TGUAN may see a spike in orders as its customers rush to stock up ahead of price hikes (prompted by the rising cost of input resin). However, we acknowledge that a more sustainable recovery in demand still hinges on a stronger global economy. We cut our FY23F earnings by 5% mainly to reflect higher electricity cost. We maintain our TP of RM3.05 and OUTPERFORM call.

We came away from a post-results engagement with TGUAN feeling reassured of its FY24 and longer-term outlook despite current macro challenges. The key takeaways are as follows:

1. Customers may rush to stock up ahead of price hikes. Amidst the rising cost of input resin (see chart on next page) that will eventually prompt plastic packaging producers to raise products prices, stockists and users of plastic packaging users may rush to stock up. Already, TGUAN has recently seen a pick-up in orders for its courier bags and nano stretch film. However, we acknowledge that a more sustainable recovery in demand for plastic packaging products still hinges on a stronger global economy.

2. Certain products are more resilient. Amidst macro headwinds, we expect the demand for TGUAN’s stretch film (especially nano stretch film) to stay resilient given: (i) its price competitiveness vs. those produced by European and US producers, stemming from TGUAN’s lower energy and labour costs; (ii) TGUAN’s proprietary technology in producing thinner but stronger film, making its product more economical, environmentally friendly (i.e. using less resin to produce the same square metres of film) and suitable for automated packaging (because of the added strength). In 2QFY23, stretch film made up half of TGUAN’s total turnover. Similarly, we expect the demand for TGUAN’s industrial bags (comprising lamination films, oil bags, sugar bags, shrink film, stretch hood) to stay robust given that they are mainly used in the F&B and FMCG sectors which are less affected by the economic downturn. In 2QFY23, industrial bags contributed to 17% of its total revenue.

3. Expansion plans proceeding as planned. Meanwhile, its 9th nano stretch film machine has been commissioned, and the installation of its 10th nano stretch film machine is on-going. These additions should boost its overall stretch film capacity by 25%-30% and help it to supply to countries like Spain, Mexico, Germany, UK and USA.

4. Higher electricity cost. Starting in Aug 2023, TGUAN will be facing a monthly increase of RM1m in electricity costs after opting out from the Green Electricity Tariff (GET) programme. The decision was made due to the higher GET rate of 21.8 sen/kWh (from 3.7 sen/KWh), compared to conventional ICPT surcharge of 17.0 sen/kWh. Note that this increase is higher than what we had expected as TGUAN clarified that 90% of its electricity consumption was under the GET programme which we had estimated at only 20%-30% previously. TGUAN plans to raise ASP in order to pass on the higher electricity cost to its customers. To further mitigate the impact, it is working to ramp up its solar PV system installation.

5. Conserving cash. TGUAN will not declare a dividend for 2QFY23 despite being in a net cash of RM63.3m. It is more inclined to channel the excess cash towards funding its on-going expansion plan as mentioned as well as to use it as a buffer in the event the global economy turns south. As such, we cut our FY23F dividend by 14% to 4.75 sen (from 5.50 sen).

Forecasts. We trim our FY23 earnings by 5% largely to reflect higher electricity cost.

However, we keep our TP of RM3.05 based on 11x FY24F PER, at a discount to the sector’s average historical forward PER of 13x to reflect TGUAN’s low share liquidity. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 5).

We continue to like TGUAN due to: (i) the growth potential of the local plastic packaging sector as Malaysian players like TGUAN are gaining market shares from overseas producers that are losing competitiveness due to rising production costs, Its aggressive push into the European and US markets with environmentally-friendly products. (ii) TGUAN’s earnings stability underpinned by a more diversified product portfolio and steadily growing clientele base, and (iii) its expansion plans for premium products, such as nano stretch films, courier bags, food wraps and some industrial bags (wicketed bags, oil/flour/sugar bags). Reiterate OUTPERFORM.

Risks to our call include: (i) a sudden surge in resin costs, (ii) weak demand for packaging materials due to prolonged global recession, and (iii) labour shortages and supply chain disruptions.

Source: Kenanga Research - 8 Sept 2023