Some Simple Valuation Techniques for Some Furniture Stocks kcchongnz

kcchongnz

Publish date: Fri, 26 Dec 2014, 09:17 PM

“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” Warren Buffett

In the last article, we identified the goodness of some furniture companies and ranked them based on their profit margins and profitability ratios such as ROA, ROE and ROIC as shown in the link below:

http://klse.i3investor.com/blogs/kcchongnz/66908.jsp

From the analysis of profitability ratio in Figure 1 above, we ranked the goodness of the furniture companies according to the following order; 1) Homeritz, 2) Latitude, 3) Lii Hen, 4) Poh Huat, 5) Hevea, 6) Eurospan and 7) Tafi.

However, we must bear in mind that a good company is not necessary a good investment and vice verse. It all depends on the price you pay. We will go on to carry out some simple valuation, which though simple, can provide powerful, quick and dirty ways to determine which company in the same industry is a better buy.

Below describes the valuation metric used and their limitations.

Price-to-Book ratio

The book value, or net asset backing (NAB) is the net equity position left over when everything a company owes is taken away from what it owns.

Book Value = Total Assets – Total Liabilities

Price-to-book = Market Capitalization / Book Value = Price / Book value per share

The P/B ratio doesn’t rely on volatile measures like profits and has a hard accounting foundation in the company’s books, it has often been used as the key barometer of value.

The P/B ratio is tied to return on equity. Taking two companies that are otherwise equal, the one with a higher ROE will have a higher P/B ratio. The reason is clear--a firm that can compound book equity at a much higher rate is worth far more because absolute book value will increase more quickly.

Price-to-Earnings ratio

The P/E ratio is the most accepted valuation metric among investors as it is the most commonly talked about metric. The nice thing about P/E is that accounting earnings are a much better proxy for cash flow than sales. Moreover, earnings per share results and estimates about the future are easily available from just about any financial data source imaginable.

By dividing a company’s stock price by its earnings per share, investors get an instant fix on how highly the market rates it. It is effectively shorthand for how expensive or cheap a share is compared with its profits.

P/E ratio depends on the growth prospect of the company. Stocks with high P/Es usually have greater future growth prospects, and vice verse.

However, there are some serious shortcomings in using PE ratio as shown in the link below:

http://klse.i3investor.com/blogs/kcchongnz/63417.jsp

Earnings Yield

Investors define the Earnings Yield to be the inverse of the P/E ratio (or E/P) and consider it a great improvement. Why? Because yields can be compared with other investments more easily – for example banks fixed deposit rates. But, given that the P/E (and thus E/P) ignores debt – Joel Greenblatt in the “Little Book that Beats the Market” redefined it to take the debt into account. His definition compares the earnings due to all stakeholders in the firm (the operating profit) to the entire value of the firm, or enterprise value (EV).

Earnings Yield (EY) = Operating Profit (or Earnings before interest and tax) / Enterprise value

Or after tax EY = Ebit * (1-tax rate) / EV

EV=market capitalization + Total debts + MI – excess cash – other non-operating assets

A company making an earnings yield of 8.3% may be ok, 12.5% good and more than 20% may be fantastic. But still this does not take into consideration of the growth of a company.

Price-to Cash Flow – a good catch all?

The price to free cash flow ratio compares a company's current share price to its per-share free cash flow. Free cash flow is defined as cash that the operation creates minus any capital expenditure to keep it running. It’s the amount of cash left over which a company can use to pay down debt, distribute as dividends, or reinvest to grow the business. The benefits of looking at the price to cash flow versus other ratios like P/E or P/B ratios are several - firstly some companies systematically understate their assets or earnings which can make them harder to isolate with a low P/E or low P/B scan – but secondly earnings and assets can be manipulated by crafty management accountants to make companies appear more profitable or asset rich than they actually are.

Price / FCF per share = Market capitalization / FCF

As FCF is hard cash, a Price-to-FCF of 16 may be reasonable, P/FCF of less than 12 is good, and P/FCF of below 8 may be fantastic price.

