We visited SCGM’s new plant in Kulai last week. The plant, which has an extrusion capacity of 62.6m kg/year, has been operational for about 8 months. The migration process is almost complete, with a ramp up in capacity utilization rate likely in the coming months. Meanwhile, SCGM’s 3QFY19 results are expected to be announced on 26th March. Maintain Neutral call with an unchanged TP of RM1.39.

• Aiming for more orders from overseas markets. Management has indicated interest in diversifying into more overseas markets given its larger capacity now, which can cater for bigger orders. As of 1HFY19, export markets accounted for 33.3% of Group sales. In the local market, it targets i) vegetable, ii) fruit and iii) confectionary segments given the defensive nature in these markets.

• Planning to monetize old plant. Management has plans to dispose of the old Kulai plant at a price of not less than RM70m upon the completion of the migration process. The old plants, which cover a land area of 406,464 sq ft or 9.33 acres, have a combined net book value of RM17.7m.

• Seeing silver lining in resin cost. Resin cost, which accounted for 70% of total operating costs, has been on the gradual downtrend since oil prices corrected more than 22% after hitting USD84.80 in Oct 2018. PP, which accounts for 50% of total resin usage, is expected to face more competitive pricing from Petronas following the soon-to-be-completed Pengerang downstream project as Petronas’ resin capacity easily outweighs Lotte Chemical’s. PET, which made up about 40% of the Group’s total resin usage, will see a surge of supply from its main supplier, MPI Polyester Industries following the opening of a new production plant in Vietnam. We believe the Group would be able to ride on recent lower resin cost in 4QFY19 as it adopts a spot-pricing policy for resin orders, which is up to 1 month only.

• 3QFY19 results unlikely to be favourable. Though oil prices started to move downward since Oct 2018, we believe it will take a while to see the impact on SCGM’s operating costs due to the lag effect at Lotte Chemical’s level. 3QFY19 results are still expected to be affected by a rise in depreciation and resin costs.

• New plant running at optimal level. The new Kulai plant, which expands the total extrusion capacity from 41m kg/year to 67.6m kg/year, has reached 50% utilization rate. With the increased automation as well as larger power supplies, there will be lots of room to achieve greater economies of scale and margin improvements going forward.

Source: PublicInvest Research - 20 Mar 2019