Maintain NEUTRAL. 2QCY20 results were better than expected, with four packagers coming above expectations on better-than-expected margins from new premium products and low resin cost, and one within (TGUAN). YTD, SCGM, was the top performer (+90% YTD), followed by TGUAN (+47%) and TOMYPAK (+37%) on strong earnings. Raw material prices are currently on the uptrend at USD900-1,000/MT while our estimates are slightly more conservative at USD950-1,100/MT given the recent rise. All in, 3QCY20 may see better topline as packagers are focussed on the right segments namely F&B and PPE products, but margins may be marginally lower QoQ (c.2-3ppt) due to rising raw material costs and competition within the sector, cushioned by increased sale of premium products. Maintain NEUTRAL as we see a balanced risk-reward profile for the sector. We stay conservative with our applied valuation multiples for plastic packagers, i.e. at +0.5SD to -1.0SD to the 5-year historical average, due to ongoing concerns on Covid-19. Our preferred sector picks are SCGM (OP; RM:3.85) and TGUAN (OP; RM:5.65) while our least preferred pick is TOMYPAK (UP; TP: RM0.415).

Better than expected. Plastic packagers’ results came in better than expected with four coming in above and one within (TGUAN). YoY-Ytd, topline was up by 8.2% for the sector while CNP was up by 40% on better margins as plastic packagers quickly bounced back post MCO and were able to capture higher margins from better premium products whilst aided by low resin cost. CNP was up for all packagers save for SLP, which was weighed down by lower top-line during the period. All in, we increased TP and call for most plastic packagers by 40-90% on better-than-expected earnings and rerating in valuations.

SCGM the top gainer, up 90% YTD on solid results and significant margin improvements as they ventured into the face mask business on the back of its resilient F&B segment. This is followed by TGUAN, which was up by 47% YTD on positive sales of its stretch film, courier bags as well as margin improvements, and TOMYPAK (+37%) as its results returned to the black beating our expectations due to lower overheads and cost control efforts. These companies surpassed their peers’ performance as they were able to shine during the tough months of Covid-19 lockdowns with SCGM capturing strong margins from a new product line suited for the pandemic (face shield and face mask) while TGUAN recorded above-average margins and stable sales momentum. SLP declined YTD by 26% due to weaker YoY and QoQ results.

Packagers are focussed on the right segments during the pandemic, namely the F&B segment, industrial segment (courier bags) as well as venturing into sales of PPE products (face masks). As such, we expect sales momentum to be resilient QoQ. Furthermore, plastic packagers have resumed to normal business operations since the MCO eased in May-20 with capacity utilisation back to pre-MCO levels of 70-80% vs. 50-60% in March-April).

3QCY20 may see better top-line but margins may be marginally lower QoQ due to rising raw material cost. Resin prices have moved up c. 17-27% QoQ and currently range bound between USD900-1,000/MT. That said, this is still slightly below our assumptions of USD950-1,100/MT. As such, margins may see slight decline QoQ on higher resin cost but cushioned by sales of higher margin products as most plastic packagers under our coverage are focussing on improving their product mix.

Maintain NEUTRAL as we believe share prices are reflecting a fair balance between strong expected earnings growth and margin pressures ahead from higher resin cost as well as potential risks from a second Covid-19 wave. We stay conservative with our applied valuation multiples for plastic packagers, i.e. at +0.5SD to -1.0SD to the 5- year historical average, due to ongoing concerns on Covid-19. We think SCGM and TGUAN warrant better valuations of +0.5SD as we see their earnings staying relatively more resilient given their exposure to PPE and F&B. Additionally, following the recent dip in share prices for SCGM (-13% since end Sept 20) and SLP (-24% since end Aug 20), we upgraded their ratings to OP from MP on an unchanged share price.

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

Source: Kenanga Research - 7 Oct 2020