Value Idea Contest: Finding Value in Lii Hen, Malaysia's Furniture Company

Lii Hen has a solid balance sheet and derives most of its revenue from the US market. It is priced at an attractive level

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Jan 21, 2019
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1. The company

Lii Hen Industries Bhd (XKLS:7089, Financial) is an investment holding company listed on the main market of the Bursa Malaysia Securities Bhd. Through its subsidiaries companies, Lii Hen is involved mainly in the manufacture and sale of furniture. The company is based in Muar, a district in Johor, Malaysia.

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(Source: Liihen Annual Report 2017)

The group has six main subsidiary companies manufacturing a vast range of wood-based products, namely bedroom sets, solid dinettes, office furniture, upholstery sofa set, utilities shelves, occasional items and kiln drying timber processing.

2. Business

The manufacturing facilities are equipped with panel-based wood-working machines, pallet conveyor towed finishing lines, overhead conveyor finishing lines and kiln dry pressure treatment plants. Being located in Muar, a district dubbed as the Furniture City of Malaysia in recognition of the town’s contribution to the country’s wood-based industries, Lii Hen has support from its to enable the company to have better control over the movement and flow of materials, thus reducing downtime and operating costs. The company reported a total workforce of more than 2,800 workers in fiscal year 2017.

According to its 2017 annual report, its furniture products mainly cater for the overseas market, especially to the U.S. and Canada, which made up 80% of total revenue. Other markets include the Middle East, Asia, Africa and Australia (15%) and the local Malaysia market (5%). Its customers comprise major U.S. furniture importers, wholesalers and retailers.

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Lii Hen states in its company profile that it is customer orientated, always placing the customers’ needs and quality as its priority. There was a new range of products, and the bedroom suites were developed together with U.S. importers and distributors for the upper middle market segment. They proactively exhibited their products in the prominent furniture trade fair in the U.S., the High Point Furniture Fair and Las Vegas Furniture Show. The response from the fair was reported to be very encouraging.

Domestically, the shortage of manpower continues to be the main issue in the furniture industry. Being in a labor-intensive industry, Lii Hen continually strives to improve operation efficiency by investing to enhanced production facilities with automation and modern, state-of-the-art machinery. Lii Hen gradually upgraded and automated the existing production line to reduce reliance on low-skilled labor.

Moving ahead, it is believed that Lii Hen can capitalize on stronger demand from the U.S. as a result of the U.S.-China trade war as well as potential depreciation of the Malaysian ringgit against the U.S. dollar.

3. Financials

The company reported a strong balance sheet with low debt at a 0.13 gearing ratio ([long-term debt + short-term debt] / equity) in fiscal year 2017. Lii Hen also is a net cash company, with its cash and cash equivalents exceeding total debt since 2009. The company maintained a healthy current ratio of over 2.3 for the last five years.

Performance review

The company’s revenue and net profit grew at a five-year CAGR of 15.7% and 27.3%, respectively. Its return on equity (ROE) is handsomely above 20% for the last three years.

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4. Risk

4.1 Shortage of manpower and escalating labor cost

The furniture industry is labor intensive. Government policies such as the rising minimum wage have impacted the company’s earnings due to an increase in operational expenses. As mentioned earlier, Lii Hen has continually put great effort into gradually upgrading and automating the existing production line to reduce reliance on low-skilled labor.

4.2 Fluctuation of U.S. dollar against the ringgit

The uncertainty on the movement of the U.S. dollar against the Malaysian ringgit has posed a material impact on the company’s earnings. To mitigate, the company has approved a hedging policy and pricing mechanism to monitor currency fluctuations to maintain profitability.

5. Valuation

Market information:

Share price: MYR 2.760

No. of shares: 179,999,988

Market cap: MYR 496,799,966.88

Net debt: net cash MYR 53,773,000

EPS: MYR 0.40

Current price-earnings ratio: 6.9x

ROE: 24.8%

Insiders’ share ownership: 43%

There has been a decline in its share price since early 2018. This is because of the impact of foreign investors selling their shares in the overall Malaysia market thanks to the stronger U.S. dollar and rising U.S. interest rates. It is also fueled by shocking news in the general election when the opposition won by taking over from the ruling coalition that has been in power for a massive 61 years. These situations provide opportunity for investors looking for stocks selling at a discounted price.

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Lii Hen's valuation is believed to be quite attractive with a current price-earnings ratio of 6.9x, discounted at more than a 60% discount with 10-year historical value of 11.32x. The current share price is still attractive considering DCF valuation with input estimates using a conservative approach at growth (global CAGR estimate of 4%) and net operating profit margin well below its historical values.

At input estimates using its historical values, there is a chance that the stock could double if market sentiment improves. In addition, the company has continually rewarded its shareholders by paying dividends for the last 10 years without faile. It has also increased its dividend payout ratio to more than 50% for the last three years, and management are substantial shareholders with 43% ownership.