Maintain OVERWEIGHT. Recent quarterly results of our coverages came in within or broadly within our and consensus estimates, while operating margins remained strong for consumer players (16-17%), and industrial packagers (6-9%). We like the sector and maintain our OVERWEIGHT call as it continues to be driven by resilient demand, allowing plastic packagers under our coverage to embark on robust capacity expansion over the next 1-2 years, and product innovation, translating to strong double-digit earnings growth in FY17-18. This coupled with the fact that macro fundamentals remain intact, i.e. weak Ringgit environment and low resin cost which we have accounted for in our estimates, allows the sector to thrive on positive market sentiment. All in we make no changes to our TPs and calls for SCGM (OP; TP: RM4.48), SLP (OP; TP: RM3.18), SCIENTX (OP; TP: RM8.36) and TGUAN (MP; TP: RM4.76). Our top picks are SLP and SCGM as they have yet to fully price-in its full earnings potential given capacity expansions.

4Q16 results came in within or broadly within our and consensus estimates, which was similar to 3Q16. TGUAN, SLP and SCGM saw better demand, which led to YTD top-line growth of 5-25%, but basic industrial products player SCIENTX saw weaker demand leading to lower YoY revenue (-3%). All in, consumer packagers (SLP and SCGM) maintained strong double-digit operating margins of c.16-17%, while industrial packagers (SCIENTX and TGUAN) remained at 6-9%. We upgraded TGUAN FY17E CNP by 4% to RM60m to account for new machinery contributions and SCGM by 2% in FY17-18E. We also upgraded our TPs for TGUAN to RM4.76, and SCGM to RM4.48 post-earnings adjustment. This was better than 3QCY16.

Demand for plastic products remains strong. 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 and SCIENTX) sales are driven by Japanese clients, which tend to be loyal customers and rarely change suppliers, (iii) SCGM is benefiting from the multi-state ban on polystyrene (replaced by SCGM’s lunch boxes). Evidently, plastic packagers under our coverage saw strong revenue growth in the recent quarterly results (save for SCIENTX), driven by both local and export demand.

Expansions across the sector will continue to drive top-line growth in the long-run. Under our coverage, we expect capacity growth for; (i) SLP which is planning a new manufacturing facility to increase capacity by 58% to 38k MT by FY18, and targeting to penetrate the Chinese market , (ii) SCGM which is renting a 20k square foot (sq ft) facility in Kulai to house two new extrusion machines, increasing capacity by 44% to 36k MT/year in FY17, while its longer-term expansion plans include a new plant targeted for completion in FY19, which will boost production capacity by an additional 74% to 62.6k MT/year, (iii) SCIENTX which continues to ramp up its operations at its Rawang plant (+25% to 60k MT/year) and Ipoh plant (+43% to 24k MT/year) by 2HFY17, and has also invested in a new plant in the United States due in 2H18, and (iv) TGUAN which is constantly investing in capacity expansion and R&D to improve sales and margins on existing products (i.e. stretch film) and revamp its customer base to target more MNCs. We expect the continued expansions to ensure long-term earnings growth beyond FY18.

Strong double-digit earnings growth from capacity expansion plans. As a result of bullish expansion plans backed by strong demand for plastic products, we expect strong FY17-18E earnings growth of; (i) 25%-33% for SLP, (ii) 26%-29% for SCGM, (iii) 18%-19% for SCIENTX, and (iv) 12-14% for TGUAN.

Margin improvements for SLP and TGUAN from product innovation as plastic manufacturers move towards selling more niche and higher margin products in the near-term. As a result, we expect core net margin improvements in FY17-18 for; (i) SLP by +2.2-0.3ppt, and (ii) TGUAN by +0.2-1.0ppt. SCGM and SCIENTX may see fairly flattish margin growth over FY17-18 on higher fixed costs (namely from utilities, labour, production), depreciation, and tax rates on gradual paring down of investment tax allowances (ITA), but we expect margins to rise in the longer term as on economies of the scale as utilization and efficiency improve.

Resin cost remains stable at c. USD1,100-1200/MT, detached from crude oil prices. Resin cost has remained fairly stable over 2016 and is close to current levels of c. USD1,100-1200/MT due to the ample supply of resin from China, which is flooding the market. This has resulted in resin prices becoming detached from rising crude oil prices. Going forward, we expect costs to remain stable on excess supply, which will offset rising crude oil prices, especially given the reduced relationship between crude oil and resin prices.

