This article first appeared in The Edge Malaysia Weekly on April 16, 2018 - April 22, 2018
PACKAGING companies seem to be caught in a bind as the cost of resin begins to rise while the ringgit continues to strengthen. Most of them have seen sharp declines in their share price and over RM1 billion in market capitalisation has been wiped out.
The worst hit has been SLP Resources, whose share price had dropped a whopping 44% since end-December last year to RM1 as at last Wednesday.
Its peers were in the same boat — Thong Guan fell 39% to RM2.58, SCGM 39% to RM1.60, Tomypak Holdings Bhd 14% to 83.5 sen and Scientex Bhd 11% to RM7.74.
Daibochi Plastic and Packaging Industry Bhd did not fare as badly, recording a marginal 3.4% decrease year to date to RM2.20.
However, analysts are not ready to call a “buy” on these stocks because of the double whammy of rising crude oil prices and the appreciation of the ringgit against the US dollar.
“Most of the players reported weak earnings in the past few quarters as foreign exchange rates were not in their favour and resin costs were volatile. So, it is tough to say that their share prices are looking attractive at current levels, ” says an analyst with a local investment bank.
Brent crude oil futures hit US$72 per barrel on Wednesday, the highest level since December 2014, while the ringgit has appreciated 4% to 3.8745 against the greenback year to date.
The ringgit’s rise could result in forex losses while a recovery in crude oil prices is likely to lift the price of resin — a key raw material for the industry — thus eroding the bottom line of the manufacturers of plastic.
In an April 6 note, Kenanga Research, which covers all of the stocks above except Daibochi, says plastic packaging companies under its coverage saw higher resin costs last year due to demand and supply factors, with prices increasing 20% to 30% year on year.
“Most of the players under our coverage suffered a spike in resin costs in the first half of 2017 and, as a result, saw weaker earnings from margin compression.
“However, there is a possibility that resin prices could trend downwards going forward on ample supply due to excess capacity from China and India, and US shale-based resin in CY18.”
The research house says this could be a rerating catalyst for the sector, adding that a 2% decline in resin prices could increase the earnings of plastic packaging companies under its coverage by 6% to 8%.
It downgraded the players to “underweight” from “neutral” and lowered its price-earnings ratio valuation for the sector by 10% to 20%.
“We are comfortable with our sector call as we remain cautious on the higher cost environment, but we believe we have accounted for the most foreseeable downside risk in our earnings and valuations. We may look to up our valuations upon more consistent earnings delivery and favourable macro fundamentals for the sector.”
Kenanga Research adds that in the near term, earnings growth for the sector, if any, will come from margin expansion. “This is premised on better cost efficiency and product innovations that could bump up margins as the manufacturers of plastic look to sell more niche and higher-margin products.
“With plastic packaging companies continuously tapping new markets, such as China, the US, Canada and Africa, and working on more niche products to improve margins, most of them have embarked on bullish capacity expansion plans, which should accrete over the longer run.”
For instance, Tomypak is increasing its capacity by 89% by FY2020-21, SLP by 58% by FY2019, and SCGM by 65% by FY2020. Thong Guan is targeting a 10% to 15% expansion.
The earnings erosion is likely to have been a factor for the price plunge. Tomypak, for example, reported a 48% decline in net profit to RM9.52 million in its financial year ended Dec 31, 2017, because of the increase in raw material costs as well as start-up expenses for its new plant in Senai, Johor. Its revenue slipped 3.2% to RM204.28 million.
In a Feb 27 note, CIMB Research says it is trimming FY2018-19 forecast earnings per share by 16.3% to 18.6% “to reflect weak export outlook”.
“Potential de-rating catalysts are weak export demand and high raw material costs. An upside risk is a strong recovery in export sales,” says the firm, which has a “reduce” call on Tomypak with a target price of 62 sen.
SLP Resources saw its net profit for the fourth financial quarter ended Dec 31,2017, decrease by 59% to RM11.65 million due to higher raw material costs as well as a stronger ringgit, which impacted exports.
