10M21 furniture export value declined -2.8% YoY mainly due to the longer production halt this year. While we note that the worst (extended period of production halt) is likely over for the sector, nonetheless, challenges such as elevated raw material costs, persistent foreign labour shortage and concerns on the manufacturing sector’s labour practices will continue to cloud the outlook of the sector. On the balance of these, we maintain our NEUTRAL rating on the sector. Our top picks for the sector are Evergreen and Homeritz.

Furniture export for 10M21. 10M21 wooden furniture export value was RM8.15bn (-2.8% YoY). The lower export value was due to the longer production halt for the furniture industry in 2021 from June to mid-Sep (c.3.5 months vs. c.2 months SPLY). US continues to be the largest export market making up 62.8% of the total export value (compared to 61.8% SPLY).

An even tougher year for furniture industry. From our coverage, 3 out of the 4 companies (Lii Hen, Hevea, Homeritz) YTD earnings were lower compared to SPLY. The underperformance was mainly due to the longer production halt this year. In addition to this, these companies also face other challenges, including rising raw material cost and persistent labour shortage (as a result of closed borders from Covid- 19) which causes production bottleneck. The extended period of lockdown had also resulted in Malaysia furniture industry losing some of its market share to the regional market. Evergreen stood out as the only company under our coverage that recorded an earnings improvement YTD mainly supported by the robust panel boards market. Its regional production base also helps to mitigate the impact of the production halt in Malaysia as it was able to divert some of its Malaysia MDF orders to Thailand.

Elevated raw material cost. All key raw materials (rubber wood, glue, steel, foam, leather, packing materials etc.) were on an increasing trend since 4Q20. Glue cost in particular has seen a steep increase mainly due to the increase in crude oil price as well as the increase in urea price as demand for oil palm fertilizers increase.

Foreign labour shortage. The furniture manufacturing industry continues to face foreign labour shortage issue. Despite having spare production capacity in their factories, furniture companies are unable to scale up their productivity due to the production bottleneck caused by labour shortage. We understand that the government had lifted foreign labour intake ban for all sectors, but the timeline of the entry remains uncertain due to the tightening of SOPs on the entry of foreign workers as a result of the new Omicron variant. Nonetheless, should the foreign labour intake materialize, it would provide a shot in the arm for the furniture industry and would be a major catalyst to drive earnings growth in the sector going forward. We maintain our NEUTRAL rating on the sector. We believe that the worst is over for the furniture sector as a full lockdown similar to MCO1.0 and NRP Phase 1 likely can be averted. Nonetheless, sector valuation remains undemanding at this juncture as persistent labour shortage and the elevated raw material costs continue to cloud the earnings visibility of the sector, while ESG concerns on the manufacturing sector labour practices also dampen investors’ sentiment in the near term.

Top picks. Our top picks for the sector are Evergreen and Homeritz. We like Evergreen as the group’s integrated operations from upstream to downstream products allows it to be well positioned to ride on the current upcycle in the panel boards market as well as the growth in the furniture industry. We also like Homeritz

due to its position as an ODM manufacturer which allows it to withstand cost pressure and command better margin and retain customers. Other than this, the company is currently trading at an undemanding valuation of 5.6x ex-cash PE.

Source: Hong Leong Investment Bank Research - 7 Jan 2022