Weakening Ringgit may bode well for share price sentiment as the sector is an export play. We expect future earnings growth to be more dependent on capacity expansions. However, a weakening Ringgit will bode well for share price sentiment. Our sensitivity analysis suggests that a 2% decline in the Ringgit results in c.1-4% increase to earnings, implying the impact is not overly significant. We are comfortable and maintain our USD/MYR assumption at 4.25 in CY17, which is slightly lower vs. current levels of 4.44 as we choose to remain conservative.

SLP top gainer YTD, increasing by 13% as at our cut-off date (10th March 2017). SLP has been our top pick for the past three quarters and laggard play ever since SLP and SCGM saw sharp sell-downs in Aug 2016 as the bulk of their year-to-date gains were erased in line with the correction of the FBMSC index. We believe the renewed interest in SLP was on the premise of its 12M16 results meeting market expectations and on stronger margins, while we continue to like SLP for its bullish earnings prospects. Besides SLP, all other Plastic packagers under our coverage saw positive YTD gains, while only SLP managed to outpace both the FBMSC Index (+11%) and FBMKLCI Index (+5%) (refer to table below). Looking ahead, we believe SCGM has lagged in terms of share price performance compared with its peers while our valuations suggest another 28% total returns on the back of its high earnings growth of 26-29% over FY17-18. SLP has done relatively well over early 2017, but we believe that given its strong earnings growth prospects of 25-33% over FY17-18, our valuations suggest that it still has 31% total returns.

Valuations. To recap, we had previously re-based the plastic sector’s valuations (refer to our 3Q16 Sector Strategy Report titled ‘Valuation Re-Rating’ dated 8 July 2016) 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 decline (-13%) in CY14 while other plastic manufacturers had since been playing catch-up in terms of ROE, margins and earnings growth. Based on our analysis with DAIBOCI (18.0x PER) as a base, we awarded SLP valuation of 21.5x FY17E PER, SCGM at 19.9x FY18E PER, TGUAN at 14.6x FY17E PER, and SCIENTX at 17.6x on FY18E PER, and thus, we make no changes to our valuations for now.

Maintain OVERWEIGHT on positive earnings growth, backed by favourable macro fundamentals. We maintain OVERWEIGHT on the sector as it continues to be driven by resilient demand, allowing plastic packagers under our coverage to embark on robust capacity expansion over the next 1-2 years, and product innovation, translating to strong double-digit earnings growth in FY17-18. This is coupled with the fact that macro fundamentals remain intact, i.e. weak Ringgit environment and low resin cost which we have accounted for in our estimates, allowing the sector to thrive on positive market sentiment. All in, we maintain our calls and TP for SCGM (OP; TP: RM4.48), SLP (OP; TP: RM3.18), SCIENTX (OP; TP: RM8.36) and TGUAN (MP; TP: RM4.76). At current levels, Plastics Packagers under our coverage are commanding attractive total returns of 7-31%.

SLP and SCGM remain our top picks. We like SLP (OP; TP: RM3.18) for its strong earnings growth potential, of 25-33% in FY17-18 driven by increased sales to from tapping into new markets such as China, and maintaining strong sales with existing clients in Japan. We expect core net margins expansion to 19.5-19.8% in FY17-18 (from 17.3% in FY16) on the full-year effect upon commissioning of downstream machinery (i.e. printing machines) in end FY16 which will enable higher margins from value add/niche services, and on sales of higher margin products (i.e. healthcare products and MaxInflax). The Group’s capacity expansion plans (+58% to 38k MT/year) by CY18 are on track, driven by strong demand from existing clients. Lastly, SLP is a strong net cash company with a 40% dividend policy, confirming that company is committed towards shareholders’ returns and it is commanding attractive total returns of 31% at current levels. Meanwhile, we like SCGM (OP; TP: RM4.48) as it is a prime beneficiary of multi-state bans of polystyrene food containers. The company is expanding capacity with new rented facilities in FY17 while its second plant is in progress, which will boost capacity by 2.5x to 62.6k metric tons (MT)/year by FY19. As such, we are expecting strong CNP growth of 26-29% in FY17-18 and decent dividend yields of 2.3-3.0% backed by a 40% dividend policy, all in commanding attractive 29% total returns.

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

Source: Kenanga Research - 28 Mar 2017