HP receivables to rise by 9-10% YoY

As anticipated, Elk-Desa’s hire purchase (HP) disbursements in 1Q24 have eased to RM44.3mn. This decline follows the strong receivables growth in the previous FY, driven by a recovering economy and improved consumer sentiment, which has since subsided. Management attributes this 36% YoY decrease to their deliberate strategy to control disbursements more effectively. They aim to maintain a more sustainable growth rate of 10-15% amid ongoing concerns regarding inflationary pressures and the repercussions of increased policy rates.

HP Receivables on track to reaching pre-Covid levels

To recap, Elk-Desa experienced a substantial 23% YoY increase in HP receivables during FY23. Looking ahead, we anticipate that its HP receivables will continue to grow, with a projected 9% increase in FY24, followed by a slight improvement to 10% in both FY25 and FY26. We believe our forecast is reasonable due to 1) car buyers seeking more cost-effective alternatives, which could drive increased demand for used car options, 2) a growing supply of used cars in the market, and 3) ongoing dealer initiatives such as offering extended warranty program to instil confidence in buyers. Despite the anticipated moderation in HP receivables growth, we remain optimistic that Elk-Desa is well-positioned to surpass its pre-Covid levels of RM610mn by the end of FY24.

Impairment allowance to normalise

As anticipated, Elk-Desa witnessed a return to more normalised credit loss charges, with the impairment charge increasing to 1.18% in 1QFY24 from a net writeback of 1.01% in the previous year. During the quarter, Elk-Desa reported an impairment allowance totalling RM7.33mn. This increase was primarily driven by a slowdown in collection efforts and reduced customer repayment rates.

Given the persistently challenging macroeconomic environment, earnings have a potential downside risk due to higher-than-expected impairment charges. Aligning with management's guidance, we have adjusted our forecast, raising the expected credit loss charge from 3% to 4% for FY24, FY25, and FY26. This adjustment aligns with the historical average of 4.1%, as reported in FY20 and FY21.

Additionally, the net impaired loans ratio deteriorated to 2.25% in 1QFY24, compared to 1.83% last year. Management noted their commitment to address this issue by intensifying efforts to reduce the net impaired loans ratio and enhance credit recovery measures.

Softer furniture sales envisaged

In 1QFY24, revenue in the furniture segment decreased to RM12.4mn, down from RM14.4mn in the same period last year, despite the presence of the Hari Raya festive season. Management anticipates continued sluggishness in furniture sales for the upcoming quarter. However, their strategic focus will be on boosting sales growth in 3Q and 4Q. This growth will be achieved through organic expansion and a heightened emphasis on wholesaling home furniture.

Furthermore, Elk-Desa is keen on expanding its market presence in Sabah and Sarawak, both of which are populous states with growth potential. Additionally, the company is intensifying efforts to streamline logistics management, addressing potential supply chain bottlenecks and ensuring timely delivery of customer orders. On a positive note, the segment's gross margins have seen a slight improvement, rising to 37% primarily due to reduced freight costs.

Balance sheet is still lean, but gearing is expected to increase

As of the 1QFY24, Elk-Desa's balance sheet has maintained its lean structure, with manageable gearing levels at 0.52x, up slightly from 0.42x in the previous quarter. To recap, in the 4QFY22, the group's gearing level decreased to 0.26x as management prioritised debt reduction amid challenging market conditions. However, due to the growth in hire purchase receivables, we anticipate that borrowings will gradually rise over FY24/25/26. This increase is expected to occur through drawdowns of block discounting facilities and potential MTN issuances. Consequently, we predict that the group's gearing level will continue to climb. The rise in finance costs resulting from increased borrowing may exert downward pressure on potential earnings.

Impact

Taken together, we revised Elk-Desa’s FY24/25/26 net profit forecasts to RM37.3/38.7/41.1mn from RM41.2/43.0/45.5mn.

Valuation and Recommendation

Tagging a 20% discount to Malaysia’s average NBFI (such as AEON Credit and RCE Capital) updated P/B ratio of 1.5x due to Elk-Desa’s smaller market cap and lower ROEs, we adjust the stock’s fair value to RM1.28/share from RM1.23/share. Given that the risk-reward potential remains narrow, we reiterate our SELL recommendation on the stock.

We note the potential downside risks to the stock include: 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 - 8 Sept 2023