No earnings: Price-to-Sales Ratio

During the Dotcom euphoria in the late 1990s, many new technology companies mushroomed. Their share prices were chased sky high but they had no earnings at all. So the market invented this valuation metric to cater for these new economy stocks.

P/S is a key indicator for isolating potential turnaround stocks. Low P/S stocks, especially compared against their sector, can often be stocks that bounce back very quickly as they return to profitability.

Dividend Yield

Dividend yield is actually one of the oldest valuation methods. It was very popular back in the days when dividends were the primary reason people owned stocks, and it is still widely used today, mainly among income-oriented investors.

Dividend Yield = (Annual Dividends Per Share) / (Stock Price)

The appended link below described the high dividend yield investing strategy employed in Bursa and its shortcomings.

http://klse.i3investor.com/blogs/kcchongnz/62033.jsp

Simple Valuation for furniture stocks

Table 1 below summarizes the market valuations of the furniture companies.

Table 1: Simple Valuation of furniture stocks

Company	Homeriz	Latitude	Lii Hen	Poh Huat	Hevea	Eurospan	Tafi
Price	0.820	3.650	2.700	1.410	1.630	0.810	0.440
PE	8.1	6.2	6.7	6.3	5.2	8.0	25.8
Price-to-book	1.8	1.1	1.0	0.9	0.6	0.7	0.6
Price-to-sales	1.3	0.5	0.4	0.4	0.4	0.6	1.1
EY= Ebit/EV	21%	23%	24%	24%	17%	37%	16%
EV/Ebitda	4.4	4.1	4.0	3.4	3.4	2.2	3.0
Price/FCF	5.9	5.0	23.5	6.4	4.1	4.1	14.5
Dividend Yield	4.6%	1.4%	4.4%	5.7%	1.2%	0.0%	0.0%

Eurospan appears to be the cheapest furniture stock with an earnings yield (EY) of 37% and P/FCF of just 4.1. However, as its “Goodness” ranked at the bottom, and its turnover is smallish, I would walk over on this stock, similarly for Tafi, as they may be hard hit when the economic tides turn.

Latitude, Lii Hen and Poh Huat all have similar low P/E ratio and EY of about 6.5 and 24% respectively. As Latitude has the highest profitability ratios among the three with ROE and ROIC at 19.1% and 23.6% respectively, it is hence my first choice as an investment candidate. My second choice is Homeritz as although the profitability ratio of Homeritz is much higher with ROIC at 42%, Latitude has a much higher turnover and better reinvestment opportunity than Homeritz. Latitude also has a much lower P/S and P/B of 0.5 and 1.1 compared to 1.3 and 1.8 respectively of Homeritz.

My third choice would be Poh Huat with a much lower P/FCF of 6.4 compared to 23.5 of Lii Hen. Both of them have high earnings yield of 24%. They are both good companies selling at cheap prices except I don’t really like Lii Hen’s low FCF. I stay neutral on Hevea as its profitability ratios and earnings yield are far below the top four picks above, although it has a lower P/FCF ratio..

Conclusions

All the furniture companies mentioned here are doing very well in their business in the last couple of years with high profitability ratio of ROE and ROIC well above 10%. All of them are also selling at very good price with earnings yield of more than 15%. Basing on a combination of “Goodness” and “Value”, my choice of the furniture companies to invest is first Latitude, followed by Homeritz, Poh Huat and Lii Hen, in that order.

For queries and feedback, please contact ckc13invest@gmail.com.

K C Chong (On Boxing Day 2014)

Discussions

3 people like this. Showing 27 of 27 comments

calvintaneng

YES,

DUE TO CRASHING RINGGIT ALL FURNITURE COMPANIES THAT EXPORT OVERSEAS WILL DO VERY WELL

JUST LOAD UP ALL YOU CAN AFFORD!

2014-12-26 22:57

sense maker

P/FCF and dividend yields of Liihen as stated by you are incorrect or inappropriate for reference.

Liihen's dividend yield is 6.48%(based on past 4 quarters' total dividend of 17sen/ current price).

