Srithai Superware

Srithai Superware Plc (SITHAI)

Investment thesis: We have initiated coverage on SITHAI with a conviction BUY rating and a YE12 target price of Bt20.50, pegged to a PER of 13.4x. We expect an exceptional 3-year earnings CAGR of 27%, driven by an ongoing strategic migration up the value chain from low-margin plastic moldings for the automotive and home appliance industries to fat-margin, high-growth PET bottle and food packaging applications. The stock currently trades at an FY12 PER of 10x, equal to its long-term mean, implying PEG of 0.2x and a PBV/ROE ratio 0.1, deep discounts to the Consumer sector multiples of 27x, 0.9x and 7.3x respectively. We have identified four major investment themes.
Theme 1—PET bottle business is taking off: SITHAI is a big supplier to Coke and now has a contract to supply Pepsi (since Sermsuk and Pepsi split). The firm also guides that it has a forthcoming contract with a major bottled water firm (15% market share). As such, we expect an explosive 3-year Food & Bev Packaging sales CAGR of 42%, FY11-14. There is also scope for upside to our projection from sales expansion in Pepsi Vietnam and new food packaging projects for CPALL.
Theme 2—strategic migration to boost GM by 200 bps: The firm is easing out from low-margin OEM manufacturing (plastic parts for the automotive and electrical appliance industries) and expanding into products that pay fatter margins. We expect FY12 GM to jump 200 bps YoY as a result. Furthermore, 3Q12 price rises for some product lines of up to 10% will boost GM.
Theme 3—balance sheet supports CAPEX & a good DPS: The debt/equity ratio was just 0.7x at end-March; SITHAI’s debt covenant is a hefty 2.0x. In theory, the firm could borrow another Bt5.5bn without upsetting its bankers. Management guides for only Bt1bn in CAPEX in FY13. The assumed dividend yield is 6.3%, based on a payout ratio of 65%.
Theme 4—a re-rating is deserved: SITHAI currently trades at a 63% discount to the Consumer mean. But its business is transitioning from a low-margin maker of OEM parts to a fat-margin vendor of Food & Bev packaging. Once the market recognizes that fact, it will bid the stock up.

Background
Srithai Superware (SITHAI) is one of Thailand's biggest manufacturers of molded plastic and melamine
resin products for industrial and consumer use—PET bottles, screw caps, ready-to-eat food packaging, pallets,
battery cases and parts used in the automotive and home appliance industries.
Its operation comprises three broad categories—Industrial (plastic molding), Household products
 (made from melamine resin) and Trading (health and consumer products branded Snatur).

Outlook
Explosive new business growth story—earnings to double in two years: We anticipate: 1) a 3-year plastic sales CAGR of 11%, FY11-14, 2) steady melamine tableware sales growth of about 3% annually and 3) hefty YoY gross margin expansion of 200 bps in FY12. The plastic sales growth driver is SITHAI’s Food & Bev Packaging unit, which started operating in FY08 and took off in FY10 (an FY09-11 sales CAGR of 90%). We expect the unit to deliver a three-year sales CAGR of 42%, FY11-14. SITHAI’s existing melamine tableware business sales should post steady growth of at least 3% annually, supported by export sales to the Middle East and South Asia. As such, we currently model for a three-year earnings CAGR of 27%, FY11-14 for SITHAI. There would be scope for upside if the Food & Bev Packaging unit were to expand faster than we currently assume.

Food & Beverage Packaging—the growth driver
Food & Bev leading industrial sales growth: SITHAI’s overall industrial sales CAGR, FY09-11, was 23%. The Food & Bev Packaging unit really started to take off in FY10, a year after it started making PET bottles and caps for the carbonated softdrink (CSD) and bottled water industries. The company supplies Coca Cola Thailand and will start making PET preform and screw cap bottles for Pepsi Thailand this October. Bottled water firms are also big clients. SITHAI’s existing customers account for more than 25% of Thailand’s drinking water market (Figure 3) and it will soon start supplying a brand that accounts for another 15%.
But the PET bottle is just a fungible commodity product, right? It’s actually more complicated than you might think. In 2008, SITHAI bought a license to use the bottle cap design technology of Universal Closures Ltd (UCL), a British firm that specializes in developing packaging for food & beverage and personal care applications. UCL’s technology is one of only a handful that Coca Cola has approved for use as packaging for its beverages. The closure design uses a one-piece fabrication method that requires less PET than other methods. The bottle cap weighs less and is of a higher quality than other designs. In this regard there is a barrier to entry in addition to the investment cost. There are also other hurdles for potential market entrants.
SITHAI has two contracts, both of durations of three years, to supply Pepsi’s operations in Vietnam (starting July) and Thailand (starting October). Within acceptable cost parameters, established CSD brands generally prefer supply reliability and product quality over price considerations.

