Moving into 2H18 we believe that the sector will remain unfavourable as we opine that weaker MYR alone is insufficient to mitigate the negative factors of (i) potential minimum wage hike and (ii) high rubber log wood prices. However, we favour the furniture players over the engineered wood players, as they are not involved in intense price war. We maintain our Neutral stance on the sector, due to the absence of near-term major catalyst.

Weaker MYR in 2H18. Despite having projected MYR to weaken in 2H18, we remain less bullish on the wood-based manufacturing sector (and hence our Neutral stance), as we opine weaker MYR alone is insufficient to mitigate the negative factors, which include (i) concerns of a significant hike in minimum wage and (ii) stubbornly high rubber log wood prices.

Minimum wage hike expected to hit by year-end. Post GE 14, the new government has pledged to hike Malaysia’s minimum wage to RM1,500/month from RM1,000/month currently. While it remains to be seen if the minimum wage hike would materialise, a hike is negative to the sector’s earnings, given its heavy reliance on labour. Ceteris paribus, every RM100/month increase in minimum wage will lower our FY19 net profit forecasts by 1-14% (see Figure #2).

Rubber log wood prices remain high. We understand that prices of rubber log wood have been holding up due to shortage of supply, and this does not bode well for the sector. Among the wood-based players, Evergreen will be the most severely affected by the stubbornly high rubber log wood prices, as prices for its operations in Thailand (which account for 40% of its total MDF capacity) has almost doubled in between 2Q and 3Q (due to supply shortage arising from rainy season).

Particleboard prices remain depressed. Overcapacity for particleboard in Thailand (with 10 additional new production lines being added since mid-2017) has resulted in prices declining since 3Q17 (see Figure #3). We believe prices of particleboard will likely remain depressed in the near term. While HeveaBoard managed to maintain selling prices of its particleboard thus far (given the superior quality of its products), it may soon have to lower, as the price gap between premium and mass market products has widened significantly.

Furniture players better off compared to particleboard players. Moving forward into 2H18, the furniture makers will be facing another hurdle with the potential surge in labour cost. However, we opine that the surge in labour cost can be partially cushion by (i) stronger USD against the MYR (Figure #4), (ii) lower material prices (particleboard) and (iii) previous upward ASP adjustment.

Forecast. We cut our FY18-20 earnings forecast on Evergreen by 16-28% to account for higher log prices in Thailand operations. Post earnings downgrade, TP on Evergreen is lowered to RM0.42 (previously: RM0.51) with HOLD rating maintained. We also cut our FY18-20 earnings forecast on Homeritz by 13-18% respectively to account for higher operational cost assumptions with TP lowered to RM0.67 (previously: RM0.78) and we maintain our HOLD rating. We also take this opportunity to upgrade our rating on HeveaBoard to HOLD (from Sell previously) with unchanged TP of RM0.83, as valuations have become more palatable given the recent sharp share price retracement.

Maintain NEUTRAL. We maintain our Neutral stance on the sector, due to the absence of near-term major catalyst.

Source: Hong Leong Investment Bank Research - 11 Jul 2018