Maintain OVERWEIGHT. Latest quarterly results were within our expectations and we are comfortable with our sector call as macro-economic fundamentals such as the favourable USD/MYR exchange rate which weakened further in Nov 2016, while resin cost of USD1,100- 1,200/MT is in line with our expectations. As such, we have increased our CY17 USD/MYR forecast to 4.25 (from 4.10), resulting in FY17E earnings higher by 1%-6% for Plastic Packagers under our coverage, and consequently higher TPs. Our Top Picks are SLP and SCGM. We also believe it is an opportune time for accumulation after the sell-down of both stocks from Aug 2016 along with the FBMSC index, while their fundamentals have remained intact, commanding attractive upsides of 38% for SLP (OP; TP:RM3.18) and 21% for SCGM (OP; TP:RM4.05). Going forward, the sector remains a preferred haven for investors as we believe there are more upsides, especially in coming quarters due to expectation of QoQ improvement in margins and earnings on better product mix. We make no changes to our valuations basis, and maintain OUTPERFORM for SLP (TP: RM3.18), SCGM (TP: RM4.05), and SCIENTX (TP: RM7.63) but downgrade TGUAN to MARKET PERFORM (from OP) upon value realisation TGUAN (TP: RM4.60).

3Q16 results within expectations. Plastic packager’s 3Q16 results came in well within our and consensus expectations, which were similar to 2Q16. YoY, plastic packagers’ earnings were up by 14%-110% mostly on improvements in top line, coupled with better margins as the sales of USD-denominated products increased alongside sales of highermargin 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 and SCGM) operating margins remained strong at 17%. All in, post results reporting season, we made no changes to our earnings forecasts as results were in line, but upgraded our call for TGUAN to OUTPERFORM (from MP) on decent total returns as at the day of our report. Exporters riding the wave of a stronger USD. This export-focused sector is a beneficiary of higher USD/MYR. We expect slight-to-moderate positive earnings impact as we increase the USD/MYR assumption in CY17 to 4.25 (from 4.10), for higher FY17E earnings of 1%-6% for Plastic Packagers under our coverage. We reiterate our view that future earnings growth will be more dependent on margin expansions, but a weakening Ringgit bodes well for share price sentiment. Plastic packagers’ core net margins have been flattish QoQ in CY16, remaining at 8-9% for industrial packagers and 17% for consumer packagers, well within our expectations. Looking ahead to FY17, we expect industrial packagers to maintain margins close to current levels of 8- 9%. However, we expect consumer packager SCGM’s margins to improve slightly to 19% (from 17%) on better utilization of high-margin product lines such as F&B lunch boxes and disposable cups, as well as upgrades to high-speed manufacturing equipment, while we expect consumer packager SLP’s operating margins to increase to 21% (from 17%) post commissioning of downstream machinery by FY17 (i.e. printing press), allowing SLP to command better margins on existing products from value added printing services and improved sales of higher margin products (i.e. Maxinflax and healthcare products).

Capturing strong demand… We expect demand for plastic products under our coverage to remain resilient as; (i) their niche products (i.e. FMCG or plastic bags) are client specific and catered to detailed or stringent requirements, (ii) a large portion of plastic packagers (TGUAN, SLP) sales are driven by Japanese clients, which tend to be loyal customers and rarely change suppliers, (iii) SCGM is benefiting from the ban on polystyrene (replaced by SCGM’s lunch boxes).

…with bullish expansion. The strong current and expected demand drives plastic packagers’ aggressive expansion: (i) SLP is planning a new manufacturing facility to increase capacity by +58% to 38k MT by FY18, and targeting to penetrate the Chinese market, (ii) SCIENTX continues to ramp up of the BOPP plant and expand in its Rawang (+25% to 60k metric tons (MT)/year) and Ipoh (+43% to 24k MT/year) plants, and has recently invested in a new plant in the United States due 2H18, (iii) SCGM is renting a 20k square foot (sq ft) facility in Kulai to house 2 new extrusion machines while its longer-term expansion plans include a new plant targeted for completion in FY19, which will boost production capacity by 2.5x to 62.6k MT/year. Additionally, SCGM is on the lookout for another plant to rent in the near term to accommodate the increased sales before its new plant is completed in Dec-18 (FY19). Lastly, while TGUAN is less aggressive on capacity expansion, the company is consistently investing in R&D to improve sales and margins on existing products (i.e. stretch film) and revamp its customer base and target more MNCs. We expect the continued expansions to ensure long-term earnings growth beyond FY18E.

Source: Kenanga Research - 5 Jan 2017