5 Reasons Why You Should Own HEVEA (5095)

Part 3 of a 6-Parts Series

3)    Cost Control and Pricing Power

In an attempt to dissect the financial performances and future prospects on the various listed furniture manufacturing peers of Hevea, it may be necessary to enlist below their respective and latest available results :

                                                        Hevea          Homeriz        Latitud       Pohuat          Liihen

Revenue (RM m)                              389.5            112.9           361.5          357.97           316.0

    Changes (2012/2013)                  +4.5%           +9.3%          +38%          -8.7%            -8.7%

Net Profit (RM m)                              22.31            15.12           33.6           16.78              17.9

    Changes (2012/2013)                  +42.9%          +2.8%        +138%        +10.6%          -16%          

Earning Per Share (sen)                   24.68               7.6            34.54          14.8                29.8

Market Cap (RM m)                           115.7            142.0           256.6         155.3             109.8  

Issued Shares (m shares)                   90.4             200.0            97.2          113.4               60.0

Price Earning Ratio                            5.18x             9.34x            7.64x        10.83x            6.14x

    @ 7/3/2014                                   @1.28            @0.71          @2.64       @1.37            @1.83

Net Tangible Asset (RM)                     2.55              0.44               2.78          1.47              2.43

Discount to Market Price                    50%             -161%             5.0%           7%               25%

Earning Capacity                               19.3%            10.7%          13.1%         10.8%            16.3%

***all data are as at 7/3/2014

One has to take note that Hevea per se is not in direct competition with any of its peers as Hevea is in the high-end particle board and ready-to-assemble furniture business. Homeriz specializes in leather furniture while Latitud, Pohuat and Liihen compete head-on with each other in the crowded rubber wood furniture sector. The closest nemesis of Hevea should be Mieco Chipboard Berhad, once the pioneer and behemoth in the particle chipboard sector, but the latter’s jaw dropping financial and lackluster stock market performance has lagged the current pack of contenders by miles and therefore it is out of this assessment.

On a revenue basis for the FY2013 ended December 31, Hevea came up top with RM 389.5m with Latitud next at RM 361.5m. Nevertheless, Latitud scored the highest percentage of Year-on-Year gain in revenue with a leap of almost 38% over the previous year. However, this 38% or RM 99.5m increase in revenue include the equity accounting of all the subsidiaries of Latitude International Group Limited (“LIGL”), a company listed on the Singapore Stock Exchange (“SGX”) which Latitud acquired in FY2013. Latitud prior years turnover have been somewhat consistent, having reported RM 262m, RM265m, RM 290m and RM 262m for the FY 2012, 2011, 2010 and 2009. Had it not because of the equity accounting of LIGL, Latitud FY2013 revenue would have been flat. On a 5-years basis (FY2009 to FY2013), suffice to say that Latitud’s revenue is stuck in the RM 260m+ range with little growth.

Meanwhile, Pohuat and Liihen who are both based in Muar, Johor, coincidentally reported a drop of an identical 8.7% in their revenue for FY2013. Pohuat disclosed a revenue of RM 392m, RM 359m, RM 356m and RM 330m for FY 2012, 2011, 2010 and 2009. By looking at this set of numbers, one would have thought that the revenue of Pohuat is in the range of RM 360m per year, and the FY2013’s RM 357.97m falls exactly in this range. Again, on a 5-years basis, there is hardly any growth in term of revenue expansion by Pohuat.

It’s same kampong contemporary, Liihen somehow showed a little encouragement. Although witnessing a drop of 8.7% in its revenue to RM 316m in FY2013, Liihen has been able to display an escalation of business done on a 5-years basis, having registered RM 347m, RM 285m, RM 261m and RM 219m for FY 2012, 2011, 2010 and 2009.

The same trend of an escalating revenue can also be found in Hevea as well, as it turned in RM 372m, RM 373m, RM 363m and RM 327m for FY 2012, 2011, 2010 and 2009.

We are going to leave out Homeriz in the discussion of revenue for now because all these contenders except Homeriz are in the wood-based furniture sector, which bring us to the most pressing and important factor – the raw material in the name of rubber wood.

Most of us, if not all, would agree that the rubber trees have long ceded its economic prowess to oil palm. With the fast diminishing acreage of rubber tree plantations in place for the more economically viable and less labour intensive oil palm estates, manufacturers of rubber wood furniture were having tough time in sourcing cost effective and a steady supply of rubber wood.

The contenders here have adopted different strategy to deal with this major headache. Some have gone abroad to set up shops in order to be closer to the source of raw material. Latitud and Pohuat are the two  that have a major throughput subsidiary in Vietnam, now the world’s second largest rubber trees planter. As a matter of fact, Latitud’s Vietnam subsidiary contributed RM 289.9m in FY2013 revenue vis-à-vis RM 73.3m from it’s Malaysia operation. At the same time, Pohuat’s Vietnam subsidiary contributed RM 224m as compare to RM 127m from Malaysia in FY2013.

