Lii Hen’s 1Q20 core net profit of RM18.5m (QoQ: -18.8%, YoY: -0.3%) accounted for 23.6% of our full year estimate. We deem the results below expectations as we expect Lii Hen to report significantly weaker earnings in 2Q20 earnings as we believe Covid-19 will have an adverse impact on order volumes along with the MCO hitting production. After accounting for weaker volumes ahead and annual report model adjustments, our FY20/21 forecasts fall by 16.4%/0.7%. Our TP falls from RM4.37 to RM3.65 (9x mid-FY21 PE). We maintain our BUY call. While we expect Lii Hen to report weak 2Q earnings, at current price levels, it is yielding 6.8% based on a payout ratio of 45%. As of end-Mar, Lii Hen has a net cash position of RM148.4m (RM0.82/share or 34% of market cap).

Below expectations. Lii Hen’s 1Q20 core net profit of RM18.5m (QoQ: -18.8%, YoY: -0.3%) accounted for 23.6% of our full year estimate. We deem the results below our expectation as we expect Lii Hen to report significantly weaker earnings in 2Q20 as Covid-19 will have an adverse impact on order volumes and production disruption from the MCO. Core net profit was arrived after adjusting for foreign exchange gains, gain on disposal of PPE, and loss on derivative instruments.

Dividend. Declared DPS of 2.5 sen (going ex on 9 Jul 2020). (1Q19: 3.5 sen)

QoQ. Sales shrank 9.6% due to (i) implementation of MCO from mid-March onwards and (ii) seasonality (4Q is typically a slightly stronger quarter). As ringgit strength was relatively stable over both quarters (approximately 4.15/USD), weaker sales translated to core PATAMI declining by 18.8% to RM18.5m in 1Q20.

YoY. Despite the MCO, Lii Hen managed to record flat volumes, with marginal sales increase of 0.9% coming from weaker ringgit during 1Q20 of 4.15 (vs. 4.09/USD in 1Q19). Although there was a minimum wage increase of RM100 per month, margins were largely in-tact, as core PATAMI was flattish (-0.3%).

Outlook. We expect Lii Hen to feel the full impact of the MCO impact in 2Q20 as operations were ceased between 18 Mar and 13 May. Overall, we expect FY20 earnings to decline -21.1% in YoY. Despite an expected weak 2Q20 expected ahead, the loosening of lockdown rules in Malaysia and the US (which accounts for ~75% of Lii Hen’s sales) could offer some reprieve. Additionally, should ringgit remain at its current level of 4.28/USD, weaker order volumes ahead will be partially mitigated by this. Note that ringgit strength has averaged 4.24/USD YTD vs. 4.14.USD in FY19. Despite Vietnam’s reputation as a manufacturing hotbed, we note that the cost of labour in the country has risen dramatically in recent years, reducing its attractiveness as a manufacturing hub. Figure 2 shows the narrowing cost of labour between Malaysia and Vietnam.

Forecast. After accounting for weaker volumes ahead and annual report model adjustments, our FY20/21 forecasts fall by 16.4%/0.7%. We introduce FY22 earnings at RM85.7m.

Maintain BUY, TP: RM3.65. Alongside the earnings cut, we also lower our PE target from 10x to 9x in view of the less than sanguine near term outlook from Covid -19. This is however, partially mitigated by the rolling over of valuation horizon from FY20 to mid-FY21. All in all, our TP falls from RM4.37 to RM3.65 but BUY rating is intact. While we expect Lii Hen to report weak 2Q earnings, at current price levels, it yields 6.8% based on pay-out ratio of 45%. As of end-Mar, Lii Hen has a net cash position of RM148.4m (RM0.82/share or 33.9% of market cap).

Source: Hong Leong Investment Bank Research - 23 Jun 2020