KapitalWise. Latitude Tree Holdings Consumer Goods Furniture manufacturer Stock Code: 7006.KL Malaysia BUY. Investment Considerations

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Cuthbert Norris
5 years ago
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Latitude Tree Holdings Consumer Goods Furniture manufacturer Stock Code: 7006.KL Malaysia BUY Current Price RM 5.00 Target Price RM 5.90 Est. Upside Potential 18.10% Market Cap RM 486.

1 Latitude Tree Holdings Consumer Goods Furniture manufacturer Stock Code: 7006.KL Malaysia BUY Current Price RM 5.00 Target Price RM 5.90 Est. Upside Potential 18.10% Market Cap RM m 52-week Range RM 4.62 RM 8.10 Average Volume 29,160 (Source: FT) Shares Outstanding 97,208,000 Free float 17.08% (Source: FT) Beta 0.58 (Source: Reuters) Valuation Basis DCF + Comparable Dividend Yield 2.40% (Source: FT) Investment Considerations Source: Yahoo Finance Please refer to reputable share price providers for more accurate data 1) One man s ceiling is another man s floor The Fall of MYR The company has benefitted from the weaker MYR against major currencies, resulted in a massive amount of FX gains in the cash flow generation (RM10m in FY16 which represents 13.7% of the net income). Despite the significant operations in Vietnam, the majority of the revenue was contributed by the United States (93% of the revenue). However, with the uncertainty of the United States, economy after the election result and the home improvement goods are showing sign of slowdown might reflect challenging outlook. We have projected a moderate growth of 3.3% (compared to 9.9% historical CAGR). Operations strategically located in Vietnam will lower its production costs relative to Malaysia but exposes to geopolitical risk which might jeopardise the operations. 2) Net cash position with decent cash flow generating ability. Currently, the company is supported by strong balance sheet with net cash position (RM 102m in FY16). Cash balance of RM183m is more than adequate to cover the total liabilities of RM181m. Cash flow generating ability as indicated by the Fund from Operation margin sustained at above 6%. However, the Capex/Sales ratio is quite volatile which fluctuates around 1% to 8%. Our cash flow projections assume Capex/Sales of 3.5% which, in absolute terms, is higher than the historical (on average). Although the revenue posted a robust growth, the decline in net profit was attributable to 1) higher tax expense and 2) lower other income. FY15 s net income was boosted by the recognition of unrealised FX gains of c. RM7m. Despite the decline, the company is able to show better costs control which may be attributable to favourable FX translation (higher top-line while costs stay relatively flat). Gross profit margin increased from 16.6% to 17.7% in FY16. From peer comparable, it also shows that Latitude Tree is one of the best performers in terms of cash flow generation and profitability. 3) Attractive valuation suggested by DCF model and relative valuation. We utilised DCF model and relative valuation and assigned 70% and 30% respectively. Currently, the Multiples of Latitude is trading at an undemanding level (one of the lowest in the industry). We believe that there is a lot of upside potential with its cash flow generating ability and its low multiples suggest it could experience multiple expansion. The fair value according to our calculations and assumptions is RM5.90 with the implied upside of 18.10%. The risks to our buy recommendation are discussed in page 8. Contributor Jackson Yuen jacksonyuen@yieldmountain.com Date 05/11/2016 KapitalWise Page 1 of 11

Headquartered in Malaysia with major operations in Vietnam.

91% Konsortium Kontrek Sdn Bhd 10.40% Lin Chin-Hung 5.86% Lin Tzu-Lang 5.18% Lin Cheng-Hung 5.

Although it benefits from less reliance on the domestic market, it is negatively constrained by the

It has been said that the United States contributes to 93% of the Latitude Tree s revenue.

similar evidence from Deutsche Bank research.

