TGUAN reiterated its guidance for a soft market over the immediate term. However, it sees resilient demand for its nano stretch film in Europe and the US. We maintain our view that a more sustainable recovery still hinges on a stronger global economy. We cut our FY24F earnings forecast by 7%, lower our TP by 6%to RM2.86 (from RM3.05) but maintain our OUTPERFORM call.

We came away from a post-results engagement with TGUAN feeling reassured of its longer-term prospects. The key takeaways are as follows:

1. Soft market demand. Despite a QoQ pick-up in orders in 3QFY23, the demand for TGUAN’s various plastic products (e.g. garbage bag, food wrap, courier bag) in 4QFY23 remained soft. The US market is coping with high inflation and interest rates and this challenging market condition will persist into FY24. To recap, in FY22, garbage bags, food wrap, courier bags accounted for 14%, 6% and 4% of TGUAN’s total sales, respectively, with the balance largely coming from stretch film (47%) and industrial bags and film (16%).

2. Unperturbed by higher selling and distribution expenses. In 3QFY23, its selling and distribution expenses surged 32% YoY to RM9.1m, mainly due to: (i) increased marketing in Europe and US, and (ii) aggressive promotional activities for its tea and coffee business (its F&B division accounted for 8% of FY22 total turnover). While these higher expenses will recur in coming few quarters, we view them as necessary and strategic to strengthen distribution, brand awareness and the existing market further as well as expanding into new markets. We anticipate these costs to eventually pay off in terms of growing sales.

3. Mitigating higher energy cost. TGUAN experienced a monthly increase of about RM1m in electricity expenses after discontinuing the Green Electricity Tariff (GET) program in Aug 2023 (as the tariff under the scheme is no longer attractive). Recall, the GET program covers about 90% of its electricity consumption previously. Nevertheless, the overall impact on its profitability has been manageable (as evidenced in its gross profit margin holding up at 15% in 3QFY23). This is attributed to: (i) electricity cost constituting only about 5% of total production costs, and (ii) electricity generated from its solar panels. We believe TGUAN could mitigate the higher cost of electricity with a more favourable product mix with greater proportion of high-margin products.

4. Bright spots in selective products. Despite the current global challenges, TGUAN remains optimistic about its nano stretch film which is seeing improving margins. It has commissioned one of its two cutting-edge 67-layer nano stretch film machines (its 9th nano stretch film machine) with another (its 10th nano stretch film machine) expected to come online in FY24. These premium stretch films are largely for the European and US markets. In FY22, Europe and the US contributed 14% and 9% of TGUAN’s total sales, respectively. In Europe, TGUAN expects a sustained growth trend in nano stretch film sales over the next three years. The focus in Europe is to establish direct collaboration with local MNCs (vs. through third-party distributors). On the other hand, TGUAN sets a target to triple its exports to US by leveraging on distributors to fast-track the market penetration.

Forecasts. We cut our FY24F earnings forecast by 7% to reflect a softer demand for various plastic packaging products amidst a challenging global environment.

We also reduce our TP by 6% to RM2.86 (from RM3.05) based on 11x FY24F PER, at a discount to the sector’s average historical forward PER of 13x to reflect TGUAN’s low share liquidity. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 5).

We maintain our view that a more sustainable recovery in the demand for plastic packaging products will still hinges on a stronger global economy. However, we continue to like TGUAN due to: (i) the growth potential of the local plastic packaging sector as Malaysian players like TGUAN are gaining market shares from overseas producers that are losing competitiveness due to rising production costs, its aggressive push into the European and US markets with environmentallyfriendly products, (ii) TGUAN’s earnings stability underpinned by a more diversified product portfolio and steadily growing clientele base, and (iii) its expansion plans for premium products, such as nano stretch films, courier bags, food wraps and some industrial bags (wicketed bags, oil/flour/sugar bags). Reiterate OUTPERFORM.

Risks to our call include: (i) a sudden surge in resin costs, (ii) weak demand for packaging materials due to prolonged global recession, and (iii) labour shortages and supply chain disruptions.

Resin and Crude Oil Pri

Source: Kenanga Research - 28 Nov 2023