Downgrade to UNDERWEIGHT (from NEUTRAL). 4Q17 results were mixed, with three coming in below (TGUAN, SCGM and TOMYPAK), and two within our estimates. The underperformance was due to higher-than-expected cost for various reasons, including high start-up cost, raw material cost, higher-than-expected repairs and maintenance, and less favourable product mix. YTD, packagers saw declines of 6-39%, alongside the de-rating of the FBM Small Cap Index (-12% YTD) vs. the FBM KLCI (+4% YTD). We lower our CY18-19 USD/MYR forex to RM3.90 (from RM4.10) in line with in-house estimates, lowering FY18-19E CNP by 4-3% for packagers under our coverage while our average resin cost estimates of USD1,100-1,300/kg are in line with current levels. Although resin cost was volatile in CY17, there is a possibility of it trending downwards in CY18 on excess capacity from China, India, and US shale-based resin - a potential re-rating catalyst for the sector. We lower our valuation basis based on quantitative and qualitative factors, and in line with our in-house strategy which de-rated small caps since Feb 2018. All in, we lower our PER valuations for all plastic packagers by 10-20%, implying -0.5 to -1.0 SD below the 4-year fwd. average, lowering TPs by 5-21%. Maintain all calls, save for SCIENTX which we downgrade to UP (from MP).

Mixed bag of results. Plastic packagers’ 4Q17 results were mixed with 3 coming in below, and 2 within our estimates, similar to 3Q17. The weaker-than-expected results were due to various reasons including higher start-up cost, raw material cost, higher-than-expected repairs and maintenance, and less-than-favourable product mix. YoY-Ytd, better sales volumes led to top-line growth of 8-32% (save for TOMPAK at -3%). However, higher cost resulted in negative growth in bottomline for TGUAN, SLP and TOMYPAK. QoQ, earnings were disappointing from TGUAN (-76%), and TOMYPAK, which recorded its first ever net loss, on higher cost and expenses. We believe most cost are temporary (i.e. start-up cost, maintenance and freight cost) but we remain cautious on the impact in upcoming quarters. Other packagers were fairly flattish QoQ, between -1% and 2%.

During 4QCY17 results, we lowered our earnings estimates for TGUAN, TOMYPAK, SCGM and SLP by 10-33% for FY18 on weaker margins, closer to current levels, but may look to increase our margin assumptions if earnings improve. We also downgraded our applied PERs by 4-8% in light of weaker margins. As a result,

our TPs for TGUAN, TOMYPAK, SCGM and SLP are lowered by 15-37% but calls were maintained. This was slightly worse than 3Q17 when we lowered our TPs for TOMYPAK, SCGM and SLP.

Plastic packagers saw YTD losses on weak earnings and in tandem with the decline in the FBM Small Cap Index (-12%).

Plastic packagers declined by 6-39% YTD, alongside the de-rating of the FBM Small Cap Index (-12% YTD) vs. the FBMKLCI (+4% YTD). Furthermore, we believe plastic packagers that have underperformed in terms of weaker earnings (i.e. SCGM, TGUAN and TOMYPAK) suffered the brunt of YTD declines. SCGM was the top decliner, down 39% YTD which we reckon was due to earnings missing expectations four quarters in a row while the near-term outlook remains challenging in light of higher cost from the new factory, most of which we have already priced into our earnings.

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, and SCGM by 65% by FY20, while TGUAN is targeting c.10-15% expansion. 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 CY18-19 USD/MYR forex to RM3.90 (from RM4.10). In tandem with weaker USD/MYR exchange rates of late, we are lowering our CY18 USD/MYR forex to RM3.90 (from RM4.10) in line with our in-house estimates. As most plastic packagers are net beneficiaries of a stronger USD, our forex assumptions prompted us to lower our earnings estimates by 4-3% on average in FY18-19 for SLP, TOMYPAK and TGUAN. We have previously lowered our USD/MYR forex for SCIENTX and SCGM in the recent results season.

Resin cost volatile in the near term, but there is a possibility it could trend downwards in CY18. CY17 saw higher resin cost due to demand and supply factors, with prices increasing by up to 20-30% (YoY) for plastic packagers under our coverage as most of them suffered resin cost spike in 1H17. As a result, most plastic packagers under our coverage saw weaker earnings from margin compressions this year. However, there is a possibility that resin prices could trend downwards going forward on ample supply of resin due to excess capacity from China and India, and US shale-based resin in CY18, which could be a rerating catalyst for the sector. Resin prices for plastic packagers under our coverage are currently range-bound between USD1,100-1,300/kg, in line with our CY18 estimates, but we believe it may trend downwards slightly in 2H18 on increased supply. We opt to be conservative and maintain our resin cost assumptions for now. However, 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 re-rating catalyst for the sector; assuming a 2% decline in resin prices, this could increase plastic packagers’ earnings under our coverage by 6-8%.

Source: Kenanga Research - 6 Apr 2018