD. With its 47% export exposure, SCGM is a net beneficiary when the USD strengthens. Costs are largely denominated in ringgit as resins are sourced locally. Our sensitivity analysis shows that every 5% strengthening of the USD increase FY17-18E revenue by 2% and CNP by 10-9%.

OUTPERFORM call with TP of RM3.81 based on a Fwd. PER of 19.9x applied to CY17E EPS of 19.2 sen. Our Fwd. PER of 19.9x is based on a slight discount to SLP’s Fwd. PER of 21.5x with a potential total return of 20.1% and positive earnings and margin prospects, we initiate our coverage with an OUTPERFORM call on SCGM.

Source: Kenanga Research - 4 Oct 2016