Maintain UNDERWEIGHT. 2Q18 results were mostly below expectations, save for SLP and TGUAN, which came in within. This was due to lower sales, higher raw material cost, lowerthan-expected utilisation rates, and less-than-favourable product mix. YTD, packagers’ share prices declined by 30-47%, outpacing the FBMSC (-17% YTD) mainly due to consistently weak earnings for most plastic packagers, save for SLP, as well as a sector de-rating in tandem with FBMSC. Going forward, we are optimistic on top-line growth as capacity expansion plans come to fruition, but we caution that the high cost environment is taking a toll on margins and earnings. We believe we have accounted for more foreseeable earnings risks and maintain our resin cost estimates of USD1,200-1,400/MT which is close to current prices of USD1,100-1,300/MT. All in, we maintain our valuation for most of our plastic packagers on unchanged TPs and calls, save for SLP which we upgrade to OP (from MP) as valuations appear more compelling at current levels of 16x Forward PER vs. 2-year historical average of 27x PER, and peers’ PER range of 13-52x PER, backed by confidence from consistent margins and earnings deliveries.

2QCY18 results came below expectations. Plastic packagers’ 2Q18 results report cards saw three coming below while the two were within expectations. The weaker-than-expected results stemmed from lower sales, higher raw material cost, lower-than-expected utilization rates, and less-than-favourable product mix. SCIENTX missed due to lower income recognition from the property segment. YoYYtd, better sales volumes led to improved YoY top-line growth of 4-16%, except for TOMYPAK and SLP, which saw declines due to lower volume. QoQ, earnings was unexciting for most save SLP (+29%) and TGUAN (+13%) which came off a lower base in 1Q18, while SCIENTX and SCGM’s CNPs declined by 10% and 114%, respectively, on lower sales and income recognitions from the property segment. All in, during the results seasons, we lowered earnings and TPs for SCIENTX, SCGM and TOMYPAK on weaker results, while we upgraded our TPs for SLP and TGUAN on better valuations and post rolling valuation base forward to FY19.

Share prices declined in light of weak results, ranging from -30% to -47% YTD, outpacing the FBM Small Cap Index’s decline (-17% YTD). We reckon the weak share price performance from plastic packagers was mainly due to consistently weak earnings, save for SLP, and the sector declined in tandem with the FBMSC de-rating earlier this year. We believe SLP’s selldown is unwarranted as it is one of the top decliners YTD (-41%) among packagers under our coverage (save for SCGM), despite earnings consistently meeting expectations over the past three quarters, unlike its peers. SCGM was the top decliner YTD at 47%, likely due to results falling into the red for the first time in the recent 4Q18 results. All in, packagers’ share prices declined by 30-47% (save for SCIENTX at +1%) mostly due to similar reasons mentioned above (refer to Table 1).

Capacity expansion likely to drive higher top-line. Capacity expansion across the sector is expected to deliver higher top-line growth progressively over the longer run, assisted by continuous demand for niche plastic products (i.e. FMCG or healthcare segment), and increased use of stretch film driven by Industry 4.0. TOMYPAK is expected to increase capacity by 44% in FY20- 21, SLP by 58% in FY19, while TGUAN will commission an additional stretch film production line in 4Q18, and SCGM to boost capacity by 65% with the commission of its new Kulai factory by end of CY18. SCIENTX is not undergoing any capacity expansion in the near term as they continue to aim on ramping up utilisation rates.

Higher costs continue to weigh down margins. Despite expectation of higher revenue from capacity expansion, margin compression remains a concern among the packagers. Volatile raw material prices (+c.9% YoY) and the variability of a lower margin product mix, coupled with higher cost incurred during the fit-out stages from on-going capacity expansion, have caused margins to decline in recent quarters. Resin prices are staying range-bound between USD1,100 to 1,300/MT. Based on the resin price chart below (refer to Table 2), we noted that resin prices have been decreasing YTD (-c.3% YTD), close our current estimates of USD1,200-1,400/MT and may signal a possibly better QoQ performance moving forward. Margin-wise, upstream consumer plastic packager SLP was the strongest at 15% EBIT margins, while SCGM’s was eroded to 3% EBIT margins (from 13% YoY, in 4Q17), and downstream consumer packager, TOMYPAK, saw margins wiped out as it sunk into the red (vs. 9.3% EBIT margins YoY, in 2Q17). Meanwhile, industrial packager, SCIENTEX’s EBIT margin was flattish at 7%, but TGUAN experienced margin compression to 5% EBIT margins (from 8% YoY in 2Q17). All in, we are weary of the rising cost environment for plastic packagers under our coverage.

Maintain UNDERWEIGHT as valuations are mostly trading at -0.5 to -2.0SD (based on the 4-year average) since 2014 when the sector began to gain prominence on positive macro fundamentals. We will continue to monitor cost factors in upcoming quarters which had previously caused weak earnings, while we believe we have priced in most foreseeable earnings risk. Maintain all calls and TPs, save for SLP which we upgrade to OP (from MP). We like SLP at current levels for its attractive valuations of 16x Forward PER vs. 2-year historical average of 27x PER, and peers’ PER range of 13-52x (except for TOMYPAK) as results have been trending upwards while SLP’s margins have held up well compared to its peers. We are comfortable with our sector call due to lacking re-rating catalysts and the margin-crimping high cost environment. However, we may look to up our valuations upon more consistent earnings deliveries and favourable macro fundamentals for the sector.

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

Source: Kenanga Research - 5 Oct 2018