1Q18 core earnings of RM9.1m came in below our expectation (17%) on higher-than-expected cost. No dividend, as expected. Lower FY18-19E CNP by 27-30% to RM38-39m on margin compressions. Downgrade to UNDERPERFORM (from OP) on a lower TP of RM2.25 (from RM3.20) based on a lower FY18E FD EPS of 20.8 sen and lower Target PER of 10.8x.

1Q18 core net profit (CNP) of RM9.1m came in below our expectation at 17% hit. This is the second consecutive quarter which TGUAN has missed expectation. Similar to 4Q17, top-line was well within our expectation at 26%, but bottom-line missed due to higher cost attributable to lower gross profit margins for certain plastic products, higher freight cost, distribution and administrative expenses, staff cost and losses for the F&B segment, dragging 1Q18 CNP margin to 4.2% (vs. 7.4% in 1Q17, and 1.8% in 4Q17). No consensus available. No dividend, as expected.

Results Highlights. YoY-Ytd, TGUAN?s top-line was up by 8% driven by growth from its plastic segment (+8%) as well as the F&B segment (+11%). However, EBIT margin declined by 3.8ppt on higher cost from product gross margins, higher operating expenses from freight and staff cost and losses from the F&B segment. This dragged down CNP by 39%. QoQ, top-line improved by 2% on increased sales volume of plastic products. EBIT margins improved by 4.1ppt on lower cost for the plastic segment while the F&B segment managed to narrow its losses. All in, CNP increased by 139%.

Outlook. TGUAN has plans for a PVC food wrap line and stretch film line from which we expect earnings to accrete mostly in FY18; while we are estimating capacity to grow by 5% in FY19. TGUAN is consistently investing in R&D to improve sales and margins on existing products (i.e. stretch film) and continues to revamp its customer base to target more MNCs. The Group is focusing on continued expansion into high- margin production lines to sustain the plastic segment?s margins going forward.

We lower FY18-19E CNP by 27-30% to RM38-39m. In light of higher cost, we are slashing FY18-19E CNP margins to 4.6-4.6% (from 6.3- 6.5%), closer to current level of 4.5% on higher operating cost. We may look to revise up our earnings upon better cost management and margin improvements in coming quarters.

Downgrade to UNDERPERFORM (from OP), on a lower TP of RM2.25 (from RM3.20). We lower our FY18E FD EPS to 20.8 sen (from 28.5 sen) upon lowering earnings and on a lower Target PER to 10.8x (from 11.2x) which is -0.5SD below its 5-year average, on weaker margins. We believe our call is warranted as we are more cautious on earnings going forward in light of two consecutively weak quarters signalling cost pressures. As such, we opt to be prudent with our estimates, but may look to upgrade earnings and valuations upon margin improvements.

Risks to our call include; (i) volatile plastic resin prices, (ii) foreign currencies fluctuations, (iii) higher-than-expected contribution from its China-based subsidiaries, and (iv) higher-than-expected margin.

Source: Kenanga Research - 25 May 2018