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The Magic Formula for some furniture companies kcchongnz
The Magic Formula for some furniture companies
“The secret to successful investing is to figure out the value of something and then-pay a lot less”
Joel Greenblatt
Exactly ten months ago, I did an analysis of some furniture design and making companies listed in Bursa as shown in the appended link here:
http://klse.i3investor.com/blogs/stock_pick_challenge_2013_2h/40360.jsp
Since then, all these furniture companies have been doing quite well. Most of them have their revenue and profit increased for the last one year with the exception of Tafi Industries which was still making losses for its last quarter. Tafi is hence omitted from this update analysis.
The share price of those furniture companies have also increased by huge amount ranging from 37% of Homeritz, to 101% of Hevea. For the same period, the broad market only increased by 2%. Table 1 below shows the increase of share price of those companies in the last 10 months.
Table 1: Share price comparison of some furniture companies
|
Company |
Homeriz |
Lii Hen |
Latitude |
Eurospan |
Hevea |
Poh Huat |
|
Price 8/12/13 |
0.575 |
1.65 |
1.81 |
0.510 |
0.950 |
0.910 |
|
Price now 9/9/14 |
0.790 |
2.48 |
3.44 |
0.995 |
1.91 |
1.40 |
|
Gain |
37% |
50% |
90% |
95% |
101% |
54% |
As all the share prices of these furniture companies have increased substantially in just 10 months, are they expensive now, and if not which one is a better buy? Before that let us carry out an analysis of their latest trailing twelve month (ttm) financial statements ended 30th June 2014.
Profitability and operation efficiencies
Table 2 in the appendix shows the ttm revenue and profits of the furniture companies. Latitude has the highest revenue and net profit of RM651m and RM64.3m respectively for ttm ended 30th June 2014, whereas Eurospan has the lowest revenue and net profit of RM65m and RM5.7m respectively.
As shown in Table 3 in the appendix, in terms of net profit margin (NPM), Homeritz excels by a wide margin of 19.7%, the only one with double digit net profit margin, followed by Latitude from far behind at 9.9%. Poh Huat has the lowest net profit margin at just 5.5%.
The high net profit margin of Homeritz boost up its return on assets (ROA) to a high 0f 22.8%, although its asset turnover (AT) is one of the lowest at 1.2, and its return of equity (ROE) to 26.6%, even with the lowest leverage at just 1.2. Homeritz thus has plenty of room to further enhance its ROE if it can increase its sale and add on some leverage.
The other two companies which have very good financial performance are Latitude and Lii Hen, both with ROA and ROE above 10% and 15% respectively. The return on invested capital (ROIC) of Homeritz is particularly extraordinary at 45.7%. The rest are also doing very well with their ROA and ROE of more than 7.5% and 10% respectively. All the companies earn double digit ROIC, the first portion of Greenblatt’s Magic Formula. Yes, all the furniture companies here were doing well for the last financial years with all margins and efficiencies outperform the industry benchmarks, thanks to the resilient local and overseas furniture market.
Figure 1 below shows the comparisons of margins and efficiencies of the six furniture companies. It is pretty obvious which is the one outperforming the rest with a wide margin. Homeritz, with its value added design input, is clearly a much more efficient furniture companies among the whole lot.
Ranking in operation efficiencies and management effectiveness
With the size of the companies, their past year profitability and efficiencies, I would rank the companies from the best according to the following order:
- Homeritz
- Latitude
- Lii Hen
- Hevea
- Poh Huat
- Eurospan
I rank Eurospan arbitrary at the bottom due to its smallish operations and hence more risky due to volatility of earnings. But does the market agree with me with its valuation?
Market Valuation
Table 4 in the Appendix shows the market valuations of the furniture companies. It is surprisingly that Eurospan and Poh Huat were given highest PE ratio of 7.8 as shown as they are the less efficient as shown in Figure 1 above. They were also with the lowest earnings yield (Ebit/EV) of about 15%, the second component of Greenblatt’s magic Formula. The rest are all having earnings yield of well above 20%. It is rather bewildering that the higher margin and more efficient companies were accorded with lower PE ratio and higher earnings yield which logically should be the other way round. For example, Homeritz with the highest ROIC of 45.7% is selling at the second cheapest at an earnings yield of 25%, whereas Hevea with the lowest ROIC of 11.4%, is trading at a lower EY of 16%, the second highest price of them all.
On the other hand, market valuation based on book value shows Homeritz is “correctly” priced at the highest price-to-book value of 1.8, and Hevea the lowest at 0.7 as shown in Table 4.
