Despite soft demand and rising competition, TGUAN guided for growth driven by ongoing innovation, responsive services and aggressive marketing, especially of more high performance sustainable stretch films in Europe and North America. Additionally, it is ramping up production in its industrial bag division and has commissioned a new stretch hood line, optimising production efficiency. We tone down our FY24F earnings forecasts marginally by 3% to reflect short-term cost pressures, with FY25F numbers unchanged. We also make minor housekeeping adjustments on the share base due to ESOS, hence our TP is trimmed slightly to RM2.80 (from RM2.86), but we maintain our OUTPERFORM call.

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

1. Its stretch film division (which accounts for half of total sales) is expected to drive growth over the next five years, fuelled by sustainability demands and high-speed automation trends. The demand for its stretch film, especially nano stretch film, remains relatively stable, thanks to: (i) proprietary technology that produces thinner yet stronger film, making it more cost-effective and environmentally-friendly with less resin used, and (ii) compatibility with automated high-speed wrapping.

As an early adopter of nano stretch film in Asia-Pacific, the company continues to strengthen its global market position. It has recently secured new customers in Portugal and Poland, despite soft demand in Europe. It is seeing double-digit YoY growth in the US. Europe and US contribute about 14% and 7% of turnover, respectively, and it is nibbling on the NE Asian market as well.

2. TGUAN has guided that it is ramping up production in its industrial bag division, driven by increased orders for food packaging like bread, oil and sugar bags. We attribute the resilient demand for these products to their extensive use in the F&B and FMCG sectors.Industrial bags made up 18% of revenue in 2QFY24, up from 17% last year.

3. A new stretch hood line has been commissioned, allowing for greater streamlining and dedicating existing blown film lines solely to shrink film production. It is also promoting shrink film products to bundle mineral bottles among local suppliers rather than traditional carton boxes, due to: (i) lower transportation costs from reduced weight, (ii) improved space efficiency, (iii) easier handling and recyclability.

4. On a prudent note, while rivals are attempting to encroach into TGUAN’s export markets, it is believed that TGUAN holds only <5% of the European and US markets. Given this small share, along with TGUAN remaining well ahead in market visibility, service responsiveness and product development, the risk of disruption is low.Possible pricing pressure from a firmer MYR and cost inflation from higher wages are potential headwinds, but they can be managed through improved efficiency, richer sales mix and gradual passing on to customers.

Forecasts. We trim our FY24F earnings forecasts by 3% to account for short-term cost pressures, while keeping our FY25F numbers unchanged.

Valuations. Due to housekeeping adjustments to the share base as a result of the ongoing ESOS, our TP is trimmed by 2% to RM2.80 (from RM2.86) based on 11x FY25F PER. Our ascribed PER reflects 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).

Investment case. We continue to like TGUAN due to: (i) the growth potential from exports as more competitive local players, such as TGUAN, gain market shares from overseas producers, (ii) its aggressive push into Europe and US markets with environmentally-friendly, high-performing products, and (iii) its expansion plans for premium products, such as nano stretch films, food wraps and some industrial bags (wicketed bags, oil/flour/sugar bags). We believe the recent drop in share price are caused by investors’ concern on earnings growth, and such innovative initiatives by TGUAN may act as a re-rating catalyst as soon as it successfully gains more market share in the advanced economies. 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) supply chain disruptions.

Source: Kenanga Research - 26 Aug 2024