We initiate  coverage on  EFB  with a BUY recommendation and a TP of MYR1.11  (52%  upside).  We  are  valuing  the  stock  based  on  P/BV  by applying 0.7x P/BV to its BV  of MYR1.59. We expect EFB  to turn around in  FY15,  propelled  by  operational  efficiency,  better  selling  prices, favourable forex and lower raw material prices.  Currently, the company is still trading below its BV/share of MYR1.56 as at end-Sep 2014.  A leading MDF player.  Evergreen Fibreboard Bhd (EFB) is a prominent manufacturer  of  medium  density  fibreboard  (MDF),  particleboard, furniture, value-added wood-based products and resin.  It has 10 plants located  in  Malaysia,  Thailand  and  Indonesia  with  a  combined  annual production exceeding 1.3m m3.

A painful lesson.  EFB reported  its first loss in FY13 with a net loss of MYR42.8m,  attributed  to  weak  demand  from  its  major  market,  new supply from other regional producers, an increase in logistic cost and a drop in ASP.

Internal restructuring. Currently, the company is embarking on a series of  restructuring  exercises  in  FY14-FY16  periods:  i)  shifting  one  of  the Malaysian production lines  to its Indonesian plant to achieve economiesof scale and greater cost savings; ii) upgrade its machine and equipment in Segamat plant, with more automation processes to improve efficiency; and  iii)  streamlining  its  Batu  Pahat  plants’   operations  for  better  cost savings and smoother production flows.

Favourable  external  factors.  With  >70%  of  export  sales,  EFB  is benefiting  from  a  stronger  USD.  In  addition,  the  company  is  also enjoying lower raw material costs, thanks to lower rubber wood logs and crude oil prices (both constituting 60% of its total cost).

Initiate BUY with a MYR1.11  TP.  We believe that the company would turnaround  in  FY15,  premised  on  improved  efficiency  internally, favourable  forex  and  relatively  stable  raw  material  costs.  Our  TP  is derived  by  applying  0.7x  P/BV  to  its  FY15F  BV  of  MYR1.59.  EFB currently trades at  FY15F P/B of 0.46 and FY15F P/E of 10.4

Key Risks.    i) fluctuation in the prices of raw materials; ii) unfavourable forex movements; iii) execution risk – restructuring is underway.

Investment Thesis

Internal restructuring.  EFB experienced deteriorating margins in FY11-12 periods, with  net  margin  dropping  to  3.1%  in  FY12  from  a  high  of  11.3%  in  FY10,  and eventually posting a net loss of MYR42.8m in FY13, due to higher industry supplies, lower ASP and higher raw material costs .  In the aftermath of a painful  FY12-13,  the management  is  taking  bold  steps  to  diagnose  its  operations  and  long-term  future plans.  Currently,  the  management  is  embarking  on  a  series  of  restructuring exercises, with three core steps to be taken during the FY14-FY16F period: i) shifting one of the Malaysia production lines  to its Indonesian plant in Palembang to achieve economies  of  scale  and  greater  cost  savings,  ii)  upgrading  its  machine  and equipment  in  the  Segamat  plant  for  more  automation  processes  to  improve efficiency,  and  iii)  streamlining  its  Batu  Pahat  plants’  operations  for  better  cost savings and smoother production flows.

Lower raw material costs.  Wood (mainly rubber wood) and glue are its core cost components, accounting for about 60% of its total cost  as shown in Figure 9 in the Appendix.  The  rubber  plantation  sector  is  facing  declining  selling  prices  of  latex. According to the Malaysian  Rubber Board, the ASP of latex was at 362.23 sen/kg in Dec 2014, compared with 541.24 sen/kg in Dec 2013, down 67% YoY.  Management guided that there is no obvious correlation between latex price and rubber wood log supply, but under such circumstance, rubber plantation owners are more willingly to sell their rubber plantation concession for logging purposes. At the same time, low crude  oil  prices  also  bode  well  for  its  adhesive  production.  We  foresee  relatively stable raw material costs going forward.