For a company's with PE below 7, with capital expenditure not much higher than depreciation, P/FCF will not be much higher than 7 for valuation purposes. Increase in funds tied up in working capital such as stocks and receivables in recent 2 quarters of 2014 due to the increase in sales volume is one-off in nature as it will not happen each year, and thus it should be excluded for valuation purposes in a simple single-year calculation method.

Had you used a spreadsheet for DCF model, the increase in working capital would have hit just one out of the multiple-years time horizon which expand into perpetuity using a long-term growth rate. So, using a 23.5 times P/FCF for valuation of liihen is misleading.

Cheers.

2014-12-26 23:17

sangharimau

Sensemaker aka Chan Keng Chung is a substantial shareholder of Liihen, so his comment is biased

2014-12-26 23:37

sangharimau

Likewise, KCChong has a major weighting of Latitude in his portfolio, so his comment is also biased.

2014-12-26 23:39

sangharimau

If you look at Hevea, PE only 5.2, Price-to-book 0.6, Price-to-Sale 0.4, these numbers are the best among the whole bunch, how can it fell out from the top four?

2014-12-26 23:40

calvintaneng

HAHA

Calvin Tan is not biased at all

I have zero Furniture Stocks

SO I TELL ALL TO BUY UP ALL EXPORTING FURNITURE STOCKS FROM MALAYSIA

JUST BUY,BUY & BUY

YOU WILL THEN BOOM. BOOM & BOOM By Coming Chinese New Year!

2014-12-26 23:42

Ooi Teik Bee

KC Chong is not biased, I had also done all analysis for all major furniture stocks, it is true that Latitud is the best in term of all ratios. Latitud is the best of all furniture stocks even though I have more Hevea shares than Latitud.

2014-12-26 23:44

kc888

So many ppl know about tis furniture stock alr, still exciting probably to small fishes only.......haha

2014-12-26 23:54

kcchongnz

Posted by sense maker > Dec 26, 2014 11:17 PM | Report Abuse

P/FCF and dividend yields of Liihen as stated by you are incorrect or inappropriate for reference.

Liihen's dividend yield is 6.48%(based on past 4 quarters' total dividend of 17sen/ current price).

For a company's with PE below 7, with capital expenditure not much higher than depreciation, P/FCF will not be much higher than 7 for valuation purposes. Increase in funds tied up in working capital such as stocks and receivables in recent 2 quarters of 2014 due to the increase in sales volume is one-off in nature as it will not happen each year, and thus it should be excluded for valuation purposes in a simple single-year calculation method.

Had you used a spreadsheet for DCF model, the increase in working capital would have hit just one out of the multiple-years time horizon which expand into perpetuity using a long-term growth rate. So, using a 23.5 times P/FCF for valuation of liihen is misleading.

Me:

Thanks sense maker for the feedback.

As an individual retail investor trying to compare the performance of 7 companies, that is the best I can do with the limitations of time and information; ie I am using a single year trailing twelve month result. That is already tedious enough trying to search for information and to sum up the 4 quarter results. That is also why this article is "Some simple valuation techniques", not "Comprehensive Analysis" which I am not in a position to do it.

So I apologize for any mistake made and appreciate the feedback and constructive criticisms, the more the better. I am sure there are a lot more mistakes there.

FCF is lumpy in nature and I agree the single year figure is not representative. The mistake I made in Lii Hen FCF was more because I took an outdated unaudited annual figure in 2012. So for apple-to-apple comparison, with the latest FCF of 25433 in 2013, the P/FCF of Lii Hen is 6.4, the same as Poh Huat.

I would also take sense maker's number on dividend yield as I think nobody here knows better on Lii Hen than him.

Price wise Lii Hen is as attractive as Poh Huat, but Lii Hen has better operating numbers. So my choice now is Lii Hen over Poh Huat.

