Does SCGM Bhd Pack The Punch For Investor?

SCGM Bhd – A Closer Look

SCGM Bhd (“SCGM”) was incorporated in Malaysia on 29 June 2007 as an investment holding company with its subsidiary, Lee Soon Seng Plastic Industries Sdn Bhd (“LSSPI”) principally involved in manufacturing and trading of plastic products. In a span of 34 years, the Group has grown to become a leading thermoform food and beverage (“F&B”) packaging manufacturer in Malaysia.

As at 25 October 2019, the Group has a market capitalisation of approximately RM249.74 million. In this article, we will take a closer look at the business, management and financial aspects of the Group, to gauge its suitability as an investment.  

Business highlights

SCGM provides one-stop plastic packaging solutions to customers in Malaysia and overseas across wide-ranging sectors, including F&B, electronics and medical industries. The table below shows the geographical and customer segmentations of the business over FY2015 to FY2019. 

Source: 2019 annual report

Broadly, SCGM produces 2 different products: extrusion sheets/ thermoplastics and thermo-vacuum formed plastic packaging. Extrusion sheets are semi-raw materials that can be sold or used as a raw material for thermo-vacuum products. Sales of extrusion sheets accounted for 13.3% of the Group’s total sales for financial year (“FY”) 2019.

On the other hand, thermo-vacuum formed plastics are plastic products that go through the process of heating extrusion sheets as well as forcing it over a mold surface with the help of vacuum. The thermo-vacuum products are typically for use in packing F&B (sandwiches, cakes, biscuits, salads, fruits, etc.) and electronic products (liquid crystal display, hard disk drive parts, etc.). Sales of thermo-vacuum plastic products to F&B and electronic customers accounted for 80.6% and 6.1% of the Group’s total sales for FY2019 respectively. Picture samples of SCGM’s thermos-vacuum products are shown below.

In the last quarter of FY2019, the Group completed the transfer of machinery from the previous Kulai plant to the new factory. Situated on a15-acre land with a built-up area of 600,000 square feet, the RM121 million new plant is significantly larger than the previous premises. The larger space afforded SCGM increased floor space to house additional machinery, as well as streamline processes to maximize efficiency. With the new Kulai plant and its Klang Valley manufacturing facility, SCGM’s extrusion capacity rose from 41.0 million kg per year to 67.6 million kg per year.

We share below our views on the strength and weaknesses of the Group’s business model: –

• SCGM operates in an industry where competitors are abundant. The commoditized nature of their products also means that customers are price sensitive. To maintain cost leadership, SCGM has had to invest in advanced extrusion and thermoforming machinery technologies, which require significant capital outlay. However, an advantage of high-speed automated machinery is that it requires less manpower and helps the Group to counter workers wage inflation.

• The raw material of SCGM’s products are petroleum based derivatives such as Polyethylene (PE), Polypropylene (PP), Polyvinyl Chloride (PVC) and Polycarbonate (PC). Consequently, the costs of raw materials move in tandem with fluctuations in crude oil prices. A spike in crude oil prices (and in turn raw material costs) will affect the Group’s bottom line unless it is able to pass on cost escalations to its customers.
  
  

To be fair, factors such as oil and resin prices are not within management’s control. In such circumstances, we seek an experienced management team to navigate the challenging industry landscape.

• Historically, the Group’s growth in sales has come from the F&B segment, where there is increasing consumer demand for more environmentally friendly products. Heading the call for sustainable food packing, SCGM has introduced a line of eco-friendly products in an effort to reduce its carbon footprint. Developed in collaboration with Sugianto Tandio (the founder and world-renowned innovator of eco-tech plastic solutions), SCGM’s “Benxon” – brand degradable plastic packaging obtained SIRIM certification (Malaysia Regulator) for the usage of the Eco-Label mark from June 2017 onwards. This demonstrates management’s adaptability to changing industry trends.

