This article first appeared in Corporate, The Edge Malaysia Weekly, on June 13 - 19, 2016.

SOMETIMES, private, individual investors can influence market opinion, and thus share prices, when they invest their own money in stocks that they believe are undervalued. An example is engineer-turned-investor Koon Yew Yin and wood furniture maker Lii Hen Industries Bhd.

The stock saw a surge in trading volume on May 23, with 4.1 million shares traded, the day after it posted a 96% jump in net profit for the quarter ended March 31 (1QFY2016). The company concurrently declared a first interim dividend of four sen per share, a threefold increase from 1.3 sen (adjusted for bonus issue and share split) a year ago. On May 30, Koon started to buy an additional 320,400 Lii Hen shares on the open market at RM2.74 and continued to accumulate hundreds of thousands of shares at higher prices in the following days. 

In just seven days, Lii Hen shares shot up 62 sen or 22.4% to close at an all-time high of RM3.39 last Wednesday. During the same period, the sector’s aggregate market capitalisation increased 6.5%. A few other furniture counters also saw increased trading volume in the last two weeks. Other stocks that performed better than the sector included Jaycorp Bhd and Poh Huat Resources Holdings Bhd, which gained 9.5% and 8.1% respectively. 

As shown in Chart 1, Lii Hen’s share price performance was lagging its peers in the past year, but it has turned into a leader following its 1QFY2016 earnings release, overtaking Latitude Tree Holdings Bhd as the largest furniture company by market capitalisation. Does this mean investors are revisiting the sector after a heavy selldown in January due to concerns over the strengthening ringgit? More importantly, has value begun to emerge given the cheap valuations and improved first-quarter (1Q) earnings?

As furniture manufacturers ride the upward cycle, the industry is still under-covered by analysts, resulting in it being one of the cheapest export sectors, if not on Bursa Malaysia. The wood furniture sector is trading at only 8.8 times its trailing 12-month earnings, vis-à-vis rubber glove makers’ 18.7 times and electrical and electronics makers’ 14.8 times. 

Interestingly, although wood furniture is the most value-added segment of the timber industry, upstream players command richer valuations — wood-related products and board makers are trading at a trailing price-earnings ratio (PER) of 13.8 times while timber companies are trading at a trailing PER of 10 times.

To be sure, furniture stocks, like any other export stocks, could be volatile in the short term as the sector’s share price performance is highly correlated to foreign exchange (forex) rates and emerging market currencies have become more volatile recently. That said, looking beyond the short-term volatility, the sector’s medium-term growth should be supported by positive growth in the US furniture industry as the sector is following the broader economic recovery and the improving housing market in the US.

Chart 2 shows that the aggregate sales of the four largest furniture makers in the past five years — Lii Hen, Latitude Tree, SYF Resources Bhd and Poh Huat, which accounted for nearly 80% of the sector’s total market capitalisation. One notable observation stands out; sales to the US have surged in the last two years and the industry leaders seem to have captured most of the growing demand from the nation.

Although Latitude Tree and Poh Huat have shifted their more labour-intensive production to Vietnam and reported their segmental sales according to manufacturing countries, the bulk of their production in Vietnam is exported to the US. Combined sales to the US and from Vietnam increased a hefty 51% to RM1.3 billion in FY2015 from RM886.7 million in FY2013, outpacing the 36% increase in domestic sales.

Looking ahead, the key question is: Will the industry demand continue to grow? The answer is likely “yes” as there is still ample room for cyclical upside in residential investment in the US (see Chart 3).  Although US residential investment as a percentage of gross domestic product has been recovering since 2011 from the all-time lows of the 2008 subprime crisis, it is still one standard deviation below the historical mean of 4.7%, at 3.6% as at January, according to US Department of Commerce data.

In the first quarter, furniture shares were generally weighed down by concerns that a stronger ringgit could hurt the bottom line. However, judging by the latest results, furniture makers are still benefiting from forex gains. Save for TAFI Industries Bhd and Latitude Tree, all furniture makers reported improved earnings from a year ago. Because, although the ringgit has recovered against the greenback in 1Q2016 from its multi-year lows in 4Q2015, it is still weaker compared with 1Q2015. 

Take Lii Hen, for example. Its 1Q2016 net margin improved by 3.1 percentage points to 12.7% from 9.6% a year ago, largely boosted by the strengthening of the US dollar against the ringgit. The average US dollar rate in 1Q2016 was 4.20, which was still 18% higher than the average rate of 3.55 in 2015.

Forex gains aside, Lii Hen’s underlying business is performing well. Revenue increased almost 50% year on year (y-o-y) to RM165.4 million, mainly due to a 48% surge in US sales. Thanks to the margin expansion and higher asset turnover, its return on equity (ROE) increased to an amazing 30.7% — the highest among its peers (see Table 1).

Based on Table 1, it appears that the top five companies by market capitalisation have better financial metrics, that is, the industry leaders tend to have better operating margins and ROE and are likely to have a net cash position. Except for SYF, which is in a debt position, all pay out dividends to shareholders, with Lii Hen and Poh Huat offering a yield of more than 4%.

However, SHH Resources Holdings Bhd stood out among the smaller caps with above-margin financial metrics. It also has the lowest trailing PER of 6.5 times with a generous dividend yield of 5.3%, the highest in the industry, as it declared a 10 sen dividend for FY2015, up from two sen per share in FY2014.

In terms of share performance, micro-cap Len Cheong Holding Bhd is the best performer with a 94% year to date (YTD) return, followed by Sern Kou Resources Bhd (56%) and Lii Hen (30%). The worst performer YTD is Latitude Tree, which saw its 1Q earnings more than halved to RM8.3 million from RM19.5 million a year ago, largely due to an unrealised forex loss of RM6.7 million.

Except for Poh Huat, SYF and Jaycorp Bhd (which have different financial year ends at end-July), all furniture companies have reported their 1Q earnings with a 17% y-o-y increase in aggregate bottom line, mostly thanks to the outperformance of Lii Hen (see Table 2). On a quarter-on-quarter basis, earnings contracted 37%, due to the forex impact arising from the stronger ringgit in the first quarter, particularly so for the smaller caps.

Investors who wish to ride the recovering US housing market through export-oriented furniture stocks should also take note that not all furniture companies have exposure to the US economy. Out of the 13 companies, only Lii Hen, Latitude Tree, Poh Huat and SHH Resources have large US exposure. Coincidentally, these four companies tend to have superior financial metrics, stronger balance sheets and pay out better dividends.

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.