Thong Guan (1)

Profiting From Humble Plastic Bags

Publish date: Sat, 5 Jul 2014, 12:51 PM 

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1. Introduction

I bought Thong Guan way back in 2002. Sold it shortly for a small profit and move on to something more exciting.

Thong Guan recently reported good results. The company is also in the middle of doing a rights issue. The rights seemed attractive. In view of the above, I decided to take a closer look.


2. Principal Business Activities

Thong Guan manufactures stretch films, garbage bags, flexible packaging, calcium carbonaten and PVC food wrap.

Stretch Films   -  Thong Guan is a specialist in the manufacturing of Cast LLDPE stretch film with annual production capacity of over 60,000 metric tons. 



Garbage Bags  -  Thong Guan has been exporting garbage bags to Japan, its largest market, since the 1980s. The group has production capacity of over 40,000 Tons per annum.

Flexible Packaging  -  Thong Guan’s Flexible Packaging division serves various industries including the food and beverage industries, industrial segments, agriculture, medical, building and construction segments along with packaging for retail and domestic use.

Calcium Carbonate  -  Thong Guan’s Calcium Carbonate (CC) is designed to improve the performance of polyethylene film, sheet, and injection and blow moulding applications. The company's CC contains 75% of natural, fine and surface treated CaCo3 combined with LLDPE resins and additive to improve dispersion and melt flow.



Food Wrap  -  Thong Guan's PVC food wrap is marketed under the name "Purewrap".




2. Financial Information

Based on 105 mil shares outstanding and share price of RM2.38, Thong Guan has market cap of RM250 mil.

The group has strong balance sheets. Group borrowing is RM39 mil while cash is RM78 mil. As such, the group is in net cash position of RM39 mil. Net assets is RM296 mil.

The group reported net profit of RM28 mil for the financial year ended 31 December 2013. Based on market cap of RM250 mil, PER is 8.9 times.




3. Historical Profitability

Thong Guan has been consistently profitable since 2000, even during the 2008 financial crisis.

(RM mil)	2000	2001	2002	2003	2004	2005	2006
Revenue	133	141	177	228	322	380	470
Net profit	12.3	6.1	10.8	21.5	26.8	22.9	21.6
Net margin (%)	9.2	4.3	6.1	9.4	8.3	6.0	4.6
DPS (sen)	5.00	5.00	0.00	5.00	5.00	5.00	3.00

(RM mil)	2007	2008	2009	2010	2011	2012	2013
Revenue	518	565	409	489	540	631	721
Net profit	12.1	4.6	15.2	19.8	27.0	27.2	28.1
Net margin (%)	2.3	0.8	3.7	4.0	5.0	4.3	3.9
DPS (sen)	3.00	2.00	4.00	5.00	6.00	7.00	8.00

Since 2009, the group has been increasing dividend payout consistently.
DPS rose from 4 sen in 2009 to 8 sen in 2013.
Based on latest market price of RM2.40, dividend yield is 3.3%.



4. Rights Issue

Thong Guan is in the process of undertaking a rights issue to raise up to RM52.6 mil.

The rights issue is on the basis of 1 rights ICULS and 0.5 free warrants for every share held.

The ICULS has conversion price of RM1.00 and bears 5% coupon.
The free warrants have exercise price of RM1.50.

Both instruments expire in 5 years. The rights issue has been approved by shareholders in EGM.

The RM52.6 mil proceeds will be utilized as follows :

(a) RM33 mil for purchase of machineries to expand production of PVC food wrap, stretch film and blown industrial films.

(b) RM18 mil for working capital purpose.

(c) RM1.6 mil for others.



5. Prospects of Malaysia Plastic Industry

(a) plastic industry is one of the most dynamic sectors in the country's manufacturing sector.

(b) produce an array of products including automotive components, electronic parts, construction materials, household goods, packaging materials, etc.

(c) Malaysia is one of the largest plastic producers in Asia with over 1,500 manufacturers. The products are exported worldwide including EU, China, HK, Singapore, Japan and Thailand.

(d) the success of this industry is attributable to the existence of a developed petrochemical sector in Malaysia.

(e) the largest sub sector is plastic packaging involving both flexible (films and bags, etc) and rigid (containers). Malaysia is one of the world's leading suppliers of plastic bags.

(f) future prospect is expected to be bright with further growth in export sector for packaging material

(Source : rights issue circular)



6. Prospects Of The Group

(a) the group has annual combined production capacity of 120,000 MT of plastic products.

(b) currently operating at 89% utilization rate.

(c) core manufacturing operations located at Sungai Petani, Kedah. Also at KK (Sabah), Suzhou, China, and Bangkok.

(d) to further grow its operations, the group intend to implement the following strategies :

(1) maximizing existing capacity utilization and add on capacity to areas where demands consistently outstripped supplies and products that offer higher profit margin.

(2) expand focus on environmentally sustainable products such as thinner films produced from technologically advanced materials and machinery.

(source : rights issue circular)



7. Factors That Can Affect Profitability

(a) Raw Material Cost

According to the group's FY2007 and FY2008 annual reports, it seemed that increase in raw material cost (naphta, natural gas, polyehylene resins, etc) will to a large extent be passed on to customers. High raw material price is usually matched by higher turnover.

(b) Foreign Currency Exposure

The group's profitability is very sensitive to Ringgit movement against customer countries currency (EU, Australia, Japan, SIngapore). Strengthening of Ringgit will adversely affect the group's price competitiveness and depress profit margin.

(c) Labour & Electricity Cost

Labour and electricity are major cost components. Higher cost will have negative impact on profit margin. 

(d) Tariffs

In 2010, the European Union imposed anti-dumping duties on China and Thailand based producers. This has benefited Malaysian producers like Thong Guan. The tariffs once imposed, will be in place for several years.



8. Concluding Remarks

(a) Thong Guan is a company that has been in operation for many years. It has proven itself to be able to compete in international market despite challengers from other low cost producers (especially China). Based on the abovementioned track record, Thong Guan should be able to continue to do well going forward.

(b) Just like any other manufacturing industries, the plastic industry is subject to various factors that affect its profitability and competitiveness. However, over the years, Thong Guan has demonstrated that it can make the necessary adjustment to mitigate the challenges brought about by the changes.

(c) the rights issue is attractive. Based on estimated theoretical ex-price of RM2.10 (in the rights issue circular, the company states that based on market price of RM2.18, theoretical ex-price is RM2.04) and warrant exercise price of RM1.50, the warrants should be worth at least RM0.60 per unit.

As 1 ICULS comes with 0.5 free warrants, the effective subscription cost for the ICULS is only RM0.70. Based on coupon of 5%, effective yield will be 5 / 7 = 7.1%. As a result, the rights ICULS should be well received and fully subscribed.

(d) the bulk of the rights proceeds has been earmarked for capacity expansion. This will be the driver for profit growth over the next few years.

(e) Despite all the good points that I mentioned above, I would like to caution that my analysis is based on publicly available information. Unless given access to senior management who is willing to share certain information (especially near term prospects), manufacturing companies' future profitability is not easy to predict due to the many factors that can potentially affect their operations.
If you are interested in gaining exposure to Thong Guan, you need to be patient and be willing to hold long term.

Have a nice day.