2014-12-27 05:41

SS661M

If we exclude dividend payout (which is not an indicator of financial strength), Hevea won 4 (PE, PB, P/sale, P/FCF) out of 6 comparison metrics. The reason of low EY is due to high depreciation, which is non cash item. Depreciation will diminish slowly and eventually fall to a level corresponding to maintenance capex (if no further expansion). If we look at the EV/ebitda, it isn't look too bad. Why not put Hevea in the 3rd spot? :))))))

2014-12-27 08:31

SS661M

Expectation on Latitude & Homeritz: Increase in earning as a result of rise in sale & higher margin.
Expectation on Hevea: Besises the above mentioned points, we can also expect degearing & lower depreciation as magnifier of earning increment.
Pls correct me if I m wrong:)

2014-12-27 08:41

kcchongnz

Posted by sangharimau > Dec 26, 2014 11:40 PM | Report Abuse
If you look at Hevea, PE only 5.2, Price-to-book 0.6, Price-to-Sale 0.4, these numbers are the best among the whole bunch, how can it fell out from the top four?

Great comments. The top four picks are my choice. It need not to be your choice. I respect your top choice as Hevea, for Hevea does appear to be the cheapest based on those metrics mentioned by you. I like all those metrics too.

Not only those, Hevea also is cheap if you look at other equity-focus metrics such as P/CFFO, P/FCF if you know what I mean. They are also important metrics.

It is just that I look harder into the firm, not just the equity shareholders. That is why I like earnings yield in the form of Ebit/EV. I did explain why in this article itself, for example a company with higher ROE should deserves a higher P/B. I also explain what are the pitfalls of depending too much on P/E ratio, instead of EV/Ebit; and why P/S may not be important for these furniture companies as they are all making money.

All the above only measure the “cheapness” of a stock, but not considering the “Goodness” in my the other article here:

http://klse.i3investor.com/blogs/kcchongnz/66908.jsp

In term of “goodness”, you can see Hevea is far behind with its ROA, ROE and ROIC.

My order of choice is a combination of “Goodness” and “Cheapness”, not just “Cheapness”.

However, I respect your choice.

2014-12-27 10:02

kcchongnz

Posted by SS661M > Dec 27, 2014 08:31 AM | Report Abuse
If we exclude dividend payout (which is not an indicator of financial strength), Hevea won 4 (PE, PB, P/sale, P/FCF) out of 6 comparison metrics. The reason of low EY is due to high depreciation, which is non cash item. Depreciation will diminish slowly and eventually fall to a level corresponding to maintenance capex (if no further expansion). If we look at the EV/ebitda, it isn't look too bad. Why not put Hevea in the 3rd spot? :))))))

Even you say Hevea is the first choice, I can’t say you are wrong too because Hevea is really the cheapest except for earnings yield in term of Ebit/EV, the firm based valuation.

Hevea has a lower earnings yield more so because of its high enterprise value due to the debts, although the accounting earnings does also contribute.

Just bear in mind that boasting up equity based value can cut both ways; in time of economy upturn, leverage amplifies return to shareholders, but in time of economic downturn, it cuts the other way. Hevea was almost at the verge of bankruptcy in 2008 during the financial crisis because of heavy debt. And what do you think the position of the economic pendulum now?

Depreciation, although is non-cash, it is a real cost of doing business. A company has high depreciation because it had high capital expenses. Why do you think there won’t be another high capital expenses in the near future, if there was one a few years ago?

But again as I have responded to the above comments about my choice of Lii Hen and Poh Huat over Hevea is because of the higher profitability ratio of others based on the present. Hevea’s latest ROE and ROIC at 11.9% and 11.1% is not that impressive as they are also not much higher than its cost of capital, especially cost of equity, in my opinion. Of course the future may change but I have no foresight of that.

2014-12-27 10:41

ks55

Furniture stocks are cyclic in nature. PE, ROI etc may seem good now because RM is going to depreciate further against USD. Share price of these counters are high relative to market. Who say SKPetro expensive @ 4.00 when oil price was above 100 USD?