Management

Dato’ Sri Lee Hock Seng (68, Malaysian) Executive Chairman	Appointed as Executive Chairman / Managing Director on 19 December 2007. Re-designated as Executive Chairman on 9 December 2015. One of the founders of LSSPI and has been the Managing Director of LSSPI since its incorporation on 4 May 1984. Responsible for the strategic business development and future directions of the Group. Frequently travels abroad to keep abreast with the latest developments in the packaging industry and to explore new market prospects for the Group.
Dato’ Sri Lee Hock Chai (57, Malaysian) Managing Director	Appointed as Executive Director of SCGM on 19 December 2007. He is also Executive Director of LSSPI since 4 May 1984. One of the founders of LSSPI. He was promoted as the Managing Director of SCGM on 9 December 2015. He is presently responsible to implement and execute the strategic business development plan of the Group. He has more than 34 years of experience in the field of research and development.
Dato’ Sri Lee Hock Guan (58, Malaysian) Deputy Managing Director	Appointed as Executive Director on 19 December 2007 and was re-designated as Deputy Managing Director on 15 March 2017. He has been an Executive Director of LSSPI since 4 May 1984.He presently assists the Managing Director in areas which include overall material requirement planning, manpower, product capacity, general machinery maintenance and overall safety in production activities.
Mr Lee Hock Meng (65, Malaysian) Executive Director	Appointed as Executive Director on 19 December 2007.Joined LSSPI in 1990 as a Logistics Manager. He is presently responsible for overall shipping and logistics management for the Group.

(Source: 2019 annual report)

As investors, we prefer businesses that are founder owned and managed. Since the directors of SCGM are also substantial shareholders, we trust that they would be motivated to ensure the continued success of the Group.

Financials

(Source: 2019 annual report)

While sales have doubled from RM106.63 million to RM219.57 million over the past 5 years, profits have unfortunately not grown in tandem. In fact, the Group has recorded its first ever annual loss of RM5.12 million in FY2019 since listing. Management has attributed the loss in FY2019 to i) higher resin prices (due to higher crude oil prices), ii) increases in depreciation and finance costs and iii) a significant jump in tax cost due to deferred tax liabilities recognized on the new machinery and new Kulai plant.

At the same time, the Group’s financial position has deteriorated from a net cash position of RM2.13 million in FY2015 to a net debt position of RM107.68 million in FY2019. Nevertheless, SCGM has continued to a declared generous dividend in FY2019, well above the dividend policy of 40% of profits. With the gearing level at an all-time high of 0.69x, the Group could consider reducing its dividend payout temporarily to pare down its debts.

(Source: Google Finance)

The Group’s share price has since seen a sharp sell-off following the recent poor performance. This is in spite of management’s efforts to provide some share price support through a series of insider and company share buybacks.  

(2017 – 2019 insider trades, Source: KLSE investor)

(2018 – 2019 share buybacks, Source: KLSE investor)

Conclusion

As investors, we should not be swayed by the action of insiders, instead we should think for ourselves if there are any merits for an investment. At a market valuation of RM249.74m, the stock is currently trading at 15.23x FY2018 profits after tax, indicating that the stock is more than fairly valued.  

Therefore, any further upside in share price would depend on whether the Group is able to turnaround its business. I would track the quarterly results of the Group to look for signs of improved performance. I would also look at securing answers to following questions: –  

1. What is the outlook for resin prices and how great of an impact would it have on profit margins?
2. What are the Group’s plans to improve plant utilization and control costs?
3. What are Group’s strategies to secure more customers in both local and overseas markets given the large plant capacity?
4. Does the Group have any plans to dispose its old Kulai plant since the migration process to the new plant is completed?
5. Does the Group have plans to pare down its borrowings?

Notwithstanding the above comments, my view is that SCGM does not have the attributes of a high-quality business. The business does not seem to have a competitive advantage or “economic moat” and operates in a highly competitive industry. At this juncture, I will set it aside for now as a potential investment.

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