A growing and glowing story: Scientex Berhad

“Growth is never by mere chance; it is the result of forces working together.”

James Cash Penney

Few retail investors are interested in Scientex Berhad. The share price hardly moves (in the short term), there ain’t no excitement. Why bother about it?

Historical Share Price movement

Figure 1a below shows the steady increase in share price of Scientex (SCI) from 2000 to 2014. It has risen from an adjusted price of less than 62 sen 14 years ago to the close of RM5.74 on 21st July 2014, 8.3 times increase in price, or a compounded growth rate (CAGR) of 16.7% a year. This compares to 104% or a CAGR of just 5% for the broad KLCI during the same period. The steep rise of share price of SCI was actually from March 2009 when it recovered from the US sublime housing crisis when the share price rose from 85.5 sen to RM5.74 now for a total rise of 580%, or a CAGR of 43.5%, compared to 116%, or a CAGR of 15.6% for KLCI. The extra-ordinary return of SCI over the broad index is truly extraordinary.

Figure 1a: Scientex historical share price movement

Corporate background 

Established  in  1968,  SCI  was  previously  involved  in  the production of  polyvinyl  chloride leather cloth as well as  sheeting for industrial and  consumer  products. SCI diversified into property development in 1995, with its existing projects now predominantly centered in Johor and Melaka.  SCI’s  property  development  division  is currently  sitting  on an  undeveloped  land bank of  990  acres  with  a  total remaining GDV of MYR4.4bn to be developed over the next 10 years.

After the takeover of GW Plastic Bhd end of 2012 and the acquisition of Seacera Polymer Sdn Berhad early this year, SCI became one of the world’s leading industrial packaging manufacturers with various products such as stretch film, laminated bags, bulk bags, corrugated carton boxes etc. It is now the third largest stretch film manufacturer in the world and the largest in Asia with about 33% market share. Its annual production capacity of flexible stretch film reaches 194,000 tonnes per year. The group manufactures resin-based film for the logistics, food & beverage (F&B) and fast-moving consumer goods (FMCG) segments. Its products are being exported to over 60 countries around the world.  

The group’s manufacturing division contributed 79% of its topline and 54% of consolidated EBITDA in 1QFY14, while the remainder was from its property division. SCI’s  growth  will  be driven  further by  the expansion  of  its  manufacturing  production  lines  as  well  as  sustainable growth  in  its  property  development in the coming years. Figure 1 below shows the corporate structure of SCI.

The quality growth story

Figure 2 below shows the unabated growth, except with a little kink during the US sublime crisis in 2009, of SCI from RM250 million sales in 2003 to the Billion Ringgit Club of RM1.23 billion in 2013, a CAGR of 17.3% for the last 10 years.

I normally am not too excited about this type of high revenue growth story unless it is accompanied with corresponding earnings growth. SCI does satisfy this quality growth as shown in Figure 3 below.

Earnings grew in tandem with sales from RM7.0m in 2003 to RM112.5m in 2013, or a CAGR of 32% for the last 10 years. More importantly, the earnings growth is accompanied with continuous growth in cash flows. Figure 3 shows that cash flows from operations have been consistently more than net profits, signifying the excellent quality of earnings and its growth.

The great story is replayed in its balance sheets with its growth in equity as shown Figure 4 below.

The common shareholder equity grows by 8% and 13% for the last ten and five years respectively. This is despite SCI having been giving good dividends all these years. Just how has SCI been funding this high growth?

Return of Equity (ROE)

The ROE of SCI improves by leaps and bounds from less than 2% ten years ago, surpassing 10% in two years later in 2005, and surging to 17.5% in 2013. The high ROE provided surplus funds from its ordinary business to be invested to improve business operations without the shareholders having to invest more capital. It also means that there is less need to borrow. That is exactly what SCI is able to achieve as shown in Figure 5 below.

How is the efficiency of SCI compared to its peers? The picture in Figure 6 below paints a thousand words. It shows the comparison among some flexible plastic packaging companies with SCI.

It is evidence that SCI is the best among its peers in terms of operational efficiencies.

I always say that a good company is not necessary a good investment if the price is not right. Let us examine the market valuation of SCI compared to some of its peers.

Some Simple Valuations

At the close of RM5.74 on 18^th July, 2014, SCI is trading at a price 11.6 times its 2013 earnings and 2.1 times its book value, 6.2 times its cash flows and 8.4 times free cash flow as shown in Table 1 below. Its enterprise value is 1.3 times its sales. Earnings yield at just 9.4% appears to be slightly pricey.

Table 1: Comparisons of valuations of SCI with its peers

Comparing with another leader in flexible plastic packaging company Daibochi with slightly lower efficiencies, despite SCI being four times the size of Daibochi in revenue, Scientex is trading much cheaper in every aspect. For example, PE and P/B ratio at 11.8 and 2.1 is 30% cheaper than those of Daibochi. Earnings yield wise, it is 40% cheaper.  Its price to cash flows and sales are also much cheaper.

Compared with Thong Guan, Scientex PE ratio is higher by 30% and earnings yield lower by 20% and hence appears to be pricier. However, SCI’s ROE is 80% higher and its price-to-CFFO is 50% lower

Scientex price to cash flows are also cheaper than all other companies. Its price to earnings and book value are generally higher though compared with other companies.

Discount cash flow analysis

Using the following data and assumptions, the discount cash flow analysis shows that the intrinsic value of SCI is RM8.51. This represents a margin of safety of 33% investing in SCI at RM5.74.

Data and assumptions

Average Free Cash Flow for firm the last 5 years RM93.3m

Growth in FCF, next 5 years 12%, 7% subsequent 5 years and a terminal growth of 3% after.

Discount rate 10% as its earnings and cash flow are stable and with high earnings visibility.

The results are shown below:

Scientex third quarter 2014 results

SCI announced its third quarterly 2014 result ended 30^th April 2014 on 19^th June 2014. For the nine months period, revenue increased by 37% to 1.175b while net profit increased by 27% to 101.7m, or 45 sen per share. The growth story appears to be well alive.

Catalyst?

With such a convincing growth story, do you really need a catalyst for its share price to go up? Think about it, may be a corporate exercise such as a 1 for 1 bonus will be good as SCI has heaps of retained earnings of 5 times its share capital to do that. Another possible corporate exercise is the spinning off its highly profitable property development arm to unlock its true value.

Conclusions

SCI has a long history of glowing growing story, thanks to its dynamic management with the same interest alignment with the shareholders. More importantly there is clear visibility of its high future earnings growth too. It has growing high efficiencies which provide it with internally generated capital for future growth.  It is the biggest among its peers in Bursa and hence a good marketing network, pricing power and cost advantages over its peers for sure. I particularly like its abundance in cash flows. However, taking everything into consideration, its market valuation is inexpensive, and in fact much lower than Daibochi, its nearest investing rival in every aspects. The margin of safety of 30% provides adequate safety net investing in this stock.

Does this mean that we can have our cake and eat it too by investing in SCI at RM5.74? 

K C Chong on 21st July 2014.