Are Furniture Stocks Still in Vogue? So what’s Up with Hevea?

HeveaBoard Bhd (5095) is a Company that manufactures and sells high grade particleboards (PB) and ready-to-assemble (RTA) furniture. I understand that this stock has been heavily covered and monitored by most investors and finance houses, but I’d like to break it down to the lay investor.

Hevea has a very small presence in Malaysia – 3% of annual turnover, and it largely sells its furniture overseas, especially Japan (31%), China (22%), Australia (8%), and Korea (5%). About 78% of its turnover is from the Asia Pacific region and 5% from Europe. Focusing on Asia Pacific is the right strategy as this region is experiencing sustained growth.

Check out the article from Forest & Wood Products Australia regarding the potential growth of PB and MDFs in the Asia Pacific region:

http://www.fwpa.com.au/statistics-count-newsletter/1246-viewpoint-particle-board-and-mdf-market-development-in-asia-and-access-to-low-grade-logs-and-residue-materials.html

Below is a summary of the article:
There will be sustained demand in PBs and medium-density fiberboard (MDF) – particularly in Asia Pacific which is led by China. China as part of its 5-year plan (2016 – 2020), placed a ban on native forest harvesting nationwide.

The ban by China on commercial logging in key forest areas is further corroborated by the website below from the Ministry of Environmental Protection, The People’s Republic of China. China is the world’s largest timber importer and second largest consumer. The article mentions that “by 2020, China's timber needs will rise to 700 million cubic meters.” There is definitely some serious demand in China and this is just backed-up by the growth Hevea is experiencing from China. Check out the revenue growth from China in the past 7 years.

The article by The PRC’s Ministry of Environmental Protection:
http://english.sepa.gov.cn/News_service/media_news/201703/t20170317_408329.shtml

Chart 1: Asia Pacific Sales by Destination

I’d say not all is rosy for the PB and the MDF industry as there are headwinds specifically in the supply of raw materials. This is evidenced by the recent flood in Southern Thailand which significantly affected the supply of rubber wood. Note that Hevea consumes rubber logs (as mentioned in The Edge’s article). As it is, PB prices have been increasing due to supply constraints. In addition, we have been seeing an appreciation of the MYR against the USD (which is a bane for exporters), and the shortage of labour which was mentioned by Hevea’s managing director. Hence, in the current and near future, escalation of costs is inevitable for PB manufacturers.

Also manufacturers of MDF can easily switch to PB manufacturing, as seen by Evergreen Fibreboard; likewise can be said for PB manufactures. This denotes low barriers to entry in this industry. However, there are many grades of PBs, and Hevea manufactures high grade low formaldehyde PBs. Based on my current research there are a few listed low formaldehyde PB manufacturers like Hevea, such as Meico, Subur Tiasa and Evergreen (future). All which are doing relatively well in terms of sales and profitability.

Financial Summary
(Source: Annual Reports, Quarterly Reports and www.xe.com)
Q2 2017 represents cumulative (Q1 & Q2 2017)

Chart 2 is the detailed breakdown of revenue and profits between the 2 product divisions of Hevea. Note that it’s not perfect as the figures do not exactly tie-up. It can be seen that both divisions profited greatly from the depreciation of the MYR against the USD.

Hevea has been enjoying double-digit PBT margins since 2015 when the MYR significantly depreciated against the USD. PBT margins for PB and RTA segments in 2016 were 20% (2015: 19%) and 15% (2015: 14%) respectively. For exporters like Hevea, a weak ringgit is an advantage.

From what I’ve analyzed, this company has quite a low effective tax rate. In 2016, the effective tax rate was approximately 11% (2015: 11%). Quite low considering corporate tax rates are 24% (2015: 25%). This was mainly due to the utilization of deferred tax assets which were not recognized in the financial statements of about RM11 million (2015: RM12.5 million). Hevea still has around RM34million of deferred tax assets not recognized in the financial statements that can be set-off against taxable profits.


Chart 3: Bloomberg USD/MYR 5-year chart
The above USD/MYR 5-year chart gives an idea of how the MYR has depreciated. However, the rate of change in the depreciation of the MYR may have slowed down as evidenced by the MACD. Looking from the chart, there should be long-term support for USD/MYR at 4.0000.

Chart 4: Financial Health of Hevea

(Source: Annual Reports, Quarterly Reports)
Q2 2017 represents cumulative (Q1 & Q2 2017)

It can be seen that Hevea is in a net cash position of about RM98 million based on the latest financial statements. Net Assets per share was 80 cents while Net Cash per share was 17 cents. The balance sheet is relatively healthy – net cash position and current assets were approximately 4 times the value of current liabilities.

Chart 5: Hevea’s Cash Flow
(Source: Annual Reports, Quarterly Reports)

Cash flow is reasonably healthy. Capital investments in 2016 & 2017 have been more significant than other years as they were for expanding production capacity and upgrading product quality. Also, in 2017, the company embarked on a new business venture to turn its by-products into raw materials for its mushroom business. This division is only expected to bear fruit in 2018.

Return on capital investment has been decent as this was evident by an increase in revenue and improvement in profit margins in 2016 and 2015. In 2017, the company has only spent half of its planned capital investment. The remaining RM20million may be spent either in Q3 and Q4 2017.

Hevea has a consistent trend of achieving higher sales and profits. In addition, due to the increased demand of PBs and furniture in China, there should be future growth in Hevea’s revenue. Based on Chart 2, growth has been more evident in its RTA segment than its PB segment. Management has been investing a large amount of cash in its RTA segment; hence, I would foresee more growth in this division. I would think that the process of producing PBs are simpler and this process can be duplicated by most companies. However, producing RTAs and developing its own brand may bring about sustained and better profits. I gather that the company has its own children furniture line called KREA Kids, but I’m not too sure whether this brand has taken off successfully. It has a Facebook account, website, and a presence in Lazada, but it seems as if it has not garnered much attention. But anyways, there is potential in this product, but it’s just a lack of awareness in the local public of the dangers of being exposed to formaldehyde.

So if you have the time, go check out these websites:
https://www.facebook.com/kreakidsmalaysia/
http://www.lazada.com.my/krea-kids/
http://www.mykreakids.com/

I’m doing them a favor.

The Future for Hevea
This company has been trading at a relatively higher PE compared to its furniture peers. But, due to its strategy to focus on the demands of China, increased investments in RTAs and PBs, a higher PE might be accorded to this company.

Q2 2017 results have been mediocre, it should be noted that the profitability of its RTA segment was affected by cost pressures. Typically, Q2 and Q3 are not its best quarters, Q1 and Q4 are its best performing quarters due to the seasonality of its sales. In conclusion, investors have many options, either to wait for things to normalize until Q4 2017 or Q1 2018, or opt to invest their money elsewhere. Either way, it’s always good to keep a decent company like Hevea on the investment radar.

Also, do checkout my technical analysis on HeveaBoard after a month of posting this fundamental analysis article HERE.

Thanks !

If you like my posts and this blog please SUBSCRIBE in the link above or follow me on Google+ !!!    THANKS

Note: This is not a recommendation to buy or sell this stock by the writer. The writer owns shares in this company. The writer intends to share his view point on this stock’s potential investment value, any decision to invest or sell shares in this company is entirely at the reader’s own risk.