Evergreen has decided to move its MDF Line 2 from Batu Pahat to PT Hijau in Indonesia amidst continuous inefficiencies and issues operating in Malaysia. We are positive on this development as Indonesia possesses strong advantages in both the cost and demand side. We are wary of the near-term headwinds arising from uncertainties around the global economy but believe that Evergreen is relatively better positioned to ride through the challenges due to its more resilient target market from Indonesia and Middle East which will partially cushion the weakening demand from US. In addition, we believe that this decision to relocate will bear fruits for Evergreen in the longer-term. Maintain BUY with a lower TP of RM0.74 pegged to 9x P/E based on FY23 EPS of 8.2 sen.

We Hosted a Virtual Meeting With Evergreen Recently With the Following Key Takeaways:

Relocating BP MDF Line 2 to PT Hijau. Management has shared that they are in the midst of planning to move their Batu Pahat (BP) MDF Line 2 to PT Hijau in Indonesia. Dismantling of the line will begin in 4Q22 and will be commissioned in PT Hijau by 4Q23 with 19% of the group’s total MDF manufacturing capacity being moved to Indonesia. One of the main reasons is due to the persistent issue of insufficient rubber wood as a result of (i) more rubber plantations are being replaced by oil palm plantations as well as existing rubber plantation owners (mainly smallholders) neglecting their fields due to the foreign labour shortage; (ii) the next generation being unwilling to take over from the pioneering generation; and (iii) a general lack of funds to carry out proper upkeep of the plantations. Beside this, management also shared that certain states are imposing new royalty charges on plantation wood (including rubber wood), thus increasing the cost of business in Malaysia. Through this royalty charge, the supply of wood is also disrupted as all wood shipments would have to be certified by a forestry ranger. Without one, no shipment of wood can be made, thus ruling out the transport of wood stock at night, during weekends and holidays. In addition, there is also a lack of support from the Malaysian government to protect raw materials for local primary industries as wood chips are freely exported which further deprives local industries of critical wood supply. For these reasons, the group has decided to go ahead with its relocation plans to Indonesia.

Why move to Indonesia? One of the primary advantages Indonesia has is its plentiful rubber wood supply as the country possesses the largest rubber plantation by acreage in the world at 3.6m hectare while the country continues to replant new rubber trees to replace the aging trees. Moreover, there is also >1m hectare of rubber wood within a 300km radius from the PT Hijau plant (compared to <1m for the whole of Malaysia), which is why wood cost is the lowest for the group’s Indonesia operations. Other than this, Indonesia does not face an issue of foreign labour shortage, while the cost of labour is also lower than Malaysia. Cost of business is also much lower than Malaysia as wages in the country is the lowest among the group’s 3 countries of operations (Malaysia, Thailand and Indonesia). Besides also having a more competitive electricity tariff, the price of urea is also subsidized in Indonesia. To capitalize on this, Evergreen will start up a new glue plant so that PT Hijau will benefit from lower glue cost than purchasing from the international market. Lastly, PT Hijau owns its own jetty which allows for more efficient export operations. As for demand, besides the growing middle class and higher purchasing power of the local market, the ASP also remain elevated as it is costly for the local furniture makers to import boards due to higher shipping costs which benefit local MDF manufacturers like Evergreen. On top of this, the new line being moved to Indonesia which can produce both thin and thick boards will complement PT Hijau’s existing line which mainly produces thicker boards. Therefore, there are benefits from both the cost and demand side in Indonesia.

Better overall efficiency. With this move, we believe the group’s overall efficiency will improve with the Malaysia’s operations mainly focusing towards the group’s downstream segment, i.e. value-added boards and RTA as Malaysia has the skilled workers and ecosystem to support the downstream industry. On the other hand, for a commodity product like MDF, a low-cost structure is critical. Malaysia has no buffer to handle supply shocks (e.g. heavy rain disrupting wood supply; prolonged disruption in foreign labour) which causes problems for primary industries. By moving to Indonesia, these issues would be overcome as there is plentiful supply of rubber wood as well as a large worker pool. Paired with a modernized machine in L2 and its own jetty, PT Hijau will be highly cost competitive both in the local Indonesian market and the export market.

Forecasts. Due to the uncertainties in market conditions ahead, we cut our forecasts for FY23/24 by -20%/-22.1%.

Maintain our BUY rating with a lower TP of RM0.74 (from RM0.82) pegged to 9x P/E based on FY23 EPS of 8.2 sen. We are positive on the group’s initiatives and decision to streamline its operations by focusing its MDF operations in Indonesia and downstream segment in Malaysia as it plays to each country’s advantages. We are wary of the near-term headwinds arising from uncertainties around the global economy but believe that Evergreen is relatively better positioned to ride through the challenges due to its more resilient target market from Indonesia and Middle East which will partially cushion the weakening demand from the US. In addition, the current strong USD would also bode well for the group as >70% of its revenue is denominated in USD while costs are mainly in local currencies (1H22: RM4.27/USD vs 2HTD: RM4.51/USD).

Source: Hong Leong Investment Bank Research - 17 Oct 2022