2 Company Profile Core business operation is manufacturing of household furniture (such as Bedroom, Living Room and Dining Set). It also has PPE rental and investment holdings. Headquartered in Malaysia with major operations in Vietnam. Export-oriented with significant exposure with United States. Top 5 Shareholders Lin Chen Jui-Fen 24.91% Konsortium Kontrek Sdn Bhd 10.40% Lin Chin-Hung 5.86% Lin Tzu-Lang 5.18% Lin Cheng-Hung 5.14% As of 7 th October 2016 Furniture segment represents over 95% of the revenue. Although it benefits from less reliance on the domestic market, it is negatively constrained by the concentration risk of the US. It has been said that the United States contributes to 93% of the Latitude Tree s revenue. In our previous research on JayCorp, we discussed that the housing market is strengthening and we saw a similar evidence from Deutsche Bank research. The selling figures and unemployment claims suggest the economy is improving. However, home improvements and goods have seen growth sliding toward negative territory. We believe there is a potential risk due to its exposure to the United States but the management plans to explore opportunities in other countries such as Taiwan, China and Australia which might take some time to realise. Page 2 of 11

As shown in peer comparable, the industry is not lucrative by nature hence cost controlling becomes the key to earning an abnormal profit.

3 Currently, Latitude tree has three factories in Malaysia, two factories in Vietnam and one factory in Thailand. Vietnam operations contributed significantly through exporting goods (almost 80% of FY16). As shown in peer comparable, the industry is not lucrative by nature hence cost controlling becomes the key to earning an abnormal profit. We believe production in Vietnam has contributed positively to the bottom line result due to its lower production costs relative to Malaysia and Thailand (in terms of labour and other costs). Despite the cost advantages, it comes with the political and geopolitical risks of which any increase in geopolitical tension might jeopardise its production. Vietnam has experienced anti-china protests and riots and disputes in the South China Sea, and Latitude Tree s operations were affected by 2014 s riot. We believe the geopolitical risks are manageable in foreseeable future as the economic integration is getting deepened between ASEAN and China due to the establishment of AIIB. As it is an export-oriented stock, any weaken in MYR would lead to cash contribution in the form of FX gains. Below is the exchange rate between USD and MYR. We looked at the FX gains in the Cash Flow Statement rather than the Income Statement. The percentages shown underneath is the FX gains / Net Profit to indicates how currency movements would affect the cash flow generation. +RM 0.8m 6.4% +RM 4.2m 42.9% +RM 1.0m 4.1% +RM 4.8m 8.7% +RM 29.1m 37.4% +RM 11.1m 15.3% The currency forecast (USD/MYR) is taken from tradingeconomics.com, and they forecast that USD will remain in the region of 4.1 and 4.3 in the foreseeable future. However, it might not take into account the possibility of interest rate hike by the Fed which may boost the USD value when the money starts to shift from emerging markets to the United States. We do not attempt to forecast the currency due to its complexity hence the above is for your information. Page 3 of 11

4 Peer Comparable The followings are the peers identified using Financial Times and public sources. The lists were all Malaysian companies. JB = Jaycorp = manufacturing of rubberwood furniture and packaging and others. EH = Euro Holdings Bhd = manufacturing and trading of office furniture. FF = Federal Furniture = manufacturing of furniture, renovation and interior design. SHH = SHH Resources = manufacturing of wood-based furniture. SK = Sern Kou Resources = manufacturing of wooden furniture, Kiln-drying and lamination. SWS = SWS Capital = manufacturing and sales of leather upholstery and wooden furniture products. PH = Poh Huat Resources = manufacturing furniture products. LL = Latitude Tree = manufacturing of wooden furniture and components (rubber-wood furniture). Key Takeaways from peer comparable (based on the FYE): - As pointed in the JayCorp s analysis, Poh Huat s (PH) investment metrics might not be accurate despite our effort of checking hence the investors are advised to do their own due diligence. - Latitude Tree is one of the best performers in terms of EBITDA margin and Fund from Operations Margin. - Its investment metrics, although, are not the lowest, but they are (in our opinion) trading below the peers average. - Leverage is also sustainable at current level as with most of the peers with good interest coverage ratio. - Enterprise value metrics are showing Latitude is trading at the lowest multiple. Page 4 of 11

5 Financial Summary Page 5 of 11

Valuation Although the company has consistently distributed dividend, dividend discount model might not give a true fair value in view of the firm has retained most of the earnings (dividend will

We have made some assumptions for cash flow projections which will be discussed below.

