Maintain NEUTRAL. 4QCY19 results were a mixed bag with three coming in within, one below (SLP) and one above (TOMYPAK as results were not as bad as expected despite being loss-making). However, recent turn of events (i.e. Covid-19 and drop in oil prices) in 1QCY20 has led to a grim outlook for the economy and sector as a whole. YTD, plastic packagers have recorded steep share price declines (-28-45% YTD, in tandem with the FBMSC at -37%). Furthermore, we are of the view that lower oil prices may not be all that great for the sector as we are of the view that it may put downward pressure on average selling prices given the Covid-19 climate. All in, we expect group margins to hold but are concerned over top-line erosion from both selling prices as well as sales volume due to the MCO as the manufacturing and supply chains will continue to be disrupted if the Covid-19 situation prolongs. All in, earnings have been trimmed by 20-31% (save for TOMYPAK down 89% and SCGM unchanged since recent upgrade on 31st March 20). NEUTRAL on plastics given the sharp sell-downs YTD, and on lower valuations to -1.5SD to -2.0SD (from average to -2.0SD). As a result, our TPs are lowered by 9-48% (save for SCGM). We will continue to monitor the situation in coming months and we do not discount further downsides should the situation worsen in FY20. .Our preferred pick is SCGM (MP; TP: RM1.40) as they have a product to compensate the shortfall in earnings during the Covid-19 period.

Mixed results. Plastic packagers’ results were mixed with three coming in within, one below (SLP) and one above (TOMYPAK as its results were not as bad as expected despite being loss-making). This was slightly worse than the previous quarter when 3 came in above. YoY, SCIENTX was the only packager under our coverage that saw top-line growth at 23%, while others saw top-line declines on waning demand and as customers adopt a wait-andsee approach amidst the global uncertainties and falling raw material prices. However, due to better product mix and lower tax rates, bottom-line was up for all packagers, save for SLP (-17%) which was weighed down by lower demand, while TOMYPAK continued to be loss making.

All packagers down, in tandem with the FBMSC. Due to Covid-19’’s impact on equity markets and the economy, all plastic packagers under our coverage were down, by 28-45% YTD, in tandem with the FBMSC at -37%. SCGM saw the steepest decline at 45%, likely due to the fact that SCGM is more focused on the local consumer market which has been impacted by the Movement Control Order (MCO) since 18th March 2020. Meanwhile, SCIENTX had the lowest decline YTD (-28%) likely due to its economies of scale as a market leader and product diversification of industrial as well as consumer goods.

Declining resin price environment may not be all that great. Oil prices have plunged recently to USD27/barrel (- 59% YTD), while resin prices have not seen a sharp dip as yet, declining only by 4-7% YTD. However, we believe this may put additional downward pressure on resin prices going forward which are currently hovering at USD790- 900/MT p.a. which is slightly lower than our full-year estimates of USD850-1,000/MT p.a. In most circumstances, lower raw material prices may appear to be favourable to a particular sector. However, considering that resin is a publicly traded commodity and given the extremely challenging Covid-19 environment where some plastic packagers’ clients are adopting a wait-and-see approach or are halting operations for the time being, we are of the view that plastic packagers may come under pressure to lower prices in order to remain competitive, negating the benefits of lower raw material prices. As such, we believe plastic packagers may be able to maintain current margins in this climate but we are extremely concerned of top-line erosion's.

Highly frosty earnings outlook. In terms of earnings, undoubtedly Covid-19 has taken a toll on plastic packagers. Since the MCO which came into effect on 18th March 2020 and extended till 14th April (for now), most plastic packagers under our coverage are operating, but at sub-par capacity (of c.40-60% currently) vs. 60-70% previously. All in, we expect top-lines to decline by 2-3% assuming a one-month MCO. As a result of lower resin prices, we believe plastic packagers may be able to maintain current margins but due to the declining top-line from potentially lower selling prices, and lower volume from dire market conditions, we expect an erosion of top-line by 12-15% for plastic packagers under our coverage. This is premised on our assumption that FY20 may experience 3 months of MCO for now given the gravity of the situation and to be conservative with our estimates as there is no definitive cure for Covid-19 yet. As a result, plastic packagers’ earnings estimates have been trimmed by 20-31%, save for TOMYPAK by 89% for FY20 on widening losses and a low base, while SCGM was recently upgraded (31st March 2020 during the 3QFY20 results review), earnings forecasts by 44-37% for FY20-21 on better margins in the near term given a better product mix and inclusion of face-shield products for medical personnel since Feb 2020.

Maintain NEUTRAL. In the near term, we believe the sector warrants a NEUTRAL call. We have lowered our stocks’ valuations to -1.0SD to -2.0SD to the 5-year PER or PBV averages for now (from average to -1.0SD, save for TOMYPAK), as most manufacturing and supply chains will continue to be disrupted as the Covid-19 situation prolongs. For now, we are comfortable with our TP’s which reflect: (i) a base-level earnings downside, and (ii) the lower-end of valuation multiples for FY20. Additionally, we will continue to monitor the situation in coming months as our current assumptions reflect only a 3 months disruption in FY20 (our current base case scenario), and we do not discount the possibility of further downsides should the situation worsen in coming months. On the bright side, we believe this sector will be quick to bounce back to pre-virus valuations soon as this Covid-19 kerfuffle is over.

Source: Kenanga Research - 3 Apr 2020