Kenanga Research & Investment

ESG - The Circular Economy’s Implications on Plastic Sector

Publish date: Mon, 25 Oct 2021, 10:30 AM

The recent 12th Malaysia Plan (MP) prioritised advancing sustainability, and highlighted Embracing the Circular Economy as one the game changers. Some stick-based measures introduced like the Extended Producer Responsibility (EPR) would incur cost on the part of the producer, while discouraging use of single-use plastics at eateries and public events would affect local demand, when implemented. That said, channel checks suggest that there may be opportunities for income generation for producers with the EPR if well executed. Positive measures from the 12th MP include the green-related incentive schemes (GTFS, GITA and GITE) could foster environmental solutions within the sector. The beneficiary of the whole transition to the circular economy are local waste recycling companies (such as TEXCYCL; NR). Plastic packagers can also benefit from the transition, with most already having biodegradable or degradable products, but demand for such products is not overly significant, likely due to the pricing factor (which can be up to 3-5x more expensive) and lack of policy-driven enforcement. A better approach adopted by most listed packagers is by switching to mono-layer plastic products for easier recyclability, while some are beginning to utilise recyclable materials in their production. All in, we have applied a 5-9% ESG discount for packagers under our coverage to impute our Kenanga ESG scoring and Collected For Recycling (CFR) rates. Maintain NEUTRAL on the sector while our Preferred Pick is SCGM (OP; TP: RM2.97) for its above sector average material disclosures and high CFR rates for its raw material.

The recent 12th Malaysia Plan (announced on 27th September 2021) prioritised advancing sustainability, with one of the game changers being Embracing the Circular Economy. The circular economy is needed to extend the lifecycle of a product, particularly one as damaging to the environment as single-use products, which involves refurbishing, repairing, reusing, and recycling a product for as long as possible.

Sales turnover for the plastics sector increased by 2.3% to RM48.5b in CY20 (from RM47.4b in CY19), charting positive growth in spite of the Covid-19 pandemic, based on data from the Department of Statistics. As the plastic packaging sector is a significant contributor to the local economy, it stands to reason that priority and urgency should be given through policy to aid the transition from a linear economy to plastic circularity.

Circular Economy model is the best option for now. A recent study by The Pew Charitable Trusts and SYSTEMIQ in the United States suggests that a recycling model or collect and dispose alone is not sufficient to treat the plastic problem. This does not account for the devastation of GHG emissions every time virgin plastics are produced. Considering that the Malaysian government has plans to discuss the viability of carbon pricing (i.e. carbon taxes and the Emission Trading Scheme), the recommendation for the best carbon taxation system as mentioned in the 12th Malaysia plan would eventually increase the cost of virgin production due to higher emissions.

The Plan for Plastics

On a macro level affecting the plastic sector, the 12th MP aims to: (i) reduce GHG emissions intensity to GDP up to 45% by 2030 based on emissions intensity in 2005, (ii) encourage businesses to develop the circular economy and the sharing economy models, and (iii) enhance policies, regulations, green financing and economic instruments. Some of the sector specific measures mentioned are highlighted in the table below.

State of Affairs of Malaysian Plastic Packagers

Local listed plastic players under our coverage are in the transition phase and the process of developing environmental solutions such bio-degradable plastics, or mono layer plastics for easier recyclability. On top of that, plastic packagers, through product innovation and regular R&D, are constantly pushing to create thinner and more sustainable stretch film variants which utilises less raw material that are cheaper to produce.

SLP, TGUAN and SCGM have their own versions of biodegradable or degradable products on top of their transition to more recyclable plastics. However, demand for biodegradable products is not overwhelming or significant at this juncture, making up c.5-6% of company earnings. The lack of demand is largely attributable to the high costs which in some cases are 3-5x higher than normal plastic products, (in part attributable to the polylactic acid (PLA) component required) or the absence of policy and implementation on a national scale to enforce environmentally friendlier alternatives. Additionally, degradable products may not be the best solution as it may have other ramifications such as creating microplastics that are harmful to the environment.

SCIENTX (through DAIBOCI) and TOMYPAK produce flexible packaging. Their clientele includes large MNCs such as Nestle, which is shifting to 100% recyclable and reusable packaging by 2025. This in turn has already pushed local plastic packagers to come up with alternatives such environmentally friendly packaging that can be reused and recycled moving towards a more circular economy. This bold step by large MNCs is a clear sign of credible demand for green plastic packagers due to ongoing public pressure on large MNCs which are the main clienteles for single-use plastic.

Potential in Waste Recycling Sector

Trash to cash. A study conducted by World Bank Group “Market Study for Malaysia: Plastics Circularity Opportunities And Barriers” suggested that Malaysia’s total value of recyclable material that could be unlocked is USD1.3b per year. However, only 19% of these materials are recycled, resulting in around USD1b to 1.1b income loss annually. Currently the rate of recycling for key plastic resins remains low in Malaysia at only 24% as at 2019, based on the study.

As such, a transition to a circular economy would benefit recyclers. At present, most plastic recyclers are not listed. Among the listed players, (TEXCYCL: NR) engages in Scheduled Waste Recycling in Malaysia, specialising in industrial waste. The Group is currently able to process 31 (40%) of the 77 available waste codes in Malaysia and is able to either recover/reuse or recycle 95% of incoming waste. Other companies involved in the recycling space but not specific to plastic packagers include, (ANALABS; NR), and (HHHCORP; NR).

Imputing ESG into our Plastic Stocks’ Valuations

We believe that the overall harmful impact of plastic packaging to the environment warrants a discount to current valuations. For starters, we are applying a maximum ESG discount of 10% based on: (i) our Kenanga ESG disclosure score, and (ii) the CFR rates for resin used by the packagers under our coverage (refer to chart below). Going forward, we will review the ESG discount penalty over time as we monitor these players’ ESG progress, with hopes that plastic packagers will continue to make progress on ESG management as we recognise that rehabilitating and transitioning the sector to a circular model will take time.

Source: Kenanga Research - 25 Oct 2021

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