This article first appeared in The Edge Financial Daily on November 22, 2019
Thong Guan Industries Bhd
(Nov 21, RM3.42)
Maintain outperform with a higher target price (TP) of RM4.10: Thong Guan Industries Bhd’s first nine months of financial year 2019 ended Sept 30 (9MFY19) core net profit (CNP) of RM43.6 million came above our expectations at 89%. Its top line came in within our expectations at 79%, while its earnings before interest and tax (Ebit) margin was strong at 7.7%, versus our expectation of 6.6%. Ebit came in at 92% of our expectation on a better-than-expected product mix. No dividend was declared, as expected, with the bulk of dividends likely to be paid out for the fourth quarter based on historical trends.
Year-on-year, its top line increased by 9% for 9MFY19 on strong sales from increased exports of stretch film, garbage bags and courier bags. However, its Ebit margin improved by 2.6 percentage points (ppts) on better product margins and aided by a lower-resin-cost environment this year which translated straight into its bottom line which was also up by 59%. Quarter-on-quarter, its top line was up by a strong 12% on higher demand for stretch film, garbage bags and courier bags. This, coupled with a rise in its Ebit margin (+2.2ppts) due to the abovementioned reasons, increased CNP by 45% despite a slightly higher effective tax rate of 18% (versus 14.4%).
Thong Guan cautioned that the global outlook may weigh on demand — in terms of sales growth from existing customers — and the pace of market expansion. Moving forward, Thong Guan will continue to seek new customers and markets for its products. The group is also constantly investing in research and development to improve sales and margins of existing products, targeting more multinational companies. Thong Guan is focusing on continued expansion into higher-margin production lines to sustain the plastic segment’s margins going forward.
We increase its estimated FY19 (FY19E)-FY20E CNP by 26% each to RM61.6 million-RM63.3 million post estimating its Ebit margin to be 8.3% (from 6.6%) on expectations of improving product margins in the coming quarters, bolstered by the low-resin-cost environment. At the current levels, FY19E-FY20E dividends of 9.3 sen-9.6 sen imply 3%-3.1% yields based on an unchanged 24% payout ratio in line with historical trends.
Going forward, we may lift our valuations further should we see better earnings consistency and strong margin growth above its historical high of 9.7%. We are comfortable with our “outperform” call as we believe we have priced in most earnings risks and we are comfortable with the average valuation.
Risks to our call include volatile plastic resin prices, foreign currency fluctuations and lower-than-expected margins. — Kenanga Research, Nov 21