What’s New

• Facing short-term headwinds. We met the management of HeveaBoard (Hevea) recently and came back feeling cautious on its outlook. We gather that the current supply side issues in respect of shortage of foreign workers and overcapacity of particleboard in the industry could pose a challenging outlook to the Group in the immediate term. Besides, unfavourable forex movement, i.e. weakening of USD against MYR also weigh on its earnings prospects. Despite all the headwinds, we maintain our BUY call on the stock as we believe its value emerges following recent slump in share price.

Comment

• Lingering labour issue. To recap, Hevea recorded dismal 3Q17 core earnings (-55.1% yoy, -52.5% qoq) on the back of lower revenue and margin, mainly attributable to unexpected severe shortage of foreign labour which resulted in higher operational costs as optimum production capacity could not be achieved for its RTA Furniture besides its annual maintenance of plants. We understand that the hiring and workers permit renewal hiccups were related to the new government policy introduced earlier whereby the Group faced a huge shortfall of 450 foreign workers especially with the trial orders coming from its new veneer based products from Japan. Currently, the Group is relying on local workers for its production workforce. However, management highlighted that the domestic factory workers are less reliable as retention rate is as low as 30%. The Group expects new foreign workers, about 300-500 to arrive by end of March this year, will bring its workforce to 1,900 workers from existing 1,500 workers. Still, it is far below the Group’s optimal headcount of 2,300 workers.

• Anticipate lower capacity for RTA Furniture. Hevea is currently concentrating in clearing backlog orders for its RTA Furniture. We understand that there will be no compensation for delay in orders to customers. However, the Group now expects to see 20% decline in its shipments of RTA Furniture, i.e. 480 containers/month from 600 containers/month previously. Moreover, we opine that the Group may not able to fully meet the demand from Japan for its new veneer-based RTA furniture products with the lingering labour issues. Hence, we do not foresee its new veneer-based RTA furniture products for Japan market (of which the plant was completed in August last year) to further boost its existing production capacity for FY18F as against the Group’s earlier expectation of 20% increase in current RTA Furniture production capacity to 720 containers/month.

• Overcapacity of particleboard. The particleboard industry is now facing some overcapacity issue following production expansion in Thailand. Taiwanese companies operating in Thailand are believed to be dumping excess capacity to Korea and China. We even understand that some local players have stopped production for a few months due to oversupply issue. Nevertheless, Hevea’s utilisation rate for its particleboard production is still relatively high at c.90% as compared to previous c.100%.

• Downward pressure on ASP of particleboard. Selling prices of particleboard have dropped by more than 15% since then. The price war is particularly rampant in low graded particleboard, E2 which the Group has stopped production few years ago, and to a lesser extent to premium particleboard. With the product price gap widening between Hevea and its competitors (more than 30% gap due to its premium particleboard offerings), the Group started feeling the pressure from customers for price cuts. However, we understand from management that the Group still manage to hold up its selling price well at this junction or even successfully negotiated for slightly higher selling prices (<3%) to pass on higher input costs (raw material prices and unfavourable forex) thanks to its high quality product propensity.

• Adverse impact of weakening USD against MYR. Management highlighted that the Group hedges its 40% sales proceeds to mitigate the risk of forex fluctuations. With recent sharp rally of MYR against USD, i.e. from as high as 4.40 USDMYR (average 3.95) during 4QCY17 to current 3.90 USDMYR, management acknowledged that the negative impacts to the Group is unavoidable with the time lag of about 2-3 months for the Group to partially price in the forex factor to customers.

• Margins expected to trend down. We could see the Group’s profit margins to inch down for 2017F/2018F against 2016 as dragged down by: 1) higher operational costs as failure to achieve optimum production capacity for RTA Furniture as a result of shortage of foreign workers, 2) lower utilisation rate expected for particleboard production due to overcapacity and price war, 3) unfavourable forex as raw material costs are mainly denominated in MYR whilst export proceeds are in USD coupled with realised or unrealised forex loss incurred, 4) prevailing high rubber wood prices following rainy season during end of last year. However, management is not too concerned about the chemical glue costs as it is not rising as much as crude oil prices.

• Cultivation of gourmet fungi business is on track. Management mentioned that trial run for the mushroom operation is successfully completed and commercialisation is underway with harvest period of 45 days. The Group sticks with its initial target of 3 tonnes/day production and expects to rake in RM800k-1m monthly sales for both domestic and export markets with over 30% profit margin.

• 4Q17 results remain tepid. The Group shall announce its 4Q17 results on 27 Feb 18. We envisage Hevea to register RM10-15m core net profit for its 4Q17 results (headline net profit could be lower in view of forex loss), which is significantly weaker yoy but better qoq. Hence, full year 2017 core net earnings could be around RM62.6m (after our earnings revision), declining 18.8% yoy.

Earnings Outlook/Revision

• We slash our net earnings estimates for 2017F and 2018F by respective 5.0% and 11.6% to RM62.6m and RM71.9m after lowering our sales volume and utilisation rate for RTA Furniture and particleboard, ASP, forex assumptions and margins for both business segments. Meanwhile, we introduce our 2019F net profit estimate of RM88.6m with expectation of meaningful sales rebound and margin recovery amid stabilisation of USDMYR, resolve of labour issue and easing overcapacity.

Valuation/Recommendation

• We keep our BUY call on Hevea but with a lower target price of RM1.27 (previously RM1.58) following our earnings downgrade. Our fair value is now based on 10x (from 11x) 2018F fully-diluted PE in view of prevailing cautious sentiment on small and mid-cap counters and challenging industry outlook.

• Medium-to-long-term outlook still intact. While the Group continues to face headwinds in the short-term, we reckon that Hevea is a fundamentally sound company underpinned by its: 1) excellent track record; 2) resumption of strong earnings growth in 2019F; 3) sturdy balance sheet with net cash position; and 4) decent dividend yield of over 5%. We advise investors to accumulate the stock as we see its value emerges following recent slump in share price.

Source: JF Apex Securities Research - 12 Feb 2018