We attended SCGM’s 2Q18 results briefing and came away feeling cautious of their near-term earnings due to margin compression (similar to 1Q18 and 4Q17) due to higher cost and penetrative pricing. The longer term outlook is intact with the new factory set to be completed by 2H19. Lower FY18-19E earnings by 11-5%. Maintain MARKET PERFORM but lower FD Ex-All TP to RM2.75 (from RM3.00).

Margin compression on higher cost and penetrative pricing. 1H18 results were below our expectation for the 3rd consecutive quarter, with CNP margin at 10.4% (vs. our estimate of 12.1%). We had previously lowered our earnings to account for higher resin cost, but we believe the crux of the problem is due to: (i) higher-than-expected expenses (i.e. sales and administrative expense, and staff cost), and (ii) penetrative pricing affecting margins.

Expansion plans on track. SCGM’s rented factory in the Klang Valley is gradually coming on stream since 2Q18, with stronger contributions expected in coming quarters. The factory has one thermoform and one extrusion machine for now, while we expect 4 more thermoform and one extruder by 3Q18, adding a total of 5k MT/year of capacity. The construction of the second factory in Kulai, Johor is also well on track, and is currently 85% completed (as at 2Q18), while the completion timeline is maintained at Dec 2018 (2H19). Post completion, the new factory will bring total group’s capacity to 67.6k MT/year (+78% from current levels).

Outlook. The Group’s longer-term expansion plans for a new plant are targeted for completion in Dec 2018 (2HFY19) 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 constructing its Kulai factory. We expect low effective tax rates of 13-18% for FY18-19 as SCGM will benefit from the reinvestment allowance.

We lower FY18-19E earnings by 11-5% to RM24.7-33.4m accounting for weaker margins. We lower FY18-19E CNP margins to 10.9-11.7% closer to current levels (from 12.2-12.2% on: (i) higher expenses from staff cost, and sales and administration expense with the new factories coming on stream, and (ii) lower product margins as the sales mix encompasses penetrative pricing.

Maintain MARKET PERFORM but lower our FD Ex-all TP to RM2.75 (from RM3.00). Our FD Ex-all TP is based on a lower FD CY18E EPS of 14.3 sen (from 15.3 sen) and a lower FY18E Target PER of 19.2x (from 19.6x) on SCGM’s weaker earnings and margins. Even so, our applied PER is still the highest among plastic packagers under our coverage, namely above its upstream consumer packaging peer SLP (18.7x PER) due to its stronger earnings growth and better margins. We maintain our MARKET PERFORM call as most downsides have been priced in, especially in terms of margins, 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.

Risks to our call include; (i) higher-than-expected resin cost, (ii) weaker product demand from overseas, (iii) foreign currency risk from strengthening Ringgit, and (iv) new entrants/competition biting into its market share.

Source: Kenanga Research - 11 Dec 2017