TGuan: Moving Up The Value Chain

In stock market investing, I like growth, especially when a small company grow into a big company.

Thong Guan seems to have the potential to be one of such companies.

TGuan, which is based in Sg Petani, is a small company with market cap of RM200mil (RM1.97 x 105mil shares).

It has 2 business divisions:

• Plastic products manufacturing & trading
• Food & Beverage manufacturing & trading

Its plastic products include stretch film (like Scientex), garbage bags, PVC food wrap etc.

Its F&B products are mainly tea & coffee marketed as "888" brand, and also some organic food.

TGuan was established way back in 1942 and was initially involved in distribution of coffee and tea. It ventured into manufacturing and trading of plastic products in the 1970s.

It was listed in 1997 on second board and was promoted to main board in 2002.

It was once the largest stretch film producer in Asia Pacific region. However, I think this title should belong to Scientex now.

Anyway, TGuan is still the largest manufacturer of PVC food wrap in Malaysia.

In year 2014, TGuan tabled a 3-year RM100mil expansion plan until 2016.

This aggressive capex aims to expand its plastic manufacturing division especially its stretch film and PVC food wrap .

CIMB Research expects TGuan's production capacity to increase by 40% from 120,000MT in early 2014 to 170,000MT per annum in 2016.

The initial plan laid out includes:

• Install thin stretch film machines with in-line pre-stretching capability & edge-folding
• Increase PVC food wrap production lines from 4 to 10 lines
• Install 33-layer nano-tech stretch film line
• Install its first blown film line
• Setting up an R&D center

Before this capex plan in early 2014, TGuan already has:

• 11 stretch film lines (9 in Malaysia, 2 in China) with annual capacity of 80,000 MT
• Garbage bags lines with annual capacity of 40,000 MT
• 4 PVC food wrap lines with annual capacity 6,000 MT

From TGuan's 2014 annual report, it is mentioned that TGuan has successfully installed the thin stretch film line in 2014.

At the same time, two additional PVC food wrap lines (5th & 6th) have also been added to increase its production capacity to 720 MT/month, or 8,640 MT/annum.

From its latest FY15Q2 quarterly report released in Aug15, it seems like the nano-tech stretch film line, blown film line and R&D center are still not in place.

Anyway, it has acquired organic noodles manufacturing facilities recently for its F&B division.

In 2016, it will continue to increase its PVC food wrap lines to 10 line with total production capacity of 15,000 MT annually.

Besides, I believe that it will also increase the production capacity of its thin stretch film gradually.

So, we know that PVC food wrap production will get an 150% rise in production capacity. How much net profit can it contribute to TGuan in the future?

This PVC food wrap business is a JV with a Korean company Power Wrap Inc since 2011. TGuan has 85% shares in it.

In FY14, TGuan's PVC food wrap division (TGPW) contributed RM32.8mil revenue and RM3.25mil profit to TGuan. 

Since the additional 5th & 6th lines were ready only at the end of year 2014, the figures above should be derived from 4 production lines.

This means that 150% increase in capacity can potentially raise the profit contribution from TGPW to RM8mil (should be operating profit).

As TGuan owns 85% of TGPW, it will work out to be around RM7mil.

Meanwhile, its stretch film capacity might also get some significant increase in capacity, especially the thin & nano-tech film which fetch higher margin.

In FY14, TGuan's PATAMI dropped 38% despite a slight increase in revenue.

The drop in profit is mainly due to forex loss and impairment of receivables etc which adds up to almost RM10mil.

Without these special items, TGuan's PATAMI should stay flat at around RM27mil since 2011.

With outstanding shares of 105.2mil, its "revised" EPS for FY14 should be 25.6sen.

At recent share price of RM1.97, it is trading at lowish PE of 7.7x.

I don't have any clue on how much profit its additional stretch film production can give.

If both PVC food wrap and thin stretch film can contribute an extra RM10mil net profit a year once fully operational, its projected FY16-17 net profit could be RM37mil.

Anyway, this is just a rough guess.

From info available online, TGuan's projected net profit for FY16 is RM35mil, RM27mil & RM40mil from RHB, Kenanga & CIMB respectively.

Base on the median projected net profit of RM35mil by RHB, its projected EPS in FY16 will be 33.3sen.

If given a PE ratio of 10x, its target price will be RM3.33!

Nevertheless, this is not the end of the story.

In order to raise fund for the massive expansion, TGuan undertook rights issue of 2 ICULS and 1 warrant for every 4 TGuan's shares in 2014.

This exercise was ex-ed in Sep14 with the listing of 52.6mil ICULS and 26.3mil warrants.

Both ICULS and warrants can be converted to TGuan shares at 1:1 with conversion price of RM1.00 & RM1.50 respectively before they expire in Oct 2019.

All ICULS are mandatory to be converted but holders can only do so after 2 years from listing, which is after Oct 2016.

This potential additional shares of 78.9mil shares is huge with a potential earning dilution of 75%, as TGuan's current outstanding shares are just 105.2mil.

If TGuan's PATAMI can reach RM35mil in FY16, its fully diluted EPS will be 19sen, though in accounting, diluted EPS is not calculated like that.

If its PATAMI stall at RM35mil until FY19, and all the ICULS and warrants are converted into mother shares, then it will not be good.

If I'm sure that its net profit can continue to grow beyond FY16 to FY19, then I will surely invest in it now.

However, no one can predict until year 2019.

Its profit may continue to grow due to penetration into new markets or Tokyo Olympic effect.

Its profit may also drop due to stiff competition, higher operating and raw material cost etc.

It might also implement another round of cash call for further expansion.

TGuan is a growing company with good balance sheet and cash flow.

Earlier this year it suffered significant forex losses due to high USD denominated loans used for expansion.

It has recently pared down its borrowings substantially and I can foresee healthy cash flow in the near future.

Sales to its major export market Japan suffers a bit recently after the increase of VAT (value-added tax) in Japan from 5% to 8%.

However, TGuan still enjoys the largest market share (12%) of garbage bag in Japan.

I think this is a remarkable achievement for a small cap company.

The only thing I don't like is its relatively huge ICULS and warrants.

I do not invest in SAM Engineering because of this similar reason. Just look at SAM now.