We recently participated in the 10th Malaysian Plastics Manufacturers Association (MPMA) International Plastic Conference 2024 and came away optimistic on the long-term outlook for the sector as plastic's versatility make it difficult to be replaced but more recycling is needed - the main aim of Malaysia's Plastic Neutrality Masterplan 2024-2030. In the nearer term, sustained orders are expected through CY25, driven by global economic activity with local exporters set to gain more market share from overseas rivals. Exporters may suffer temporary margin compression from recent rapid strengthening of the MYR amid an overall growth that is still inching up going by order flow. All said, we believe much of the negativity over the sector has been priced in, hence our OVERWEIGHT call for the sector with our sector pick being TGUAN (OP; TP: RM2.80) for its inexpensive valuations and potential to capture more overseas orders. We nevertheless highlight more regulatory developments are expected by November for which details are scant for now.

Integral across diverse sectors but more sustainable circular practices emphasized. Valued for its versatility, durability, and adaptability, especially as industries transition towards lightweight and resilient materials, plastic is integral across diverse sectors today, from consumer goods, electronics, automotive, aerospace, construction, and food production. Even the renewable energy sector needs plastics for solar panels and wind turbines, while in healthcare, they are critical for sterile packaging and medical devices. While plastics offer invaluable functionality, their environmental impact has prompted governments and industries to reconsider material choices as well as adopt more sustainable circular practices.

Malaysia's Plastic Neutrality Masterplan 2024-2030. Employing 175,000 workers across 800 companies (not including the petrochemical segment) and generating about RM90b in revenue with sizeable exports to Europe, USA, Singapore, Australia and Japan, the Malaysian plastic industry is sizeable. However, there is growing recognition in Malaysia to upscale recycling and reduce plastic waste. As such, the Masterplan 2024 - 2030 outlines four main objectives: (a) to achieve zero plastics to landfill and to be circular and have net-zero, (b) to sustainably address plastics pollution in Malaysia, ensuring economic development, environmental protection and societal wellbeing, (c) to provide guidance and promote sustainable business practices in ensuring plastic circularity and sustainability through circular economy approach, and (d) to harmonise actions along the plastic value chain through adoption of life cycle approach. A circular economy in the plastics sector involves redesigning products for longevity, increasing recycling capacity, and minimizing single-use applications. Key initiatives include advancing recycling technologies including chemical recycling for complex plastics to encourage the use of recycled materials, implementing extended producer responsibility (EPR) schemes, and investing in public education to increase awareness of sustainable consumption alongside the implementation of separation at source (SAS). By setting actionable targets and encouraging stakeholder collaboration with milestones set through 2030, the Masterplan envisions Malaysia as a leader in plastics sustainability, aligning with national and global environmental goals 2024 Orders and Outlook for 2025. According to the association, the demand for plastic remains healthy across Malaysia in 2024 with exporters reporting 10% improvement YoY. For 2025, the outlook anticipates demand to continue improving albeit still slowly with the steady adoption of recycling technologies, such as chemical recycling, and the gradual imposition of extended producer responsibility (EPR) schemes to incentivize sustainable practices. This transition, while costly and complex, is expected to reduce overall virgin plastic demand over time, encouraging investments in sustainable alternatives and recycling infrastructure.

Forex Impact. Malaysian plastic exporters sell products and purchase resins both in USD. As such over the long term there is a natural hedge against MYR/USD fluctuations. However, considering recent rapid strengthening of the MYR in 3Q 2024, and some resin inventories acquired when the MYR was weaker, the benefits of cheaper resins will not be immediate and are expected to surface only over the next quarter, or two as new lower-cost inventory replaces the old. In addition, a stronger MYR means that USD-denominated revenues translate into lower MYR selling prices upon conversion, thus reducing profit margins in local currency terms.

Demand to Favour More Sustainable Packaging. Concerns on the environment over plastics are shifting the focus towards managing plastic waste rather than eliminating plastics altogether, given their essential role. This has led to increased circular economy initiatives and sustainable packaging solutions. Investments in innovative packaging are crucial for efficient waste collection, sorting, and recycling. Companies like BPPLAS (OP; TP: RM1.42) and TGUAN (OP; TP: RM2.80) have been gaining traction with their nano stretch films, while SLP (OP; TP: RM1.05) is seeing increased customer interest in its machine direction-oriented (MDO) PE mono films. SLP is also actively promoting its sustainable packaging solutions in ASEAN countries, capitalising on the demand for recyclable materials by SE Asian manufacturers with customers in Europe or US.

We acknowledge potential downside risks to margins due to: (i) increasing operating costs, including labour and electricity, (ii) rising freight costs and (iii) the impact on ASPs from the recent strengthening of the MYR. However, a shift towards high-margin premium products, increased automation and investment in solar energy installation could partially mitigate these cost pressures.

Watching for developments under UNEA Resolution 5/14 where details should emerge by Dec this year. The Intergovernmental Negotiating Committee (INC) was established under UNEA Resolution 5/14 with the goal of creating a legally binding global treaty to end plastic pollution. This initiative covers the full life cycle of plastics, from production to waste management, with an emphasis on reducing marine and environmental pollution. The expectations from the upcoming INC session include significant regulatory changes, such as restrictions on primary plastic polymer production and the inclusion of Chemicals of Concern (CoCs) in the treaty. There was lack of details on these during the conference and we will monitor the upcoming session (25 Nov - 1 Dec 2024 at Busan, Republic of Korea). These changes could impose supply-side constraints and impact the development of recycling technologies, which may challenge the industry's ability to manage plastic waste efficiently. For the industry, this could mean shifting towards sustainable alternatives, redesigning products for circularity, and navigating stricter regulations that may affect both production and operational costs.

Our sector top pick is TGUAN. We continue to like TGUAN due to: (i) the growth potential from exports as more competitive local players, such as TGUAN, gain market share 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 bread bags, oil/flour/sugar bags). We believe the recent drop in its share price is also caused by investors' concern on volumes 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.

Under our coverage, we have two more stretch film players namely BPPLAS and SCIENTX (MP; TP: RM4.15), which are also developing innovative packaging solutions. We favour BPPLAS for its: (i) strong foothold in the SE Asia market which is expected to remain resilient despite global economic uncertainties, (ii) strong cash flows and balance sheet (a net cash position) that will enable it to weather downturns better, and (iii) long-term capacity expansion in high-margin premium stretch film and blown film products, positioning it to capitalise on the next up-cycle.

We also like SCIENTX for: (i) the expanding global market share of the local plastic packaging industry due to cost advantages compared to overseas competitors, (ii) its strong market position, being the largest flexible plastic packaging manufacturer in the region, and (iii) the robust demand for its affordable housing with overwhelming take-up achieved.

Source: Kenanga Research - 4 Nov 2024