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This article first appeared in The Edge Financial Daily on August 4, 2017

HeveaBoard Bhd
(Aug 3, RM1.74)
Initiate coverage with a buy call and target price of RM2.12:
HeveaBoard Bhd is a fundamentally sound company, enjoying a three-year compound annual growth rate of 53.1% in headline net profit from 2013 to 2016. It ceased production of lower-grade particle boards (E2) in mid-2014. Currently, HeveaBoard focuses on production of premium-grade particle boards — E1, E0 and super E0 graded products — with low formaldehyde emission, higher physical strength and profit margins. The group has just started to produce non-added formaldehyde, which is superior to the above-mentioned grades in respect of quality and pricing. We understand that HeveaBoard is the only particle board maker in Malaysia to manufacture such premium products.

HeveaBoard is a leading local particle board and ready-to-assemble (RTA) furniture manufacturer. It boasts a proven track record as it has managed to cling on to profitability even during business downcycles. It has consistently posted profits in the past 10 years, compared with its closest comparable peers such as Mieco Chipboard Bhd and Evergreen Fibreboard Bhd, mainly attributable to its concentration in operational efficiency and high value-added and margin products rather than sales volume alone.

Given prevailing headwinds faced by the group in the likes of a rebound of the ringgit against the US dollar (the ringgit has strengthened against the US dollar by 4% to 5% year-to-date), foreign labour and rubberwood shortages in the furniture industry, we believe HeveaBoard still commands a resilient business model which is unfazed by the current unfavourable operational atmosphere judging from the recent quarterly results.

The group recorded a 24.6% year-on-year increase in its first quarter of financial year 2017 (1QFY17) headline net profit on the back of a higher revenue by 8.8%. Although HeveaBoard is a net beneficiary of US dollar appreciation with over 90% of its revenue being US dollar-based and its cost is ringgit-based, the group’s strategy of selling premium products with a higher average selling price and strong pricing power following the shortage of rubberwood could cushion the impact of margin compression. The group has the flexibility of adjusting product prices to factor in currency fluctuations with receiving orders three to four months in advance. Our sensitivity analysis indicates that every 1% strengthening of the ringgit against the US dollar would reduce the group’s earnings by 6.6% in 2017 to 2018.

We envisage the group’s core net earnings to continue its growth trajectory in 2017 and 2018 by a respective 23.2% to RM94.9 million and 15.4% to RM109.5 million on the back of a rising top line of +9.8% and +12.7% respectively. The positive earnings momentum is mainly underpinned by continued growth in sales of RTA furniture especially in Japan, ongoing efforts in selling high-margin particle boards, and high value-added and its wide range of RTA furniture. Besides, HeveaBoard commands a healthy balance sheet with current net cash/share of 18 sen, which allows it to have ample flexibility to gear up for future capacity expansion and mergers and acquisitions should any opportunities arise.

With the foreseeable surge in export orders for RTA furniture, the group is ready to take on more orders of new veneer-based products from Japan starting from 2018 onwards with additional factory premises and production facilities to be completed by end-2017. The new RTA plant is believed to increase its existing furniture capacity of 7,200 containers/year by 20% to 8,640 containers/year and further lift the group’s top line and bottom line by 11% to 12% respectively for 2018. We believe export sales to Japan are sustainable or even stronger, especially approaching year 2019 for RTA furniture as well as particle board, in view of the upcoming Olympic Games to be held in Tokyo, Japan, in 2020.

HeveaBoard has allocated RM10.5 million in equipment to cultivate King Oyster mushrooms this year. We are positive on this new business venture as the group can utilise its existing waste, which is currently sold to boiler users at a discount as raw materials to cultivate mushrooms. We understand that the business could render a higher profit margin for the group compared with its RTA furniture and particle boards, and the payback period is short with 45 days of harvest time. The project will be carried out in three phases with three tonnes of production per day under phase 1. Assuming a 30% product margin and RM10 million revenue generated from phase 1, we would expect the group to rake in RM3 million in earnings for 2018.

We estimate the group’s 2017 and 2018 core net earnings to trend upwards, growing by 23.2% and 15.4% respectively. The group’s net profit margin is expected to remain elevated at around 16% to 17% in line with its strategy of focusing on high value-added and margin products, coupled with increasing operational efficiency following automation and a lower effective tax rate. We have imputed the contribution of the mushroom cultivation business into our earnings forecasts, while yet to factor in earnings from the new RTA plant. — JF Apex Securities, Aug 3

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