We believe that the positive factors currently outweigh the negative ones for WTK, as the impact from strong log prices and volumes as well as the weak MYR/USD rate more than offset the impact of the weak plywood demand and prices. We upgrade our recommendation to BUY (from Neutral) with a higher SOP-based TP of MYR1.08 (from MYR1.00, 14% upside), as valuation has fallen to 8.2x FY16 now, below its three-year historical average of 10x.

Key highlights from our recent visit: i) log production to decline by 15-20% in FY15, but some recovery expected for FY16; ii) log prices continuing to rise; iii) lower productivity equals higher log costs; iv) subdued plywood demand in 1H15, although some recovery expected; v) stalled new planting at the palm oil division; and vi) oil and gas venture slowly taking flight.

Strong log performance to offset weaker plywood outlook. Although WTK Holdings (WTK) should harvest less logs this year due to delays resulting from the illegal logging clampdown in the state, this should improve going forward, as operations have normalized since Jul/Aug. This, in addition to the still rising log prices and weak MYR/USD rate, should bode well for WTK’s earnings. We believe this will more than offset the weakness in demand and pricing for plywood products.

Raising earnings forecast. All in, we raise our forecast by 14.1-14.5% for FY15-16 and 2% for FY17, after: 1) reducing our log export percentage for FY15; 2) raising our log price assumptions; 3) raising our log harvest volume assumptions for FY16-17; 4) raising our log cost assumptions; 5) reducing our new planting assumptions for the plantation division; 6) imputing contributions from the oil & gas division; and 7) imputing our latest in-house MYR/USD exchange rate assumptions of MYR3.90/USD for FY15 (from MYR3.86), MYR4.30 for FY16 (from MYR4.00) and MYR4.20 for FY17 (from MYR4.00).

Upgrade to BUY. Post-earnings revision, our SOP-based TP is lifted to MYR1.08. We believe WTK is one of the prime beneficiaries of the weak MYR/USD, given that the bulk (close to 90%) of its earnings is in USD, while its costs are in MYR. We highlight that every MYR0.10/USD change in exchange rate could increase WTK’s net earnings by c.13-15%. In addition, with the continued strengthening in log prices, we expect WTK’s earnings to grow by a three-year CAGR of 17% per annum over the next three years. Valuations are now at a more attractive 8.2x P/E FY16F, which is below its three-year historical average of 10x.

Key highlights from our recent visit: i) log production to decline by 15-20% in FY15, but some recovery expected for FY16; ii) log prices continuing to rise; iii) lower productivity equals higher log costs; iv) subdued plywood demand in YTD-15, although some recovery expected; v) stalled new planting at the palm oil division; and vi) oil and gas venture slowly taking flight.

Weak log supply in 2015. In 7MFY15, WTK produced 249,916 cu m of logs (-13% YoY), which is slightly better than our projected -14% decline in log production for FY15. Management is projecting to log about 400,000-420,000 cu m of logs this FY15, which translates into a YoY decline of 14%-18%. The decline came about as a result of the clampdown of illegal logging which slowed down processes significantly since end-2014, although we highlight that WTK was not directly affected by this clampdown in terms of frozen accounts and the likes. We understand that things have returned to normal since Jul/Aug and management is expecting an improvement in log harvesting in FY16, as a result. We are leaving our log production forecast unchanged at 420,0000 cu m for FY15 but raising our FY16-17 forecasts to 430,000-440,000 cu m, reflecting a 2% growth per annum. We are reducing our log export forecasts as management highlighted that it only exported 30% of its harvests in 1H15, lower than its usual 35-36% per annum. This is due to the fact that WTK prioritises its plywood production over log exports, given the scenario of reduced log harvests. We have therefore reduced our log export projection to 30% of harvests in FY15 (from 35%), but maintaining it at 35% for FY16-17. Rising log price trend expected to continue. WTK recorded an average export log price of USD285/cu m in 2Q15, bringing its 1H15 average export log price to c.USD273/cu m. This implies an increase of 15.2% YoY and 10% QoQ. Going into 3Q15, management continues to see an increasing price trend for its log orders, on the back of a still-strong demand from India, which takes up 75-80% of WTK’s log exports, and the shortage in log supply from Malaysia. This price trend has also been highlighted in the recent Japan Lumber reports. Based on this scenario, we are raising our export log price assumptions to USD270/cu m for FY15 (from USD245) and to USD280-290/cu m for FY16-17 (from USD260-270).

Lower productivity equals higher log costs. Given the reduction in log supply, WTK’s unit log costs have risen to about MYR540/cu m in 1H15 (from MYR460/cu m in FY15). As log production is expected to improve in 2H15, these costs should also moderate to about MYR500/cu m in 2H15. We have thus adjusted our log cost assumptions upward to MYR540-600/cu m for FY15-17 (from MYR460-500/cum).