Conclusions
All the furniture companies mentioned here are doing very well in their business with high ROE and ROIC. All of them are also selling at very good price with earnings yield of more than 15%. If I were to choose which furniture companies here to invest, I will certainly choose Homeritz with extraordinary efficiency of 45.7%, far ahead of others, and at the same time, trading at one of the most attractive earnings yield (ebit/EV) of 25%. The next one which I will also invest is Latitude which also has a very high efficiency of ROIC at 25.5%, and selling at a low PE ratio of 6.1 and an earnings yield of 24%.
I have done exactly that. What about you?
KC Chong (10th September 2014)
Appendix
Table 2: Revenue and net profit of furniture companies
|
Company |
Homeriz |
Lii Hen |
Latitude |
Eurospan |
Hevea |
Poh Huat |
|
Revenue |
129913 |
356528 |
651025 |
65195 |
403007 |
372180 |
|
Operating profit |
29781 |
33112 |
75540 |
6906 |
37816 |
25212 |
|
Net profit |
25601 |
23783 |
64333 |
5674 |
30866 |
20382 |
|
EPS, sen |
11.0 |
39.6 |
56.6 |
12.8 |
32.6 |
18.3 |
Table 3: Margin, operation efficiency and management effectiveness
|
Company |
Homeriz |
Lii Hen |
Latitude |
Eurospan |
Hevea |
Poh Huat |
Benchmark |
|
Net profit margin |
19.7% |
6.7% |
9.9% |
8.7% |
7.7% |
5.5% |
6.4% |
|
Asset turnover |
1.2 |
1.5 |
1.4 |
1.1 |
1.0 |
1.5 |
0.9 |
|
ROA |
22.8% |
10.0% |
13.5% |
9.2% |
7.5% |
8.0% |
5.6% |
|
Leverage |
1.2 |
1.6 |
1.5 |
1.3 |
1.6 |
1.5 |
|
|
ROE |
26.6% |
15.5% |
20.9% |
11.9% |
12.3% |
12.2% |
11.6% |
|
ROIC |
45.7% |
18.9% |
25.5% |
19.8% |
11.4% |
14.3% |
7.0% |
Table 4: Market Valuations of furniture companies
|
Company |
Homeriz |
Lii Hen |
Latitude |
Eurospan |
Hevea |
Poh Huat |
Benchmark |
|
Price |
0.790 |
2.480 |
3.440 |
0.995 |
1.910 |
1.400 |
|
|
PE |
7.2 |
6.3 |
6.1 |
7.8 |
5.9 |
7.7 |
16.4 |
|
Price-to-book |
1.8 |
1.0 |
1.1 |
0.9 |
0.7 |
1.0 |
1.6 |
|
Price-to-sales |
1.2 |
0.4 |
0.5 |
0.7 |
0.4 |
0.4 |
1.1 |
|
EY= Ebit/EV |
25% |
28% |
24% |
24% |
16% |
15% |
|
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Discussions
6 people like this. Showing 12 of 12 comments
Hi kcchongnz:
Some additional points:
1) Liihen is in a net cash position. So, its leverage or net debt is nil.
2) The extra cash in hand Liihen holds provides liquidity safety in case of an economic downturn. Based on the formulas you use, this extra cash in hand has a punitive effect as it lowers ROE and ROA since it is a part of the denominators. As such, the picture is rather distorted unless some of the extra cash in hand is scaled down to industrial benchmark in calculating ROE and ROA for comparison with other players.
3) Some companies are already paying great dividend like Liihen but others still have to pay off its net debt for another 1 to 2 years before it can sell a good dividend story to the investors. Dividend yield is a big consideration for an investor.
Anyway, good luck and thanks for the write-up.
2014-09-10 18:25
Hevea posted fantastic results in spite of its high gearing, and therefore high finance cost. It is aggressively paying down its debt and therefore, growth prospect is much stronger as finance cost shrinks. In addition to its growth prospect and low valuation for both price to book and price earning ratio, I like their business because it uses wood chips as raw material and also sells particle board as well as furniture. Wood chip is easier to source as opposed to solid wood. Its particle board whose main market is China is also turning a profit. Overall, on top of its attractive valuation, I believe its business model is more resilient than the rest of the furniture companies you mentioned above. I am vested in Hevea.
