Tat Seng Packaging Group Ltd - Proxy to China's manufacturing and consumer sectors
What Is The News?
- Tat Seng Packaging Group Ltd (Tat Seng) recently announced its FY16 ended December full year financial results.
- Tat Seng recorded a 16.7% year-on-year (y-o-y) growth in PATMI, despite 1.3% y-o-y lower revenue. A final dividend of 2.0 cents and 1.0 cent special dividend were proposed.
- In this report, we highlight the growth drivers for Tat Seng, and suggest a valuation for the stock.
- No stock rating provided, as we do not have coverage on Tat Seng. However, our back-of-the-envelope dividend discount model (DDM) valuation of S$0.89 suggests that the market is currently mispricing the stock.
- Tat Seng designs, manufactures and sells corrugated paper packaging products such as corrugated boards and cartons for the packaging of electronics and electrical, food, pharmaceutical and other products.
What do we think?
Proxy to China's manufacturing and consumer sectors
- Tat Seng's exposure to the manufacturing and consumer sectors is through the sale of corrugated containers and paper packaging products. The forward indicator of the Manufacturing Purchasing Managers Index (PMI) for China suggests that demand for corrugated containers and paper packaging products is to be maintained.
Upstream players of the supply chain have also benefited
- Hong Kong Exchange-listed players from the upstream part of the supply chain such as Nine Dragons Paper Holdings (stock code: 2689) and Lee & Man Paper Manufacturing (stock code: 2314) have also benefited from the higher level of industrial and manufacturing activity in China.
Attractive dividend yield
- Tat Seng has a track record of paying dividends, and currently has a trailing yield of 7.0%, based on FY16's 4.0 cents dividends and the last close price of $0.57.
- As disclosed on the company's website, "Tat Seng Packaging Group Ltd is a leading manufacturer of paper packaging products listed on the mainboard of SGX-ST since 7 September 2001. Tat Seng designs and manufactures paper packaging products for the packing of a diverse range of products according to customers' specifications, and sells other packaging related products."
- The raw materials used in producing Tat Seng's products include paper, printing ink and glue. Paper supplies for the Singapore operations are sourced globally, while paper supplies for the China operations are sourced domestically.
- Two business segments by geography, predominantly in China Tat Seng reports its business segments by geography – Singapore and China. 85% of FY16 revenue was from within China (FY15: 84%), with the rest derived from Singapore.
Diversified customer base engaged in manufacturing and consumer sectors
- Tat Seng's customers include MNC and local manufacturers. Tat Seng discloses its customer base according to six sectors. For FY15, the three largest customer sectors were Printing, Publishing & Converters (40%), Medical, Pharmaceutical & Chemical (27%) and Electronics & Electrical (20%). There has been no change in relative distribution between customer segments over the last few years.
- Five sites catering to local demand in China Tat Seng has five facilities in China – namely, Suzhou, Jiangsu province; Hefei, Anhui province; Nantong Rugao and Natong Tongzhou, both in Jiangsu province and lastly, Tianjin.
Favourable macro indicators for paper packaging demand
- Paperboard is used to produce corrugated containers and folding cartons. Corrugated containers/boxes are made from containerboard, which consists of the linerboard (smooth outer surface) and the corrugating medium (known as inside fluting).
Paperboard and papers is the most widely used substrate globally
- According to leading packaging consultancy Smithers Pira, Paper and Board is the most widely used packaging substrate globally; accounting for 38% of global demand that was estimated to be worth US$776 billion in 2015. Global demand for Paper and Board has grown at a 10-year CAGR of 4.6% until 2015.
- Paper is used to produce two types of packaging: corrugated containers and folding cartons.
- Corrugated containers are the protective medium used in the transportation and storage of consumer and industrial goods.
- Folding cartons are the packaging that consumers see on store shelves.
Corrugated box demand is tied to industrial production and manufacturing activity
- We focus our attention on China as 85% of Tat Seng's revenue is derived from within China. China's Industrial production consists of three broad categories: Manufacturing, Mining and Utilities. Manufacturing production has been higher than the overall industrial production. Manufacturing Production growth in China has moderated, but is still above 6% y-o-y.