Weak plywood demand in 1H15, although some recovery is expected. WTK’s plywood division saw sales volumes drop 13.5% YoY in 1H15, on the back of weak Japanese demand. However, since July, management has been seeing a pickup in demand from Japan, likely due to the reversal in Japanese housing starts of +2% YoY in YTD-July (from 2% in YTD-Apr 2015). WTK has also been shifting its product mix slightly, to produce floorbase plywood which is a notch lower in quality. This is expected to help push demand up, given its lower selling price. WTK continues to target its plant utilisation rate at 60-70%, which is above the breakeven point of 55-60%. Average selling prices of its plywood products averaged about USD555/cu m in 1H15 (-7.7% YoY). Management highlighted that the decline in USD-based prices was as a result of price pressure from customers in Japan, given the weak Yen and the strong USD. This pricing pressure is still being seen now, which means prices could decline further going forward. We therefore believe our price assumptions of USD513-537/cu m for FY15-17 is achievable. On the cost front, plywood costs have remained relatively flat at MYR1,800-1,850/cu m, which is in line with our forecasts.

Not much progress at the plantation division. There has been very little progress at WTK’s plantation division YTD (Aug 2015). In FY14, it planted 500ha of landbank, and YTD (Aug 2015), it has also planted a similar 500ha only, bringing total planted landbank to 12,300ha. WTK does not expect to be able to plant up any more landbank in the medium term, due to native issues at its NCR (Native Customary Rights) land. As such, we have adjusted our new planting targets downwards accordingly, projecting new planting of 500ha for FY15 and zero for FY16-17 (from 2,000ha per annum previously). We do expect, however, for some 2,500ha of new areas to come into maturity in FY15 and another 2,000ha in FY16. Oil and gas venture slowly taking flight. WTK entered into the oil and gas (O&G) industry in Nov 2014, acquiring a company which provides and operates offshore support vessels (OSV), equipment and engineering consultation for O&G activities. The company is also a vessel charter contract holder and licensed operator by Petroliam Nasional (Petronas). Currently, WTK has three workboats, which are chartered to Petronas for a 2-3 year tenure. The charter for the first boat was locked-in on Sep 2014, the second in Mar/Apr 2015 and the third in Sep 2015, with charter costs fixed during the rental period. WTK is taking delivery of a fourth boat in Apr 2016. In 1H15, WTK garnered MYR0.5m in profit before tax on a revenue of MYR2.1m. Management has highlighted that the insignificant profit in 1H15 was due to the high mobilisation costs involved when taking delivery of a new vessel during that period. Management is hoping to achieve a profit before tax of c.MYR10m in FY15. As we previously had not included the contribution from this division into our forecasts, we are doing so now, although we are more conservative with a profit before tax of MYR4-8m for FY15-17F.

Risks Main risks. These include: 1) a reversal in Japan’s economic recovery, resulting in a decline in the country’s housing starts, 2) log production recovering in a significant manner in Malaysia, or if Indonesia lifts its ban on log exports, 3) a significant change in direction of the MYR/USD exchange rate, 4) the imposition of import duties on large export markets like India and Japan, and 5) a change in supply/demand dynamics leading to a sharp fall in crude palm oil (CPO) prices. Forecasts Raising earnings forecasts. All in, we raise our forecasts by 14.2-14.5% for FY15-16 and 2% for FY17, after: 1) reducing our log export percentage for FY15; 2) raising our log price assumptions; 3) raising our log harvest volume assumptions for FY16-17; 4) raising our log cost assumptions; 5) reducing our new planting assumptions for the plantation division; 6) imputing contributions from the oil & gas division; and 7) imputing our latest in-house MYR/USD exchange rate assumptions of MYR3.90/USD for FY15 (from MYR3.86), MYR4.30 for FY16 (from MYR4.00) and MYR4.20 for FY17 (from MYR4.00).

Valuation and recommendation Upgrade to BUY. Post-earnings revision, our SOP-based TP is lifted to MYR1.08 (from MYR1.00). We believe WTK is one of the prime beneficiaries of the weak MYR/USD, given that the bulk (close to 90%) of its earnings is in USD, while its costs are in MYR. We highlight that every MYR0.10/USD change in exchange rate could increase WTK’s net earnings by c.13-15%. In addition, with the continued strengthening in log prices, we expect WTK’s earnings to grow by a three-year CAGR of 17% per annum over the next three years. Valuations are now at a more attractive 8.2x P/E FY16F, which is below its three-year historical average of 10x.

Financial Exhibits

SWOT Analysis

Company Profile

WTK Holdings is involved in the harvesting of timber and the manufacturing of plywood and sawn timber. All of its natural forest concession, plywood mills and sawn timber mills are situated in Sarawak.

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Source: RHB Research - 23 Sep 2015