Short-term impact from rising raw material prices but stock still offers value for longer term investors

After a meeting with the management of Srithai Superware (SITHAI), we are still positive on the stock as a long-term investment even though the company faces some short-term negative factors.

SITHAI is directly impacted from rising in raw material prices, particularly polyethylene and polypropylene. The company can partially offset this with forward contract purchases and passing on some of the cost to customers, especially to original equipment manufacturer (OEM) customers under its cost-plus pricing policy. Nevertheless, we have had to revise our 2003 and 2004 earnings projections down 15% and 12%, respectively.

SITHAI is adopting several new strategies to enhance profitability, including 1) increasing productivity by reducing production cycle time, waste reduction and energy savings; 2) becoming more selective on clients; 3) outsourcing to enhance cost competitiveness; 4) optimising inventory turnover; 5) launching new products and designs; and, 6) emphasising brand awareness. The company has set target sales growth of around 5-6% this year mainly from the automobile and electrical plastic parts customers.

In 2002, SITHAI generated positive cash flow generating of Bt735mn, or Bt2.57 per share, representing P/CF of only 2.68x. With this strong cash flow, we expect the company would be able to reduce its debt this year by Bt400mn, versus scheduled repayment of Bt200mn. This would lower the company's net debt to equity ratio from 0.2x to 0.05x by the end of 2003. In 2004, SITHAI should be in a net cash position. The management believes the SITHAI board will consider resuming dividend payments from this year's earnings.

Since we have revised down our near-term earnings forecasts, we have had to also adjust our DCF fair value estimate to Bt9 from the previous Bt9.50. We still think the company's current share price has already absorbed the negative factors, trading at 2003 PER of 8.8x and EV/EBITDA of 3.4x. Since the stock is trading at a 19% discount to our new fair value estimate, we rate SITHAI as a LONG-TERM BUY.

• SITHAI's plastic and melamine product businesses contribute around 56% and 42% of total sales, respectively. Its plastics business generated gross margins of only around 10% due to severe competition in the market and high volume negotiations with OEM customers. Meanwhile, its melamine business could produce gross margins of 40% as a result of brand awareness in premium quality products, like "Superware."

• Total gross margins have narrowed from 26% in 2001 to 23% in 2002 due to rising raw material costs, especially in 4Q02. We still believe the company could maintain gross margins of not less than 20% this year as a result of forward contract purchasing in raw material and cost plus around 10-20% margin for its new OEM customers starting in the middle of this month.

• Most of the company's plastic sales are made-to-order engineering products (automobile and electrical parts) and battery cases to serve the OEM market. These two types of products account for 37% and 19% of plastic sales, respectively. Fortunately, the company has long-term contract sales, which factor in raw material costs in the pricing formula. By being able to pass on higher costs, SITHAI should be able to maintain its gross margin on plastic products at around 10%.

• The company's major raw materials are polyethylene and polypropylene (PE & PP) representing around 60% of its total cost. The management admitted that raw material prices have risen 56% and 57% from last year's average to Bt36/kg and Bt44/kg, respectively. However, the company has purchased a forward contract for raw materials in January until the middle of April to ease the impact of higher raw material prices.

• For its melamine business, SITHAI should be able to maintain its margins. Melamine powder accounts for 70% of its total cost, but melamine powder prices have been stable over the last five years. The major concern, however, is China dumping melamine product prices in the world market. To counter this, SITHAI is launching a new brand, offering a discount of around 30% from its premium Superware brand.