Investment Merits

• Customers more likely to place orders amidst stabilising resin  prices

• Long-term shift towards higher-margin product mix

• Growing customer base and increasing number of export markets

• Owned and managed by founding family, allowing pursuance of  long-term objectives

Company Profile

Thong Guan Industries (TGUAN) sells plastic (>90% of sales and  earnings) and tea & coffee products. Deriving 80% of its revenue from  exports, it mainly exports to Europe, US, Japan, Southeast Asia, South  Korea, and Australia. In FY22, TGUAN derived 47%, 16%, 14%, 6%  and 4% of its revenue from sale of stretch films, industrial bags,  garbage bags, PVC food wraps, and courier bags.

Highlights

Stabilising resin prices brings greater certainty. Since 1Q23, resin  prices stabilised relative to a volatile FY22 – which saw prices fall 7- 39%. Volatile resin price environments are generally not favourable for  TGUAN, as its margins soften when prices rise, and its customers delay  orders when prices fall – in anticipation of lower average selling prices,  or ASPs. With resin prices relatively stable in FY23, the company would  have less margin volatility, with its customers more willing to place  orders – given the greater price certainty.

Continued shift towards higher-margin product mix. Over the longterm, TGUAN has achieved higher margins from improving its product  mix. In the decade before FY14, its gross margin fluctuated between 7- 13%. Since FY15, it has improved to 14-16%. The company has been  improving its product mix by increasing sales of higher-margin products,  such as its premium Nano stretch film (60% of stretch film sales) and  courier bags. Looking ahead, TGUAN is aggressively growing Nano  stretch film sales in Europe, US, South Korea, and Australia. It is also  growing its courier bag customer base in America.

Stable garbage bag and recovering PVC sales. TGUAN's sales and  earnings are supported by various types of plastic products, some with  stronger growth prospects than others. One of its most stable and  reliable businesses is its sale of garbage bags to Japan. The recurring  orders from the Japanese distributors provide a stable and predictable  demand. The PVC food wrap business has propelled TGUAN's growth  between 2011 and 2017, as there was insufficient supply in the region  to meet the growing demand from supermarkets, restaurants, and  hotels in Southeast Asia. Although its PVC sales took a hit during the  pandemic, it is steadily recovering – currently at a healthy c.70%  utilisation.

Continuous growth across its products. Although stretch film  demand from European customers (its main market for stretch films)  slowed in FY22, TGUAN is continuously growing its customer base in  Europe, and expanding into the US and China. The company is also  growing its industrial bag business by expanding product offerings in  shrink film and bread bags. Although demand for TGUAN's courier bags  slowed with the post-pandemic decline in e-commerce sales, it is  onboarding new American retail giants as customers to drive growth of  its courier bag segment.

Company Report Card

Latest results. TGUAN’s 4Q22 revenue fell 11% QoQ mainly due to  lower volumes and ASPs, as resin prices fell throughout the quarter.  However, lower resin costs helped lift gross margin to 15.8% from 14%.  Further boosted by a lower effective tax rate, its core net margin  improved from 6.9% to 9%. In FY22, revenue rose 14% YoY, driven by  higher ASPs – due to higher resin prices – and higher volumes, driven  by continued economic recovery. As resin cost trended upwards in  FY22, gross margin fell from 15.4% to 14.9%. With a lower effective tax  rate and removing one-off items, core net margin rose from 7.7% to 8%.

Balance sheet. As of end-FY22, TGUAN had net cash of MYR49m. It  has been in a healthy net cash position since FY12, despite growing  long-term borrowings to fund its continued expansion.

Dividends. The company does not have a dividend policy, but pays  quarterly dividends. It had a dividend payout ratio (DPR) of 37-23% in  FY20-22. Due to its ongoing expansion, we expect a sustainable DPR  of c.25% in FY23-25, implying FY23 yield of 2.7%.

Management. TGUAN is led by Dato' Ang Poon Chuan and his  brothers Dato' Ang Poon Khim and Datuk Ang Poon Seong. They are  grandsons of the founder Ang Thong Guan. Also at the helm is Ang See  Ming (Alvin), Dato’ Ang Poon Chuan’s son. The family has steered the  business towards numerous years of continuous growth, achieving a  10-year earnings CAGR of 14%. The company’s biggest shareholder  (38%) is Foremost Equals – owned by the Ang family.

Investment Case

Continuing a six-year streak of earnings growth. We forecast  TGUAN to continue its earnings growth in FY23-25. Its revenue should  grow from higher sales volumes, driven by recovering PVC food wrap  demand, and growing customer base for its stretch film, industrial  packaging, and courier bags. The company’s margins should also  improve in FY23, with stable and lower average resin prices (vs FY22).

Fair value. We ascribe a fair value range of MYR3-3.25, based on 10x  and 11x FY23F P/E. The 10x and 11x are close to +1SD and +2SD of  its 5-year mean of 8.5x. TGUAN's larger peer Scientex has a 5-year  mean P/E of 11x, while its smaller peer SLP Resources (with higher  margins) currently trades at c.13x FY23F P/E. With strong growth  prospects allowing it to grow despite near-term volatile resin prices, we  believe it deserves a higher valuation than the current 7.7x FY23F P/E.

Key risks include higher-than-expected costs, lower-than-expected  orders, inability to pass on higher costs, and negative perception of  plastics companies due to ESG concerns

Source: RHB Securities Research - 16 May 2023