This article first appeared in The Edge Financial Daily on July 2, 2019

SCGM Bhd
(July 1, 84.5 sen)
Maintain underperform with a target price (TP) of 69 sen: We came away from SCGM Bhd’s analyst briefing last Friday with a view that it is going to take another four to six months for the company to turn around as it faces various hiccups amid heightening cost pressure and its ability to reach optimal capacity utilisation levels in the near term. Share price weakness will likely persist until signs of turnaround prevail. The TP is based on 15 times financial year 2020 (FY20) earnings per share of 4.6 sen.

The group has been under margin pressure for 10 straight quarters since the third quarter (3Q) of FY17 as rising operating costs have outpaced sales growth. The group even registered unprecedented losses at the gross level in the most recent 4QFY19. Resin, which made up at least 60-70% of total operating costs, saw a 9% year-on-year (y-o-y) rise. Fixed costs such as depreciation, upkeep, utilities and labour, jumped 22% y-o-y following commencement of the new Kulai plant. Remaining costs that are related to administrative, selling and marketing expenses rose 2% y-o-y.

We understand that the new Kulai plant, which accommodates 62.6 million kg extrusion capacity per year, was four months behind the initial opening timeline. During the tail-end of the construction period, it faced technical glitches in the utilities infrastructure which required additional capital expenditure of RM20 million to RM30 million to construct the transmission line. Construction works were also slow as it crossed an ongoing track project in Johor Baru. Another costly move was the complicated migration process, which had a longer-than-expected drag on their entire production lines and resulted in mounting order backlogs.

Current utilisation level is at about 23.4 million kg or 50% of the total installed extrusion capacity (75% is considered full capacity). To turn around, the management guided that quarterly sales need to surpass RM60 million, or a 20% increase from current level. To fill up the new capacity, it targets to expand its export orders through local traders and also increase sales growth through the sale of extrusion sheets, which made up 13% of group sales. It has set an utilisation level target of 70-75% by April 2020. On costing, despite seeing a gradual downtrend in resin prices (polypropylene: 50%, polyethylene terephthalate: 40%, polystyrene: 10%), it did not significantly help ease its raw material cost.

The old Kulai plant, which is sitting on a book value of RM10 million, would easily fetch more than RM50 million in proceeds. — PublicInvest Research, July 1