Recent quarters have been disappointing with results missing expectation four quarters in a row, largely due to margin compressions. 1Q18 results have shown a reprieve, but TOMYPAK may not be out of the woods just yet. We may revise up our earnings and valuations upon concrete margin improvements. Maintain earnings. UNDERPERFORM on an unchanged TP of RM0.510.

Tough four quarters. 1Q18 results came below our and consensus expectations at 7% and 6% respectively, with CNP declining by 84% YoY to RM1.1m. The last four quarters (2Q17 to 1Q18) came in below expectations, mostly on higher-than-expected cost, compressing margins, with 4Q17 making all-time low with losses of RM4.4m (*as per FY17 Bursa announcement dated 27th Feb 2018). Although there was a reprieve since 4Q17’s low earnings, TOMYPAK may not be out of the woods just yet.

Expecting weaker margins going forward. 1Q18 CNP margin was at 2.1%, which is a far cry from FY17A CNP margins of 5.7%, FY16A at 9.0% and FY15A at 10.8%. The margin compressions began mainly from 2Q17 onwards on higher raw material cost and factory overheads. Notably, TOMYPAK plans to increase capacity up to 36,000MT by FY20- 21 and incurring additional costs while also grappling with higher raw material cost environment likely brought about by higher resin and printing ink costs.

Capacity expansion plans on track. We expect capacity to increase gradually up to 36,000MT p.a. by FY20-21 (from c.25,000MT p.a. in FY17A) upon completion of a new plant in Senai. Phase 1 of the capacity expansion will come on-stream from 2H17 to 1H18, while Phase 2 and 3 will see capacity growing gradually from FY20 onwards. As such, we are expecting capex of RM40-30m in FY18-19.

Maintain FY18-19E CNP of RM9.3-13.1m for now. Post the recent results, we had cut earnings by 41-35% for FY18-19. Considering the higher costs in recent quarters, we are expecting FY18-19E CNP margins of 3.6-4.1%, which is lower than FY17A. We are comfortable with our margin assumptions for now, but may consider revising up our earnings should there be better cost management and margin improvements in coming quarters. We maintain our effective tax rate assumptions of 13-20% for FY18-19 on expectations of tax incentives from capacity expansion plans. FY18-19E NDPS of 1.2-1.6 sen implies 1.5-2.0% yield.

Maintain UNDERPERFORM and TP of RM0.510. Our TP is based on 1.0x PBV on FY19E FD BVPS of 0.51x (-2.0SD to the 5-year average) as stable earnings and profitability remain uncertain. Note that we recently switched our valuation method to PBV (from PER) due to earnings volatility in light of persistent missed earnings expectations over four quarters. Our valuations are based on FY19 as we believe this better encapsulates TOMYPAK’s value once the bulk of Phase 1 expansion is completed. We believe valuations are stretched warranting an UNDERPERFORM call as we have priced in most positives, including TOMYPAK’s bullish expansion plans of +44% up to FY20-21, as well as accounting for weakness from margin compressions, while the near-term outlook for earnings stability remains challenging. As such, we opt to be conservative with our valuations, but may upgrade our earnings and valuations upon more concrete margin improvements.

Risks to our call include; (i) lower-than-expected resin cost, (ii) better product demand, (iii) stronger-than-expected product margins, and (iv) foreign currency risk from a strengthening Ringgit.

Source: Kenanga Research - 8 Jun 2018