In a Feb 26 note, AffinHwang Capital cuts its 2018 to 2019 estimated earnings for SLP by 32% to 44%.
“We expect higher cost pressure from rising resin cost, higher utilities and staff cost and unfavourable product mix to drag the earnings before interest, tax, depreciation and amortisation margin to 12% to 13%, similar to its 2010 to 2014 Ebitda margin of 10% to 12%, but sharply lower than 16% to 22% in 2015 to 2017, when resin costs were lower and the ringgit was weak.”
Affin-Hwang has a “hold” call on SLP Resources with a target price of RM1.38.
What the industry players say
Thong Guan Industries Bhd
Executive director Alvin Ang See Ming
From our point of view, the group, like the other industry players, was affected by higher material costs as well as a stronger ringgit. We have also been hit by higher operational costs and promotional activities.
We are assessing the current market environment. If it prevails, we expect at least a low double-digit growth (in revenue).
The group has in play operational efficiency programmes that will allow us to evaluate our current cost structure and enable us to improve our margins. A few new lines will be installed and fully commissioned before the end of the year and we expect them to contribute to the group’s financials going forward.
SCGM Bhd
Group managing director Datuk Seri Lee Hock Chai
We believe that the recent weak investor sentiment is largely due to global economic uncertainties and exchange rate fluctuations amid the changes in trade policy between China and the US.
Investors are also concerned about the negative impact of the strengthening ringgit on exports as well as the impact of rising raw material and operating costs on the overall financial performance of the company.
Despite the recent pessimism in the market, we believe our share price will eventually reflect the strong fundamentals of the company.
We are optimistic that the financial year ending April 30, 2019 (FY2019), will start bearing fruit for us as our new factory in Kulai is expected to begin operations this December.
The commissioning of the factory will increase the group’s extrusion capacity by 64.9% to 67.6 million kilogrammes per year, enabling us to meet the higher demand and improve our cost efficiency through higher automation.
We are a beneficiary of the polystyrene ban in the Klang Valley, Penang and Melaka. Johor also recently banned polystyrene products and other states may potentially follow suit. We are also increasing the variety of products in our biodegradable range.
Scientex Bhd
Managing director Lim Peng Jin
The prospects for the year ahead remain positive, following recent increases in production capacity both organically and through acquisitions, as we target to meet rising global demand for flexible plastic packaging.
About 75% of our manufacturing revenue is from export markets, providing a good degree of natural hedge against foreign exchange volatility in our raw material imports. Overall, we would also continue to target growth in both our local sales and exports.
Scientex remains on a growth trajectory, driven by increasing sales of our flexible plastic packaging products in line with strong demand and expansion of our client base, in addition to resilient demand for affordable homes in Peninsular Malaysia. Thus far, the group has achieved double-digit revenue growth of 15% in 1HFY2018, and we are confident of maintaining a strong growth pace for the rest of the year.
Our recent acquisition of Klang Hock Plastic Industries, which is expected to be completed by May, will not only provide additional earnings but also strengthen our range of products and market position as one of the largest flexible plastic packaging players in Asia.
Daibochi Plastic and Packaging Industry Bhd
Managing director Thomas Lim
Despite recent market sentiment, our share price has remained relatively stable. We attribute this to investors’ appreciation of our growth outlook, commendable profit track record and healthy balance sheet.
Also, in response to concerns over the recent rise in the cost of plastic resin, our existing agreements with customers allow significant hikes or declines beyond the contractual price to be passed through to either parties. While we procure our raw materials in US dollars, a major portion of our sales is also conducted in the greenback, thus providing a significant degree of natural hedge against foreign exchange fluctuations.
We expect to deliver a strong set of results in FY2018, with the potential of hitting double-digit growth in our top line. This comes on the back of new contracts secured at our Malaysian operations for major F&B and FMCG brands in Southeast Asia and in the ANZ region, in addition to a full-year contribution from our Myanmar operation that commenced in 3QFY2017.
Additionally, we are seeing commendable progress in securing new customers and contracts at our Myanmar operation, which we look forward to growing expediently into a sizeable player in Southeast Asia.
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