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Monday, December 29, 2014

Plastics and Packaging - All Eyes on Consumer Packaging

We reiterate our OVERWEIGHT call on the Plastics and Packaging sector as: (i) the gradual decline in raw materials prices will lead to margin expansion for plastic players, (ii) strengthening USD/MYR exchange will benefit exporters (which form the majority of the domestic players), and (iii) plastic players face minimal impact from GST implementation. Within the plastics and packaging space, we foresee industry packaging manufacturers to show flat earnings growth in 2015 as they are affected by lower industrial packaging demand with the slowdown in the world economy. However, stable earnings growth is expected for consumer packaging players as prospects are highly correlated to F&B and FMCG companies, which are relatively resilient to economy downturn. Within our coverage, we prefer TGUAN (OP; TP: RM3.28) for: (i) its 2-year CAGR earnings growth of 10.7%, (ii) undemanding FY14-15E Fwd PER of 6.7x-5.6x, and (iii) decent FY14-15E net dividend yields of 4.5%-5.3%. However, within the consumer packaging space, we like DAIBOCI (NOT RATED) for its client base (mostly F&B related).

A slow quarter for industrial packaging players. Both companies under our coverage came in below our expectations. SCIENTX’s (UP; TP: RM5.49) 1Q15 net profit fell 38% QoQ largely due to: (i) the adoption of market penetration strategy for the consumer packaging PE film which caused EBIT margin compression for its the manufacturing segment and (ii) foreign exchange loss of c.RM5.0m from USD borrowings. TGUAN’s (OP; TP: RM3.28) 3Q14 net profit contracted by 39% QoQ mainly due to lower contributions from its China and Sabah-based subsidiaries as both were besetted with higher operating costs. We expect the industry packaging manufacturers to continue showcasing flat QoQ earnings growth in the coming 4QCY14 reporting season on lower industrial packaging demand with the slowdown in the world economy. However, we expect constant growth for consumer packaging (ie DAIBOCI and SLP) as it is highly correlated to F&B and FMCG companies, which are relatively more resilient to economy downturn.

Lower resin costs = better profit margins? Our analysis suggests that the relationship between crude oil prices and resin prices is positively correlated (more than 90% correlation over a 10-year period). About 60-70% of the sector‘s operating costs are in raw materials such as LLDPE, LDPE and HDPE. Thus, a drop in resin prices should lead to margin improvement. However, there is evidence from historical data that there is a 3-6 months lag effect for plastics and packaging companies to enjoy EBIT margin expansion when resin prices fall. Moreover, rises/declines in raw materials price will have minimal effect on margins for players that have shorter contract lead time (i.e. film makers like SCIENTX, TGUAN and BPPLAS that adjust the selling prices of their products every 1-2 months); but will have a positive effect on the players that have longer contract lead time (especially for players like DAIBOCI and SLP).

We believe that crude oil prices will stabilise at USD70/bbl-levels in 2015. Thus, we foresee resin price trend to also stay flat or drop further in the medium-term; contributing to margin improvement for plastic and packaging companies in the upcoming quarter. From our sensitivity analysis, a 5% drop in resin prices would lead to 3.6% - 9.0% improvement in TGUAN and SCIENTX net profit, respectively.

Shielded from GST-implementation and beneficiaries of the strengthening USD/MYR. A majority of the Malaysian plastic packaging companies are net exporters, hence GST implementation will not have a significant impact on costs (as export goods are zero rated status); whilst the strengthening USD/MYR (most of the sales are denominated in USD) will lead to forex gains. Our in-house average FY15E USD/MYR forecast is MYR3.43/USD, hence, we believe that plastic packagers’ prospects will continue to showcase firmer forex gains. For instance, the recent sharp rally in the USD/MYR rate has seen SCIENTX recording c.RM5.0m in unrealised forex losses due to its mostly USD borrowings (77.0% of 1Q15 borrowings are denominated in USD) which make it more costly to repay. Most of TGUAN’s trade and receivables are denominated in USD; for 9M14, TGUAN recorded a net foreign exchange gain of RM0.2m .

OVERWEIGHT call on the sector. Overall we are positive on the sector as we believe plastic players are natural winners given the: (i) lower raw material prices and; (ii) strengthening USD/MYR exchange rates environment. Beyond that, as exporters, they will have minimal impact from GST implementation which most of the Malaysian companies are besieged by while M&A activities may put local plastics players in a better position to compete regionally on the back of stronger manufacturing capability and higher economies of scale in the long run. Within the industrial packaging space, we favour TGUAN (OP; TP: RM3.28) for: (i) its 2-year CAGR earnings growth of 10.7% backed by capacity expansion in the PVC food wrap segment, (ii) undemanding FY14-15 Fwd PER of 6.7x-5.6x (note that conversion of ICULS will only take place after two years, hence, there is no immediate dilution in the short-term), and (iii) decent FY14-15E net dividend yield of 4.5%-5.3%. Within the consumer packaging space, we believe DAIBOCI (NOT RATED) is a compelling proposition for investors looking for defensive earnings growth (given resiliency in consumer product demand even in economic downturns).

Source: Kenanga

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