Maintain NEUTRAL. 3Q17 results were mixed, with three coming in below (SLP, SCGM and TOMYPAK), and two within our estimates. YTD, packagers saw gains of 2-51%, save for SLP (-4%) on weak earnings. Going forward, we expect capacity expansion to drive growth in the longer run on continuous demand for niche products, and stretch film through Industry 4.0. Evidently, all plastic packagers are undertaking capacity expansion plans, which will be completed by FY19-21. We lower our forecast CY18 USD/MYR forex to RM4.10 (from RM4.25) in line with in-house estimates, and FY18-19E CNP by 2-3% on average, for packagers under our coverage. Resin cost has been volatile in CY17, but could trend downwards in CY18 - a potential re-rating catalyst for the sector. Resin prices are currently range bound between USD1,100-1,200/MT, in line with our CY18 estimates. Maintain plastic packagers’ PER which is based on a discounted PER to the rubber gloves sector (refer to our report dated 29th September 2017, ‘Taking A Breather, Selective on TGUAN’). Based on respective quantitative and qualitative factors, SCGM has the highest PER at 19.2x, SLP at 18.7x, TOMYPAK at 18.3x, SCIENTX at 17.4x and TGUAN at 15.3x on CY18E. We are comfortable with our sector call on stable macro fundamentals (i.e. resin cost stabilising, and post accounting for lower exchange rates), and factoring earnings risks from margin compressions, while positives have been priced in. TGUAN (OP; TP:RM5.55) remains a laggard and is our Preferred Pick.

3Q17 a mixed bag of results. Plastic packagers’ 3Q17 results were mixed with 3 coming in below (SLP, SCGM and TOMYPAK), and 2 within our estimates (SCIENTX and TGUAN). The weak results were due to higher raw material cost, higher-than-expected repairs and maintenance, and less than favorable product mix. YoY, plastic packagers fared better, recording top-line growth of 6- 42% (save for TOMPAK at -1%), translating to positive bottom-line growth for most (2-6%), except SLP on higher labour cost, and less favorable product mix. All in, we lowered earnings for SLP (30-13% for FY17-18E), TOMYPAK (22-7% for FY17-18E) and SCGM (10-18% for FY18-19E) as well as TP, while SCIENTX and TGUAN were left unchanged.

TOMYPAK top gainer YTD at 51%. Most plastic packagers have done well year-to-date recording mostly positive growth of between 2% and 51%, save for SLP (-4% YTD). We believe TOMYPAK’s bullish rally was due to its strong 1Q17 results (released on 18th May 17). Although subsequent quarters did not meet our expectations, we believe investors like TOMYPAK for its longer-term prospects of increased capacity in the longer run (+89% by FY20-21). SLP was our top loser as results missed our expectations for three consecutive quarters due to weaker-than-expected margins. We believe TGUAN is a laggard as its fundamentals remain intact, and is the only plastic packager under our coverage, which has consistently met expectations, while share price is only up 2% YTD.

Capacity expansion driving growth in the longer run. We expect growth to be driven by resilient demand for niche plastic products, and stretch film through Industry 4.0. With plastic packagers continuously tapping into new markets such as China, United States, Canada and Africa, and working on more niche products (i.e. FMCG or healthcare segment) to improve margins, most plastic packagers have embarked on bullish capacity expansion plans, which should accrete over the longer run. TOMYPAK is increasing capacity by 89% by FY20-21, SLP by 58% in FY19, SCIENTX by 12% in FY19, and SCGM by 73% by FY20, while TGUAN is targeting c.10-15% p.a. In the near term; earnings growth, if any, will come from margin expansions. This is premised on better cost efficiency and product innovations that could bump up margins as plastic manufacturers look to sell more niche and higher margin products.

Lowering forecast CY18 USD/MYR forex to RM4.10 (from RM4.25). In line with weaker USD/MYR exchange rates in recent months, we are lowering our CY18 USD/MYR forex to RM4.10 (from RM4.25) in accordance with our in-house estimates. As most plastic packagers are net beneficiaries of a stronger USD, our lower forex rate prompted us to lower our earnings by 2- 3% on average in FY18-19E for packagers under our coverage.

Resin cost volatile in the near term, but expected to trend downwards in CY18. 9MCY17 saw higher resin cost due to demand and supply factors, with prices increasing by up 20-30% (YoY) for plastic packagers under our coverage as most of them suffered resin cost spike in 1Q17, while some of this higher cost was carried through to 2Q17. As a result, most plastic packagers under our coverage saw weaker earnings from margin compressions this year. However, there is a possibility of lower resin prices in CY18 on increased supply from China, India and US shale based resin which would be a re-rating catalyst for the sector. Going forward, we may look to lower resin cost assumptions pending further clarity of the effects of additional resin supply on prices. We believe this could be a positive rerating catalyst for the sector; assuming a 2% decline in resin prices, this could increase plastic packagers’ earnings under our coverage by 6-8%. Resin prices are currently staying range-bound between USD1,100-1,200/MT, in line with our CY18 estimates.

Valuation. We make no changes to plastic packagers PER’s under our coverage which is based on a discounted PER to the rubber gloves sector (refer to our report dated 29th September 2017, ‘Taking A Breather, Selective on TGUAN’). Due to the rubber gloves sector’s similarities to plastic packagers (i.e. net exporters, beneficiaries of weaker Ringgit vs. the USD and strong product demand as final products are fairly inelastic), we are attaching a discount on plastic packagers compared to the rubber gloves sector PER based on respective quantitative and qualitative factors. SCGM has the highest PER at 19.2x, SLP at 18.7x, TOMYPAK at 18.3x, SCIENTX at 17.4x and TGUAN at 15.3x on CY18E earnings.

Maintain NEUTRAL. We lower earnings for all plastic packagers under our coverage by 2-3% on average in FY18-19E, to account for the lower exchange rate, but make no changes to our valuation basis. As a result, we have lowered our TP’s for all plastic packagers, but make no changes to our calls. We are comfortable with our sector call on stable macro fundamentals as resin cost has come off from YTD highs of USD1,400/MT, and post accounting for downsides from lower exchange rates, and earnings risks from margin compressions.

Preferred Pick is TGUAN (OP; TP: RM5.55) as it a laggard despite solid earnings and fundamentals, while share price has yet to play catch up (+2% YTD). Despite its solid earnings and fundamentals YTD, and being the only plastic packagers that met expectations this quarter, TGUAN’s share price performance (-5% YTD) remains a laggard vis-à-vis its peers. We like TGUAN for its stable earnings growth, and expect 12-6% top-line growth in FY17-18E, premised on modest capacity growth assumptions of 13-15% and on slightly improving net margin assumptions of 7-8% (vs. 3-7% over FY14-16A). We believe growth going forward will be driven by its ability to increase sales of its higher margin products, (i.e. Nano-33 stretch film and MaxStretch) and increased sales to Europe, Australia and New Zealand. Furthermore, its healthy balance sheet (strong net cash position of 0.14x) is better than its peers, save for SLP, and we expect this to be maintained going forward. The Group had consistently paid out c.25-30% of earnings despite having no formal dividend policy. Based on our newly applied PER of 15.3x on FY18E, TGUAN is commanding an attractive 38% total return despite our modest valuations.

Risks; (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 - 5 Jan 2018