We believe that 1Q18 earnings will be weaker (both yoy and qoq) mainly due to (i) new implementation of foreign labour levy, (ii) rising crude oil price, (iii) stronger MYR vs USD, and (iv) long festive season (Chinese New Year). We remove our positive stance on HeveaBoard and Evergreen as the particleboard players are impacted by ongoing intense price competition. The higher packaging, coating and labour cost will also pressure furniture makers in the near future. In view of continuous hike in cost and slowdown in expansion plans in the sector, we downgrade the sector to NEUTRAL from Overweight.

Expect weak 1Q earnings. We believe 1Q18 earnings will come in weaker (both YoY and QoQ) mainly due to (i) implementation of foreign labour levy (Figure #1), (ii) rising crude oil price (which has risen by 19% to US$79 per barrel YTD), which has in turn resulted in higher adhesive prices, (iii) stronger MYR vs USD (+4% QoQ and +11% YoY to MYR3.95/US$ in 1Q18), and (iv) long festive season (Chinese New Year), which affected productivity.

Gloomy days for board players are not over yet. Despite recent weakening of MYR (against USD) and rubber log wood prices augur well for the sector’s prospects, we believe near term earnings outlook for the board players will remain weak. This is mainly on the back of oversupply of particleboard in the domestic market and higher crude oil price. Besides, we note that HeveaBoard is still facing manpower issues to operate at optimum capacity at the RTA segment.

Furniture makers to see margin compression. Apart from wood cost, Lii Hen’s largest cost of production consist plastic packaging and coating spray, and labour costs, which account for 11% and 19% of total production costs. We are expecting plastic and spray prices to follow suit with the rising oil price trend, as they are both by-products of oil. Hence, we opine that given the higher cost environment it will be a tough year ahead for the furniture makers.

Earnings forecast. Despite signs of weakening MYR post GE14 (Figure #2), we opine that the near term increase in raw material and labour cost would more than offset the rising USD. In light of higher raw material and labour cost assumption we lower FY18-19 earnings by (i) 21%-23% for Lii Hen, (ii) 31%-32% for Hevea and (iii) 23%-24% for Evergreen. Our TPs are tagged to a 10x PE multiple on a rolled forward FY19 EPS.

Lower DPS assumption. In consideration of the lower earnings, we opine the sector will be driving a lower dividend yield in FY18: Lii Hen (7%), Hevea (3.5%), Evergreen (2.2%) and Homeritz (5.7%).

Downgrade to NEUTRAL. Post earnings cut, our TPs are accordingly reduced but most of our calls are maintained with the exception of Hevea which we downgrade from Buy to HOLD. As the sector is over crowded with new players and lack of expansion plans. We downgrade the sector to Neutral from Overweight,

Source: Hong Leong Investment Bank Research - 22 May 2018