We attended SCGM’s analyst briefing and came away feeling concerned of the Groups constant issues with escalating cost, causing EBIT to decline (-81% YoY), while topline has not been able to grow at a faster pace. However, post moving to the new factory in end FY19, we expect transition cost to be minimised and SCGM can focus on ramping up utilisation rates. Maintain FY20-21E CNP. Maintain UP on TP of RM0.805.

A worrying pre-existing cost situation. We came away from SCGM’s briefing feeling concerned of its high-cost situation, which continues to linger. To recap, SCGM’s FY19 results recorded a CNL of RM4.4m (missing our expectations of RM2.2m profit in FY19). Top-line was within expectations (at 97%), but EBIT margins of 1.8% were weaker than our expectations of 3.3% due to higher-than-expected cost incurred from increased raw material cost and factory transition cost (EBIT declined 81% YoY). Given that the largest cost component is raw material cost, which has been increasing for SCGM (est. +9% YoY) compared to a slower topline growth rate of 6% YoY, we believe cost issue will remain a major concern until we see a consistent trend of declining raw material prices.

Focusing on increasing utilisation for now. SCGM has officially moved into the new factory in end FY19, with a total capacity of 67.6k MT/year running on a utilisation rate of c.45%. As such, SCGM’s main target going forward would be to focus on ramping up utilisation rates over FY19-20E. We reckon that the breakeven utilisation rate would be at c.50% while we are expecting modest utilisation rates of 51-55% in FY19-20E for now. However, we may look to increase utilisation rates further upon updates of strong improvement to utilisation rates and demand growth. The ideal utilisation rate would be at 75%, which could imply a bottom-line of RM40m assuming more normalized EBIT margins of c.15%. However, we believe this may take time to materialise as the Group would have to grow sales aggressively both locally and internationally amidst its rising raw material cost environment.

FY20-21E likely to see dividends despite being a challenging year. We believe the Group will continue to pay out dividends as it has managed to pay out 1.5 sen in FY19 (1.8% yield at current levels) despite it being a loss-making year due to its decent cash pile. Note that this is also above SCGM’s dividend policy of 40% of net profit to shareholders. As such, going forward, we are confident that SCGM would be able payout 1.0 sen each in FY20-21E (implying a 177-61% payout ratio in FY20-21E).

Maintain FY20-21E CNP of RM1.4-4.2m on operating margin assumptions of 3.0-4.6% (vs.1.8% in FY19A) as we believe transition cost will not be an issue going forward, but we are still concerned on the Group’s raw material cost and may look to lower margins further if raw material continues to escalate for SCGM. FY20-21E dividends imply 1.2-1.2% yield.

Maintain UNDERPERFORM with a Target Price of RM0.805. Our TP is based on an unchanged ascribed PBV of 0.9x and FY20E BVPS of RM0.91. Our ascribed PBV multiple is based on -2.0SD to its 4-year historical average Fwd. PBV as margins and cost remain under pressure. However, we will continue to monitor its earnings trends and may look to upgrade our valuations upon convincing margin recovery.

Risks to our call include; (i) lower-than-expected resin cost, (ii) higher product demand from overseas market, and (iii) stronger foreign currency from weakening Ringgit.

Source: Kenanga Research - 1 Jul 2019