Riding on RTE food growth: Apart from beverage packaging, there is great potential for ready-to-eat (RTE) food packaging. SITHAI currently supplies ready-to-eat food packaging to CPALL, popcorn buckets & cups to MAJOR and Chinese noodle packaging to CPF. The revenue contribution from food packaging remains small at about 5% of total plastic sales, but we expect it to rise in tandem with the expansion of the RTE food industry. Within the global food industry, Asian players mostly rank in the first quartile in terms of revenue growth with a mean 5-year earnings CAGR of 16%.

Steady melamine product sales growth
Domestic melamine tableware market leader: SITHAI has an overwhelming 80% share of the melamine resin tableware market, a position it holds because of its reputation for quality. As such, sales growth is likely to be dominated by exports. We forecast an FY11-14 sales CAGR of 3%. The GM for melamine tableware products is typically 25-30% and SITHAI has posted a double-digit operating profit margin for the last three years straight. The chief constraint is that that the production process is relatively labor-intensive. SITHAI’s melamine plant currently runs at 75-80% of nameplate capacity (13,500 tonnes/year), due in large part to a shortage of labor.
Exports and offshoring: There are huge and growing markets for melamine products in the Middle East region and South Asia. With the prevailing Thai labor shortage being a constraint to melamine tableware business growth, SITHAI is considering setting up a new plant overseas, probably in India, where the scope for market growth is massive. If the firm were to announce a greenfield project, we would update our model.
Ambitious trading business target
Revenue to increase 3-fold within 3 years: The firm’s multi-level marketing (MLM) nutritional supplement business should generate Bt300m in revenue this year. It isn’t yet profitable because of the huge initial investment cost. Management guides that sales will triple to around Bt900m in FY15, which would seem achievable. The GM of an MLM business is typically 50%, according to management, but SG&A also tends to be huge, as commissions generally range 20-30%. 

Margin expansion
Business in transition: SITHAI is transforming from a low-margin (2-5%) OEM plastic parts manufacturer for the automotive and electrical appliance industries to fat-margin (typically 15%), high-growth PET bottle and food packaging applications. The Food & Beverage Packaging unit’s FY11 sales comprised 24% of the Industrial business’s revenues and 14.6% of the top-line. Management targets expanding this proportion to 50% within 2-3 years. Our sensitivity analysis (Figure 7) indicates that every 10% increase in the Food & Bev Packaging unit’s proportion of total sales would enhance GM by 73-109 bps.
Higher wage costs versus price rises: 1Q12 GM expanded by 200 bps YoY, driven by SITHAI’s ongoing business transformation. The company’s personnel expenses costs rose in 2Q12 with the minimum wage increase, which is likely to bring on some short-term GM squeeze. We ran a back-of-the envelope calculation to determine the scale of the squeeze. Assuming a 25% jump in wage costs and the same sales breakdown, GM would decline by 230 bps, but would bounce back in 3Q12 because on July 1 SITHAI upped its prices for melamine tableware products and for some industrial products. As such, the net impact would be GM expansion of 113 bps in 3Q12. But actual GM squeeze may be milder than our numbers suggest—sales of Food & Bev Packaging applications are rising much faster than sales of anything else and the labor component of F&B applications is low.
Regional expansion plans: SITHAI is building a factory in Vietnam that is due to start operating in 2H13. Management is also considering a venture in India. The chief motivation is that wage costs in the two countries are much lower than in Thailand. But the Vietnamese plant will initially represent only a tiny proportion SITHAI’s current total production capacity. India is still a concept in progress.

Risks
Raw material price fluctuations: Raw material prices are the key risk, as they comprise around 70% of costs. SITHAI can pass through cost rises to customers, but there is a time lag of from one to three months, depending on the product.
Exchange rate risk: Currency movements bring some risk of margin squeeze. But there is a substantial degree of natural hedging.
Failure to expand overseas: If SITHAI’s overseas expansion plans were to come unstuck, its scope for long-term growth would be diminished.

Recommendation and valuation
Compelling valuation—initiate BUY call, TP of Bt20.50: SITHAI currently trades at an FY12 PER of 10x, equal to its long-term mean, implying PEG of 0.2x and a PBV/ROE ratio 0.1. But the company is transforming and its net margin is expanding as a result. Because of its ongoing transition to a fatter margin business model, we think it is much more appropriate to compare the stock to the Consumer sector than to manufacturers. The Consumer sector trades at multiples of 27x, 0.9x and 7.3x respectively. As such, we have initiated coverage with a BUY rating and a YE12 target price of Bt20.50, pegged to 0.5SD above its long-term average.