Plastics and packaging sector
Maintain “overweight”: Both companies under our coverage came in below our expectations. Scientex Bhd’s first quarter of financial year 2015 (1QFY15) net profit fell 38% quarter-on-quarter (q-o-q) largely due to: (i) the adoption of market penetration strategy for the consumer packaging PE film which caused earnings before interest and tax (Ebit) margin compression for its manufacturing segment; and (ii) foreign exchange loss of RM5 million from US dollar borrowings.
Thong Guan Industries Bhd’s 3QFY14 net profit contracted by 39% q-o-q mainly due to lower contributions from its China and Sabah-based subsidiaries as both were beset with higher operating costs.
We expect the industry packaging manufacturers to continue showcasing flat q-o-q earnings growth in the coming fourth quarter of calendar year 2014 reporting season on lower industrial packaging demand with the slowdown in the world economy. However, we expect constant growth for consumer packaging (that is Daibochi Plastic and Packaging Industry Bhd and SLP Resources Bhd) as it is highly correlated to food and beverage and fast-moving consumer goods companies, which are relatively more resilient to economy downturn.
Our analysis suggests that the relationship between crude oil prices and resin prices is positively correlated. About 60% to 70% of the sector’s operating costs are in raw materials. Thus, a drop in resin prices should lead to margin improvement. However, there is evidence from historical data that there is a three to six months lag effect for plastics and packaging companies to enjoy Ebit margin expansion when resin prices fall. Moreover, rises and declines in raw materials prices will have minimal effect on margins for players that have shorter contract lead time (for instance, film makers like Scientex, Thong Guan and BP Plastics Holdings Bhd that adjust the selling prices of their products every one to two months), but will have a positive effect on the players that have longer contract lead time (especially for players like Daibochi and SLP).
We believe that crude oil prices will stabilise at US$70 (RM245) per barrel levels in 2015. Thus, we foresee the 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% to 9% improvement in Thong Guan’s and Scientex’s net profits. — Kenanga Research, Dec 29
This article first appeared in The Edge Financial Daily, on December 30, 2014.