Dear Readers

Today we dissect Scientex Berhad (“Scientex“) to find out what it takes to be “healthy, friendly & happy”.

Scientex consists of two main arms; the manufacturing of plastic packaging products and property development.

Plastic packaging manufacturing

Product packaging typifies the way the goods are sold. Not only does packaging secures goods, it also adds shelf life to certain perishable products and also ensures that products, such as food and medicine, remains hygienic. Moreover, packaging is often seen first before the actual product. Hence packaging gives a presentable appearance which entices buyers and also adds value to the price of the product.

In logistics and warehousing, packaging assists with warehouse organisation and space utilisation. Imagine a scenario where boxes, containing goods, are stacked on a pallet. In order to utilise space efficiently, boxes may be required to be stacked vertically. But staking boxes vertically may increase the risk of the boxes collapsing. However, when the boxes are secured by using a stretch film, the risk of boxes collapsing drops significantly. Hence, efficiency is space utilisation translates to profit.

The point in which I am proposing is that plastic packaging is a vital component of the clockwork of consumerism. And Scientex, being at the forefront of plastic packaging manufacturing, is able to cash in on consumerism.

Scientex produces a variety of plastics packaging. They can be grouped into 4 broad categories:

1. Industrial packaging.
2. Consumer packaging.
3. Automotive interior.
4. Green Energy products.

Industrial packaging includes, among others, stretch films (to wrap around pallets), woven bag (bags to store fertilizers, animal feed, cement, etc), raffia string and FIBC bag (basically supersized tote bags which can fit up to 500kg -1000kg of materials).

On the consumer side, Scientex’ manufactures plastic wrapping and packaging for breads, beverages, ramen/instant noodles, fresh food products and feminine products. It also provides the printing services for the wrappers and packaging.

Scientex produces polymer products and skin materials from PVC or thermoplastic polyolefin (“TPO“) sheets for the automotive sector which are used to wrap, among others,  seats, dashboards, door trims, consoles and armrests giving those items a leather-like appearance and touch. Its clients are mainly Japanese (Toyota, Honda, Subaru, and Suzuki), American (Ford and GM) and local (Proton and Perodua) automotive manufacturers.

On the green energy front, Scientex manufactures films or ethylene vinyl acetate (“EVA“) films which encapsulates solar cells, in solar PV modules. Its functionality is to prevent humidity and dirt from affecting the performance solar cells.

Overall, the manufacturing of plastic packaging represents about 70% of Scientex’s revenue. Notwithstanding that, manufacturing contributed only 30% of Scientex’s operating profit, in FY2017. That accounts to about RM97 million of RM325 million operating profit; translating to a razor thin operating profit margin of about 4%.

Close to 75% of manufactured products were exported overseas where main markets , in terms of revenue contribution, include Japan (21%), followed by Korea (11%) and Indonesia (6.7%), as per FY2016 annual report.

Property development

Scientex’s property development division is a major contributor to top line despite the absence of any synergy between said and the plastic manufacturing division.

Scientex’s property development division focuses on landed housing developments in suburbia across Johor, Melaka and Perak. These property developments consist affordable housing, like Scientex Kulai, Scientex Klebang and Scientex Senai, to luxurious housing developments,  such as Scientex Skudai and E’roca Hills (Kulai).

The gross development value of all of its projects is about RM1.5 billion.

Despite recording less revenue (about 30% of revenue), property development contributed 70% of Scientex’s FY2017 operating profit. Hence, RM227.5 million of operating profit was generated from property sales, in FY2017. That represents an operating profit margin of about 9.5%.

Financials

Scientex has a lot going for it in the past 5 years. During that time, its top line has been increasing exponentially to a point that it doubled. No small feat indeed.

In August 2016, Scientex underwent a corporate exercise in the issuance of 1:1 bonus issue of shares. As such, there was a dilution in earnings per share, seen in FY2017.

By my calculations, earnings growth rate, is at 18.9%, throughout the years under coverage. However, to achieve such a high rate of growth, the company had to increase its borrowings. Debt is being used to, improve production in its local plants, fund the expansion of its manufacturing operations in the US, and acquire land to sustain its property development.

