• Initiate coverage on HeveaBoard Berhad (HeveaBoard) with a BUY call and a target price of RM2.12, based on 11x 2018F fully-diluted PE. We advise investors to accumulate the stock despite recent share price rally as our fair value for HeveaBoard renders a 27% upside to current share price, in addition to the estimated dividend yield of 4.3%. HeveaBoard is a fundamentally sound company, enjoying 3-year Compounded Annual Growth Rate (CAGR) of 53.1% in its headline net profit from 2013 till 2016.

• Rising demand for the Group’s environmental and health-friendly products with higher average selling prices (ASP). The Group ceased production of lower graded particleboard (E2) in mid-2014. Currently, HeveaBoard focuses on production of premium grade particleboards, i.e. E1, E0 and super E0 graded products with low formaldehyde emission, higher physical strength and profit margins. Notably, the Group has just started to produce non-added-formaldehyde (NAF), which is superior to the abovementioned grades in respect of quality and pricing. We understand that HeveaBoard is the only particleboard maker in Malaysia to manufacture such premium product.

• Strong track record against its closest comparable peers. HeveaBoard is a leading local Particleboard and Ready-to-Assemble (RTA) Furniture manufacturer. The Group boasts a proven track record as it managed to cling on to profitability even during business downcycles. The Group has consistently posted profits in the past 10 years as compared to its closest comparable peers such as Mieco Chipboard and Evergreen Fibreboard, mainly attributable to its concentration in operational efficiency, and high value added and margin products rather than sales volume alone.

• Growth remains intact amid headwinds. Given prevailing headwinds faced by the Group in the likes of rebound of MYR against USD (Ringgit has strengthened against US Dollar by 4-5% ytd), foreign labour and rubber wood shortages in the furniture industry, we believe HeveaBoard still commands a resilient business model which is unfazed by the current unfavourable operational atmosphere judging from the recent quarterly results. The Group recorded a 24.6% yoy increase in its 1Q17 headline net profit on the back of higher revenue of 8.8%. Although HeveaBoard is a net beneficiary of USD appreciation with over 90% of its revenue being USD-based and cost is RMbased, the Group’s strategy of selling premium products with higher ASP and strong pricing power following the shortage of rubberwood could cushion the impact of margin compression. Moreover, the Group has the flexibility of adjusting products prices to factor in the currency fluctuations with receiving orders 3-4 months in advance. Going forward, we expect RM will stabilise at the current level of RM4.2 to RM4.3 in 2H17-2018, and hence, shall not pose any major threat to the Group. Our sensitivity analysis indicate that every 1% strengthening of RM against USD would reduce the Group’s earnings by 6.6% in 2017-18.
   
• Stellar earnings growth and sturdy balance sheet. Moving forward, we envisage the Group’s core net earnings to continue its growth trajectory in 2017F and 2018F by growing a respective 23.2% to RM94.9m and 15.4% to RM109.5m on the back of rising topline, +9.8% and +12.7% respectively. The positive earnings momentum is mainly underpinned by continued growth of sales in RTA Furniture especially in Japan, ongoing efforts in selling highmargin particleboards, and high value added and wide range of RTA Furniture. Besides, HeveaBoard commands a healthy balance sheet with current net cash/share of 18 sen, which allows it to have ample flexibility to gear up for future capacity expansion and M&A should any opportunities arise.
   
• Anticipating strong demand from Japan. With the foreseeable surge in export orders for RTA Furniture, the Group is ready to take on more orders of new veneer-based products from Japan starting 2018 onwards with additional factory premises and production facilities to be completed by end 2017. The new RTA plant is believed to increase its existing furniture capacity of 7200 containers/year by 20% to 8640 containers/year and further lift the Group’s topline and bottomline by 11-12% for 2018F. We believe the export sales to Japan is sustainable or even stronger, especially approaching year 2019 for RTA Furniture as well as Particleboard, in view of upcoming Olympic games to be held in Tokyo in year 2020.
   
• Venture into gourmet fungi business for local market. HeveaBoard has allocated RM10.5m in equipment to cultivate King Oyster mushroom during this year. We are positive on this new business venture as the Group can utilise its existing waste, which are currently sold to boiler users at a discount, as raw material to cultivate mushroom. Besides, we understand that the business could render higher profit margin to the Group as compared to its RTA Furniture and Particleboard, and the pay-back period is short with 45 days of harvest time. The project will be carried out in 3 phases with 3 tonnes production per day under phase 1. Assuming 30% product margin and RM10m revenue generated from the phase 1, we would expect the Group to rake in RM3m earnings for 2018F.

Earnings Outlook

• We estimate the Group’s 2017F and 2018F core net earnings to trend upwards, growing by 23.2% and 15.4% respectively. The Group’s net profit margin is expected to remain elevated at around 16-17% in line with its strategy of focusing on high value added and margin products coupled with increasing operational efficiency following automation and lower effective tax rate.
   
• We have imputed the contribution of the mushroom cultivation business into our earnings forecast whilst yet to factor in the earnings from the new RTA plant.

Valuation/Recommendation

• We initiate coverage on HeveaBoard with a BUY call and a target price of RM2.12, based on 11x 2018F fullydiluted PE. The PER assigned for valuation is at the upcycle PE of small cap stocks.

• We like the stock for its: 1) resilient business model; 2) excellent track record against its peers; 3) commendable future earnings growth; 4) sturdy balance sheet with net cash of 18 sen/share; and 5) attractive dividend yield of over 4%.

Source: JF Apex Securities Research - 3 Aug 2017