This article first appeared in The Edge Financial Daily, on December 15, 2015.

Tomypak Holdings Bhd 
(Dec 14, RM2.57) 
Maintain reduce with an unchanged target price (TP) of RM1.84: In an interview with The Edge weekly, Tomypak Holdings Bhd managing director Eddie Lim said the company is planning RM120 million to RM140 million in capital expenditure (capex) to triple production capacity over 10 years. Phase 1 involves a capex of RM80 million for the construction of three factories. A new plant should be ready by October 2016 for the start of commercial production in 2017. This will double Tomypak’s production capacity to 35,000 tonnes per annum. Phase 2 is expected to start in 2018 and phase 3 in 2021. 

The company recently proposed a 1:2 rights issue at RM1 per share with free warrants for rights subscribed. The rights issue, if fully subscribed, should raise more than RM50 million, enough to partially fund phase 1 of the plan. An extraordinary general meeting is set for March or April 2016. 

We think the company’s growth plan is overly ambitious. In phase 1, Tomypak hopes to double its production capacity by end-2016. However, we believe it will take at least a few years to fully utilise the new capacity. Overseas multinational corporation (MNC) customers are very sticky and it could take a minimum of two to three years for them to switch suppliers, assuming Tomypak is successful in luring these MNCs away from their regular suppliers.

The company could target non-MNC domestic food and beverage (F&B) customers, and start a price war strategy with its competitors to fill up its production capacity. However, profit margins could suffer as a result. Most non-MNC domestic F&B customers are price-sensitive and less concerned with quality and reliability. This is a market Tomypak’s peer, Daibochi Plastic and Packaging Industry Bhd, has moved away from over the past few years. 

The domestic flexible packaging business experienced a soft patch in 2015. Post the April 2015 goods and services tax implementation, domestic orders fell by around 10%, which is not a surprise. We are concerned domestic demand may take another year or so to recover. Any growth for Tomypak must come from export orders. 

We maintain our earnings per share forecasts and TP, based on a 40% discount to Daibochi’s 2017 13 times price-earnings ratio target. We are keeping this sizeable discount as we are still unsure about how the company managed to achieve its rapid profit margin recovery after the entry of a new major shareholder in the fourth quarter ended Dec 31, 2014. Switch to Thong Guan Industries Bhd. — CIMB Research, Dec 13