As a result of higher short-term borrowings, Scientex’s operating cash flow has been pretty tight. However, it is not a cause for concern for a growing mid cap company.

Insofar as dividend is concerned, Scientex paid decent dividends of an average of 20 cents per financial year under coverage; except in the FY2017, where it paid only 16 cents. Dividend payout is very erratic in my opinion as it ranges from 50% – 20%.

Potentials in  manufacturing 

The Nano6 stretch film which are manufactured by Scientex is still competitive in many ways. It is touted as one of the world’s thinnest stretch films. The film is light, thin, more durable and offers a good transparency (making barcode scanning less cumbersome). Nano6 may be the driving force for the production and sales of stretch films and it is surely worth keeping tabs on it.

Scientex’s collaboration with a Japanese company, Futamura Chemical Co. Ltd, in 2016, led to the construction of Malaysia’s biggest biaxially-oriented polypropylene (“BOPP“) film production plant in Pulau Indah, Selangor. The plant is said to have a capacity of 60,000 tonnes. However, it will only be operating at half of its maximum capacity by the end of 2017. While most of its productions are exported to Japan, there is a strong local demand for BOPP which Scientex is looking to exploit. At the moment, Malaysia imports much of its BOPP needs from overseas.

The US remains an untapped market for Scientex. That market only contributes nominally to Scientex sales; less than 1% of exports of plastic packaging. However, things are about to change when Scientex completes its production plant in Arizona. The plant is slated to manufacture stretch films (presumably Nano6) for the US market.  The plant has a maximum output of 30,000 tonne of stretch films per annum and is expected  to boost Scientex’s overall manufacturing capacity of stretch films from 150,000 tonnes per annum to 180,000 tonnes per annum. This expansion will be completed in the end of 2017 with a cost of about USD25 million. Commercial rollout is expected in the first quarter of 2018.

I have mixed feelings about this expansion since the US market only contributes nominally to Scientex’s sales. I foresee Scientex having to spend time and money to develop supply and logistics chains while incurring marketing expenses to build a customer base in the US. As a result, meaningful contribution, if any, can only be seen sometime in FY2019 or FY2020. However, the abundance of shale-gas based resin, for raw material, and savings in logistics, and supply chain, are potential upsides to this venture.

Potentials in property development 

Scientex has purchased 26.4 hectares of freehold land in Rawang. The land is located in the greater Klang Valley region and costs RM85 million. The purchase will only be completed in the first half of 2018. With the addition of the Rawang land, Scientex’s land bank now stands at 1,093 hectares (as at August 2017) and is able to sustain the company for 10 to 15 years.

There are a couple of housing development which will be unveiled in FY2018 for bookings. These projects are located in Durian Tunggal, Melaka (197.4 acres) and Kulai, Johor (121.2 acres).

With many high end developments slowing down, the affordable housing segment, which has been the main thrust of Scientex, continues to enjoy breeze sales due to high demand and affordable pricing. Having survived the general slowdown in the property market in 2017, I expect the property market, in 2018, to be kind to Scientex due to a good mix of affordable housing along with other premium developments.

Conclusion

Scientex is appealing, in my opinion, for the following reasons:

1. It has a strong reputation and achievements in the plastic packaging industry, especially in the industrial packaging segment.
2. It is expanding its consumer packaging segment, especially in the BOPP production.
3. Strong presence in property development with a focus on affordable housing.
4. Strong access to new packaging and plant technology from Japan and Germany.
5. Keeping up with reinvestment, by modernising and expanding plants, and replenishing land bank.

I find Scientex unattractive for the following reasons:

1. US expansion is a big gamble considering that, in my opinion, it has been a market in which they have neglected thus far.
2. Its expansion and modernisation of plants and equipment may endure a gestation period of a couple of years before there can contribute positively to earnings.
3. Profit margin in the manufacturing business is already tight even in an environment of low crude oil prices.
4. Scientex’s share price is selling at a premium. Its fair value, from my calculation (which may well vary yours), is within the range of about RM7.40 – RM7.60 per share.

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