6 Valuation Although the company has consistently distributed dividend, dividend discount model might not give a true fair value in view of the firm has retained most of the earnings (dividend will fail to capture the total shareholders return). Therefore, we believe the discounted cash flow model and relative valuation are more appropriate. We have made some assumptions for cash flow projections which will be discussed below. And for relative valuation, we are still using the multiples that we used for JayCorp s analysis (same industry) and updated the latest market capitalization and enterprise value (obtained from Gurufocus) to reflect the most recent trading multiples. Discount Rate We have adjusted the beta using 0.55 instead of 0.33, so it reverts back to the mean relatively quick. The CAPM suggests the appropriate rate of return is 6.32% and we have used 10% rate of return due to the high foreign investment and political risks as well as low average trading volume (low liquidity). Page 6 of 11

7 As the firm is showing sign of deleveraging over time as measured by Debt / EBITDA (through the combination of better EBITDA generation and reduced bank debts) hence we have projected a bank debt at the current level for the foreseeable future. Any reduction of bank debt would further enhance the cash flow generation in the form of reduced interest expense. We projected the revenue would be growing at 3.3% due to the uncertain outlook associated with the United States, but the FX gains might offset the weak trading performance as well as the management s attempt to expand into high growth regions. EBITDA is expected to be in the region of 10% to 13% (FY16: 15.1% and FY15: 15.4%). Our Capex/Sales is estimated at around 3% of sales which is still higher, in absolute terms (on average), compared to the historical Capex and the estimates are in line with the industry average. The terminal growth is assumed to be at 1%, and at discount rate of 10%, the fair value is RM 5.67 with a suggested upside of 13.36%. We used the same peers from JayCorp and updated the current market value to reflect latest multiples. At the current trading multiples, it is considered low which we believe Latitude Tree has a scope for re-rating in multiples. At the adjusted average, Latitude Tree is still attractive. The fair value based on the relative valuation is RM6.46 or 29% estimated return. To conclude, we assign a higher weight to the discounted cash flow model because it considers the potential cash inflow of the business using riskadjusted discount rate. A weight of 70/30 suggests the value is RM 5.90 (upside of 18.1%). Sensitivity analysis and information on projection are provided at appendix. Page 7 of 11

8 Principal Investment Risks The Weaker United States trading outlook Its high dependent on the United States comes with the risks of slowing economy that will reduce the market s sentiment and delay in consumption. Any adverse development will lead to deteriorated financials. Diversification will become the core objective of the firm. High Capex constrains its cash flow generation Capex is a significant cash outflow which is quite volatile (fluctuate between 1% and 8%, average 3.44%). Any adverse increase might weaken its cash flow temporarily, but we have factored in a Capex/sales of 3.5% which is we deem as good representative. Currency fluctuation will reduce the financials If the USD unexpectedly weakened substantially, it could reduce the cash position through translation losses and also making the goods relatively expensive. However, with lower cost of production, it might has some headroom for further pricing pressure. Geopolitical risks in Vietnam Operations This is a potential threat of which any prolonged period of rising geopolitical uncertainty with Vietnam might jeopardise the operations. In 2014, there were over 300 factories destroyed including Latitude Tree s. Investment Ratings Buy Neutral Sell = Share price may exceed 15% over the next 12 months = Share price may fluctuate within the range of ± 15% over the next 12 months = Share price may fall more than 15% over the next 12 months Investment Research Disclaimers The opinions and views expressed in this report are solely of the contributor. Any projections or estimations may not be accurate. Market conditions and investor s sentiments could result in materially different outcomes. Past performance is not necessarily an indicative of future performance, and the contributor will not accept for any loss arising from information contained in this report. This report is not intended as an offer to buy or sell the securities discussed. Seek independent advice to understand the investment risk arising from taking investment actions based on this report. Consider your unique circumstances (such as time horizon, liquidity and risk tolerance) before investing as not all investment are suitable for every investor. The contributor currently has no financial interests with the company analysed in this report. The company has not paid the contributor to write this research. The contributor currently has no shareholding in the company analysed in this report. The contributor may invest in the company analysed in the future but will only do so after 48 hours of publishing of this report. Background of the contributor Currently working as a Credit Analyst in a Hong Kong-based Bank, analysing the retail, corporate and syndicated loans in various industries (Food and Beverage, Construction, Clothes Manufacturing, etc.). Passed Level 3 of the CFA Program. MSc Banking and Finance from the University of Sussex. BA (Hons) Accounting from the University of Portsmouth. Currently pursuing the ACCA qualification. Page 8 of 11

9 Appendix 1 Information on historical and projected financials 2009a = Actual result 2017e = Estimated result Margins = % of revenue Page 9 of 11

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