We maintain our NEUTRAL view on the sector. Engineered wood players will continue be affected by particleboard price war. On the other side, furniture players will benefit from (1) lower cost environment (particleboard, MDF, spray, packaging, and resin); and (2) possible higher sales as a result of improving US economy. We opine that the minimum wage hike will have minimal impact to the industry, as margin will be cushion by stronger USD against Ringgit.

FY18 was not a pleasant year. Malaysia furniture sector underperformed in 2018, with industry revenue improving marginally by 3.5% and GP margin declining 5.1ppt YoY. Revenue was impacted by the weaker USD against Ringgit, but was cushioned by higher sales volume. Earnings was further dragged by higher cost from (1) introduction of foreign labour levy in Jan 2018; (2) chronic high rubber log wood and resin prices; and (3) severe oversupply of particleboard that resulted in lower selling prices.

Furniture demand in US is expected to increase. Growth in the US construction sector is expected to boost furniture demand, with approximately half the intended projects expected to be residential. Coupled with the 49-year-low unemployment rate of 3.7%, we believe demand for furniture in the States will grow in 2019.

Furniture players in Malaysia are unfazed by minimum wage hike. Starting Jan 2019, furniture players are contended with higher labour costs from the increased minimum wage of RM1,100 (10% hike). However, we believe the higher cost will be more than mitigated by USD strength (vs Ringgit), lower wood engineered product prices (such as particleboard and MDF) and lower resin prices.

Bullish USD outlook. Our in-house forecast of RM/USD is RM4.10-4.30/USD as we expect a less favourable global growth outlook and the continued monetary policy normalisation process in US and Euro areas. A high single digit revenue growth is expected, mainly due to stronger USD against Ringgit (which only traded at an average of RM4.03/USD in FY18) and stable sales volume.

Another tough year for the board makers. Overcapacity of particleboard in the region still lingers. We believe selling prices of engineered wood products will remain depressed (if not weakening further) in the near term, as some of the new capacity in Thailand have yet to come on board and demand weakness remains. We believe E2 board price has plunged by about 20% to around ~RM450-500/cm3 from ~RM550- 600/ cm3 in early 2017.

Forecast. We maintain HOLD on HeveaBoard with an unchanged TP of RM0.65 based on P/B multiple of 0.84x. We have previously cut our TP post P/B multiple downward revisions (Strategy Report dated 19 Dec 2018) in anticipation of weak earnings, absence of growth catalyst and strong competition ahead.

Maintain NEUTRAL. Despite stronger USD outlook and lower material cost, we take a cautious stance on the sector due to uncertainties in market competition. Our top pick is Lii Hen (BUY, TP: RM3.33) for its position as one of the market leaders in the wood based furniture space in Malaysia, strong balance sheet (net cash per share of 21.1 sen as at end of 3Q18), generous dividend payout (dividend yield of 5.6%) and ongoing efforts to adopt effective cost management.

Source: Hong Leong Investment Bank Research - 10 Jan 2019