- Lii Hen Industries Bhd
- Poh Huat Resources Holdings Bhd
- Latitude Tree Holdings Bhd
What are the similarities among these three companies?
1. All three are based in Malaysia and primarily engaged in manufacturing of furniture products: living room sets, dining sets, bedroom sets, etc.
2. Their biggest customers are from US, so they export the products to US. This benefits them significantly as they earn USD while USD strengthen against MYR since mid 2011 (and MYR continues weakened till now).
3. They were valued very low in 2011-2012 (P/E < 4x; P/B < 0.5x).
4. Since 2011-2012, earnings have grown by double to quadruple.
5. Valuation multiples re-rate to 7-9x P/E.
6. After several years of strong earnings and free cash flow, they are all in strong net cash and P/B is above 1.0.
7. The combination of growing earnings and rising valuation multiples trigger the share prices to increase by 7 – 10x in past 5 years. In the chart below, the orange color is Lii Hen, blue color is Latitude Tree, and red color is Poh Huat. Both Latitute Tree and Poh Huat declined since start of 2016, but Lii Hen continued to rise.
8. The worst thing is I didn’t own any of the shares after I first discovered them in 2014. No matter how great a stock you discovered, if you don’t own it, it doesn’t count.
MYR did weakened significantly against many currencies in past 5 years. Against SGD, it weakened from 1:2.4 to 1:3.1 now, around 23% drop. But the average net return will still be above 100% for 2-3 years of investment.
My First Encounter
I first encountered Lii Hen in 2014 during stock screening for my previous Fund. Together with its competitors, they were having great two years with rising revenue and profit, and consequently, their share prices rose accordingly. They were very small at that time with market cap below MYR 200m (they are still quite small now) and MYR was depreciating substantially. ROE was also in low teens. I checked out the annual reports, but the management, like many others, did not explain much about the business. I just put Lii Hen aside and didn’t pay attention to it.
This gets me to thinking: How can I revise my investment process so that I don’t miss out such opportunities?
Why the share price rose?
US economy and housing recovery and strengthening USD have provided windfall profits for these furniture exporters from Malaysia. On average, the revenue grew by high single digit per year over the past 5 years, and their gross margins rose from low teens to high teens. From this, you can deduce that rising USD against MYR was expanding the gross margin substantially. As SG&A as a percentage of revenue remains relatively stable, the operating margin grew from 4-5% to 10-15%. Thus, earnings grew by double to quadruple over the past 5 years.
The growing earnings did catch the market attention. The valuation multiples re-rated from 3-4x P/E to 7-9x P/E. That re-rating itself more than double the share price. Combining the earnings growth and re-rating, the companies saw the share price rose by 700 – 1000% in 5 years.
Why low P/E?
P/E of 3-4x is really telling you that the market is generally ignoring this industry and expects a dim outlook. That was mostly true from 2006 to 2011. MYR was also strengthening against USD during that period, and as US had a worst housing market crashed, the market wouldn’t want to invest in furniture exporter to US.
After re-rating, the P/E remains low at 7-9x. This tells you that the market in general is still not bullish about the prospect of the industry, despite the fact that the companies’ fundamental have improved substantially. Going forward, if the companies can still maintain earnings growth (and FCF growth) of mid to high single digit, I believe, they will get re-rated further to higher valuation multiples.
My Second Encounter
I re-looked at these players in October 2015. Despite outstanding performance over the past 3 years, the managements still did not explain much about the business in the annual reports, to my disappointment. These are small cap and sell-side analysts don’t cover them.
Instead of digging further, I stopped there and looked at other companies. I was very concerned about the weakening MYR and didn’t dare to get any exposure to Malaysian stocks. Besides, there are several things to understand for this furniture manufacturing industry.
For furniture makers, it’s hard to have a competitive advantage. Probably none. Furniture design can easily be copied. The furniture can be manufactured in a country with cheaper labor cost and exported overseas. Malaysia’s labor cost is not low compared to other developing countries’. If somehow MYR strengthens against USD, then it will be the furniture exporters’ turn to experience falling margin. I can’t predict where the forex is moving. For these furniture exporters to continue doing well, we’ll need to check and monitor the US housing demand too. Macro factor like this is very difficult to analyze and predict with confidence.
The Advantage of Professional Investors
One good thing being a professional analyst/fund manager working in buy or sell side is that he/she can call the management for a meeting. Usually, the management will accept a 1-hour meeting. You can then ask many things to learn about the company and the business.
Specifically, you will want to know:
- Revenue: volume, price, the drivers, growth, whether sustainable
- Expenses: cost breakdown into COGS, SG&A, depreciation, which ones are rising, how they are managed
- Funding/interest expense: interest rates, loan amount, any covenant
- Capex: growth vs maintenance
- Company specific questions: production capacity, how their products differ from competitors’, customer concentration, order backlog, etc
- Business and industry in general
You may not get all the answers in one hour. Sometimes, the CEO or CFO or Finance manager or IR are well prepared with the numbers, sometimes they are not. You can also develop a sense whether the management is being candid with you or they are evasive. Being a retail investors, you don’t get a chance to talk to the management and ask them many questions.
I haven’t dug into any of these companies. Will probably do when I have some spare time to understand the industry better. This can help better prepare myself when similar investment opportunities arise in the future.