Export-oriented.  EFB’s products include MDF and  particleboard, mainly catering to the furniture industry. Aside from supplying its products in Malaysia, EFB exports its products to ASEAN countries such as Thailand, Indonesia, Vietnam as well as Middle Eastern countries such as Saudi Arabia, United Arab Emirates (UAE), Jordan, Egypt, Syria, etc. In FY13, the company generated over MYR720m of export sales, about 77%  of  its  total  sales.  Up  to  3QFY14,  the  company  recorded  total  export  sales  of MYR586m, which was 85% of total group sales.  Figure 10 in the Appendix shows the revenue distribution per geographical area.

Favourable  forex.  EFB  has a  presence  in  Malaysia,  Thailand and  Indonesia,  with about 70-85% of its total sales being export-based, mainly in USD term. EFB is going to  benefit  from  a stronger  USD.  To  recap, the  company  posted  over  MYR720m  of export sales in FY13, which constituted 77% of its total sales. It recorded total export sales  of  MYR586m  up  to  3QFY14,  representing  85%  of  total  group  sales.Meanwhile,  MYR  has  continued  to  decline,  depreciating  by  6.4%  against  the  USD during the Oct-Dec 2014 period. Our economist team believes that the MYR could stay weak at around MYR3.30-3.50/USD or even exceeding the level temporarily in the short term.

No  customer  concentration  risk.  EFB  has  over  500  customers  from  local  and overseas  markets.  None  of  its  customers  is  contributing  >10%  of  its  total  sales, hence mitigating customer concentration risk.

Valuation & Key Risks 
BUY, TP MYR1.11. We initiate coverage on EFB with a BUY recommendation and a TP  of  MYR1.11,  which  represents  a  52%  upside  return.  We  are  valuing  the  stock based on P/BV by  applying 0.7x P/BV to its FY15F  BV  of MYR1.59.  Historically, the company has  been trading at a low average P/BV of 0.3x in FY13 to a high average P/BV of 1.5x in FY07. We believe that the company should be re-rated in view of the business recovery. On top of that, our P/BV valuation is still at a 53% discount to its peak average P/BV of 1.5x, which we think is prudent.  Currently, the company is still trading below its BV/share of MYR1.56 as at end-Sep 2014.

After  a painful  lesson  in  FY12-13,  management  strives  to improve its  efficiency  by restructuring  and  streamlining  its  operations.  We  forecast  a  milder  net  loss  of MYR4.7m for FY14  (from net loss of MYR42.8m in FY13), before turning around in FY15 with  a forecast  net profit of MYR35.6m  as shown in Figure 12 in the Appendix. Our  forecasts  are  premised  on  an  improvement  in  overall  operations  arising  from better efficiency, lower log and glue costs,  better selling prices and  favorable  foreign exchange rate. The industry sentiment has improved, with market players no longer slashing prices for greater market share. Peer comparison. The closest peer of  EFB  is a Thailand-listed company, Vanachai Group PLC (Vanachai), which mainly produces MDF and particleboard. In terms of P/BV valuation, EFB  is trading at a  lower multiple  compared with Vanachai. Overall, we like  EFB  as the company is set to turnaround in FY15. In addition, management displays  determination  and  commitment  in  streamlining  its  operation,  on  top  of favourable external factors that would likely benefit the industry as a whole.

Key  risks.  i)  fluctuation  in  the  prices  of  raw  materials,  which  are  linked  to  rubber industries and oil price movements; ii) unfavourable forex movements; iii) execution risk – management is determined to restructure and streamline its operation for better cost control and improved efficiency.

Financial Overviews 
Experienced a challenging period.  Since its listing in 2005, EFB reported its first loss  in  FY13  with  a  net  loss  of  MYR42.8m .  Weak  demand  from  the  major  market especially the Middle Eastern market arising from prolonge  civil unrest, new supply from  other  regional  producers  in  Indonesia,  Thailand,  and Vietnam,  an  increase  in logistics cost and a drop in ASP have severely impacted its profit in FY13.

