Maintain NEUTRAL. While healthy top-line growth is expected to continue, a rising cost environment from raw material cost pressures, variability of favourable product mix and higher operating expenses are a bane to the sector. Average resin prices are currently in a range-bound mode and fluctuating between USD1,000/MT and 1,200/MT. However, we have factored in a more conservative resin cost estimate of USD1,200-1,400/MT given resin price volatility. The latest quarterly results season saw the sector continue to underperform the broader market with the top decliner being SCGM (-22.0% YTD). Bucking the trend though was top gainer TGUAN (+14.5% YTD) reporting improved operating margin and earnings. All in, we made no changes to our TPs and calls as we are comfortable with our valuations and earnings estimates given that we have priced in most of the foreseeable risk during the recent results season. Sector upsides are limited by the lack of re-rating catalyst and the margin-crimping high-cost environment.

Mix 1QCY19 results. Plastic packagers’ results were mixed with 2 below, and 3 within. The quarter saw fewer surprises vs. 4QCY18 when only 2 came within. TOMYPAK and SCGM came below due to weaker top-line and higher-than-expected raw material costs. Meanwhile, SCIENTX, SLP, and TGUAN were within expectations. YoY-Ytd, TGUAN is the only stock that recorded bottom-line growth (+55%) due to better operating margin. SCGM, SCIENTX, SLP, and TOMYPAK saw declines ranging 0.2% to 88% attributable to a variety of reasons such as higher raw material cost and finance cost, less favourable product mix, and higher effective tax rate. QoQ, SCIENTX saw CNP growth of 40% mainly due to its property segment. SLP and TGUAN saw its CNP declined by 31% and 22% respectively due to reasons such as weaker top-line, higher tax-rate and weaker USD that translated to lower selling price. TOMYPAK widened its losses due to lower recognition of tax income while SCGM recorded losses on lower sales and higher operating expenses.

Results weighed on share price performance. Plastic packagers’ share price movements in 1HCY19 were mixed with SLP (+7.8%) and TGUAN (+14.5%) being the top gainers under our coverage as results met expectations. Meanwhile, SCIENTX (-1.7%), TOMYPAK (-12.3%) and SCGM (-22.0%) declined Ytd as recent results missed expectations on the back of compressed margins and volatile earnings. While the broader market has shown strong recovery (FBMSC +14.4% Ytd), the plastic packaging sector has yet to reciprocate and continues to underperform due to these concerns. We believe the sector requires strong earnings growth and consistent margins in subsequent quarters to see a recovery in share price performance. Note: Our strategy cut-off date was on 21 June 2019.

Focused on ramping up utilisation. Plastics packagers have been focusing on capacity expansion over the past three years and aims to ramp up utilisation to drive sales. For now, we expect SLP to gradually increase annual capacity by 58% by FY21. SCIENTX will continue focusing on ramping utilisation, targeting 75% over the next few years while TOMYPAK is also set on improving utilisation to c.67% by FY21. SCGM is working hard to increase capacity utilisation from current levels of c.50%. Meanwhile, TGUAN will continue to invest in R&D to improve sales and margins for existing products (i.e. Stretch Films).

Source: Kenanga Research - 4 Jul 2019