Investment Highlights

• We maintain our BUY call on Lee Swee Kiat Group (LSK) with a lower fair value (FV) of RM0.90/share (from RM1.00/share previously), based on an FY23F target PE of 11.7x, at parity to its 5-year median. There is no ESG-related adjustment based on our neutral 3-star rating.

• The lower fair value mainly stems from reduced earnings estimates as we cut FY22F-24F earnings by 8.1%/10.0%/7.5% mainly due to sales performance for Cuckoo-Napure A-series mattresses coming in below expectations in FY21 and 9MFY22, following a meeting with management recently. These are the salient highlights:
  • Amid weakening global growth and tightening monetary climate, the export segment (mainly latex foam) is expected to remain sluggish in 3Q-4QFY22, despite lower freight costs and depreciating ringgit. Fortunately, this was counter-balanced by stronger domestic demand.
  • We believe the robust domestic demand was underpinned by (a) rising market share against other local competitors (Exhibit 1), (b) higher disposable income following the special EPF withdrawal of RM40bil (RM10K per member) in Apr 2022, and (c) the gradual return of consumers to physical stores.
  • This is consistent with the latest Malaysia Retail Industry Report’s favourable forecast on furniture & furnishing segment, which is estimated to register a strong surge of 2.3x YoY in 3QCY22, subsequently from a +82% YoY growth in 2QCY22 (Exhibit 2). Nevertheless, we conservatively expect 3QFY22 performance to be comparable to 2QFY22, in view of weaker demand from the export front.
  • However, LSK guided that domestic demand in Oct has started exhibiting some softness. We believe this was attributed to the rising Overnight Policy Rate (from 1.75% in May 22 to 2.50% now) and depleting impact of EPF special withdrawals. As a higher interest rate means increased home loan repayments (Exhibit 3), Malaysian consumers could delay purchasing high-value-added goods (eg. premium natural latex mattresses).
  • LSK recorded total sales of 9-10k A-series mattresses in 9MFY22, which was 29%-43% higher than 7k achieved in FY21. However, this accounts for only 35-38% of management’s initial FY22F target of 26k. LSK attributed the below-target performance to higher inflation and rising interest rate which dampened customers’ purchasing power. Hence, LSK lowered its FY22F target to 12-14k (46-54% downward revision).
  • Based on channel checks, LSK’s competitor, Coway (Prime II Series mattress), is also experiencing similar challenges. On a positive note, there is not much concern on the monthly rental collection as >97% of the customers have been paying on schedule.
  • Historically, a significant fall/hike in natural latex price will translate to a reverse direction in net margin in the particular quarter, with an inverse correlation of -0.74 during pre-pandemic FY17-19. This is mainly due to LSK adjusting its selling price with a lag time of 1-2 months. Natural latex price has decreased by 16.9% QoQ in 3QFY22, which could expand LSK’s net profit margin by an estimated 2.5-3.0%-point in the quarter from 10% in 2QFY22.
  • On a positive note, rising interest rate is beneficial to LSK in view of its net cash position of RM11.7mil (translating to 7.0 sen/share or 11% of market cap). Nevertheless, the positive net interest impact is minimal to FY22F earnings.
  • Against the backdrop of weakening RM against US$, LSK guided that the impact will be minimal as its business operates on a natural hedge structure. We estimate that for every 3% strengthening of US$, net profit will just marginally increase by 0.05% in FY22F.
• The stock currently trades at a compelling FY23F PE of 8.2x, which is an unjustified 30% discount to its 5-year median of 11.7x while offering a decent dividend yield of 4.8%.

Source: AmInvest Research - 31 Oct 2022