KUALA LUMPUR: The protracted slump in crude oil prices and the weakened ringgit against the greenback are proving to be a boon for local plastics manufacturers — the former is an essential raw material in the production of polyethylene resin (polyethylene), the most common form of plastic, and the latter provides obvious foreign exchange gains for export-oriented players.

One company that is expecting a windfall from these two developments is SCGM Bhd (fundamental 3; valuation 2.1), which exports up to 47% of its products and, according to its executive chairman Datuk Seri Lee Hock Seng, is anticipating record profits in its fourth quarter ending April 30, of financial year 2015 (4QFY14).

Lee said falling crude oil prices have resulted in cheaper production of polyethylene — which will benefit  the company.

“We generally use Singaporean dollars and US dollars for our dealings. The weakness of the ringgit is good for SCGM as we see extra benefits in terms of foreign exchange gains,” Lee said.

Kenanga Investment Bank plastics analyst Ooi Mong Huey said low oil prices have resulted in a 30% drop in the price of polyethylene.

“This will result in short-term improvement on the margins of plastics manufacturers,” she said. In a report dated Jan 22, Ooi had maintained an “overweight” call on the plastics and packaging sector.

Ooi said that despite a challenging economic landscape, downstream players such as SCGM and Daiboci Plastic and Packaging Industry Bhd are least likely to be affected as their clients are mostly food and beverages companies.

“The demand of plastics packaging is expected to grow in tandem with population growth and urbanisation, based on historical statistics,” she had said.

Within the sector, Ooi’s top pick was Thong Guan Industries Bhd (fundamental 2.1 ; valuation 1.8), which she has placed an “outperform” call on, with a target price of RM3.28.

Malaysian Plastics Manufacturing Association president Lim Kok Boon said the impact of the cheaper oil price should be seen towards the 2Q15.

“Depending on how companies have been holding their inventory, some may already be seeing the benefits [of the cheaper oil] in the first quarter [of 2015], but most will see better profits in the second quarter,” he said.

On the impact of the currency, Lim told The Edge Financial Daily that local plastics companies mostly buy and sell their products in US dollars, so they would definitely benefit from foreign exchange.

Despite signs of a possible slow down in global economic growth — World Bank cut its global growth forecast this year to 3% from 3.4% — Lim said the industrial packaging business, which is dependent on the global economy as stretch film is used primarily in the shipping business, should still see growth this year.

The food packaging business, which is “recession proof”should also provide some buffer from any possible economic slow down.

“During times of recession, people eat indoors more often and most food items are wrapped in plastic,” said Lim, adding that the same could be seen during the global financial crisis of 2008 and the Asian economic crisis of 1997/98.

But Thong Guan is not experiencing the positive effects of the foreign exchange yet. Its executive director Alvin Ang said the effects of the weaker ringgit may actually be negative for the company — at least in the short term.

“The appreciation of the US dollar is generally good for us as 75% to 80% of our sales is dollar-denominated. However in December, we had some carried-over hedged dollar position against the ringgit, which might set us back a bit.”

Ang said the positive effects of the weaker ringgit will only be reflected in its 2Q results after the unwinding of the hedging effects.

He also noted that the upcoming goods and services tax should level the playing field for those who have been complying with tax regulations and those who have not.

Meanwhile, Lee shared that SCGM will be setting up a factory in Japan soon, which should start contributing profits to the company from FY16 onwards.

“Japan’s higher requirement for hygiene and safety standards was one of the main reasons we chose to expand into that market first,” said Lee, adding that the company is also considering India and Australia.

As such, Lee is confident that revenue for FY16 will be “better” than FY15.

Both SCGM and Thong Guan were chosen as Insider Asia’s Top 10 stock picks for 2015 in The Edge weekly (Jan 5-11). Since then, SCGM has risen 18% or 35 sen to its closing price of RM2.25 last Friday — with a market capitalisation of RM183.2 million, while Thong Guan has gone up 14% or 31 sen to close at RM2.33, giving it a market capitalisation of RM244.09 million.

This article first appeared in The Edge Financial Daily, on February 9, 2015.