We attended SCGM’s 1Q18 analysts’ briefing and remain neutral on their long-term outlook. Margin compression in 1Q18 (similar to 4Q17) was caused by changes in sales mix due to penetrative pricing and higher costs. As such we lowered FY18-19E earnings by 10-8% to RM27.7-35.1m. However, the longer-term expansion is on track with capacity expanding up to 88% by 2H19. Maintain MARKET PERFORM but lower FD Ex-All TP to RM3.05 (from RM3.35).

1Q18 saw margin compression on higher cost of raw materials, higher expenses and changes in the sales mix. To recap, 1Q18 results were below our expectations due to weaker EBIT margin of 13% vs. our estimate of 16% on: (i) higher raw material cost (+30% YoY), (ii) higher expenses (i.e. utilities, and staff cost), and (iii) change in sales mix as the group adopts a more penetrative pricing strategy to gain market share.

Expansion plans are well on track with the newly rented factory in Klang Valley coming on-stream in Sept 2017 with one thermoform machine thus far, while we expect 4 more thermoform machines and 2 extruders by 2H18, adding 5k MT/year of capacity. This new plant will produce lunch boxes and shorten delivery time to the Klang Valley and Northern peninsular markets. Additionally, construction of the second factory in Kulai, Johor is also well on track, and is currently 65% completed while the timeline or completion is still by Dec 2018 (FY19). Once completed, the new factory will bring total group capacity to 67.6k MY/year (+88% from current levels).

Outlook. SCGM was the silver sponsor for the 2017 South East Asian Games as well as the ASEAN Para games in Kuala Lumpur in 3QCY17, which should bode well for sales of disposable lunch boxes and cups. In line with the Group’s longer-term expansion plans for a new plant targeted for completion in Dec 2018 (FY19) in Kulai, boosting production capacity to 67.6k MT/year, we are expecting FY18-19E capex of RM60-54m, with FY18E capex to be utilised for; (i) the 2nd factory construction in Kulai, and (ii) the new Klang Valley rented factory, while FY19 capex of RM54m will be utilised for the Kulai factory construction. All in, we expect FY18-19E effective tax rates of 13-18% as SCGM will benefit from reinvestment tax allowance.

We lower FY18-19E earnings by 10-8% to RM27.7-35.1m on lower margin assumptions. Accounting for weaker margins this quarter, we have lowered our CNP margins to 12.2-12.2% (from 13.6-13.3%) due to: (i) increased resin cost by 30% YoY (c. RM5900/MT), (ii) higher other expenses such as utilities and staff cost from the newly rented plant in Klang Valley, and (iii) slightly lower product margins as the sales mix encompasses more penetrative pricing which we expect to persist for the next two years.

Maintain MARKET PERFORM but lower our FD Ex-all TP to RM3.05 (from RM3.35). Our FD Ex-all TP is based on a FD CY18E EPS of 15.3 sen (from 16.8 sen) post accounting for the bonus issue and full conversion of warrants and an unchanged Fwd. PER of 19.9x based on a slight discount to SLP’s Fwd. PER of 20.5x due to SLP’s better margins and higher ROEs. We maintain our MARKET PERFORM call as most downsides have already been priced in, while the group’s longer-term prospects are intact in light of: (i) decent earnings growth from long-term extrusion capacity expansion, and (ii) F&B container market opening up on state-wide polystyrene container ban.

Source: Kenanga Research - 11 Sep 2017