2014-09-10 19:13
You may also find it interesting that despite Japan increasing their consumption tax since April 1st, which hit their furniture sales as Japan is their main market for ready-to-assemble furnitures, Hevea still posted solid Q2 results. This is because sales of particle board, which goes mainly to China, posted solid gains. This is the same comment by Cold Eye, if particle board market sux, it can always use the boards internally to make furnitures. If market is good, it can sell the boards. This is a nice feature of Hevea that is not quantifiable.
2014-09-10 19:21
Sense maker, thanks for the comments. appreciate that.
1)Yes, debt can distort ROE. Lii Hen does have net cash (cash -total debt), so do most of those companies except Hevea. However the leverage in DuPont Analysis of ROE is not whether if the company is net cash or not, but that "leverage" is Total asset/Total equity, of which debts contribute most of the numerator of that ratio. In fact the financial leverage of Lii Hen is the highest at 1.6. Homeritz's financial leverage is only 1.2, and Latitude 1.5 as show in Table 3.
2) Yes again, excess cash distorts ROE, but it will be fully reflected from ROIC, ie the return on invested capital, where excess cash is less off from invested capital, IC. In this respect, Lii Hen is better than other companies, but not as good as Homeritz and Latitude. In fact Homeritz is way ahead as shown in Table 3 with ROIC at 45.7%, against the 18.9% of Lii Hen.
3) Partly agree with you on this point. I think Homeritz dividend yield is as good as Lii Hen.
2014-09-10 19:25
soojinhou,
Hevea certainly has it plus points. Yes its good qualitative aspect is as important. And price-to-book and price-to-sale which Hevea is the lowest are also important valuation metrics. Its future prospect is also important if you are certain and best if you can quantify them.
However, earnings wise, though Hevea is the lowest, I more care about EV/Ebit, ie the valuation of the whole firm. this is because Hevea with a lot of borrowings whereas others don't, it is more appropriate to value the whole firm which both capital providers should be taken into considerations. Like what sense maker said, it distorts the efficiency and valuation metrics.
2014-09-10 19:37
Poh Huat has just annunced its quarterly results......I have commented the same in the stock quote....just reproduce here for sharing purposes....
As expected, the company announced its 3rd quarter results early this round as compred to all previous round. It was actually hinted from the "intention to deal during closed period" announcement on 11/8. The company declared its first ever 3% interim dividend this round, which never happen before. It is a great improvement as I think they try to follow its competitor's (Lii Hen) trend by declaring dividend quarterly ! Both Lii Hen and Poh Huat are located at the same industrial area in Muar furniture town.
At a glance, the company profits was doubled to RM12.5mil from RM6.3mil. "The improvement in the bottom line was due to the absence of the allowance for impairment losses of RM5.56 million recorded in the previous corresponding quarter" Disclosed in the Notes. It was a very good news as we know there will have a steady profit moving forward.
Segmental wise, its Malaysia division is improving progressively. However, its Vietnamese division incurred lower profit margin due to "the disruptions brought on by the anti- Chinese riots and loss of factory efficiency arising from the development of new products". Again, this is one-off event and should not concern us. We also can see that its Vietnamese division is still in increasing tread if we compare to its precedding quarter as tabled in Note B2. I noticed the quarterly report has been very transparent and analytical as compared to its earlier released Notes. This show the company is willing to share its business activitties to the investors which is a plus point to existing and potential investors.
The company financial position is strong too. It is technically a debt-free company, given its cash balance of RM50.8mil against bank borrowing of RM46.9mil. I belive it can declare even more dividend in the coming months. Assuming history is the guide on this company where it declared a sepcial dividend of 2% last year and another 3% final dividend in last financial year 2013. I expect the same trend to repeat this year. So, total dividend is expected to 8% (3% declared + 2% special + 3% final). This is no problem given its huge cash balance sitting in the banks.
Let's go beyond this current quarter, and we expect the coming final querter to be similar to its previous final quarter which recorded an EPS of 9.88 sen, the whole year EPS could go to 21.83 sen (11.95 sen + 9.88 sen). Further assume they will follow Lii Hen unofficial dividend policy of 50%, I can expect Poh Huat will declare even higher dividend this year of up to 9 ~ 11 sen !! This will translate an expected yield of 7.1% !
2014-09-10 21:13
Bot some hevea and latitude. Shud hv done it earlier. But I dont think is late now.
2014-09-11 07:50
kc, why u din use Graham Formula
Value=current earning x (8.5 plus twice expect growth rste)
2019-10-11 19:26
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kcchongnz .how about AHB :)
2014-09-10 14:54