Scientex: Email Exchange with IR (01/15)

After the group released its first quarter report for FY2015, I dropped an email to their IR for some enquiries. They replied back and seem like the strengthening of USD may do more harms than good to the group. However, the increase in production capacity, decline in raw material price and higher margin should help to can the loss in foreign exchange

Below are the details of the email. 

1) Operating profit margin from manufacturing segment dropped from 6.12% in Q1FY14 to 4.59% in Q1FY15. What is the reason behind for this drop in operating profit margin and is it temporary?

A: 1Q15 operating margin drop was mainly due to product mix in the manufacturing segment, where we adopted a market penetration strategy to gain market share in the consumer packaging sector in South East Asia. In the broader sense, we foresee this to be a temporary phenomenon. On the whole, we see continued strong demand in the region.

2) The group made a provision for unrealised foreign exchange loss of approximately RM5.0 mil in Q1FY15. Which currency is that and why the management concluded that the group will experience a potential loss? What are the precaution steps to be taken to prevent such circumstance from happen again?

A: Most of our loans are in USD which works as a natural hedge for our export sales in USD. For the moment there will be no change to this policy.

3) With the recent drops in crude oil price which directly reduce the chemical material cost, to what extend the group is benefit from this? Does the group foresee requests from customers to reduce the selling price due to the drops in material costs?

A: For consumer packaging, we typically deal with manufacturers who sell to end-consumers, and contracts are negotiable annually. Therefore Scientex will benefit from improved margins in this segment. As for selling price reductions, there is more value-added components involved (e.g. printing, slitting, bagging) which enhances our overall margin.

For industrial packaging, the price adjustments are done monthly, and there are fewer value-added functions compared to consumer; so the margin increase isn’t as substantial.

4) Is the group's management on inventory FIFO type? Any time lag between commodity price and the group's material cost?

A: Typically FIFO, and the time lag is minimal.

5) Regarding the weakening of RM against USD recently, I checked back the foreign currency sensitivity analysis in AR2014, page 117. The statement is as below,

" (iii) The Group’s sales less cost of sales and other items of expenses denominated in USD during the financial year ended 31 July 2014, offset against the Group’s exposure in USD in the statement of financial position at the end of the reporting period for a 3% change in foreign currency rates. A positive number below indicates a profit where the Ringgit Malaysia strengthens 3% against the USD. For a 3% weakening of the Ringgit Malaysia against USD, there would be a comparable impact on profit or loss, the balances below would be negative."

For a 3% weakening of Ringgit Malaysia against USD, there will be impact on loss of RM2.59 mils on the group's net profit after taking consideration of all the group's sales, cost of sales, other expenses and borrowings that all denominated in USD currency.

Is my interpretation correct? Understand it's just an estimation.

A:  Yes.

Let's say RM will weaken around 10% against USD in FY2015, the estimated loss is around RM8mils on the group's net profit based on the foreign currency sensitivity analysis in AR2014. 

It's roughly around 5.4% loss ( RM8/RM148) on the group's net profit in FY2014. 

Is it acceptable for you?