Upside potential for furniture stocks is there, but by what percentage ?
What is the risk involved if market suddenly (or eventually) crash ?
Not to forget when market crash, bad share drop, good share also drop. The higher the share price, the harder it will drop. The most recent price appreciated, the earliest it will drop. All are relative.

Cyclic stocks are akin to growth stock. Potentially borrow more to cater for growth. Once business environment turn adverse, they will be the hardest hit.

Play safe, go for defensive stocks. What are the defensive stocks for Malaysian market, ask kcchongnz.
Is Bursa coming closer to serious market correction? Ask kcchongnz.

2014-12-27 12:50

SS661M

KC. This one is off topic but i like to seek your view. If the capex is huge due to price of real estate, are we supposed to offset the depreciation by fair value gain? The management can build a plant in the middle of no way to minimize the cost of doing business. It can also build on a strategic location with the intention of fair value gain. However, they are unlikely to include fair value gain in the income statement. Are we underestimated this company in this circumstance?

2014-12-27 15:38

jyap

BDB-OR is good buy now, major share holder PKNK hold 54% of DBD and pumped in 1K++ acres land with market value RM 200m++ ( settle as RM 100m cash + RM 100m via news share at RM 1.35 ). After completion of right, PKNK will only receive abt rm40M ( minus of 54% BDB cash for right issue subscription ) and PKNK will increase BDB holding to 67%, New shares for PKNK at rm 1.35, now sell at 0.72 cents?????

2014-12-27 16:12

kcchongnz

Posted by SS661M > Dec 27, 2014 03:38 PM | Report Abuse
KC. This one is off topic but i like to seek your view. If the capex is huge due to price of real estate, are we supposed to offset the depreciation by fair value gain? The management can build a plant in the middle of no way to minimize the cost of doing business. It can also build on a strategic location with the intention of fair value gain. However, they are unlikely to include fair value gain in the income statement. Are we underestimated this company in this circumstance?

As your question is an off-topic one, my answer is a layman opinion here.

Fair value gain has nothing to do with the ordinary business of the company. I always look at the core business.

For a plant, wherever it is located, there is no depreciation on the land, but only the building sit on it. So I think there is not much difference in where you build your plant in term of depreciation cost.

This is my thinking as a non accountant. So I am not sure what are you getting at.

2014-12-27 16:41

KBYap

Posted by KBYap > Dec 28, 2014 08:50 AM | Report Abuse X

Furniture makers face labour and rubberwood shortage

By CHONG CHEE SEONG
MUAR
johor@nstp.com.my

MALAYSIAN furniture manufacturers are facing two acute problems -- shortage of labour and rubberwood -- resulting in a 4.6 per cent drop in the country's total export last year.
Johor Furniture Association president Bo Eng Chee said the country's export from January to November in 2010 was RM7.3 billion as compared with RM6.9 billion in the same period of last year.

He said the drop affected the export of wooden, metal and plastic furniture.

Bo, who is also the Muar Furniture Association (MFA) president, said the MFA and the Malaysian Timber Industry Board would jointly submit a memorandum to the Plantation Industries and Commodities Ministry next month to address the two problems.

He said the shortage of rubberwood in the country had resulted in the price of the wood going up from RM1,400 to RM1,800 per metric tonne since last October.

He called on the government to stop the export of rubberwood and ensure a sufficient supply for the domestic market.

On the shortage of foreign labour, Bo said the implementation of the amnesty programme (codenamed 6P) for legal and illegal foreign workers was the main cause.

He said the shortage compelled furniture manufacturers to reject foreign orders for fear of it affecting their production and delivery of export goods.

Bo said it had a significant impact on export, adding that the furniture industry is one of Muar's economic lifelines and accounted for about 45 per cent of national furniture export.

He said a good opportunity had come to Malaysia in recent years when China's furniture industry lost its competitive edge and manufactuers in Thailand were affected by floods.

"Unfortunately, we are unable to capitalise on it because of the lack of workers and rubberwood."

Bo said the government should formulate a plan to ensure a sustainable supply of foreign workers and rubberwood to avoid interruptions in plant operations which have adverse effects on productivity.

