This article first appeared in The Edge Financial Daily on September 5, 2017

SCGM Bhd
(Sept 11, RM2.97)
Maintain outperform with an unchanged target price (TP) of RM3.63: We came away from SCGM Bhd’s analyst briefing last week with some encouraging takeaways. Despite seeing a slowdown in profitability, dragged by a sharp increase in resin material cost which offset the strong double-digit growth in revenue, management believes it can achieve stronger earnings growth this year.

Meanwhile, its first Klang Valley plant is scheduled to open this month and is expected to be fully operational by early next year. We continue to maintain our “outperform” call with an unchanged TP of RM3.63.

Though the ban of polystyrene as takeaway food containers in Kuala Lumpur has been in effect since the start of the month, management might see lukewarm response as execution remains the key concern. We understand that there are five degradable container product suppliers in Klang Valley. Out of the five, three are mainly importers from China while SCGM and another Ipoh-based player are the only local manufacturers.

All segments delivered decent growth during the quarter except for electronics. Food and beverages, which contributed 44.5% of the group’s sales, posted 11% year-on-year (y-o-y) growth driven by stronger sales volume in lunch boxes and cups. Electronics and extrusion, medical & others surged 90.7% while the electronic segment slipped 2.1%. Local sales grew at a stronger pace, up 64% (vs exports: +11.8% y-o-y) as the company added more local customers (local: +29 vs overseas: +7) in the first quarter of financial year 2018 (1QFY18).

Lunch boxes and cups, which remain the key growth driver for the group, contributed 21% of total sales. Nevertheless, lunch box sales were relatively weaker compared with the last two quarters, mainly dragged by the Hari Raya celebration in June. Earnings before interest, taxes, depreciation and amortisation (Ebitda) margin, which has been on the downtrend since 2QFY17, fell from 21.8% in 1QFY17 to 18% currently, mainly due to a sharp increase (+30% y-o-y) in resin cost, which makes up about 70% of the total production cost.

We estimate the 47,000 sq ft new Klang Valley factory will contribute additional 20% sales to the group. Management targets to break even in less than a year.

Lastly, management sees a lower effective tax of 15%-16% for FY18-FY19, supported by the reinvestment allowance and double taxation for being the recent Southeast Asian Games sponsor. — PublicInvest Research, Sept 11