Recovery in HP receivables

Hire purchase (HP) receivables recovered as the economy reopened and consumer demand improved. For Elk-Desa, HP receivables accelerated by 19%  YoY in CY22 to RM560.3mn in December 2022. To recap, total HP receivables decreased by around 10% in CY21 due to various Covid-19 movement restrictions implemented. The growth in HP receivables also surpassed management's modest guidance of about 8-10% due to ongoing cautiousness around inflationary pressures and rising policy rates.

On track to achieving pre-Covid levels

ELK-Desa is on pace to boost the HP receivables portfolio back to pre-Covid levels, given the steeper-than-expected return in HP receivables in CY22. By the end of FY24, management is targeting to increase the HP receivables to  RM610mn. We predict that the rise in HP receivables would likely moderate and expand at a softer but steady pace of 8% to RM606.6mn and RM655.1mn in  FY24 and FY25, taking into account the substantial increase in CY22 and management's expectations. We believe our forecast of 8% is reasonable given that the company grew at a 4-year CAGR of around 7%.

Impairment allowance to normalise

Credit loss charges continued to improve throughout FY23, decreasing YoY from 2.92% to 0.04% in the most recent 3QFY23 results announced. Elk-Desa reported a considerable decrease in non-performing accounts YTD due to reversals in impairment brought on by the outstanding collections achieved in the 2Q and 3Q of FY23. The management saw that the increase in economic activity coincided with an improvement in asset quality and that targeted EPF withdrawals helped to support the improved repayment trend. According to Elk-Desa, the net impaired loans ratio strengthened to 1.58% as of 31 December 2022 from 2.89% in FY22.

Heading into FY24, we reiterate that additional impairment reversal is unlikely and that collection should progressively normalise over the next few quarters. That said, we maintain our credit loss charge at conservative assumptions of 3.0% for FY24 and FY25 vs 0% for FY23 and the average 3-year (FY20-22) credit loss charge of 3.8%. However, the net impaired loans ratio could improve further as the Covid-19 act, passed to temporarily release parties from performing their contractual responsibilities for a specific duration, was repealed after October 2022.

Better growth prospects for the furniture business

The revenue in the furniture segment climbed to RM40.4mn from RM29.1mn a  year earlier, rising sharply from a low base when the MCO affected the furniture business in FY22. The management anticipates that the furniture industry will continue to gain from the uptick in consumer confidence and the rising demand for high-quality, value-for-money- furniture items. Strategies to grow this segment include working closely with furniture dealers to identify products that appeal to consumers. Efforts are also being stepped up to optimise stock and logistics management skills, which includes controlling any supply chain bottlenecks brought on by logistical hiccups to guarantee the prompt delivery of client orders and increase the capacity of the present warehouse.

Lean balance sheet but gearing expected to increase

As of 3QFY23, Elk-Desa's balance sheet remained lean, with gearing levels remaining manageable at 0.43x. To recap, the group's gearing level decreased to 0.26x in 4QFY22 as management concentrated on reducing borrowings due to the challenging market environment in the prior FY. Given the rising interest rates, the decision was timely. Nevertheless, due to the rise in hire purchase receivables, we anticipate borrowings to rise throughout FY24 and FY25 via drawdowns of block discounting facilities and possible MTN issuance. In light of this, we predict that the group's gearing level will rise. Rising finance costs as a  consequence of increased borrowing might reduce potential earnings.

Impact

Taken together, we adjusted Elk-Desa’s FY24 and FY25 net profit forecasts to  RM42.3mn and RM43.3mn from RM45.0 and RM45.8mn. FY23 net profit is maintained at around RM51.3mn.

Valuation and Recommendation

Tagging a 15% discount to Malaysia’s average NBFI (such as AEON Credit and  RCE Capital) P/B ratio of 1.3x due to Elk-Desa’s smaller market cap and rolling our valuation base year to FY24, we adjust the stock’s fair value to  RM1.18/share. The new TP also reflects the Bonus Issue that has been completed with the quotation of 151.6mn new shares, on the basis of 1 new share for every 2 existing Elk-Desa shares held. We reiterate a HOLD recommendation on ELK-Desa, backed by the group’s lean cost management and attractive 5-6% dividend yields.

Meanwhile, we note that Elk-Desa’s share price has risen sharply since we initiated coverage on the stock. The stock is currently trading above +1 std dev of the 5-year PBV valuation cycle. We note the potential downside risks to the stock includes: i) softer-than-expected earnings growth in FY24 on the back of lower HP receivables and normalisation in impairment charges, ii) increase in finance costs due to the increase in OPR, and iii) slower-than-expected demand for furniture envisaged.

Source: TA Research - 22 Mar 2023