Latitud and Pohuat may seems to be benefitted from the abundant source of rubber wood supplies and the considerably lower labour cost in Vietnam economically, but it is also a dagger that cut both ways. For the same reason that Latitud and Pohuat are setting up factories in Vietnam, the home grown Vietnamese rubber wood furniture manufacturers are not lagging in seizing the same opportunities the country has to offered. As a matter of fact, this frenzy has propelled Vietnam to become the second largest furniture exporter in the world, trailing behind China.

Liihen, however decided to go upstream by setting up its own rubber trees plantation in Johor through a lease and profit sharing joint venture with a state-owned institution, Perbadanan Islam Johor in 2005. Unfortunately, until today this effort has failed to takeoff as planned due to the various stakeholders, bureaucracy and political interference. There were probably not less than two false and futile starts that Liihen is going ahead with the plan, based on the official announcement disclosed by Liihen since 2005.

On the other hand, the acute shortage of rubber wood posed no major threat to Hevea’s revenue and bottom line. Firstly, rubber wood as a percentage on the cost of raw material is less than 50% of the finished products of Hevea as the composition of particle board consists of various type of sub-grade tropical wood slabs and off cuts, as well as arcasia, a type of plantation wood which can be sourced cheaply and abundantly. Secondly, unlike Latitud, Pohuat or Liihen which uses the best part of a rubber tree trunks to make their furniture, Hevea on the contrary is using the residues of these rubber trees and henceforth the much cheaper cost input.

The ability of Hevea to control the cost of its raw materials helped to justify the much higher Earning Capacity (Net Profit over Market Capitalization) of an impressive 19.3%, trumping its nearest peer Liihen’s 16.3%.

Liihen may be enjoying the second highest Earning Capacity for now but its honeymoon will soon be interrupted by the entering to the ring of bedroom furniture business which is Liihen’s main forte, of another lesser known contender, Sern Kou Resources Berhad. As reported in the Annual Report 2012 of Sern Kou, in order to address the overcapacity issue now faced by its production lines, Sern Kou is making its foray big time into the bedroom furniture business to compete head-on with Liihen and the likes. Consequently, expect to see the margin compression in the book of Liihen soon. By the way, could this be the reason why Liihen lost RM 30m business and an evaporation of RM 3.4m in net profit in FY2013 despite the more favourable USD?

It is important to point out here that despite the stiff competitions among Latitud, Pohuat, Liihen, Sern Kou as well as the hundred of Vietnamese manufacturers for a bigger slice of the rubber wood furniture market, none of them has been able to establish a brand name of their own as almost all served only as a contract manufacturer for USA, Europe, Middle East and Japan retail chains and conglomerates.

It goes without saying that contract manufacturers lived on the whim and fancy of their customers. This business relationship of a giant and a kid also deprived of the contract manufacturers’ pricing power. Without the power or ability to dictate pricing simply translate into limited profit margin. In order to break away from contract manufacturing and to have pricing power yourself is to establish your own brand name. And this is a daunting task and history has shown just too many wing clippers. In the name of survival or staying afloat, many preferred to remain a contract manufacturer. Latitud, Pohuat and Liihen included. But not Hevea and Homeriz. 

Hevea is indisputably recognized now as the largest particle board manufacturer in Asia. Best of all, it is in the business of high end particle board sector and therefore able to command premium on its products. To add a feather to Hevea’s cap, it has also successfully carved itself out as a “branded” product. In the home furnishing and furniture markets of China, Hevea or 亿维雅 as it is widely known there, is synonymous to top choice or the choice for home decoration and furnishing. Please google the word亿维雅to convince yourself of Hevea’s reputation in China.

It is note worthy to mention that Hevea is also the preferred contract manufacturer for Aeon Retails Inc of Japan, in supplying ready-to-assemble cabinets and furniture for all Aeon’s outlets worldwide. To meet the stringent JIS requirements (“Japanese Industrial Standards”) by the Japanese Standards Association, AEON Japan has stationed two resident Japanese quality control engineers at Hevea’s plant in Seremban, Negeri Sembilan, to monitor the manufacturing process in order to conform to the world renowned JIS strictest quality adherence. This is a testimony of highest standard not found in Latitud, Pohuat, Liihen or Homeriz. 

At home, Hevea had bagged numerous Best Supplier awards by Giant Hypermarket, Tesco and AEON in term of product quality, services and customer complains.

With the successful establishment and the relentless continuance of highest product quality together with proprietary brand name comes the pricing power in Hevea’s disposal, which has already set the right trajectory in yielding tremendous growth and profits in the coming years.