Investment Highlights

A case for furniture stocks?

• The furniture sector in Malaysia appears to be a clear winner of the trade diversion arising from the US-China trade war. The US Commerce Department first slapped a 10% tariff on furniture imports from China in September 2018. The tariff has been raised to 25% since June 2019 and will be further increased to 30% from December 2019 (Exhibit 1). As furniture exports from Malaysia are spared the tariff, this translates to a tremendous price advantage for Malaysian furniture exporters over their Chinese peers in the US market.

• The improved prospects of Malaysian furniture exporters in the US market on the back of the US-China trade war sound like a perfect growth story that equity investors constantly search for. However, the uninspiring share price performance of key listed players on Bursa Malaysia (Exhibits 3–6) tells us that the sector is still flying under the radar of investors. This is understandable given that these listed furniture makers generally have small market capitalisation and share liquidity. They are under-researched and lack investor relation initiatives.

• We recently visited a number of the players with the intention of finding out the following: 1. If Malaysia-based furniture makers have actually benefited/will benefit from the trade diversion arising from the USChina trade war, as generally believed; 2. What is happening on the ground and how are the players capitalizing on the situation; and 3. If this is a short-lived “gold rush” or a game changer for the furniture industry in Malaysia.

Malaysian furniture makers a beneficiary of trade diversion

• We gathered from furniture companies we met up with recently that they have indeed benefited from the trade diversion from the ongoing US-China trade war. They have seen increased orders, at both their operations in Malaysia and Vietnam (for those who have expanded their operations to Vietnam).

• In Malaysia, Poh Huat Resources for instance, has guided for its sales to the US from its Malaysian operations to increase by another 30% in FY19 (Oct), after surging by a third in FY18. We understand that Poh Huat Resources has spent close to RM20mil in capex for its Malaysian operations over the last 24 months, which is 4x the amount it spent in FY16–17. Over the last 1–2 years, Poh Huat Resources has seen higher orders from its existing customers and signed on new customers. It was also urged to expand its product range. Similarly, Homeritz which is relatively new to the US market, has signed on eight new US customers so far in 2019. It is currently embarking on an expansion plan that will come onstream over the next 3–5 years, subject to the demand from its customers.

• We project furniture exports from Malaysia to grow by 6.1% to US$2.7bil (RM11.3bil) in 2019, accelerating from a 3.1% growth rate registered in 2018 (Exhibit 7).

• Key Malaysian furniture players already had a significant presence in Vietnam. For Latitude Tree and Poh Huat Resources, for instance, operations in Vietnam contributed 78% and 55% of group revenues of during their just concluded financial years respectively.

• With production capacity having been fully utilised to cope with the increased orders, Latitude Tree is expanding its wooden furniture and upholstery manufacturing capacity in Vietnam by 12–35% and 15–35% respectively over the next 12 months.

• Also, due to the general increase in furniture prices in the US as a result of the tariff on Chinese imports, there has been noticeable trading down by US consumers where they now go for the cheaper ready-to-assemble (RTA) panel-based furniture over the pricier fully-assembled solid wood furniture. The younger generation in the US is also more receptive to RTA furniture, particularly for the bedroom set, as it is more practical and cost effective. Apart from the tariff advantage over its Chinese peers, Poh Huat Resources for instance, also focuses on these more affordable products in its operations in Malaysia to strengthen its foothold in the US market.

• We are mindful of the risk of the US Department of Commerce imposing duties on Vietnamese goods to stamp out the rerouting of Chinese goods to the US via Vietnam, including furniture, to get around the tariff. This could completely erase the price advantage of Malaysian players in Vietnam over Chinese players. Already, the US Department of Commerce has slapped duties on certain steel imports from Vietnam as it concluded that they originate in South Korea and Taiwan, and only relabelled Vietnam-made after some minor processing in Vietnam.

• We project furniture exports from Vietnam to grow by 20% to US$12bil in 2019, also picking up momentum from a 16% growth rate achieved in 2018 (Exhibit 8).

Capitalising on the situation

• Furniture makers in Malaysia are capitalising on the situation by expanding their capacity, as mentioned. They could also ride on it by entering into JVs with Chinese parties. We understand that Latitude Tree, for instance, is currently in JV talks with no less than six Chinese parties.

• We gathered that a JV with a Chinese partner could take the following forms: 1. A “rerouting” model where the Chinese JV partner ships the close-to-finished product from China to Malaysia, where the Malaysia partner puts the finishing touch on the product before being re-exported to the US as a Malaysia-made product; and 2. A more “genuine” model where both parties build on each other’s strengths to produce the product in Malaysia and market it in the US market. The Malaysian partner could provide land and buildings, labour and local knowledge including the supply chain. On the other hand, the Chinese partner could bring in scale, additional capital, new technology and a more extensive international clientele.

• We could sense that local players are skeptical of the “rerouting” model as its legitimacy is not tested. While the other model appears to be more palatable to them, we felt that local players have reservation with regards to the trustworthiness of the potential Chinese JV partners. There are concerns that the Chinese partners may go their own ways once they have learned up on the furniture manufacturing trade and the furniture supply chain in Malaysia.

A gold rush or a game changer?

• The most interesting takeaway from this research project of ours is that the US-China trade war has not set off the relocation of production bases of multi-national companies to South/Southeast Asia from China. It has instead sped up the process that already started years before when China was gradually losing its advantage as a low-cost manufacturing base due to rising land and labour costs.

• Vietnam has been the top choice for relocation from China given its low wages, a sizeable workforce and domestic market. However, the influx of foreign investments has pushed up land prices and labour cost, created bottlenecks along the supply chain and choked the public infrastructure such as roads and ports. This brings foreign investors’ attention to the alternatives such as Malaysia, Thailand, Indonesia and South Asia.

• Meanwhile, we are mindful of the potential competition posed by foreign players (particularly, the Chinese), if they decide to set up their manufacturing plants in Malaysia. In the case of wood-based furniture under the blue-sky scenario, it only takes a foreign player about 18 months to build the factory, train the workers and commence production. Armed with capital and efficiency (driven by scale and technology, particularly automation), they will surely give the local players a run for their money. We believe the only way the local players can defend their turf is to boost efficiency (including investment in automation to counter the ever rising labour cost), step up product innovation, and offering and expand their global market reach.

• Irrespective of the eventual outcome of the US-China trade war (even if by some miracle, the US and China manage to resolve their differences), we believe multi-national companies will have to acknowledge that world trade has changed, with protectionism and nationalism trumping over (literally) liberalisation and globalisation. As such, geographical diversification will become an important consideration (at the expense of cost and the availability of a more complete supply chain) when it comes to picking the locations for their manufacturing bases. This could potentially usher in a “manufacturing renaissance” in Malaysia, including furniture. We are more inclined to believe that the latest development is a game changer, instead of just a “gold rush” for the furniture industry in Malaysia.

• Based on our estimates, key Malaysian furniture companies now trade at 7–8x their forward earnings, which is rather consistent with their average historical forward P/Es. Given the positive structural change driven by the trade diversion from the US-China trade war, we believe that their valuations should be re-rated 8–10x higher (Exhibit 9).

Source: AmInvest Research - 11 Sept 2019