We recommend a TRADING BUY on LATITUD with a Fair Value of RM5.15 based on FY17E PER of 6.5x. We like LATITUD for its: (i) position as a beneficiary of US economic recovery, (ii) plans for expansion into upstream and distribution activities, and (iii) strong balance sheet with net cash/share of 148.7 sen. Valuation is undemanding at mean levels against peers’ Fwd. PER of 7.0x.

Established furniture maker. Latitude Tree Holdings Berhad (LATITUD) is a household OEM and ODM furniture manufacturer established in 1988. The company operates in Vietnam (c.80% of revenue) and Malaysia (c.20% of revenue) with a workforce of 8,000 workers. Products manufactured include furniture sets for living room, bedroom, and dining room of which more than 90% of productions are exported to US distributers and retailers. Major clients include A-America, Ashley Homestore and Winner Furniture, among others.

Revenues rising on the back of US housing starts. Revenue has risen in tandem with higher US housing starts, with a 3-year average of 12.1% in line with average US housing start growth of 12.6%. Forecasters expect continued improvement in housing starts at 7.0-8.3% in CY16-17. In line with this expectation, we expect revenue to continue improving 6.8-4.9% in FY17-18E.

Margin expansion on stronger USD. Earnings have improved as well, with a 4-year CAGR of 33% as core net margins expanded from 4.9% in FY13 to 10.0% in FY16. Over the same period, the USD strengthened from an average of USD/MYR3.08 in FY13 to USD/MYR 4.13 in FY16. Looking ahead, as we expect the MYR to remain stable at the USD/MYR4.00-4.20 level, we maintain a conservative margin of 9.3-9.1% for FY17-18E earnings of RM77.0-78.9m (0.3-2.4% growth).

Exploring expansions. In a recent discussion, management noted that they are considering both upstream and downstream expansions. We gather that the company could expand its supply chain via potential investments in sawmills or component manufacturers. Note that this would not be their first upstream venture, as existing upstream facilities cater to c.20% of the group’s rubber wood requirement. We also understand that management is exploring new distribution avenues via M&A or in-house development. We estimate the expansions to cost up to RM120m of which RM65m is accounted for in our FY17-18E forecasts. With its substantial FY16 net cash position of RM225m, we believe LATITUD should have no issue in funding its expansion plans.

Strong balance sheet supports 15% dividend pay-out. The company has improved its balance sheet position, turning net cash since FY13. As of FY16, LATITUD has net cash per share of 148.7 sen, or 22% of its share price. Additionally, we expect strong FY17-18E free cash flow of RM39.8- 37.6m to support our forecasted 15% dividend pay-out ratio. At this level, we expect FY17-18E dividends at 13.0-13.5 sen which translates to a dividend yield of 2.8-2.9%.

Trading Buy at Fair Value of RM5.15 based on an applied PER of 6.5x on FY17E EPS of 79.2 sen. Our applied PER of 6.5x is slightly conservative against historical mean valuation (7.0x) and LATITUD’s peer average Fwd. PER of 7.0x. We believe LATITUD is valued attractively against its peers with a Fwd. PER of 5.9x despite its above-average market cap (RM450m against the average RM380m) and higher proportion of export sales (>90% against sector average 65%). However, risks to our call include: (i) rising competition from Chinese manufacturers, (ii) weaker-than-expected USD, and (iii) weaker-than-expected US economic performance.

Source: Kenanga Research - 8 Sep 2016