Friday 09 Jun 2023
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This article first appeared in The Edge Malaysia Weekly, on October 24 - 30, 2016.


FEDERAL Furniture Holdings (M) Bhd (FFHB), the sole approved vendor of store sets for Starbucks Corp in 13 Asia-Pacific countries, wants to diversify into construction.

The furniture maker intends to buy a 60% stake in Pembinaan Masteron Sdn Bhd (PMSB), a construction outfit that is currently wholly owned by its controlling shareholder — the Choy family — for RM33 million.

The Choy family holds a 22.3% stake in FFHB, while PMSB is the family’s construction arm that services its property development business under the Masteron Group.

It may be a private developer but it is quite sizeable compared with FFHB’s market capitalisation of only RM66.1 million.

“In total, we estimate that Masteron’s land bank has a potential gross development value of RM3 billion to RM4 billion. Of this, about RM600 million to RM700 million worth of projects are already in the pipeline,” managing director Datuk Choy Wai Hin tells The Edge.

PMSB was already sitting on an order book of RM355 million as at Aug 8. Looking ahead, the group is expected to add RM500 million to its order book in the next 12 to 18 months, says Choy.

“Of course, this also depends on the property market,” he says, conceding that sales have slowed down.

However, Choy stresses that Masteron has always been focused on affordable housing. Its properties are priced below RM600,000 and this will remain the same going forward. It will continue with affordable homes that are priced at RM350,000 to RM400,000. “At this price range, sales should be more resilient,” he says.

The bulk of Masteron’s land bank is in Puchong, Selangor. One of the group’s major projects in the pipeline is the Trizen project that sits on 16.77 acres. This upcoming project, with a GDV of RM1 billion, is listed under its old name of Petaling Jaya South City on the Masteron website.

Choy also dismissed concerns that PMSB’s margins would be low because it depends on in-house projects. At the very least, he expects PMSB to reap a gross margin of about 10%, in line with the industry average.

In FY2015, PMSB generated RM15.91 million in gross profit against RM147.13 million in revenue. That works out to a gross margin of  RM10.8%. Gross margin in FY2014 was 9.4%. 

PMSB’s other expenses — including sales and distribution costs, and administrative expenses, are relatively consistent at RM7 million a year. As a result, the FY2015 PAT was RM5.52 million with a net margin of  3.75%.

For perspective, FFHB generated only RM6.69 million in profit for the trailing 12-month period ended June 30.

Note, PMSB draws 100% of its work from the Masteron Group. Hence, PMSB could be considered risky due to the high exposure to a single client.

However, to allay some of these concerns, the Choy family is giving a net profit guarantee of RM20 million from FY2016 to FY2018 (ending Dec 31).

For FY2016 alone, the vendors guarantee a PAT of RM7 million.

In total, FFHB’s 60% share of the PAT (FY2017 to FY2018) would work out to RM7.8 million. This is 23.6% of the total acquisition cost recovered in two years.

But this is only the minimum PAT contribution. The actual earnings could be substantially higher, depending on Masteron’s property sales.

In contrast, FFHB will only have to fork out RM6 million cash up front for the acquisition. The balance RM27 million will be settled through redeemable convertible preference shares (RCPS) with a maximum dividend rate of 8%, based on the nominal value of the RCPS.

For now, FFHB can easily afford the acquisition. The company has RM7.95 million cash on its books against RM10.5 million in borrowings. This works out to a very low net gearing of 0.05 times.

Note that PMSB had only RM1.96 million in borrowings as at Dec 31, 2015, and a net asset value of RM14.15 million.

It is interesting to note that the RCPS have no voting rights. They are merely entitled to dividends in preference to FFHB’s ordinary shares. The RCPS have a tenure of 10 years and can be converted to ordinary shares at any time. However, they can only be redeemed after three years.

In effect, the RCPS simply dilute any future dividends. But by issuing RCPS as opposed to ordinary shares, the Choy family averts triggering a mandatory general offer for FFHB. Depending on how the RCPS are converted however, an MGO could still be triggered at a later date.

Overall, the RM33 million price tag for the acquisition values PMSB at 9.96 times FY2015 PAT of RM5.52 million. Based on the guaranteed RM7 million PAT for FY2016, PMSB’s valuation is a more attractive 7.86 times earnings.

Against this backdrop, FFHB’s share price closed at 77 sen last Thursday. This values the company at 9.53 times historical earnings. Note also that FFHB’s earnings have been lumpy. The group saw strong earnings of RM4.49 million in the second half of last year. But that has tapered off in the first half of this year with net profit falling to RM2.2 million.

Recall, FFHB is the contractor for the world’s largest coffee franchise, Starbucks. FFHB supplies furniture and fittings for 13 countries in Asia Pacific, except China. Over 90% of FFHB’s sales come from Starbucks. 

“FFHB’s current core business can have rather volatile earnings. We have benefited in the past year or so from the weaker ringgit against the US dollar. Prior to that, however, earnings have not been fantastic. But the diversification into construction should help provide more stable earnings going forward,” says Choy.

FFHB is currently looking to tap into Starbucks’ explansion into China, where the chain plans to open about 500 stores annually, says Choy, more than one each day.

“It is still preliminary at this stage, we are still bidding for the work. Starbucks already has vendors serving it in China, so the barriers to entry are high,” says Choy.

But if FFHB can get a slice of the action, it would be a huge boost for earnings.

By the same token, considering the strategy to tap the massive China market, this probably raises the question as to whether it is necessary for FFHB to diversify into construction at a time when the property market is slowing down.

Naturally, the Choy family will have to abstain from voting on the acquisition. The second largest shareholder of the company is RHB Asset Management Sdn Bhd through several investment funds. Based on Bloom-berg data, RHB Asset Management collectively has about an 18% stake in FFHB. 

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