He said with the introduction of the 6P programme, the industry was facing a 30 to 50 per cent drop in foreign labour, forcing small factories to close down.

The 6P programme comprises registration, legalisation, amnesty, supervision, enforcement and deportation of foreign workers.

Bo called on the government to monitor the programme closely to prevent job-hopping of legalised foreign workers.

The problems only can get more acute.

Posted by KBYap > Dec 28, 2014 08:54 AM | Report Abuse X

Have you asked yourself how sales have conveniently gone up in 2013 just right for the bull market.

Have you asked yourself how is this possible when US housing is in the slump and Euro unemployment rates are so high?

Mind you they are not selling high end furniture to the very very rich who are not affected by the economic slow downs.

Posted by KBYap > Dec 28, 2014 08:57 AM | Report Abuse X

With China slowing down and its property market crashing..... I keep it vague too, you go and do your own thinking.

2014-12-28 14:15

KBYap

The problems only can get more acute.

Have you seen new rubber plantations around nowadays??? Of course not as all have been replanted with oil plam.

Local furniture business is a sunset industry as their size is limited by the limited supply of rubberwood in Malaysia.

2014-12-28 15:48

KBYap

Posted by kcchongnz > Dec 28, 2014 05:18 PM | Report Abuse

Does Homeritz uses rubber wood for its furniture production???

Very surprised and disappointed that you have written such a long writeup on local furniture companies but don't even know their main raw material is rubberwood....

2014-12-28 18:39

soojinhou

Aiyoh, don't lah find fault with KC Chong who is so generous to share his analysis with us.

2014-12-28 19:16

kcchongnz

Posted by KBYap > Dec 28, 2014 06:39 PM | Report Abuse
Posted by kcchongnz > Dec 28, 2014 05:18 PM | Report Abuse
Does Homeritz uses rubber wood for its furniture production???

Very surprised and disappointed that you have written such a long writeup on local furniture companies but don't even know their main raw material is rubberwood....

Aiyah, no need to be surprised nor disappointed one. I am just a small time retail investor trying to share some simple valuation techniques by using furniture companies' financial results as examples. Never asked you to buy any also.

Yeah, I definitely don't know a lot of things. That is undeniable and also why I write stuff in i3investor, and not for investment banks. I actually hoping to learn from people like you from here.

So first I would like to learn from you what does Homeritz do in its furniture business? What kind of business model does it use, what kind of furniture does it produce etc.

Appreciate your feedback and again please don't be disappointed for me asking you. Trying to learn from you mah.

2014-12-29 06:48

SS661M

KBYap. I m not in the furniture business but I heard that oil palm trunk can be the alternative source of furniture wood. In fact, ppl have started using cocoanut tree & oil palm tree though it isn't very popular. Some of the reasons of the unpopularity are availability of rubber trees & demand on oil palm trunk as biomass raw material. Furniture nowadays are mostly plywood + cushion based. I m not sure if cocoanut trunk & oil palm trunks can be processed to make chipboard or plywood (may be you can share). With modern technology, I don't think lack of rubber wood marks the end of furniture manufacturing.

2014-12-29 08:49

NOBY

KC, you can find those information in the prospectus on bursa website, as you correctly pointed out, Homeritz profit margins are superior to the rest as their products are higher end upholstered furniture and have their own branding.

Basically for upholstered furniture the main raw materials are leather and wood. The leather is mostly imported from italy, US or China while the wood is sourced locally. It can be rubberwood, plywood or tropical wood.

2014-12-29 09:41

SS661M

http://oilpalmproducts.com/index_files/PalmFurniture.htm

2014-12-29 10:32

SS661M

Plenty of resources are wasted! Felda replanting projects chop down thousands of acres of palm trees. These trunks are chipped and being left in the field to replenish the soil organic content. Nobody bother to collect these resources!

2014-12-29 10:50

SS661M

Another article explaining the raw materials used by different companies.
http://klse.i3investor.com/blogs/marketpulse/48164.jsp

2014-12-29 11:11

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