Eroding margin.  According to Figure  5, the company had been facing deteriorating margin since FY10, with net margin dropping to 3.1% in FY12 from 11.3% in FY10, before  experiencing  a  net  loss  of  MYR42.9m  in  FY13.  The  eroding  margin  was mainly  due  to  overcapacity  in  the  MDF  industry  regionally,  which  has  resulted  in lower ASP.

The worst could be over.  Overall, 9MFY14 revenue was flat at MYR689.8m while net  loss  narrowed  to  MYR14.2m  from  MYR36.0m  in  9MFY13.  The  0.5%  YoY increase in topline was supported by higher ASP despite a drop in sales volume of particle board in Malaysia as its production line is under major upgrade. Management guided that the ASP increased by  2-3% YoY in 9MFY14.  We believe that the worst for EFB could  be over. The company reported a milder pre-tax loss of MYR12.5m in 9MFY14  compared  with  a  pre-tax  loss  of  MYR40.9m  in  9MFY13.  Its  Malaysia operations recorded a  pre-tax loss of MYR16.2m in 9MFY14, including a MYR15m provision for log cost derived from uncompleted log concession projects. We do not foresee further provision on its unused concession.

The  company  has  reported  a  net  profit  of  MYR10.1m  in  3QFY14.  We  have  seen turnarounds  in  its  Malaysia,  Thailand,  and  Indonesia  operations,  with  reported segmental  pre-tax  profit  of  MYR2.9m,  MYR6.6m  and  MYR2.4m  in  3QFY14, compared  with  pre-tax  loss  of  MYR4.8m,  MYR0.6m,  and MYR4.9m  respectively  in 3QFY13. The turnarounds were supported by higher sales volume in Thailand, higher ASP  in  Indonesia  as  well  as  overall  lower  log  and  glue  costs.  We  expect  the company to experience minor loss in FY14 before turning around in FY15. 

No dividend until FY16.  We do not expect EFB to distribute dividends in FY14-15 as the  company  needs  to  reserve  funds  for  its  restructuring  expenses.  However,  we believe the  company would resume to reward its shareholders from FY16 onwards, with expected dividend payout ratio of >20%.

Manageable  gearing.  As  at  end-Sep  2014,  the  company  has  a  manageable  net gearing ratio of 32.5%. It has a total cash of MYR53.1m in hand, with total borrowings of MYR305.5m, of which 88% are short-term borrowings.

Corporate Background
Brief  history.  EFB,  which  started  as  a  timber  trading  and  veneer  manufacturer  in 1972, is now a prominent manufacturer of MDF, particleboard, furniture, value-added wood-based products and resin.  Figures 15-19 in the Appendix,  show some of the company’s products.  MDF is an engineered wood product formed by breaking down hard-  or  soft-wood  into  wood  fibers.  It  then  combines  with  wax  and  resin,  forming panels by applying high temperature and pressure.

A  leading  MDF  producer.  According  to  the  Ministry  of  International  Trade  and Industry (MITI), the MDF industry in Malaysia currently h as 15 plants with a combined annual  installed  capacity  of  2.9m  m3.  In  2011,  exports  of  MDF  from  Malaysia amounted  to  MYR1.1bn.  MITI  said  Malaysia  is  the  world’s  third-largest  exporter  of MDF  after  Germany  and  France.  To  date,  EFB  is  one  of  the  leading  producers  of MDF and particleboard with an annual production exceeding 1.3m m3.10  plants  with  a  presence  in  Malaysia,  Thailand  &  Indonesia.  EFB  has  six production plants located in Johor and Negeri Sembilan  to produce various products including  MDF,  lamination  of  plywood,  particle  board,  etc.  In  2004,  the  companyexpanded its horizon to Thailand and subsequently entered the Indonesian market in 2007.  The  company  has  a  plant  in  Hat  Yai,  Thailand  and  Palembang,  Indonesia respectively.  In  addition,  EFB  also  owns  two  resin/adhesive  plants  in  Batu  Pahat, Johor and Gurun, Kedah. Both plants are supplying adhesive for its own use in its Malaysia and Thailand plants.

Source: RHB