We met with Homeritz and we are reinforced on our positive view of its prospects. While we anticipate a much weaker 4Q21 for Homeritz as it was not allowed to operate during the full period, we expect a strong recovery once it resumes operations in mid-Sep. We are positive on the outlook of the company supported by (i) its current strong order book (production lead time c.180 days); (ii) its position as an ODM manufacturer (which allows it to withstand cost pressure and command better margin); (iii) improved capacity contributed by its new factory as well as its better production efficiency; and (iv) sustainable strong furniture demand. We increase our FY22/FY23 forecasts by 9.4%/7.6% to account for higher sales volume. Maintain BUY with a higher TP of RM0.78 (from RM0.71) pegged to PE multiple of 11.5x based on FY22 core EPS of 6.8 sen.

We believe Covid-19 headwinds have uncovered the underlying strengths and resilience of Homeritz’ business model. We delve deeper into these aspects in this report.

Recap. Homeritz recorded a commendable 3Q21 results with core PATAMI of RM7.3m (QoQ: +23.2%, YoY: +3.5x). Despite a 14-days closure in its factory in April as well as reduced worker capacity in May (which resulted in lower sales volume on a QoQ basis), it recorded an improvement in earnings due to higher profit margin as a result of higher ASP.

Sustained profit margin despite cost pressure. As evident in its recent results, despite the rising raw material cost pressure, Homeritz managed to sustain its profit margin by passing on most of these cost increase to its customers, thanks to its product design capability as an ODM manufacturer, which allows it to have superior pricing power relative to peers. Homeritz’ business model focuses on developing its skilled workforce and investing in R&D to develop new designs. These capabilities coupled with its extensive experience and long term relationship with customers allows it to have a better bargaining power in its product pricing.

Order book continues to build during downtime. Despite an extended period of operations closure (3.5 months from June – mid-Sep), We understand that Homeritz did not experience any order cancellation during the past 3.5 months of operation closure. In fact, Homeritz continues to build its order book during the closure period with production lead time of c.180 days in 3Q21 (vs. 120-150 days in 2Q21), and we believe this speaks volume for Homeritz’ specialised capabilities to design and customise furniture based on customers’ specifications as well as its long term relationship with its customers. Unlike OEM products where customers will be able to easily divert its orders to other suppliers, it is more difficult to find substitutes for ODM products as it requires design capabilities from the manufacturers as well as technical skills and machineries to tailor made the orders.

Further improvement in operation efficiency. As highlighted in our previous report, Homeritz’s new factory (which could boost its production capacity by up to 20%) has commenced operation since 2Q21, and the additional capacity allows it to (i) reduce production lead time and (ii) further enhance its operation efficiency through automation. Prior to the completion of this new factory, we note that the capacity for Homeritz has already improved compared to its previous level. At maximum capacity, it was able to ship out around 300 containers per month (compared to previous level of c.250). This improvement is a result of (i) its better production planning which reduces the production cycle time from design to order shipping and (ii) automation of its processes which enhances its production efficiency.

Strong furniture demand. We understand that Homeritz enjoyed an increase in demand from almost all its major export destinations. Notably, the demand from US increased to c.19% in 9MFY21 compared to c.13% in FY20. The increase of demand from US is due to the trade friction between US and China resulting in the former diverting its orders from the latter to the SEA region. Besides, we believe Covid-19 has altered our living habits that bolster well with furniture demand. Covid-19 has accelerated the adaptation of new technologies that enable workers to be connected to their work from home. As people are spending more time at home, they will spend more to enhance their home environment, including buying new furniture. This shift in lifestyle coupled with the global economy recovery should support the growth in furniture demand.

A renewed start in FY22. While we anticipate a much weaker 4Q21 for Homeritz as it was not allowed to operate during the full period, we expect a strong recovery for Homeritz once it resumes operations in mid-Sep. With a vaccinated work force, the risk of a workplace outbreak will now be better managed. Furthermore, the risk of another nationwide lockdown (similar to Phase 1) is also less likely to happen as Malaysia is moving towards the new norm of “living with the endemic”. We reiterate our positive outlook for the company supported by (i) its current strong order book (production lead time c.180 days); (ii) its position as an ODM manufacturer (which allows it to withstand cost pressure and command better margin); (iii) improved capacity contributed by its new factory as well as its better production efficiency ; and (iv) sustainable strong furniture demand.

Forecast. We leave our FY21 forecast unchanged, but raise our FY22/FY23 forecasts by 9.4%/7.6% to account for higher sales volume.

Maintain BUY, TP: RM0.78. As a result of the earnings adjustment, our TP rises from RM0.71 to RM0.78 pegged to PE multiple of 11.5x based on FY22 core EPS of 6.8 sen. Despite anticipating a weak quarter ahead, we believe Homeritz is well positioned to chart a strong recovery once operations resume supported by the reasons mentioned above. In addition, the company also has a healthy balance sheet with net cash of RM87m or NCPS of 21 sen.

Source: Hong Leong Investment Bank Research - 17 Sept 2021