- The Manufacturing Purchasing Managers Index (PMI) is a forward indicator of demand for packaging products. Corrugated box demand is tied to manufacturing activity and China's PMI has maintained above the 50 expansion/contraction inflection point for the most part of the past five years.
- Boxboard (Folding carton) packaging is tied to consumer demand Consumer sentiment in China remains robust and this should support demand for folding cartons used for consumer products.
Company Financial Analysis
- Tat Seng's fiscal calendar ends in December and reports its financial results on a half-yearly basis – typically in mid-August for 1H and late-February for full-year financial results.
- For FY16, Tat Seng's gross margin improved to 22.6% from 21.1% in FY15. Lower year-on-year (y-o-y) operating expenses and finance expense resulted in higher net profit margin of 7.0% from 5.7% in the preceding year. PATMI margin of 6.4% for FY16 was accordingly higher than FY15's 5.4%.
Track record of revenue growth
- Tat Seng has been able to grow its revenue, albeit at a slowing pace in recent years.
Resilient gross profit margin with gross profit tracking revenue growth
- Tat Seng has defended its double-digit gross margins, stabilising at around 20% for the last five fiscal years (FY12 to FY16).
- Gross profit shows long-term growth, albeit at a slower pace in recent years, in line with the slowing revenue.
Volatile net profit to common shareholders
- Net profit has been volatile but has always been profitable nonetheless.
Strong balance sheet that has little debt
- Current ratio has maintained above 1.0x, indicating that there are no problems in short-term liquidity, while the cash ratio is on an uptrend over the last five years.
- Tat Seng's debt-to-total-equity ratio stands at 33%, while its cash balance remains robust at a net-cash position (cash minus total borrowings) of S$8.3 million as at the end of FY16. This compares against current market capitalisation of S$89.6 million.
Positive free cash flow in four out of the last five years
- Tat Seng had maintained a positive free cash flow (cash from operating activities, less net CapEx) in the last five years except in FY12.
Slight lengthening of the cash conversion cycle
- The cash conversion cycle has been on an increasing trend, but averaged 32 days over the last five years.
History of paying dividends with trend of increasing payout ratio
- Tat Seng has been paying an interim dividend every year, and started paying a final dividend in FY13.
- Dividends since FY13 have been declared twice a year – interim and final. The total payout ratio has also been increasing, indicating the company's improving ability to pay out cash.
We value the stock using a dividend discount model (DDM).
- Our cost of equity of 10.4% includes a country risk premium component for Tat Seng's exposure to China, and a small firm/illiquidity premium.
- Despite the seemingly high cost of equity, we highlight that it is nonetheless lower than the firm's current return on equity (ROE) of 14.3% and lower than all of the last five year's ROE. What this means is despite the seemingly high cost of equity, the company has been able to create value for its shareholders.
Our back-of-the-envelope valuation suggests that the stock is currently under-valued
- We use the Gordon growth model for our back-of-the-envelope DDM valuation. FY16 earnings per share (EPS) grew 16.7% y-o-y. We do not believe this to be sustainable as this is a mature firm in a mature industry. We do not assume a high growth stage; our model transitions to the stable long-term growth stage immediately next year.
- Accordingly, the growth rate for earnings per share will converge to the long-term growth rate of 1.0% immediately next year. Likewise, we assume that payout ratio is ramped-up to 90% next year (from 43% in FY16), on the basis that there are no projects left in a mature industry for the firm to invest in, and cash is substantially returned to shareholders.
Our assumptions are internally consistent
- Our valuation of $0.89 gives a trailing price-to-book (P/B) multiple of 1.34x.
- The firm should command a P/B multiple >1.0x, in view of its consistently high ROE, and value-creation as ROE is higher than the cost of equity.
- ROE is the driving variable in the justified P/B multiple; the P/B multiple is less sensitive to the payout ratio because a mature stable growth phase is implicit in the Gordon growth model, so a high payout ratio is implicit in the input to the model as well.