Maintain UNDERWEIGHT. 1Q18 results were mostly below expectations, save for SLP, which came in within. This was due to high raw material cost, lower-than-expected utilisation rates, and less-than-favourable product mix. YTD, packagers saw declines of 17-53%, outpacing the FBMSC (-16% YTD), mostly due to the de-rating of the FBMSC YTD as well as weak earnings for plastic packagers. Going forward, we understand that most capacity expansion plans are on track. However, we are cautious and will continue to monitor the high cost environment brought about by higher resin and start-up cost, but we believe that most foreseeable cost pressures have been priced in for now. Our resin cost estimates of USD1,200-1,400/kg are conservative and in line with current levels. All in, we lower our PER valuations for plastic packagers by 7-17% due to weak earnings and YTD sector de-rating, implying -0.5 to -1.0 SD below the 4-year Fwd. average. As a result, we lower our TPs by 7-23%, while TOMYPAK and SCGM are unchanged based on -2.0SD PBV due to earnings volatility. Maintain all calls, save for SCIENTX which we downgrade to UP (from MP). Our Top Pick is SLP (OP; TP: RM1.00) on attractive valuations of 13x PER vs. 2-year historical average of 27x PER (and vs. peers’ PER of 12-49x) as results have met expectations and after pricing in foreseeable downsides

1QCY18 results were mostly below expectations. Plastic packagers’ 1Q18 results were mostly below expectations, save for SLP, which was within. This was weaker than 4Q17 results season with 3 coming in below, and 2 within. The weaker-than-expected results were due to various reasons, including higher raw material cost, higher start-up cost, lower-than-expected utilisation rates, and lessthan-favourable product mix. YoY-Ytd, better sales volumes led to improved YoY top-line growth of 6-26%, save for TOMPAK and SLP, which were marginally negative due to lower volume. However, margin compressions from higher cost resulted in negative bottom-line for TGUAN, SCGM and TOMYPAK. Upstream consumer plastic packagers SLP and SCGM maintained strong EBIT margins of 12-13% on sales of higher-margin products, but downstream consumer packager TOMYPAK saw margins eroding to 3% (vs. 13% in 1Q18). Industrial packager SCIENTEX’s EBIT margin was flattish at 7%, but TGUAN experienced margin compressions to 4% (from 8% in 1Q18). QoQ, earnings were unexciting for most save for SLP (+8%). TOMYPAK and TGUAN’s CNPs are recovering slowly from record low quarters in 4Q17, while SCIENTX and SCGM’s CNPs declined by 6-7% on higher cost and lower utilisation. During the results season, we lowered earnings for all plastic packagers on weaker margins, save for SLP. We also downgraded our applied PERs in light of weaker margins and switched our valuation for TOMYPAK as well as SCGM (in the latest 1Q18 results announced on 22nd June 2018) to PBV due to earnings volatility. All in, we lowered all our TPs by 8-34%, save for SLP. We also downgraded our call for TGUAN on weak earnings, but upgraded SLP to OP (from MP) in light of the steepest YTD sell-down vs. peers, despite results meeting expectations.

Plastic packagers’ share prices declined by 17-53% YTD, outpacing the FBM Small Cap Index declines (-16% YTD). We believe the strong sell-down of plastic packagers was due to: (i) sector decline, which was in tandem with the FBMSC de-rating earlier this year, as well as, (ii) the added impact of weak earnings from most plastic packagers, save for SLP. SLP is the top decliner YTD which we believe is unwarranted as earnings have met expectations over the past two quarters, unlike its peers which were mostly below. Other packagers’ share prices declined by 17-39% mostly due to similar reasons mentioned above.

Expansion plans on track... We expect growth to be driven by demand for niche plastic products, and stretch film through Industry 4.0. Most plastic packagers under our coverage are continuously targeting new markets such as China, United States, Canada and Africa, and are working on more niche products (i.e. FMCG or healthcare segment) to improve margins. We expect capacity expansion across the sector to drive top-line growth in the longer-run, assisted by continuous demand for niche plastic products. TOMYPAK is increasing capacity by 44% by FY20-21, SLP by 58% in FY19, TGUAN by c.10% p.a., SCIENTX by 44% in FY18, and SCGM by 65% by FY20. Near-term growth, if any, will be boosted by margin expansions, 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.

… but cost pressures are still a concern. Notably, strengthening raw material prices have caused margin compressions in recent quarters. CY17 saw higher resin cost due to demand and supply factors while the trend appears to have affected recent 1Q18 results as well. Resin prices are currently range bound between USD1,200-1,400/kg, but we believe there is an inclination for it to trend downwards in CY18 on increased supply. Meanwhile, plastic packagers may also see margin compressions from higher cost incurred during fit-out stages from ongoing capacity expansion. We maintain our resin cost assumptions as we opt to be conservative for now. However, we may look to lower resin cost assumptions going forward, pending further clarity of the effects of additional resin supply from China, India, and US shale-based resin on prices. Down-trending resin prices 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%.

Maintain UNDERWEIGHT as we believe valuation is mostly trading at -0.5 to -1.0SD (based on the 4-year average) since 2014 when the sector began to gain prominence on positive macro fundamentals), save for TOMYPAK at +1.0SD. We will continue to monitor cost pressures in upcoming quarters which had previously resulted in weak earnings, while we believe we have priced in most foreseeable earnings risk. That said, we are selective on SLP due to its attractive valuations at current levels. Post lowering our PERs by 7-17%, we have lowered our TP for; (i) SLP by 23% (lowered recently in our Company Update dated 29th June 2018), (ii) TGUAN by 18%, and SCIENTX by 7%, while TOMYPAK and SCGM are maintained being based on trough PBV valuations (refer to Valuations table). We maintain most of our calls, save for SCIENTX which we downgrade to UP (from MP) upon lowering our TP. We are comfortable with our valuations for now, but may look to up our call and valuation upon more consistent earnings deliveries and favourable macro fundamentals for the sector.

SLP (TP; RM1.00) Top Pick due to attractive valuations post pricing in foreseeable downsides. SLP suffered the steepest sell-down among peers YTD (-53%) vs. peers of 17-39%, despite results meeting estimates unlike its peers. Going forward, we expect better quarterly earnings as SLP recently commissioned a new blown film line in April 2018. All in, we expect capacity to increase to 32-38k MT in FY18-19 (+58% by FY19) on the back of conservative capacity utilisation rates of 65-60% (vs. 75% currently). Additionally, post pricing in conservative resin cost assumptions of USD1,350/MT in FY18-19 (vs. the Group’s blended average of c. USD1,300/MT in 2018), we recently lowered earnings by 17-22% to RM22-23m CNP for FY18-19E. However, there is still deep value in SLP, which is commanding 20% total returns on our TP of RM1.00, based on an applied PER of 15.0x (-0.5SD on 4 year historical average) vs. peers’ applied PER of 9-14x. We like SLP and believe our PER is justified due to SLP’s better margins (12% EBIT) vs. plastic packagers under our coverage of 5-8%, and the strongest CNP growth rate of 13% (2-year average) vs. plastic packagers under our coverage of -9% to +10%. Even so, at current levels, SLP is trading at 13x forward PER vs. 2-year historical average of 27x PER (vs. peers PER of 12-49x).

Risks; (i) higher-than-expected demand for plastic products, especially from importing countries, (ii) lower-than-expected resin prices, and (iii) a sector re-rating due to weaker valuations from unfavourable macroeconomic situation.

Source: Kenanga Research - 6 Jul 2018